Moneyball shows competition isn’t always a winner

One of my favourite films for this year was Moneyball. Ostensibly, it's the story of how the real-life Billy Beane (Brad Pitt), general manager of the Oakland As baseball team, took the second-poorest team in the comp almost to the top.

At a deeper level, it's about how the super-cool guys of professional baseball got beat by the nerds.

It's about how the science of statistics can tell us things we didn't know about our world.

It's about the ultimate make-or-buy decision facing businesses: do you select and train up your own people, or go out and poach someone whenever you need a new heavy-hitter.

But, above all, it's about how competition in markets can fail to live up to its advertising. (If you didn't catch all those levels, read the book by Michael Lewis - much better than the movie.)

Professional baseball in America is a market. All the teams are privately owned businesses, the owners of which are out to maximise profits.

(That's in theory. In practice, many of the owners probably treat their team as an indulgence - a way to enjoy their fortune - as much as a way to increase their fortune; an end as much as a means.)

Beane was so short of money he turned to a bunch of highly educated baseball tragics, who thought studying a potential player's statistical record through high school and college baseball was a better way of predicting his success in the big league than relying on the judgment of talent scouts.

Much to the amazement and disapproval of the traditionalists - and despite their opposition - Beane and the nerds were proved right. Eventually, other teams started copying their methods.

This says to me that, contrary to the assumption of the economists' conventional model, all the guys running all the teams weren't playing for keeps until Beane and his nerds came along.

They wanted to win the comp, but they wanted to win while playing by the unwritten rules - the game's long-established social norms - of how you should go about winning.

To them, picking players by resort to a laptop full of statistics was almost as unsporting as using performance-enhancing drugs.

Here's the point: they didn't want to win for the money - as the model assumes - they wanted to win to impress the other guys in the comp. They were playing a game, not profit-maximising.

Economists portray competition as the foolproof path to efficiency and affluence. And the idea of living in an economy without competition - where everything was supplied by monopolies, whether privately or publicly owned - has zero appeal. Competition does help keep people on their toes.

But competition isn't the unmitigated blessing economists often assume it to be. As I discussed on Saturday, Robert Frank, in his latest book, The Darwin Economy, elucidates the case where competition leads to socially wasteful arms races, where what's good for the individual isn't good for the group.

The conventional model assumes we seek to maximise absolute values: businesses maximise profits, consumers maximise utility.

In real life, however, we're often more concerned about relative values: with how our salary compares with other people's, with whether our firm has the biggest market share. We care most about how we rank.

A related competitive failure occurs when firms (and the individuals who make them up) break (Hugh) Mackay's Law of competition: focus on the customer, not your competitor.

Thanks to their defective model of human behaviour, economists assume we compete only in response to monetary incentives. They forget the urge to compete is hardwired in the brain of the human animal.

We compete because we enjoy competing. We compete because we want to see how we rank in the comp - and we're confident we'll rank well. This, much more than greed, is what motivates the world's billionaire entrepreneurs.

We compete to impress the other players in the game. But when we do, we break Mackay's Law and our efforts don't benefit the community the way the model predicts.

Speaking of misguided competition, consider this from The Economist's Schumpeter column: "The vast majority of American universities are obsessed by rising up the academic hierarchy, becoming a bit less like Yokel-U and a bit more like Yale.

"Ivy League envy leads to an obsession with research. This can be a problem even in the best universities: students feel short-changed by professors fixated on crawling along the frontiers of knowledge with a magnifying glass.

"At lower-level universities it causes dysfunction. American professors of literature crank out 70,000 scholarly publications a year, compared with 13,757 in 1959.

"Most of these simply moulder: Mark Bauerlein of Emory University points out that, of the 16 research papers produced in 2004 by the University of Vermont's literature department, a fairly representative institution, 11 have since received between zero and two citations.

"The time wasted writing articles that will never be read cannot be spent teaching.

"In Academically Adrift, Richard Arum and Josipa Roksa argue that over a third of America's students show no improvement in critical thinking or analytical reasoning after four years in college."

Clearly, and despite all its virtues, competition can sometimes do more harm than good. But don't be so sure the American unis' misguided motivations could easily be corrected by applying some KPIs - key performance indicators.

It's a safe bet those universities have already been using KPIs to reinforce their academics' obsession with publishing or perishing.

In Australia, our governments have long allowed academic-dominated research councils to hand out research grants in ways that discourage our academics - certainly the economists - from researching Australian issues.

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A little regulation brings out the best for all of us

Ask economists who is the father of economics and almost all of them will say Adam Smith. But a new book makes the amazing claim the true father is Charles Darwin. And if you ask economists the question in 100 years' time, that's what they'll say.

The book is The Darwin Economy, by Robert Frank, professor of economics at Cornell University.

Smith was the Scottish moral philosopher, who published his most famous work, The Wealth of Nations, on the eve of the industrial revolution in 1776 (just a few years after Captain Cook visited Botany Bay).

Among all his insights about how the economy works, the one for which he gets most credit is the "invisible hand". This is the notion that impersonal market forces channel the behaviour of greedy individuals to produce the greatest good for all.

Why does a business owner go to the trouble of designing a new product that consumers are likely to find appealing? Why does he invest such effort to revamp his production process to reduce costs? Simply to make more money - as many people realised before Smith.

What they didn't see was the response those actions would provoke from rival business owners, and how the ensuing dynamic - the invisible hand - would produce outcomes very different from those intended, Frank says.

If one producer comes up with a cheaper way of manufacturing a product, he can cut his price slightly and steal market share from his rivals. In the short run, his profits soar, just as he'd hoped. But the loss of market share by rival firms gives their owners a powerful incentive to mimic the original innovation.

And once the innovation spreads industry-wide, the resulting competition drives the product's price down to a level just sufficient to cover the new, lower production costs. The ultimate beneficiaries of all this are consumers, who enjoy steadily improved products at ever-lower prices.

There's much truth to this and it does much to explain why the market system has raised our material standard of living so far over the past 200 years.

So why does Frank then think economists will come to see Darwin as the true father of economics rather than Smith? Because Darwin's study of the natural world led him to a deeper insight about the often flawed nature of competition.

Although Smith was careful not to claim it, many economists (and many libertarians) have taken his invisible hand to mean that regulation of markets is unnecessary and undesirable because unbridled market forces can take care of things quite nicely on their own.

In fact, Smith was well aware that unregulated markets didn't always produce the best outcomes. For the most part, however, he imagined market failure to be the result of inadequate competition. Firms would find some way to nobble their competitors and overcharge their customers.

Critics on the left have long focused on anti-competitive behaviour as the key to understanding why markets fail. But they (and Smith) are missing an important point.

"Darwin's view of the competitive process was fundamentally different," Frank says. "His observations persuaded him that the interests of individual animals were often profoundly in conflict with the broader interests of their own species."

Consider the outsized antlers of bull elk. These antlers function as weapons not against predators but in the competition among bulls for females. Since the bull with the biggest antlers gets to mate with the females, while the others don't, the process of natural selections has given male elk ever-bigger antlers.

But big antlers are a big disadvantage when elk are being preyed on, making them more likely to be killed and eaten by wolves. So what's in the interests of the individual bull is actually contrary to the interests of the group.

While no individual bull would want to be disadvantaged by having smaller antlers than the others, all the bulls would be better off if all of them had the width of their antlers narrowed by, say, half a metre (which would leave the relative size of their antlers unchanged).

You can tell the same story about peacocks' tails, huge elephant seals and many other animals that compete to be the sexual top dog. They all suffer a "collective action problem" - they're locked in a kind of arms race from which no individual can escape, even though all individuals realise how costly the race is. The only solution to the individuals' problem is for the animals - human animals - to act collectively. For them all to agree on a truce - a strategic arms limitation treaty, so to speak - or for some external authority, such as a government, to impose a solution on all of them. All would benefit from such an imposition so, contrary to the assumption of the libertarians, all are likely to welcome it.

The Nobel-prize-winning American economist, Thomas Schelling, quotes the case of ice-hockey players. When helmet-wearing is voluntary, no one is prepared to suffer the small competitive disadvantage of wearing one. But, since helmets do increase safety, all players would vote to make them compulsory.

Frank argues that for competition to give rise to collective action problems - wasteful arms races, if you like - is more the rule than the exception. Why? Because in many important areas of life, performance is "graded on the curve". It's not your absolute score that matters, it's your relative score - that is, where you rank in the comp.

"The dependence of reward on rank eliminates any presumption of harmony between individual and collective interests," Franks says, "and with it, the foundation of the libertarian's case for a completely unfettered market system."

Frank says since individual humans' reproductive success has always depended first and foremost on "relative resource holdings" - which males look the best physical specimens and the best providers; which females look the best child-bearers and homemakers - it would be astonishing if the evolved brain didn't care deeply about relative position.

Hence the tendency as we become ever-more affluent for a growing share of our income to be spent on "positional goods" - that is goods or services which, as well as doing whatever it is they are supposed to do, also signal to the world by their expensiveness our superior position in the pecking order.

Frank concludes that the real reason we regulate markets is to protect ourselves from the consequences of excessive competition.

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How to get more bang from your bucks

The retailers may be worried we aren't spending enough this Christmas, but that doesn't mean most of us aren't spending a fair bit. We always do. And, of course, for those of us off on summer holidays, the spending doesn't stop on Christmas Eve.

Economists are great apostles of efficiency, which they advocate so we have more money to spend on consumption. Strangely, however, they have little interest in how efficiently we spend our money. Are we spending it in ways that maximise the satisfaction (or "utility") we derive? They hardly know or care.

For advice on consumption efficiency we must turn to the psychologists - particularly those who study happiness (another word for utility). Earlier this year three famous psychologists, Elizabeth Dunn, of the University of British Columbia, Daniel Gilbert, of Harvard, and Timothy Wilson, of the University of Virginia, published an article called, If money doesn't make you happy, then you probably aren't spending it right.

The truth is, once you've satisfied your basic needs, getting and spending more money is a progressively less effective way to make yourself happier. The more you spend, the less effective each extra dollar becomes.

But that's partly because some forms of spending are more satisfying than others, and Gilbert's research shows humans aren't very good at predicting what will make them happy.

So the authors propose some principles that psychological research suggests will help us get more bang from our bucks. One that's particularly apposite at this time when we celebrate the birth of Santa is: help others instead of yourself.

Somebody who had nothing to do with Santa once said it was more blessed to give than to receive. Turns out he was right. Dunn has done various experiments that show giving gifts to people or making donations to charity makes people happier than spending money on themselves.

Studies of people's brains using magnetic resonance imaging showed that when people chose to give money to a local food bank this caused activity in the part of their brain typically associated with receiving rewards.

Why should this be? Because humans are the most social animal on the planet, the quality of our social relationships is a strong determinant of our happiness. So almost anything we do to improve our connections with others tends to improve our happiness as well.

Particularly at this time of year, retailers try to entice us with offers to "buy now, pay later". I don't doubt this helps increase sales, but it's pretty much the opposite of how you gain greater satisfaction. Another principle the authors propose is: pay now and consume later.

Consume now, pay later is a bad idea because it eliminates anticipation, and anticipation is a source of "free" happiness, the authors say. Delayed gratification means you get the pleasure of thinking about how good it will be and then you get the pleasure of actually experiencing it. We also get pleasure from looking back on experiences, but we get more from anticipating them.

A third principle is: beware of comparison shopping. The trouble with comparison shopping is it focuses your attention on those attributes of the items that are easily compared, not necessarily the attributes most important to how much satisfaction you'll get from the item once you've got it home and are using it.

This may be particularly true of internet shopping, which is likely to increase the emphasis on the attribute that's most easily compared: price. That's fine - especially when you're comparing identical items. But price is only one consideration. More important ones are whether you really want the thing in the first place, and how much use you're likely to make of it.

The next principle seems odd: follow the herd instead of your head. Research suggests the best way to predict how much we'll enjoy an experience is to see how much someone else enjoyed it. That's because we're so bad at predicting our utility. It's probably also because, being such intensely social animals, we usually feel comfortable doing what everyone else is doing (even if we don't like admitting it).

Next: buy many small pleasures instead of a few big ones. Present-buying parents, please note. The reason the pleasure from acquiring new things wears off so soon is that we so quickly get used to them. Psychologists say we "adapt" to them. So a key tactic in seeking to increase the pleasure we get from things is to find ways of slowing our rate of adaptation. One way to do it is to buy a lot of little things and get satisfaction out of each of them rather than buy a few big hits.

And they say economists use jargon. See if you can translate this: "Across many different domains, happiness is more strongly associated with the frequency than the intensity of people's positive affective experiences." (Positive affect means good feelings.)

In a study of Belgians, those who had a strong capacity to savour the mundane joys of daily life were happier than those who didn't.

I've left for last a principle I've written about before: buy experiences instead of things. We adapt to the ownership of things more quickly than to experiences. We anticipate and remember experiences more than things.

Our experiences are more centrally connected to our identities. And experiences are more likely to bring us into connection with other people.

Turns out this is the retailers' problem. We're not spending less overall, we're just spending less of our income on the goods retailers sell and more on the services they don't. Overseas holidays, for instance. But not for me, this time. Come Boxing Day I'm off up the coast for a few weeks.

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Secret of successful economy is 'frameworks'

The proof we suffer from an economic cringe as well as a cultural one is our tendency to attribute our better position relative to the other advanced economies purely to good luck. In truth, it's owed as much to our markedly superior economic management over the past 20 years.

What? Poor little Oz runs its economy far better than the mighty Yanks and the haughty Europeans? You betcha.

Last week both Ric Battellino, deputy governor of the Reserve Bank, and Dr Martin Parkinson, secretary to the Treasury, warned we would not be immune from the public debt troubles of Europe and the United States.

However, Parkinson said, we can take some comfort from our starting position. ''We are located in the fastest growing region in the global economy with a number of opportunities likely to present themselves over the next decade,'' he said.

''Equally, the flexibility of our economy and our medium-term oriented policy frameworks have assisted Australia manage the impacts from external volatility.''

According to Battellino, we need to monitor the unfolding European situation carefully and remain alert to the risks. ''Having said that, I remain confident that Australia, with its strong government finances, resilient banking system, relatively low exposures to the troubled countries and strong links to the dynamic Asian region, is well placed to deal with events that may unfold,'' he said.

So it's true we're enjoying the good luck of being close to Asia and loaded with the very natural resources it's willing to pay so dearly to get its hands on. But it's also true our leaders have understood the need for us to ''enmesh'' our economy with Asia's since Malcolm Fraser's day, and have worked towards that end.

Our econocrats can take a lot of the credit for the sound state of our banks. They didn't fall for - and didn't let their political masters fall for - all the happy talk about deregulation and free markets.

But wait, there's more - much more. And Battellino offered a big clue to it. He noted that government debt in the euro area had been rising as a proportion of gross domestic product for much of the period since the 1970s.

''This occurred because governments loosened fiscal [budgetary] policy during recessions, but did not fully reverse those policies during the subsequent cyclical recoveries,'' he said. ''In aggregate, budgets in the countries that now form the euro area have been continuously in deficit for the past 40 years.''

And here's the clue: ''Clearly, there was no fiscal rule that aimed to balance the budget over the economic cycle, as there is in Australia.''

He could have said much the same about the build up of public debt in the US, which saw its credit rating downgraded this year and looks likely to induce a fiscal crunch in 2013.

The truth is our economy was quite badly managed in the 1970s and much of the '80s. But whereas that's still true of Europe and the US, it hasn't been true of us for at least the past 20 years - during which time, you'll recall, we haven't had a serious recession, while the others have had two or three.

So what's the secret of our success? Our econocrats' commitment to making the conduct of fiscal policy and monetary (interest-rate) policy subject to clearly defined medium-term ''frameworks'' - systems of rules and targets - so as to reduce their susceptibility to short-term political expediency.

With monetary policy, that's been straightforward. In 1993, then Reserve Bank governor Bernie Fraser joined the international trend for monetary policy to be conducted by the central bank independent of the elected government, guided by an inflation target. Fraser's genius was in specifying such a sensible, flexible target: 2 per cent to 3 per cent on average over the cycle.

This regime was adopted formally by the incoming Howard government in 1996. The framework has achieved its goal of reducing and ''anchoring'' inflation expectations, so the target has been achieved without great restraint on economic growth. And successive governments - Liberal and Labor - have copped without anything more than a grumble all the Reserve's moves to raise interest rates at politically inconvenient times.

As the towering public debts of the North Atlantic economies attest, the pursuit of a framework for fiscal policy has been much more our own work, with little overseas precedent to guide us. It began with the ''trilogy of commitments'' unveiled in the Hawke government's first budget of 1983, and was reinforced with new targets for reducing the budget deficit in the Keating government's post-recession budget of 1993.

But the biggest stride towards a rigorous framework came with Peter Costello's enactment of the Charter of Budget Honesty upon election in 1996. At the charter's centre was Costello's ''medium-term fiscal strategy'' to ''maintain budget balance, on average, over the course of the economic cycle''. He lived by this strategy, achieving 10 budget surpluses during his term, before the onset of the global financial crisis (to which should be added Keating's three surpluses before the recession of the early '90s).

The present Labor government endorsed the Libs' medium-term strategy and its response to the crisis was consistent with it. In Labor's second stimulus package of February 2009 it conformed to the charter's requirement that it spell out a ''deficit exit strategy'', choosing to limit real growth in its spending to 2 per cent a year and forswearing any further tax cuts until a healthy budget surplus was restored.

''Frameworks'' are a boring subject, little mentioned by the media. But they've been our secret weapon in producing vastly superior outcomes to the Europeans and the Yanks.

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Economy follows wherever our moods take us

To anyone but the economists and financiers, getting to the bottom of what the problem is in Europe is hellishly complicated. The more you read the more confused you get. But you can boil it down to the combination of the availability of credit and what Keynes called ''animal spirits''.

To anyone but the economists and financiers, getting to the bottom of what the problem is in Europe is hellishly complicated. The more you read the more confused you get. But you can boil it down to the combination of the availability of credit and what Keynes called ''animal spirits''.

Animal spirits refer to the tendency of the human animal to go through alternating waves of excessive optimism and excessive pessimism. Because we're a highly social animal, we tend to all be optimistic or pessimistic together. Animal spirits are contagious.

In principle, the availability of credit is a wonderful thing, allowing families to buy a home long before they could pay cash for it and businesses to expand beyond their owners' savings.

Taken separately, the existence of credit and animal spirits isn't a big problem. Taken in combination, however, they can be lethal. Animal spirits - also known as ''confidence'' and ''expectations'' - are the main factor causing the economy to speed up and slow down, speed up and slow down again.

Add the availability of credit - which, once availed of, becomes debt - and the amplitude of the ups and downs is greatly increased to produce the business cycle of boom and bust.

The potentially toxic combination of credit and confidence can be a problem for households, businesses, banks or governments. The risk is they borrow too much while everyone's confident the present up-and-up will last forever, then get into trouble when the mood switches and everyone fears the end is nigh.

In Europe's case the main problem is with excessive borrowing by governments. As Ric Battellino, retiring deputy governor of the Reserve Bank, explained this week, government debt in the euro area has been growing faster than gross domestic product for the past 40 years.

The 17 countries' combined net public debt at the start of the global financial crisis equalled about 45 per cent of GDP. Since then it's jumped a third to 60 per cent. If those net figures don't impress you (most of those you see are gross, taking no account of the countries' financial assets), note that these euro-wide averages include Greece with a net debt of about 130 per cent of GDP and Italy with about 100 per cent.

The trouble with debt, of course, is it has to be ''serviced''. You have to pay the interest as it falls due and sometimes also repay part of the principle. Businesses and governments tend not to repay their borrowings but just roll them over (renew them)when they come to the end of their term.

You pay interest out of current income. This is rarely much of a problem while everyone's optimistic and your income keeps growing. But when the mood swings to pessimism and the economy turns down - or when the economy turns down and the mood swings to pessimism; it's often hard to be sure which causes which - it can get a lot harder to keep up your interest payments when your income isn't growing as fast or is falling.

The trouble with interest payments, of course, is they're not optional. Many households and firms have to cut back their other spending to make sure they can make their interest payments. When too many of them have to do that, the economy takes another lurch down, taking confidence with it.

Governments, on the other hand, tend merely to run bigger budget deficits. But when you're borrowing just to meet your interest payments, your debt and your interest payments grow rapidly.

And you find you've got another problem. The very people who lent to you so happily during the optimistic phase now turn on you. They say you're a hopeless money-manager, they worry about whether they'll get their money back, they'll only lend you more money at a much higher interest rate and may even press you to repay some principal.

Whereas during the optimistic phase they probably didn't charge you an interest rate high enough to adequately reflect their risk that you wouldn't be able to repay them, in the pessimistic phase - when you're at your most vulnerable - they probably charge you more than needed to cover that risk.

It's all terribly illogical, unfair and, worse, counterproductive. The people who shouldn't have lent you so much blame you, not themselves. They go from being too optimistic, to too pessimistic; too easy to too tough. And by doing so they threaten not only your survival, but their own.

Great system, eh? It's one of the great weaknesses of the generally highly beneficial capitalist system. It occurs because the humans who inhabit the system are emotional, herd animals, contrary to economists' happy assumptions that we're all rational and markets never get it wrong. It occurs when, as until recently, economists, regulators and politicians start believing their own bulldust.

All this helps explain why the governments of the euro area, having borrowed far more than they should have over many years, are now in so much trouble. Some, of course, have borrowed a lot more than others. These are the ones in the most trouble. But since they're all yoked together in the euro, they're all in trouble together.

Once the worst case - Greece - focused their attention, the financial markets began turning one by one on the other bad cases, as markets do. Trouble is contagious. Even the strong countries - Germany and France - are sus because their strength may not be sufficient to prop up all the others.

In the modern world, countries aren't allowed to go bankrupt. They always get bailed out, usually by the International Monetary Fund. In the case of the euro area, much of the bailing out will probably be done by the European Central Bank.

But salvation for sinners always comes with hefty punishment attached, to make sure they learn their lesson. Punishment comes in the form of ''austerity'' - big cuts in government spending and increases in taxes - which initially make things worse rather than better.

At present we're going through a drawn-out period of uncertainty while all the politicians involved argue about taking their medicine. I'm confident they'll eventually get their act together but, even if they do, Europe is in for an unpleasant decade.

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PM Gillard: hard worker, hard-nosed, hard to read

Having observed Julia Gillard's government for more than a year, I must say she's hard to pigeon-hole. Is the woman who changed the government's mantra from "working families" to "hard-working families" a typical Labor prime minister, as many business critics of Fair Work believe, or a pale imitation of a Liberal leader, as her willingness to sell uranium to India and her opposition to same-sex marriage lead many critics on the left to conclude? Does she stand up to powerful industries or kowtow to them?

You can make a surprisingly long list of social changes you'd expect the Labor heartland to be pretty happy about (even though it seems far from enamoured of its first female federal leader).

The introduction of paid parental leave (which, admittedly, occurred under Kevin Rudd) is an important step in reforming the institutions of the labour market to make them more suited to the needs of the better-educated sex.

Equal pay for women in the community sector - most of the cost of which will be borne by the federal budget - remedies an age-old injustice, which never made sense and couldn't have survived in a world of shortages of labour.

Plain-packaging for cigarettes is preventive-health reform that leads the world. The international tobacco industry has few friends, but very deep pockets to fight the Gillard government with advertising and legal action.

But global tobacco has a fraction of the power the licensed clubs have in opposing compulsory pre-commitment for people using poker machines. Although this issue was forced on Gillard by her lack of a majority, she has yet to waver in her determination to get it passed by Parliament. And though it, too, is a reform without international precedent, it could do much to reduce the gambling industry's indefensible exploitation of people addicted to poker machines.

Rudd should get most credit for several other social improvements: the national homeless strategy, the national rental affordability scheme (tax breaks for investors in affordable housing) and the first injection of funds into social housing in many a long day.

Rudd started, but Gillard has continued, Labor's many measures to pare back John Howard's middle-class welfare by declaring a family on $150,000 a year to be not rich, but comfortable. These measures don't just save money, they make the budget more redistributive in favour of the genuinely deserving.

And Gillard has defied the powerful private health insurance industry by continuing Rudd's efforts to get means-testing of the health insurance tax rebate approved by Parliament.

Gillard has committed herself to making introduction of a national disability insurance scheme her top social reform in the rest of her term. By providing help to people who inherit their disability or acquire it from an accident around the home, this would fill a longstanding gap in our social safety net. It would be a historic advance (and is one of the few reforms Tony Abbott hasn't opposed).

But against all that there are a couple of areas where Gillard's performance has been anything but what you would expect from Labor. The first is her education "reforms" copied from the American Republican Party.

Trying to "incentivate" school teachers as though they were as money-hungry as chief executives merely insults their professionalism. Providing parents with greater information about the performance of schools is fine, but doing so before summoning the courage to correct the bias in federal school funding in favour of well-off schools risks hanging under-resourced public schools out to dry.

Gillard has spent four years postponing change to Howard's middle-class-welfare school-funding formula. Her response next year to the belated review will show whether her courage has recovered.

The tax concessions attached to superannuation have long been heavily biased in favour of high income earners such as yours truly. To call them middle-class welfare would be an understatement.

Rather than using the opportunity provided by the decision to phase-up compulsory employee contributions from 9 per cent to 12 per cent of salary (a multi-billion-dollar gift to the financial services industry) to shift the tax benefit from high to middle and low income earners, the government will merely use some of the revenue from the mining tax to correct the position where workers on the 15 per cent income tax rate gain no concession on their contributions.

But the most puzzling and indefensible aspect of Rudd policy continued by Gillard is the mistreatment of sole parents and, more so, people on unemployment benefits. Both groups were explicitly excluded from the over-generous pension increase in 2009.

For many years, age and invalid pensions have been indexed to average earnings, meaning they rise faster than inflation, whereas the dole has been indexed only to inflation. In consequence, the dole paid to single adults is now less than two-thirds of the single pension, a shortfall of $131 a week.

The dole is now so low it's just 36 per cent of median household income, putting it well below the commonly drawn poverty line of half median income. It's also just 45 per cent of the after-tax minimum wage - meaning there is little risk its generosity is deterring people from taking a job.

One defence of low unemployment benefits is that most people aren't on them for long. But more than half the people on the dole have been on it for a year or more. And the government is also limiting the assistance it gives the long-term unemployed to help them find a job.

This discrimination against the unemployed is now so extreme the Henry tax reform recommended it be corrected. And even the Business Council agrees.

Perhaps Gillard's lack of sympathy for the unemployed arises because, being unable to find a job, they're not hard-working.

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Reserve has re-assessed outlook for world growth

Just as a stopped clock is right twice a day, so the financial markets' belief that Europe's sovereign debt problems are the primary factor influencing the Reserve Bank's decisions about interest rates, having been wrong for most of the year, has finally proved on the money.

A psychologist would say the financial markets have been suffering a "salience" problem. Their judgments about how the Reserve will adjust the official rate have been overly influenced by the factor sticking out in their minds and also on their minds most recently: Europe.

If Europe is on their front burner, it must also be on the Reserve's. Since the outlook for Europe is so worrying and so conducive to slower economic growth, the markets have for months been predicting that big falls in our official rate are imminent.

Month after month the markets have stuck to this view, ignoring the Reserve's twice-monthly explanations of its thinking, which, while acknowledging the worries and uncertainties over Europe, have repeatedly emphasised the state of the domestic economy and, in particular, the outlook for domestic inflation, as key considerations.

So when, on Melbourne Cup day, the Reserve acted for the first time in a year and chose to lower interest rates by a notch, the markets weren't surprised. But they were right for the wrong reason. As the Reserve made clear, it was able to ease a notch because the economy wasn't accelerating to the extent it had been expecting, thus making the Reserve more confident inflation would stay on track over the next year or two.

But all that changed last week, when the Reserve eased the rate another notch, this time making it clear its decision had been influenced by the changed prospects for the global economy.

So what exactly were its motivations? Was it taking out a little insurance, fearing the worst might come to the worst in Europe? No, nothing so dramatic.

It doesn't take many brain cells to get the wind up over Europe and assume the worst. It takes more brain power to quietly assess the probability of a complete disaster. And more again to assess the strength of any troubles in Europe by the time the ripples reach the Antipodes via China.

By now, the shape of the solution to Europe's problem is reasonably clear. The 17 member countries of the euro area (or, if they insist, almost all the members of the European Union) need to sign up to a new fiscal compact, which imposes limits on the size of their budget deficits and levels of public debt relative to gross domestic product, with automatic penalties for countries that breach these limits.

The pact would also impose timetables for countries presently well in excess of those limits to comply with them, again with penalties for breaches.

Once these strictures had been ratified - thus plugging the obvious hole in the euro currency union, as well as guaranteeing the errant borrowers would mend their ways - the European Central Bank would be willing to start buying up the bonds of member countries, thus forcing down their yields.

It would cut its official interest rate to next to nothing and engage in "quantitative easing" (buying government bonds to cover deficit spending and so, in effect, printing money). Thus all the budgetary contraction would be offset to some extent by monetary stimulus.

While it's painfully apparent the European leaders are having trouble getting their act together - thus increasing the risk of disaster occurring by accident - it's also apparent they're neither fools nor suicidal.

So to assume Europe is headed inevitably for an implosion - as many punters seem to - strikes me as nothing more than unthinking pessimism. Our more experienced observers put the probability of a complete disaster no higher than about one chance in three.

This says the chances are twice as high that Europe will muddle through. But it's clear that even if the full calamity of a collapse in the euro is averted, even if everyone dons their fiscal straitjacket, the financial markets calm down and ordinary life resumes, the outlook for the European economy is particularly weak.

All those economies committed to the fiscal austerity of tax increases and swingeing spending cuts - and it will be quite a few of them - face the dismal prospect of fiscal contraction leading to reduced revenue, reduced revenue leading to a need for more fiscal contraction, and so on and on.

If you wonder how any politician could agree to such an appalling exercise, you're starting to understand why Europe's politicians have had so much trouble getting themselves up to the barrier. They've had to reach the realisation the financial markets - which went for years happily lending them more money than was good for them - are now not going to tolerate any easier or more sensible work-out of their debt problems.

For our purposes, it's now clear the greatest likelihood is negative to flat growth in Europe for at least the next year or two (the forecast period) and probably far longer. It's also clear that, while the US economy has gained momentum recently, it too faces unavoidable fiscal contraction, if not next year then in 2013.

With evidence China's exports to Europe are already being hit, the Reserve decided last week to revise down its forecasts for world growth. This will change its forecasts for domestic growth and inflation only a little, but it was enough to raise the Reserve's confidence it could cut rates another notch without jeopardising achievement of its inflation target.

Meanwhile, the financial markets are betting the official rate will have fallen by another 1.5 percentage points by the middle of next year. I call that courageous.

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Nice set of figures should shut up the gloomsters

Something strange is happening to the Australian psyche at present. A lot of people are feeling down about the economy. They're convinced it's pretty weak, and any bit of bad news gets a lot of attention.

But most of the objective evidence we get about the state of the economy says it is, under the circumstances, surprisingly strong. Consider the national accounts we got this week.

They show the economy - real gross domestic product - grew by 1 per cent in the September quarter, more than most economists were expecting. And not only that, the Bureau of Statistics went back over recent history, revising up the figures.

Originally we were told the economy grew by a rapid 1.2 per cent in the June quarter, but now we're told it grew by an even faster 1.4 per cent. Originally we were told the economy contracted by 1.2 per cent in the March quarter because of the Queensland floods and cyclone, but now we're told the contraction was only 0.7 per cent.

Those figures hardly fit with all the gloominess. So how fast is the economy travelling, on the latest numbers? We're told it grew by 2.5 per cent over the year to September, but that figure includes the once-off contraction in the March quarter, which is now ancient history.

We could do it the American way and say we grew at an ''annualised rate'' of 4 per cent in the September quarter (roughly, 1 per cent x 4), but that's too high because this quarter (and the previous one) includes a bit of ''payback'' (or, if you like, catch-up) as the Queensland economy got back to normal after its extreme weather.

(There's likely to be more catch-up in the present quarter as the Queensland coalmines finally pump out all the water and resume their normal level of exports, suggesting the Reserve Bank is reasonably safe to achieve its forecast of 2.75 per cent growth over the year to December.)

So the best assessment is that at present the economy is growing at about its ''trend'' (long-term average) rate of 3.25 per cent a year. If so, everything's about normal.

Ah yes, say the gloomsters, but all the growth's coming from the mining boom. Before we check that claim, let's just think about it. If we were viewing our economy in comparison with virtually every other developed economy, we'd be thanking our lucky stars for the mining boom.

But not us; not in our present mood. We're feeling sorry for ourselves because, for most of us, the benefits of the boom come to us only indirectly. (The other thing we ought to be thankful for apart from our luck is 20 years of clearly superior management of our economy. In stark contrast to Europe and the US, we have well-regulated banks and stuff-all public debt.)

It's true the greatest single contributor to growth in the September quarter was the boom in investment in new mines. New engineering construction surged 31 per cent in the quarter and total business investment spending rose by almost 13 per cent.

But though most of that remarkable boost is explained by mining, there was also a healthy increase in manufacturing investment.

And here's a point some people have missed: the second biggest contribution to growth in the September quarter (a contribution of 0.7 percentage points) came from the allegedly cautious consumer.

Consumer spending grew by 1.2 per cent in the quarter and by 3.8 per cent over the year to September. That's actually above its long-term trend. And consumer spending was strong in all the states, ranging from rises of 0.8 per cent in Victoria, 0.9 per cent in Western Australia (note) and 1.1 per cent in NSW, to 1.9 per cent in Queensland (more catch-up).

Although households are now saving about 10 per cent of their disposable incomes, this saving rate has been reasonably steady for the past nine months. So consumer spending is growing quite strongly because household income is growing quite strongly.

It's noteworthy that, according to Treasury, non-mining profits rose by 4.7 per cent in the quarter. And according to Kieran Davies, of the Royal Bank of Scotland, non-mining GDP grew by a solid 0.7 per cent in the quarter, just a fraction below trend.

So the notion that mining (and WA and Queensland) might be doing fine but everything else is as flat as a tack is mistaken. It's true, however, that some industries are doing it tough. Consumers are spending at a normal rate, but their spending has shifted from clothing and footwear and department stores to restaurants, overseas travel and other services.

Home-building activity declined during the quarter - a bad sign. The continuing withdrawal of the earlier budgetary stimulus meant that government spending fell by 2.5 per cent during the quarter. Public spending was a drag on growth in all states bar WA and Queensland (more catch-up).

Our terms of trade - export prices relative to import prices - improved by 2.7 per cent in the quarter (and by 13 per cent over the year to September) to be their best on record. But that's likely to be the peak, with key export prices falling somewhat in the present quarter.

The volume of exports rose by 2 per cent in the quarter, but the volume of imports rose by 4.3 per cent, mainly because of imports of capital equipment. So ''net exports'' (exports minus imports) subtracted 0.6 percentage points from overall growth in real GDP during the quarter.

Ah yes, say the gloomsters, but all this is old news - the September quarter ended more than two months ago. The economy must have slowed since then. After all, look at this week's news of a rise in the unemployment rate to 5.3 per cent in November.

It does seem true the labour market isn't as strong as the strength of economic activity would lead us to expect. This could indicate a degree of caution on the part of employers. But the rise in unemployment is slow and small, and if it's only up to 5.3 per cent we're still doing very well by the standard of the past 20 years.

As for the tempting line that everything's gone bad since the strong growth in the September quarter, just remember: that's what the gloomsters said when they saw the good growth figures for the previous quarter. Turned out to be dead wrong.

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Breakdown in relations is everyone's business

I get to meet a lot of famous and interesting people in my job, but few have had more influence on me than Dr Michael Schluter, the social thinker, social entrepreneur and founder of Britain's Relationships Foundation.

They say genius is being the first to say the obvious. If so, Schluter is one. I'm sure Socrates or Aristotle beat him to it but, in our time, Schluter is the first to forcefully remind us of something we all know: the importance of our human relationships.

We are, above all, social animals. After we've secured our physical survival, the most important thing in our lives is our relationships: with friends, neighbours, workmates and, above all, with our families - our parents, siblings, spouse and children.

Even if we've avoided speaking to them for years, even if they're dead and gone, we can't stop thinking about them. If we've cut ourselves off from our families, be sure we've sought to fill the vacuum with other relationships. Take away all our relationships and who'd have much reason to live?

So much for stating the obvious. But here's Schluter's simple, unarguably telling, point: if our relationships are so fundamental to our well-being, why do we keep forgetting to take account of them in our strivings? Wouldn't we be better off if we got into the habit of viewing all our endeavours through a lens that focused on their implications for our relationships?

How often do divorce lawyers advise people to avoid all attempts at reconciliation with their estranged spouse for fear of weakening their legal position? How often do doctors treat physical symptoms that aren't what's really troubling their patient?

How often do politicians who loudly proclaim their support for the family then consider 101 policy proposals without a thought as to their implications for people's relationships? As for economists, their model is so narrowly focused on the individual that they become oblivious to the potential effects of the policies they advocate on the relationships that sustain all individuals.

The truth is much of our ever-increasing material affluence over the past 200 years has been achieved at the expense of our relationships; by making the workings of the economy ever bigger, more complex and impersonal; by encouraging economic transactions between people who've never met, let alone had a relationship with each other.

Back to Schluter's insistent reminder: aren't we paying a price for ignoring the relational implications of all this? Wouldn't we be better off if we put the protection and promotion of our relationships back into the formula?

So far have we strayed from recognising the primacy of our relationships that the proposals of the mild-mannered, respectable, god-fearing Schluter sound positively radical.

About 150 years ago, the invention of the limited-liability company allowed people with money to invest to become owners of companies without taking any part in their management. The development of stock exchanges allowed people to buy and sell their shares in a company as easily and often as they liked. From these innovations came the huge corporations that dominate the economy today.

Economists see them as milestones on our path to prosperity. Schluter sees the downside. So, last month, in troubled Britain, he and a colleague, Jonathan Rushworth, launched a plan, Transforming Capitalism from Within: a Relational Approach to the Purpose, Performance and Assessment of Companies.

He proposes that enlightened firms submit themselves to the discipline of a 10-step ''relational business charter''. Step one is for the company to include in its articles of association a goal to become a profitable and sustainable business for the benefit of all its stakeholders - owners, directors, managers, employees, suppliers and customers - and the wider society.

Step two is to promote dialogue among company stakeholders, preferably through regular, face-to-face meetings.

Step three seeks to reduce ''relational distance'' between shareholders and the employees and other stakeholders by promoting share ownership by named individuals and family trusts rather than institutional investors such as pension funds.

The goal could be 25 per cent direct ownership pursued, partly, by encouraging employees to own shares. Ideally, a growing proportion of shareholders will live close to the company's main base.

Next, to achieve commitment, involvement and responsibility by shareholders, relational firms should encourage long-term ownership, perhaps by issuing additional shares to those who hold their shares for long periods.

Step five is for companies to help their employees achieve work-life balance by minimising long working hours and work at unsociable hours (including weekends) wherever possible. These things have a direct effect on the families of employees, particularly if the employee will not be present to share the bringing up of children.

Then firms will seek to respect the dignity of all employees by minimising remuneration differentials within the business. A ratio of 20:1 between top and bottom would be a good benchmark.

Relational companies will treat suppliers fairly and with respect, paying them promptly and giving them support to develop their businesses.

Relational companies will treat their customers and the local community fairly, respecting their concerns about reasonable payment terms and adequate service.

Step nine involves companies protecting their business and stakeholders by minimising the risk of financial instability, limiting their ''gearing'' - ratio of borrowing to shareholders' funds.

Finally, relational companies will fulfil their obligations to the wider society by paying a reasonable proportion of profits in tax in the country where those profits were earned. They will also spend a reasonable proportion of profits on corporate social responsibility.

The musings of a hopeless dreamer? I think our companies' present ruthless pursuit of profit at any cost is an excess that can't last. Schluter is a prophet pointing the way back to more sensible capitalism.

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Business economists play politics over budget surplus

Business economists have been surprisingly critical of Julia Gillard's efforts to keep her promise to return the budget to surplus next financial year, but if I were her I'd have done much the same thing.

She, her cabinet and her econocrat advisers turn out to have a much better understanding of real-world macro-economic management than the know-it-all business economists.

Their repeated statements that the government's obsession with achieving budget surplus in 2012-13 is a ''purely political'' objective show how little they understand political economy. Paradoxically, it's they who are playing politics in making such a claim.

In an ideal world - a rational world - it wouldn't be necessary for Wayne Swan and Penny Wong to turn the fiscal somersaults they did last week just to keep the budget's forward estimates pointing to a laughably microscopic surplus.

(All the ''reprofiling'' - read creative accounting - to which the budget ministers needed to resort is explained not so much by the economy's now weaker-than-expected strength of recovery, but by the extent to which the carbon tax package was, predictably, revenue negative in its first year.)

In such an imaginary world, it wouldn't matter if the budget's return to surplus was a year or two earlier or later than the year first projected. In such a world, the punters wouldn't imagine a surplus of $1.5 billion was a totally different animal to a deficit of $1.5 billion, instead of the same thing: a near-as-dammit balanced budget.

In such a world, voters would not set the bar higher for Labor treasurers than Liberal treasurers.

In such a world, voters would laugh to scorn the efforts of such reliable witnesses as Tony Abbott, Joe Hockey, Andrew Robb and Barnaby Joyce to convince them all budget deficits are bad and Australia's public debt is mountainous.

But the business economists so freely accusing the government of being ''purely political'' are guilty of more than naivety. Their political double standard is showing.

Where were they with their accusations of politicians being ''purely political'' when, almost from the first fiscal stimulus package, the Liberals began trying to inculcate their pre-Keynesian nonsense in the minds of an economically illiterate electorate?

I don't remember hearing from them. In fact, with the honourable exception of Saul Eslake, I can't remember ever hearing a business economist dare to criticise a Liberal government or opposition.

Under Abbott the Libs are at their most populist, protectionist and anti-rationalist in decades. They've been working overtime to exploit and frustrate any attempt by Labor to implement unpopular reforms. The notion of Abbott in government is frightening.

But do we hear a breath of criticism from the business lobbies or the business economists? Gosh no. The Libs might take offence.

But take a shot at a Labor government, especially one that's out of favour with big business and looks on the ropes? Sure, why not. How could the boss object to that?

Labor's problem is not that it's had bad economic policies - its response to the global financial crisis was almost too successful for its own good; its carbon price scheme was compromised more by the reneged-on deal with Malcolm Turnbull than by the subsequent deal with the Greens - but that it can't explain itself, can't educate the electorate.

Is it surprising politicians adopt less-than-pure policies when they know that, were they to be more courageous, the nation's economists - academic and business - would be missing in action when the guns were firing?

But this episode doesn't just reveal the business economists' partisanship and their dereliction in helping to educate a gullible electorate. It reveals that, even after our experience with the global financial crisis, they don't understand the central role of psychology - confidence - in any government's efforts to manage the economy through the business cycle.

The present low levels of consumer and business confidence are a consequence of various factors, not just forebodings about the turmoil in Europe. Other factors would be fears about the devastating effects of the carbon tax and, after years of propagandising by the opposition and the Murdoch press, a lack of confidence in the government's ability to manage the economy.

In such circumstances, would it really be of no consequence for the government to be seen to have broken its promise to return the budget to surplus? Can you imagine how the opposition would carry on? Do you really think that would have no effect on confidence?

There may even be some truth in the government's argument that, in view of the global financial markets' concerns about sovereign debt, this is no time for our government to renege on promises to stop adding to government debt.

So much for the naive belief the government's concern to protect its reputation as an economic manager is ''purely political''. But wait, there's more.

If there's one lesson to be learnt from the problems in the United States as well as Europe, it's the difficulty governments have in keeping the two sides of their budget within cooee. We, of course, are exemplary by comparison.

Why have we exercised so much fiscal discipline? Because of our tight ''framework'' of rules and targets to guide fiscal policy. Rules and targets governments of both colours have adhered to.

In an ideal world, governments would have no trouble exercising discipline over their spending and taxing. In the real world, governments have to give discipline a helping hand by drawing essentially arbitrary lines in the sand, then sticking to them.

Gillard's promise to achieve a surplus in 2012-13 is just such an arbitrary line. That line could be washed away by a tidal wave from Europe, of course. But sensible economists think twice before urging governments to cast aside their self-imposed pre-commitment devices.

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How budget update affects stance of fiscal policy

The most remarkable thing about this week's mini mini-budget is how many words the media could spill without clarifying a rather important question: how will it affect the economy?

One of the ways politicians (and journalists) make such announcements sound big is by giving us the cost of measures ''over four years''. But the economy is lived through, and managed, one year at a time. So it's the year-by-year figures that matter most.

We know the avowed purpose of the spending and tax measures announced along with the midyear budget update was to get the budget back on track to return to surplus in 2012-13, as Julia Gillard promised in the election campaign.
The return to surplus had been put in doubt by the effect of the turbulence in Europe on the confidence of our consumers and business people, which is stopping the economy growing as quickly as had been expected at budget time.

In consequence, tax collections are now expected to grow by about $5 billion in 2011-12 and $6 billion in 2012-13 less than earlier thought. With other revisions, this would have turned the expected surplus in 2012-13 of $3.5 billion into a deficit of $1.4 billion.

So what did Wayne Swan and Penny Wong do about it? Ostensibly, they found savings sufficient to get back to an expected surplus of $1.5 billion. But, as we'll see, it's not that simple.

We've been told repeatedly the announcement involved savings measures worth $11.5 billion over four years. We've been told less often it also involved new measures with a cost to the budget of $4.7 billion over four years.

So the measures' net effect is to improve the budget balance by a much more modest $6.8 billion over four years. Of this, just $2.9 billion relates to next financial year, the year the government's concerns are focused on.

Is $2.9 billion a lot or a little? To you or me it's a king's ransom, more than we'd ever see in 400 lifetimes. But that's not the relevant comparison. Since we're interested in the budget's effect on the economy, it's the size of the economy that's the appropriate comparison.

The nation's annual income (from its production of goods and services, gross domestic product) is about $1.4 trillion ($1400 billion). So $2.9 billion represents a mere 0.2 per cent of our annual income.

You'd thus be justified in concluding that, from a macroeconomic point of view, the measures included with the revised budget estimates on Tuesday weren't worth worrying about. But there are ways of viewing this week's new information that make it seem a much bigger deal.

Consider this. The Reserve Bank's rough-and-ready way of judging the budget's effect on the economy is to look at the direction and size of the change in the budget's underlying cash balance from one financial year to the next.

At the time of the budget in May, the government was expecting a deficit in 2010-11 of $49.4 billion (equivalent to minus 3.6 per cent of gross domestic product) falling to a deficit of $22.6 billion (minus 1.5 per cent) in the present year, 2011-12, and then becoming a surplus of $3.5 billion (plus 0.2 per cent) in the target year, 2012-13.

So, measured against GDP, it was expecting an improvement in the budget balance of 2.1 percentage points this financial year, followed by an improvement of 1.7 percentage points next year.

Now, those proportions of GDP clearly were a big deal. They represented a very rapid reduction of the budget's net support to the economy. So I judged the ''stance'' (setting) of fiscal (budgetary) policy envisaged in the budget to be ''highly contractionary''.

This turnaround in the budget balance was to be brought about by three factors. First, the withdrawal of the earlier fiscal stimulus as its temporary spending came to an end. Second, the effect of the government's ''deficit exit strategy'' of holding the real growth in its spending to no more than 2 per cent a year and granting no further cuts in income tax.

But the third factor was central: the economy's expected strong recovery from the mild recession of 2008-09 would cause faster growth in tax collections and a fall in spending on dole payments. In other words, much of the improvement would come from the operation of the budget's in-built ''automatic stabilisers''.

Right. So how has that picture been changed by the revised forecasts for the economy and the new spending and tax measures announced on Tuesday? The government recorded an actual budget deficit of $47.7 billion (minus 3.4 per cent of GDP) last financial year. It's now expecting a deficit of $37.1 billion (minus 2.5 per cent) this year and a surplus of $1.5 billion (plus 0.1 per cent).

Looking at that the way the Reserve does, the government is now expecting an improvement of 0.9 percentage points (rather than the earlier 2.1 points) this year and 2.6 percentage points (rather than 1.7 points) next year.

Taking those figures at face value, you'd say the stance of fiscal policy was now planned to be much less contractionary this year, but a fair bit more contractionary next.

Some economists have observed that this would involve ''the sharpest improvement in the budget balance for four decades'' and would mean the budget acting as a ''substantial drag on economic growth'' in 2012-13.

Just one small problem. Much of the alleged blowout in this year's deficit and seeming rapid improvement in the budget balance next year arises not from the revised economic forecasts or the substantive spending measures, but from what the government euphemistically refers to as ''reprofiling'' - shifting intended spending and tax measures around between years.

In particular, the government took net spending of roughly $4.8 billion that should have occurred in the target year, 2012-13, and moved it forward to the last two months of this year, 2011-12, thus artificially worsening the comparison of the two years by double that amount, roughly $9.6 billion.

It also improved the target year's budget balance by about $850 million by delaying for a year the start of various tax concessions associated with the mining tax package.)

So, measured the Reserve Bank way, the ''underlying'' stance of fiscal policy remains pretty contractionary in both years - and, after you look through the reprofiling, not greatly changed.

This stance seems appropriate, remembering the economy is close to full employment and monetary policy can be eased (interest rates cut) should that prove necessary.

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