Invest in children of knowledge revolution

It's annoying the way business people keep slipping the words ''going forward'' into almost every sentence and it was even worse when Julia Gillard kept repeating the slogan ''moving forward'' in the last election campaign. But I have to admit they've got the right idea: we do need to keep our minds focused on the future and what we need to do to secure it.

The world keeps changing and we must respond appropriately to that change. Most of us feel threatened by change, and it's only human to want to resist it. The temptation is to try to preserve things as they are, rather than adjust to the way they will be.

As we wonder what to do about the threat to our manufacturing industry, it's tempting to see that threat as temporary. We're in the middle of a resources boom which has lifted the value of our dollar to a level which could wipe out some of our industry. But the boom won't last long and, if we're not careful, we could find ourselves high and dry: no boom and a big chunk cut out of manufacturing. What do we do then?

This is a serious misreading of our situation. What we're dealing with isn't just another of the transitory commodity booms we've experienced many times before. It's a historic shift in the structure of the global economy as the Industrial Revolution finally reaches the developing countries. The two biggest countries in the world, China and India, which were also the biggest economies before that revolution, are rapidly industrialising and within the next 20 or 30 years will return to their earlier position of dominance.

Does that sound temporary to you?

As part of their urbanisation and industrialisation, those countries - and the Vietnams and Indonesias following in their wake - will require huge quantities of iron ore, coal and other raw materials. Not for several months but for several decades. Much of what they need will be coming from us. That says it's likely to be many moons before our dollar falls back to the US70? levels our high-cost manufacturers are comfortable with.

The other side of the re-emergence of China and India is the global shift of all but the most sophisticated manufacturing from west to east. This is a disruptive trend affecting all the developed economies, not just us. All the rich countries are having to find other things to do as their manufacturing migrates to the poor countries.

This, too, is not a process that's likely to stop, much less reverse itself. So it's not a question of hanging in until the world comes back to its senses and things return to normal. The day will never come when we're able to reopen our steel mills and canning factories.

It's a question of whether we dig in and try to prevent our economy changing, or we adapt to our changed circumstances and move into areas more suited to a rich, well-educated, highly paid economy.

In truth, we're making so much money from our sales of raw materials to the developing countries that we could afford to use a fair bit of that income to prop up our manufacturers. That wouldn't make us poorer, just less prosperous than we could be (though keeping labour and capital tied up in manufacturing would mean a lot more immigration and foreign investment to meet the needs of our rapidly expanding mining sector).

And the fact is that, throughout most of the 20th century, we diverted a fair bit of our income from agriculture and mining to subsidising our then highly protected manufacturing sector. This may help explain why so many people - particularly older people - are so ready to do whatever it takes to stop factories being closed. It's the traditional Australian way of doing things: passing the hat.

But what's the positive, future-affirming alternative? What else can we do?

Embrace the newer revolution in the developed world, the Information Revolution. While the poor countries are becoming manufacturing economies, the rich countries are becoming knowledge economies.

The knowledge economy is about highly educated and skilled workers selling the fruits of their knowledge to other Australians and people overseas. It covers all the professions and para-professions: medicine, teaching, research, law, accounting, engineering, architecture, design, computing, consulting and management.

Jobs in the knowledge economy are clean, safe, value-adding, highly paid and intellectually satisfying.

The developed economies are fast becoming ''weightless'', as an ever smaller proportion of income and employment comes from making things and an ever increasing proportion comes from providing services. Some of those services are fairly menial, but the fastest growing categories involve the highest degrees of knowledge and skill.

Employment in Australian manufacturing has been falling since the 1980s. It's sure to continue falling whatever we do to try to prop it up. By contrast, since 1984 total employment has grown by almost three-quarters to 11.4 million. Get this: all of those 4.8 million additional jobs have been in the ''weightless'' services sector.

Notwithstanding our future increase in the production of rural and mineral commodities, our economy - like all the rich economies - will continue to lose weight. The real question is whether the services sector jobs our children and grandchildren get will be at the unskilled or the sophisticated end of the spectrum.

And that depends on how much money and effort we put into their education and training. We've gone for the past two decades underspending on education and training at all levels, falling behind the other rich countries.

If we've got any sense, we'll use part of the proceeds from the resources boom to secure our future in the global knowledge economy.

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Sustainable well-being

What does federal Treasury believe? What are the values that underlie the strong line it takes in its advice to governments? A lot of people think they know, but this week its newish boss, Dr Martin Parkinson, spelt it out in an important speech.

And some of the people who think they know all about the ''Treasury line'' may be surprised. Parkinson's title was ''Sustainable well-being'' .

What does he mean by well-being? It's ''what we in the Treasury think of primarily as a person's substantive freedom to lead a life they have reason to value'', he says.

What does he mean by sustainability? ''Sustainable well-being requires that at least the current level of well-being be maintained for future generations.

''In this regard, we can consider sustainability as requiring, relative to their populations, that each generation bequeath a stock of capital - the productive base for well-being - that is at least as large as the stock it inherited.''

But because well-being is a multi-dimensional concept, he says, going well beyond material living standards - and even the environment - we can see that the stock of capital should include all forms of capital, of which there are four.

First, physical and financial capital: the value of fixed assets such as plant and equipment and financial assets and liabilities.

Second, human capital: the productive wealth embodied in our labour, skills and knowledge, and in an individual's health.

Third, environmental capital: our natural resources and the ecosystems, which include water, productive soil, forest cover, the atmosphere, minerals, ores and fossil fuels.

Fourth, social capital: which includes factors such as the openness and competitiveness of the economy, institutional arrangements, secure property rights, honesty, interpersonal networks and the sense of community, as well as individual rights and freedoms.

Running down the stock of capital in aggregate diminishes the opportunities for future generations, Parkinson says. In one way or another, eroding the productive base will lead to lower future well-being. ''Note, though,'' he adds, ''that drawing down any one part of the capital base may be reasonable as long as the economy's aggregate productive base is not eroded.

''For example, reducing our natural resource base and using the proceeds to build human capital or infrastructure may offer prospects of higher future well-being.

''A necessary, but not sufficient, condition for this to be the case is that those resources are priced appropriately and that the returns are invested sensibly.''

When you think about well-being rather than gross domestic product, he says, it quickly becomes apparent that society doesn't get an adequate return on many environmental goods. For example, water and carbon are not yet priced appropriately.

In the case of minerals and energy, arguably society is not sharing sufficiently in the returns from their exploitation, with the vast bulk of the benefits accruing to the shareholders of the firms doing the mining. As such, society is not getting the resources it would need to build up other parts of its capital stock.

''Unsustainable growth cannot continue indefinitely - if we reduce the aggregate capital stock in the long run, future generations will be made worse off. The problem is that we can be on an unsustainable path for a long period - and by the time we recognise and change, it could be too late.''

Our economy faces a number of pressures on environmental sustainability, including: climate change, salinity and resource depletion, in addition to water availability and pressures on biodiversity. Climate change policy - both in relation to reducing emissions and adapting to climate changes - is not just an environmental issue, Parkinson says. ''It is more fundamentally an economic and social challenge.''

The impact of decisions today will be felt in decades to come, and the progression of climate change impacts is unlikely to be linear (occurring at a steady rate of change). ''There are significant risks and uncertainties arising from our imperfect knowledge of the climate system. It is possible that climate impacts could suddenly accelerate. In fact, certain impacts to the climate system may lead to a tipping point where sudden, irreversible changes arise.''

Parkinson says Treasury, to do its job, needs ''an understanding of well-being that recognises that well-being is broader than just GDP, that sustainability is more than an environmental issue''.

''A focus on well-being and sustainability continue to be important parts of Treasury's culture and identity: they assist in providing context and high level direction for our policy advice; and they facilitate internal and external engagement and communication.

''Almost a decade ago we attempted to put more structure around the issue by writing down a well-being framework to provide greater guidance to staff on our mission.'' The framework is based on five dimensions.

First, the set of opportunities available to people. This includes not only the level of goods and services that can be consumed, but good health and environmental amenity, leisure and intangibles such as personal and social activities, community participation and political rights and freedoms.

Second, the distribution of those opportunities across the Australian people. In particular, that all Australians have the opportunity to lead a fulfilling life and participate meaningfully in society.

Third, the sustainability of those opportunities available over time. In particular, consideration of whether the aforementioned productive capital base needed to generate opportunities is maintained or enhanced for current and future generations.

Fourth, the overall level and allocation of risk borne by individuals and the community. This includes a concern for the ability, and inability, of individuals to manage the level and nature of the risks they face.

Fifth, the complexity of the choices facing individuals and the community. Treasury's concerns include the costs of dealing with unwanted complexity, the transparency of government and the ability of individuals and the community to make choices and trade-offs that better match their preferences.

These five dimensions ''reinforce our convictions that trade-offs matter deeply - trade-offs both between and within dimensions'', Parkinson says.

Well, that's what he thinks.

What do I think? I think Treasury has come a long way and is at its point of greatest enlightenment. But it has further to go - in principle as well as in practice.

In particular, I doubt how much trading off is possible when it comes to the environment.

Ensuring our kids are richer than we are, while destroying the natural environment because we refuse to accept the physical limits to economic growth, doesn't sound sustainable to me.

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Our future is mining, not making

The lessons from BlueScope Steel's decision to sack 1000 workers in Port Kembla and Western Port are that, in the economy, benefits always come with costs: we can't have everything and one country can't do everything well.

Leaving aside the continuing fallout from the global financial crisis, the most momentous, long-term development in the global economy is the rapid industrialisation and urbanisation of the developing countries, with Asia as the epicentre of this trend.

For the economic emergence of the developing countries to be occurring at a time when the major advanced economies of the North Atlantic have made such a hash of their affairs is a great blessing to all of us. Whereas we're used to America and Europe providing the motivating force to the world economy, now it's the strong growth in the developing countries that will keep the world growing.

Among the developed economies, Australia is almost uniquely placed to benefit from the emergence of the poor countries. That's because we're located so close to the epicentre, but also because the main thing we sell the world is raw materials, and raw materials are the main thing the developing countries need to import: energy, food and fibre and, above all, the chief ingredients of steel - iron ore and coking coal.

The world prices of all these things have shot up in recent years and all Australians - not just the miners and farmers - have benefited from them. Although these prices are sure to fall back soon enough, they're still likely to stay much higher than they were. That's because the process of economic development in Asia has so much further to run. As people in poor countries get richer and seek more protein, agricultural prices will probably go a lot higher.

But as well as higher prices, our resources boom has entered a second phase of massive investment in expanding our capacity to supply coal, iron ore and natural gas to the rest of the world. This hugely increased investment spending is set to run for years. It will underpin our economy, protecting us against recession.

That's the good news and, overwhelmingly, this is a good-news story - even though, remarkably, we seem to be in the process of convincing ourselves times are tough and that no one who's not a miner has benefited from the boom: we didn't really have eight income tax cuts in a row; the NSW and Victorian governments aren't really getting bigger shares of the revenue from the goods and services tax at the expense of Queensland and Western Australia; none of us has benefited from the high dollar; we're not taking more overseas trips; not buying cheaper electronic gear and not paying less than we would have for our petrol.

And now, just while we're feeling so uncertain and sorry for ourselves in our immense good fortune, we're reminded that with all the benefits of the resources boom also come costs. Who'd have thought it? Quick, double the gloom.

For decades we thought we were losers, being a country obliged by its history and natural endowment to earn most of its export income from raw materials. Now we discover we're winners. But world trade works by each country specialising in what it's good at. You can't specialise in everything and the truth is we've never been good at manufacturing.

Our domestic market has been too small to give us economies of scale and we've been too far away from

the developed countries that buy manufactures.

The flipside of our increasing specialisation in the export of raw materials is our Asian trading partners' increasing specialisation in what they're best at: using their abundant but mainly unskilled and thus cheap labour to produce manufactures, including steel.

Increasing their exports of manufactures is the way they pay for our raw material exports to them, including the chief ingredients of steel.

Our manufacturers are copping it two ways: increased competition with the growing supply of cheaper manufactures from the developing countries, and our high dollar, which makes our manufacturers' prices high relative to those of other countries' manufacturers.

There are limits to the resources of labour and capital available to us in Australia, so the expansion of mining will tend to pull resources away from other Australian industries, particularly those we're not relatively good at, such as manufacturing. Our high exchange rate - which always rises when commodity prices are high - is part of the market mechanism that helps shift workers and capital around the economy.

There are bound to be a lot more job losses in manufacturing. And a lot of those displaced workers are likely to end up in mining or mining construction. Some, of course, will take the places of other workers who've been attracted into high-paying mining and construction jobs. Others will fill vacancies that have no obvious links to the resources boom.

It will be tough for those workers obliged to make this transition and even tougher for those who don't make it. Fortunately, it's happening at a time when unemployment is low. Even so, governments

need to do all they can to help displaced manufacturing workers find jobs elsewhere.

What governments shouldn't do is increase protection and other assistance to manufacturing industry itself in an attempt to stave off change. It needs to adjust to the reality of a significantly changed world economy.

Efforts to help manufacturing resist change can come only at the expense of all other industries. There are no free lunches in industry assistance.

It would be a good way to fritter away the proceeds from what the governor of the Reserve Bank has called "potentially the biggest gift the global economy has handed Australia since the gold rush of the 1850s".

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Is economic reform worsening productivity?

The North Atlantic economies have pressing problems to grapple with, but here at home the biggest thing we have to worry about is our weak rate of productivity improvement. And we won't get far if we stick to the received wisdom it's all the fault of excessive government intervention.

If our econocrats want to preserve their monopoly over the advice their political masters seek, they need to be less model-bound in their thinking. Since it doesn't take much thought to realise ''more micro reform'' is unlikely to make a big difference, we need more lateral thinking.

Rather than merely assuming market failure wouldn't be a material part of the problem - or assuming nothing could be done to correct market failure that wouldn't make things worse rather than better - perhaps we should look harder to see if market failure is part of the story.

After all, it's the market that's failing to generate as much productivity improvement as it has in the past.

Then we could start looking for cleverer forms of intervention that don't end up being counterproductive. Here we could put a lot more effort into evaluating interventions, so as to build up our understanding of what works and what doesn't.

The acute government debt problems in the United States and Europe are a reminder of how much more fiscally disciplined our governments have been, going right back to the Hawke-Keating government with its various budget limits and targets.

It's a great temptation to give the public the ever-increasing government spending it demands, but then fail to summon the courage to make people pay the extra taxation needed to cover that higher spending.

For all their failings, however, our politicians have achieved balanced budgets on average over the cycle and have kept government debt levels - federal and state - quite low and manageable.

But could it be we've paid for our fiscal responsibility with lower productivity improvement? It seems clear we've been underspending on public infrastructure as part of our efforts to keep debt levels low, but adequate public infrastructure is needed to permit the private sector to raise its own productivity.

As well as physical capital there's human capital. As part of our abstemiousness, we've gone for several decades underspending on all levels of education and training: early childhood development, schools, vocational training and universities. Particularly universities.

If we've gone for so long underspending on human capital, is it any wonder our productivity performance has worsened? It's true the Rudd-Gillard government has loosened the purse strings in recent years, but there's safe to be a delay before that leads to an improvement.

Another possibility worth exploring is whether the microeconomic reforms of the past have had unintended consequences that damaged our productivity.

Micro reform is almost always aimed at increasing firms' efficiency by subjecting them to great competitive pressure - whether from rivals in the domestic market or from imports.

But the human animal has achieved the great things it has not only as a result of competition between us but also as a result of our heightened ability to co-operate in the achievement of common objectives. The economists' conventional model is big on competition, but sets little store by co-operation, since it assumes we're all rugged individualists. Could it be that, by greatly increasing the competition most firms face in their markets, micro reform has reduced the amount of productivity enhancing co-operation?

A further possibility is that, in turning up the heat of competition in so many markets, and in spreading market forces into areas formerly outside the market, micro reform has diminished our ''social capital'' in ways that adversely affect economic performance.

There's no place for trust, feelings of reciprocity or norms of socially acceptable behaviour in the economists' model, so they tend to under-recognise their importance. But you only have to observe a loss of trust within the community to realise the high cost that loss imposes on the economy as well as society.

The less we feel we can trust each other, the more avoidable costs we impose on the economy in spending on supervision and monitoring, security devices and security people.

Micro reform seeks to increase the community's income without paying any attention to the equitable distribution of that extra income. If higher earners end up with more than their fair share, the disaffection of those who lose out may detract from their productivity.

It seems clear the increased competitive pressure on firms has led many to take a more ruthless attitude towards their employees.

Firms are more anti-collective bargaining, more prone to laying off staff as soon as business turns down, more willing to award huge pay rises to executives without a thought as to how this might make other employees feel, more inclined to pay some workers more than their peers, more inclined to expect people to work split shifts or on weekends and public holidays without extra pay and more likely to demand unpaid overtime (which last does increase measured productivity, however).

Is it so hard to credit that all this might have made workers less co-operative and productive rather than more?

In the Treasury Secretary's recent speech on our poor productivity performance, Dr Martin Parkinson nominated health and education as the next candidates for major micro reform. He's right, there's plenty of scope for improvement.

But these are service-delivery sectors where it's the performance of professionals that's crucial. And economists' notions about what motivates people and how you encourage excellence are so blinkered - they assume money is the only incentive and key performance indicators work a treat - that you'd have little confidence their ''reforms'' would make things better.

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The real action is in the developing world

If the US, the world's biggest economy, starts to contract again and the Europeans' government debt problems prompt more austerity, the world economy will be plunged back into recession. Is that what you think? If so, your picture of the world economy is about 20 years out of date.

There are cultural, historical, family and language reasons why we focus our attention on Europe and the US. The media keeps us well informed about what's happening in their economies. And since, between them, they account for a big chunk of the world economy, it's easy to assume that where they go the rest of the world follows.

Indeed, that used to be true. When I first got into this game, the Organisation for Economic Co-operation and Development used to make forecasts for its 24 rich-member countries, add them up and call it the world economy.

But consider these figures from the Reserve Bank's latest statement on monetary policy. Over the four-and-a-bit years since the March quarter of 2007, the world economy has grown by about 10 per cent in real terms.

The contribution of the North Atlantic economies (the US, Canada, Britain and the euro area) to that growth was near enough to zero. So all the net growth the world's seen in that time has come from the remaining, mainly developing, economies.

Between them, the Chinese and Indian economies have grown by nearly 50 per cent, while east Asia (excluding China and Japan) grew by almost 20 per cent.

The faster the developing countries grow relative to the rich countries, the larger their share of the world economy becomes. An article in The Economist points to the many respects in which the world economy is coming to be dominated by the "emerging economies", as they're increasingly called.

As many as 11 of these economies have emerged to the point where they've been reclassified as developed rather than developing. But when you do that, you understate the extent to which the developing countries are taking over the running. So the figures that follow classify as developing all those countries that hadn't made it to developed status before 1997.

The developed countries account for only about 15 per cent of the world's population, but in 1990 they accounted for 80 per cent of gross world product. By last year that share had dropped to 60 per cent. It is projected to fall to less than half within the next seven years.

But that calculation is based on converting each country's gross domestic product into US dollars at market rates. This understates the developing countries' share of gross world product (GDP) because one US dollar buys a lot more in poor countries than in rich countries.

When you adjust for "purchasing-power parity" you find the developing countries' share of gross world product reached 50 per cent three years ago and is expected to reach 54 per cent this year. Their share of world exports has reached half, which is almost double what it was in 1990.

Much of these exports would be produced by multinational companies operating in developing countries, so it's no surprise the developing countries attract more than half of all the inflows of foreign direct investment.

So far, this conforms to the popular perception of developing countries as economies that make their living selling cheap exports to rich countries. But The Economist observes that "foreign firms are increasingly lured by these countries' fast-growing domestic markets as much as [by] lower wages".

That's the point: developing countries are increasingly standing on their own feet, generating their growth internally.

The mainstays of "domestic demand" are capital (investment) spending and consumer spending. The developing countries now account for more than half the world's capital spending, compared with a quarter 10 years ago.

Last year the US's capital spending was just 16 per cent of its GDP compared with 49 per cent in China. (Ours was 28 per cent.)

The developing countries' share of world consumer spending is only 34 per cent, though this is up from 24 per cent 10 years ago (and would be higher if you allowed for the lower prices they pay for housing and services).

Even so, their shares are: 46 per cent of world retail sales; 52 per cent of all new car sales (up from 22 per cent in 2000) and 82 per cent of all mobile phone subscriptions.

You can see from this how rapidly living standards are rising in poor countries. And when the locals start spending, some of that spending is on imports. Last year the developing countries' share of world imports rose to 47 per cent.

So whereas we're accustomed to thinking of developing countries as dependent on rich countries, it's becoming more the case that the rich countries depend on the developing countries.

Even so, because the developing countries are still at the early stages of developing their economies, their demand for basic commodities - whether locally produced or imported - exceeds their demand for sophisticated goods and services.

They account for 60 per cent of the world's annual energy consumption, 65 per cent of all copper consumption and 75 per cent of all steel use. Yet, as The Economist remarks, there's plenty of room for growth: they use 55 per cent of the world's oil but their consumption per person is still less than a fifth of that in the rich world. (Always assuming we don't run out of oil, of course.)

And here's a pertinent reason the developing countries are likely to continue growing faster than the North Atlantic economies: they're responsible for only 17 per cent of the world's government debt.

No prize for having guessed the punchline: the rich countries likely to do best over the rest of this troubled decade are those most closely plugged into the developing world.

Heard of a poor, cautious, sorry-for-itself country called Australia? It sells less than 10 per cent of its exports to Europe and only 5 per cent to the US, but about two-thirds to developing countries.

Most of those countries are in Asia, of course, the most dynamic part of the world economy. In just the past 10 years, China's share of our exports of goods and services has gone from 5 per cent to 23 per cent, and India's has risen from 2 per cent to 7 per cent.

As Wayne Swan keeps saying, Australia is in the right place at the right time.

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Sorry to be so sober. World not ending

At times like these, much of the media tends to cater to people who enjoy a good panic. The sky is falling and the proof is that billions have been wiped off the value of shares in just the past few days. Which makes me wonder how I've survived in the media for so many years. I hate panicking. So I'm always looking for contrary evidence. I just have hope there's a niche market of readers who prefer a sober assessment.

A bane of my working life is the way people imagine the state of the sharemarket to be far more important than it is in the workings of the economy. Our response to big falls in the sharemarket is based more on superstition than logical analysis, and a lot of people who should know better are happy to pander to the public's incomprehension.

We have a kind of race memory - a relic from the 1930s - that tells us a sharemarket crash is invariably followed by an economic slump. It ain't. As the Nobel-prize winning economist Paul Samuelson once quipped, ''the stockmarket has predicted nine of the past five recessions''.

Do you remember the crash of October 1987? No, probably not. There's no great reason to. It was the biggest fall on Wall Street since the Great Crash of 1929. People were panicking on that day in 1987 much as they are now.

A commentator senior to me predicted on page 1 it would lead to a global depression. In my comment - which was relegated to an inside page - I predicted no worse than a world recession. Fortunately, my thoughts were billed as ''The End Is Not Nigh''.

Turned out we were both way too pessimistic. What transpired? Precisely nothing. Neither in America nor here. In Australia the economy motored on for more than another two years before a combination of the subsequent commercial property boom and many more increases in the official interest rate finally brought us the recession we had to have.

The trouble with taking the sharemarket as your infallible guide to the economy's future is that the market itself is prone to panic. As its practitioners admit, its mood swings between greed and fear. Like all financial markets - and like the media - it acts in haste and repents at leisure. You can panic today because you can always change your mind tomorrow.

That's fine when onlookers don't take the market's antics too seriously. When they take its mood swings as authoritative, however, their reactions can cause those antics to have adverse effects on the ''real'' economy of spending and jobs that we inhabit.

In other words, what's important is not the ups and downs of the sharemarket, but the way we react to them.

In 1987, a lot of ordinary people who'd bought shares during the boom rushed out and sold them - thus buying high and selling low, precisely the opposite behaviour to the way you make money from shares. But the public soon shrugged off its anxiety and it wasn't long before the market recovered its lost ground.

Of course, a lot of things have changed since that great non-event of 1987. In those days, the link between the sharemarket and our daily lives was quite tenuous. These days, the link is much stronger thanks to the advent of compulsory superannuation - which has given most of us a fair stake in the sharemarket - and the baby boomers' proximity to retirement.

These days a sustained fall in share prices knocks a noticeable hole in people's retirement savings. That hole will refill in time, but who's to say how long it will take? Another difference with 1987 is that, this time, the sharemarkets in Wall Street and Europe really do have things worth worrying about. The American economy is quite weak and, although it's unlikely to drop back into recession unless Americans will it to, it's likely to stay pretty weak for the rest of the decade.

It's the Europeans who have by far the most to worry about, with so many heavily indebted governments locked into the euro and banks that are still in bad shape.

But yet another thing that's changed since 1987 is our economy's reorientation away from America and Europe towards China and the rest of Asia. Much of the fear that rises in our breasts on hearing of crashing sharemarkets is our unthinking conviction that what's bad for them must be bad for us.

It ain't so - not unless we unwittingly make it so. There never was a time when our economy was less dependent on the US and Europe than it is today. Well over half our exports go to Asia, with surprisingly small proportions going to the US and Europe.

It's true we're quite heavily dependent on China, but its problems are all in the opposite direction to those of the North Atlantic economies: it's growing too strongly and could use a bit of a slowdown. There never was a time when China was less dependent on the US and Europe than it is today. The notion that the world's second-largest economy lives or dies by its exports to the North Atlantic is silly.

But if all this is true, why does our sharemarket still take its lead from Wall Street? Because of its tendency to herd behaviour. By tacit agreement, what Wall Street's done overnight acts as a signal to all Australian players of the direction in which our market will be travelling.

What holds in the short term, however, shouldn't hold forever. Eventually, the price of a BHP Billiton share will reflect the profit-making prospects of BHP - and they're still very good.

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What economists don't know about productivity

Our top econocrats are out banging the drum for more micro-economic reform as the obvious answer to our flagging productivity performance, and civic-minded economics writers are taking up the call. Sorry, but, as the Scots say, I hae me doots.

Economists are trained to believe in the need for ''more micro reform''. They'd want it even if our productivity performance was fine. You get the feeling the physician is prescribing his favourite medicine without bothering to think much about the patent's symptoms.

Assuming you accept their premise that maximising economic growth is the sole object of the human exercise, the economists are right in their incessant quoting of Paul Krugman's line that ''productivity isn't everything, but in the long run it's almost everything''.

For the past 200 years, since the early days of the Industrial Revolution, the material living standards of people in the West have been rising almost continuously, thanks to continuing improvement in the productivity of labour and capital.

Have we had 200 years of continuing micro-economic reform to bring that improvement about? Of course not. So there has to be something seriously wrong with an economy that can't achieve a satisfactory rate of productivity improvement without regular injections of reform.

Like most other things in the economy, micro reform is subject to diminishing marginal returns. And when we run out of things to reform, what do we do then? A counsel of perfection isn't a lot of use.

We need to remind ourselves that governments don't actually run the economy, business people do. So if businesses aren't generating much productivity improvement, the obvious place to look is at the behaviour of business people.

But economists aren't trained to think that way. Thanks to conventional economics' foundation assumption that economic actors are always and everywhere rational - an assumption many economists claim not to really believe but which undergirds far more of what they do believe than they realise - their ideology holds that, as a general rule to which there are only limited exceptions, markets get it right.

It follows that, if the market isn't delivering satisfactory outcomes, it could be a case of ''market failure'', but it's much more likely to be a case of ''government failure''. It must be something the government's doing that's stuffing things up. Thus does every problem in the private sector become the government's fault.

This is almost the complete rationale for micro-economic reform. If you eliminate, reduce or reform government intervention in markets, thereby increasing the intensity of competition in those markets, everything will work much better. (The only major exception to the rule is tighter regulation of competition so as to counter business's natural tendency to gather and exploit monopoly pricing power.)

Though few economists seem to have noticed, our experience with micro reform in the 1980s and early '90s was surprisingly disappointing.

Under the Hawke-Keating government (and the Greiner and Kennett governments) we threw everything at it: floating the dollar, deregulating the financial system, phasing out border protection, reforming taxation, privatising a host of government-owned businesses, deregulating more individual industries than one person could remember and decentralising wage-fixing.

We gathered every bit of low-hanging fruit we could grab, and what did we achieve? A vastly improved productivity performance in the second half of the '90s - which lasted a measly five years before disappearing without trace.

We achieved a big lift in our level of productivity, but we failed to achieve what we should have achieved if micro reform was the true answer to the productivity problem: lift-off. That is, a lasting increase in our rate of productivity improvement.

In the time since then we've backslidden on little of that reform (here I don't class deciding not to denude individual workers of most of their bargaining power as a sin). Nor have we introduced much in the way of anti-competitive measures since then.

So micro reform has proved of limited potency in the search for productivity and, in any case, we've already used most of our ammunition. It's not by chance that we've had so little further reform since Paul Keating's day.

If you examine the long-term record on productivity improvement, you find most of it comes from technological advance (and much of that advance works its magic by pursuing further economies of scale - a factor that works to reduce competition, not increase it).

But if economists are so committed to productivity improvement, how much do they know about the conditions that foster technological advance? Surprisingly little. How much research effort have they put into furthering their understanding of it? Amazingly little.

Their workhorse model merely assumes tech advance is ''exogenous'' - it comes from outside the economic system, dropping from heaven like manna. That assumption is both wrong and unhelpful. Yet their attempt to understand how tech change is produced within the system - ''new growth theory'' - has been allowed to wither on the vine.

The best advice economists have to offer policymakers on promoting tech advance is a version of ''build it and they will come'': get your monetary incentives right (that is, cut the top tax rate) and sit back and wait.

Other disciplines are busy trying to unravel the mysteries of ''innovation'' and what conditions foster it. They could benefit from collaboration with rigorous-thinking economists, but it's all too touchy-feely for most economists.

Judged by their ''revealed preference'' - what they do, not what they say - economists don't have much genuine interest in productivity. They have a pet solution that does no lasting good, and if you're not prepared to swallow their nasty medicine - which no prime minister or premier since Keating's era has been - that's a sign of your lamentable moral weakness.

If our materialism-promoting politicians had any sense, they'd look elsewhere for answers.

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Are we talking ourselves into a recession?

Is it possible for a country that is the envy of the developed world to talk itself into recession? I don't know. But it seems we're about to find out. It won't be easy, of course. It's a question of whether our increasingly negative perceptions can overwhelm the reality that our economy has a mighty lot going for it. Let's start with reality, then move to perceptions.

The Europeans, and now the Americans, are rightly worried about their yawning budget deficits and huge levels of government debt. Their problem is, the more they do to reduce deficits the more they weaken their economies, at a time when they're already pretty weak. By contrast, our budget deficit isn't particularly big and our level of government debt is laughably small.

Part of their problem is the money they spent bailing out their banks - many of which still aren't back in full working order. By contrast, we've had no problem with our banks.

Despite their weak economies, the Europeans and Americans have been worried about the rising cost of rural and mineral raw materials. But what's a problem for them is income for us. The prices we're getting for our exports have rarely been higher.

As a consequence of this boom, the mining companies are spending mind-boggling amounts building mines and natural gas facilities. Were we in our right minds we'd have no trouble accepting that, since you and I live in the same economy as the miners, a lot of this income and spending rubs off on us. Instead, the incessant talk about the alleged "two-speed economy" has allowed us to imagine that, while the miners are doing well, the rest of us are stuffed. Retail sales are flat? See, I told you I was doing it tough.

Trouble is, there's little hard evidence to support this impression. Unemployment in the North Atlantic economies is about 9 per cent; here it's below 5 per cent. And this holds around the country. Using trend figures, it ranges from 4.2 per cent in Western Australia to 5.6 per cent in Tasmania, with 5.1 per cent in sorry-for-itself NSW and 4.7 per cent in Victoria. Nationally, employment grew by 2 per cent over the year to June, with WA and NSW right on the average, resource-poor Victoria topping the comp with 3.1 per cent and resource-rich Queensland achieving just 1.1 per cent. Pay rises are few and far between in the US and Europe but in poor little Oz the wage price index rose by a too-generous 4 per cent over the year to March. Again, the growth was remarkably similar around the country. Wages in WA grew by 4.1 per cent and in Tassie by 3.5 per cent. NSW and Victoria were right on the national average.

Admittedly, mining wages grew by 4.6 per cent, but workers in the (genuinely) hard-pressed manufacturing sector got 4.1 per cent and even in retailing workers averaged rises of 3.3 per cent.

Conduct a focus group and punters will tell you they're suffering mightily under the rapidly rising cost of living - which is why politicians on both sides are always encouraging the punters to feel sorry for themselves.

But when you combine healthy growth in employment with too-high wage rises you get household incomes growing faster than consumer prices. So if retail sales are weak, it's not because we can't afford to spend, it's because we choose not to - whether out of prudence or fear for the future.

There's no doubt the retailers - along with manufacturing and tourism - are doing it tough. But there's nothing in the capitalist contract that guarantees businesses an easy life. And, as an indicator of the overall health of the economy, the weakness in retail sales is misleading.

Did you (or any of the journalists carrying on this week) know retail sales account for only about 40 per cent of consumer spending? They cover mainly goods bought in shops, particularly department stores. They don't include sales of cars, nor the growing proportion of our incomes we spend on services.

New car sales have been weak in recent months, partly because of the lack of supply from Japan since the tsunami, but (though no one thought it worth telling you) this week we learnt car sales jumped by 12 per cent in July.

And that's not the only sign we're more willing to spend than many imagine. This week we also learnt that plenty of people are spending big on overseas travel. Short-term departures of Australian residents rose by 1.4 per cent in June to be up almost 11 per cent on a year earlier.

In real terms, retail sales grew by 0.3 per cent in the June quarter and just 0.5 per cent over the year to June. But total consumer spending is expected to grow by 0.5 per cent in the quarter and 2.5 per cent over the year. That's not brilliant, but it's a far cry from death's door.

So if the underlying reality of the economy is enviably good, why are we so dissatisfied and anxious? Why are we so ready to think the worst about the prospects in America and Europe and to conclude - contrary to all the evidence - that tough times for them spell tough times for us? Well, not because the media are revelling in the bad news and forgetting to mention the good. They always do that. It's just that, when we're in an optimistic frame of mind we ignore the gloom mongering, whereas when we're in a pessimistic mood we lap it up.

Alternating waves of optimism and pessimism - "animal spirits" - do much more to explain the swings in the business cycle than it suits most economists to admit. And because we're such herd animals, we tend to contract these moods from one another - even from our cousins on the other side of the globe.

Will our increasingly negative perceptions overwhelm our strong reality? If they do, they'll have a fight on their hands: thanks to the mining construction boom, business investment spending is expected to grow by 15 per cent this year and another 15 per cent next year. For your own sake, pray reality wins.


AUSTRALIAN ASX 200

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Net benefits at $50 billion and climbing

Like many major new technologies before it, the internet is steadily remaking a host of our industries - music, film, travel agencies, banking, newspapers, bookselling and now retailing more generally. You've heard a lot about the pain this is inflicting on businesses and their staff, and you'll hear a lot more.

But while we're being asked to feel bad about all the business people and workers displaced, there are two things we shouldn't lose sight of. New technology is always reshaping our economy; it's the price we pay for 200 years of ever-rising affluence. And the costs to the producers of the old technology are always outweighed by the benefits to the users of the new technology.

Today Google Australia is releasing a study by Deloitte Access Economics which attempts to measure those benefits. It finds about 190,000 people are employed in occupations directly related to the internet, with its direct contribution to the Australian economy worth about $50 billion a year, or 3.6 per cent of gross domestic product.

But the internet's wider benefits, only partly captured in GDP, include about $27 billion a year in productivity increases to businesses and governments and benefits worth about $53 billion a year to households: a more efficient way to search for information; a greater variety of items for purchase; greater convenience and a new source of recreation.

Internet browsers and search engines allow consumers to quickly and easily find information on anything from products and services, academic papers, the availability of jobs or houses to simply obtain directions or the latest on the weather.

One study finds it takes an average of seven minutes to search for a particular item online, compared to 22 minutes for an offline search. Assuming a person asks one answerable question every two days, and that workers value their time at the average after-tax wage of $22 an hour, this yields a saving worth $1.40 a day or $500 a year. Multiplying that by all internet users we get $7 billion a year.

Many markets are dominated by a small number of best-selling products. But the internet's search capacity makes it easier to find a wide range of niche products, which a study shows is reducing the market share of the big sellers. In 2000, an online store such as Amazon had about 23 million titles available, compared to 100,000 in the largest bricks-and-mortar bookshops.

In the old days you could spend a lifetime rummaging through second-hand bookshops searching for a particular out-of-print title. These days you can find it in a trice on the internet (and sometimes they'll print up a new copy just for you).

Specialised price and product comparison sites - such as Webjet, Wotif and Booko - compare prices from across the internet. And here's the trick: this doesn't just allow you to find the best price with ease, the heightened competition - and heightened emphasis on price - encourages businesses to lower their prices.

In the old days, hotels and motels charged people who walked in off the street a ''rack rate'' much higher than they charged people who came via travel agents or their employer. These days, competition often forces them to ensure the price they list on their site is their best price (a truth I learnt the hard way).

Even so, a study finds that the increase in variety provided by the internet is of greater value to consumers than the decline in prices. Assuming 40 per cent of all goods and services bought online wouldn't be readily available in the absence of the internet (as is the case for books), the increase in consumer welfare across all online retailing activities would be worth about $16 billion a year.

Now convenience. Before the widespread availability of the internet, most banking transactions involved a physical trip during opening hours and waiting in line to be served. Likewise, registering a car involved a trip to the motor registry, paying bills and submitting a tax return involved buying an envelope and a stamp, filling out the form and dropping it at the nearest post box.

For the majority of the working-age population, the ability to perform these tasks and more online saves a substantial amount of time each week. Assuming it saves a typical internet user half an hour a week, its estimated value to consumers is $8 billion a year.

I'm always using it to pay parking fines and my kids use it to fill out their tax returns (where the taxman helpfully ''pre-fills'' the return with information about your income he already knows). The latest is you can fill out next week's census form online. As for banking, I darken the doors of my bank branch only a few times a year.

On average, Australians spend 1.5 hours of leisure time a day online. If half this time is spent on recreational activities such as using social media, email and browsing, the annual value of this ''consumer surplus'' is about $1600 per person which, with a few additions, multiplies to a national benefit of $22 billion a year.

When you remember not all households and businesses are yet on the internet, that use of the net will broaden and deepen with the rollout of the national broadband network, and that we're just scratching the surface of the uses to which it could be put, its ability both to disrupt industries and to benefit consumers has a lot further to go.

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Baby boomers' wealth effect hits the retailers

Back in the early Noughties, when the property market was booming, a lot of baby boomers began contemplating their future and realised they hadn't saved nearly enough to allow them to continue in retirement the privileged lives they'd always enjoyed. They decided they'd have to start saving big time.

So what did they do? Went out and bought a negatively geared investment property, of course. Their notion of saving was to borrow to the hilt, then sit back and wait for the lightly taxed capital gains to roll in.

If you're wondering why the retailers are doing it tough at present, don't blame it all on the mug punters' conviction that Armageddon starts next July 1 with the carbon tax. Part of the explanation rests with the baby boomers learning the hard way that saving actually requires discipline.

Glenn Stevens, governor of the Reserve Bank, has reminded us of the way real consumer spending per person grew significantly faster than household disposable income for the decade to 2005. Over the period our rate of household saving steadily declined until we were actually dis-saving.

And this from a nation that hitherto had saved quite a high proportion of income. Why the change? Well, Stevens is no doubt right to explain it primarily in terms of our return to low inflation and low nominal interest rates, combined with a deregulated banking system now more than eager to lend for housing.

But there has to be more to it. For most of the decade in question we fought each other for the best house in the block, forcing house prices up and up. At much the same time, the sharemarket was rising strongly as we and the rest of the developed world enjoyed the last phase of the over-confident Great Moderation that ended so abruptly with the coming of the global financial crisis.

Over the 35 years to 1995, the nation's real private wealth per person grew at the rate of 2.6 per cent a year, pretty much in line with the growth in real gross domestic product per person.

Over 10 years to 2005, however, real household financial assets (including our superannuation and direct shareholdings) grew by 5.3 per cent a year per person. The corresponding growth in non-financial assets (most of which is the value of our homes) was 7.5 per cent.

Put the two together and our total assets grew by 6.7 per cent a year. (Our debts grew, too, of course. The ratio of debt to total assets rose from 11 per cent in 1995 to 17.5 per cent in 2005.)

So what was it that gave us the confidence during this period to let our consumer spending rip and stop saving any of our household income? One almighty ''wealth effect''. Capital gain was king.

Everywhere we turned we could see ourselves getting wealthier, year after year. The value of our homes rising inexorably, the value of our super swelling nicely. With all that going for us, who needed to save the old-fashioned way? No wonder negative gearing - of share portfolios as well as residential property - was so popular.

As Stevens says, that period of debt-fuelled wealth accumulation had to end sometime. We would come to terms with the new world of lower nominal interest rates and readily available credit, loading ourselves up with as much debt as we needed (or a bit more) and calling it a day.

The recovery in household saving began well before the global financial crisis. Even so, there's no reason to doubt the crisis did much to accelerate our return to rates of household saving - 11.5 per cent at last count - not seen since the 1980s. For one thing, it reversed the wealth effect.

In principle, the behaviour of people of all ages should be affected by the knowledge of what's happening to the market value of their wealth. In practice, however, you'd expect it to have the greatest effect on those approaching retirement - the baby boomers - or even the already retired.

Consider it from their perspective. In the months leading up to and during the global financial crisis of late 2008, they observed it smash the sharemarket and take a huge bite out of their super savings. The market has recovered a fair bit since then but it hasn't regained its earlier peak and could hardly be said to be booming.

As for house prices, the boom is long gone and prices are, in market parlance, ''flat to down''. There's no reason to believe they'll be taking off again any time soon.

Many boomers have responded to this marked change in their prospects by postponing their retirement. A government-funded survey regularly asks workers over 45 when they expect to retire. In 2009, almost 60 per cent were expecting to retire at 65 or later, up from 50 per cent two years earlier.

With little prospect of much in the way of capital gains, it's a safe bet the baby boomers are leading the way in the nation's return to a higher rate of saving.

But that doesn't spell the death of retailing. As a matter of arithmetic, it's only when households are increasing their rate of saving - as they are now - that consumer spending has to grow very much more slowly than household income is growing.

Once households have reached a rate of saving they're happy with - no matter how high that rate - consumption can resume growing at the same rate as income.

But who knows? It may not be until the second half of next year that the punters - including the baby boomers - realise how much Tony Abbott & Co conned them about the depredations of the carbon tax.

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