How to save money and wreck productivity

I've just had a great idea for raising the productivity of Australia's knowledge workers: try treating them with greater consideration so as to improve their concentration.

Simple hard-headed economics tells us that the scarcer the skills of workers, the more you have to pay for their services and the better you have to make their working conditions.

It's only those workers with few skills and who can be easily and cheaply replaced that you can get away with treating badly.

But many modern managers seem to regard these simple truths as no longer applicable. Businesses may be becoming ever more reliant on their knowledge workers and their ability to do their work well - perhaps to counter the effect of work intensification as head counts are reduced - but why not skimp on their working conditions?

Open-plan offices have been becoming more prevalent for decades, but these days it's not just a matter of replacing a warren of private offices with a cubicle farm. Why not get rid of the dividers and the modicum of privacy they provide - purely to encourage collaboration and break down silos, you understand - and move to "hot-desking" - providing fewer desks than the number of people you employ?

Even more progressive is the move to the "virtual office", where workers are issued with their own mobile phone, a laptop and a locker, but denied a particular desk. You want them moving from desk to desk each day, even morning to afternoon.

To ensure they don't break the rules and bags a particular desk, you impose a "clean-desk policy" where cleaners are instructed to toss away anything they find on desks overnight.

They may be knowledge workers but they're not likely to need books or papers for reference, are they? That's what Google is for.

I'm sure the reduced office space required has yielded savings, but I suspect it's a false economy when you take account of the effect on workers' productivity. Indeed, there is growing evidence the costs of these policies exceed the benefits.

Diane Hoskins, of Gensler, a big US office design firm, has been researching the question using surveys of more than 90,000 people from 155 companies across 10 industries.

Her people found that knowledge work consists of four modes: focus (individual work involving concentration and attention devoted to a particular task), collaboration (working with another person or group to achieve a goal), learning (acquiring knowledge of a subject or skill through education or experience) and socialising (interactions that create trust, common bonds and values, collective identity and productive relationships).

They found that the most significant factor in workplace effectiveness is not collaboration - the stated justification for most of the office changes - but individual focus work. Whoever would have thought being able to concentrate on your work could be so important?

They also found that focus is the thing the new-style offices make hardest. "Co-worker interruptions, auditory and visual distractions all combine to make focus work the modern office's most compromised work mode," she found. Who could have known?

The four work modes are highly interconnected, the researchers found, with focus as the primary component and the key predictor of all other effectiveness.So office arrangements that sacrifice individual focus in pursuit of collaboration result in decreased effectiveness for both.

Other research by Gensler finds that workers who can focus effectively are 57 per cent more able to collaborate, 88 per cent more able to learn and 42 per cent more able to socialise in their workplace than their peers who are unable to focus.

Justine Humphry, of Sydney University, says clean-desk policies are used as a way to prevent employees from "nesting": settling in one place for too long and giving it their personal stamp. This is intended to yield cost savings and productivity gains by reducing overall floor space and facilitating collaboration among staff, thereby breaking down the silos and barriers of the standard cubicle office.

Her research finds that workers continue to go about personalising and nesting in their work environments, undermining the design of a mobile and flexible office. "Studies have highlighted identity expression and professional status as key reasons for personalisation at work," she says.

"But in my ... research conducted on professional knowledge workers, it was found that personalising or nesting is also performed for practical reasons ... to enhance wellbeing, to create opportunities for privacy or collaboration, to facilitate social interaction and to save time."

It couldn't be that penny-pinching and fads in office design are part of the explanation for our less than sterling productivity performance since the 1990s, could it?

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Darwin improves on Adam Smith

What can the theory of evolution tell us about how the economy works? A lot. But probably not what you think it does.

Famous economists such as Joseph Schumpeter (author of the notion of "creative destruction") and Milton Friedman, and the contemporary economic historian Niall Ferguson, have viewed economies as Darwinian arenas: competition among firms reflects the ruthless logic of natural selection. Firms struggle with each other, with successful firms surviving and unsuccessful ones dying.

Thus evolution seems to support three pillars of the conventional, neoclassical model of the economy. First, that "economic actors" are self-interested, second, that self-interest works to the good of the public (propelling Adam Smith's "invisible hand") and, third, that together these lead the market to deliver the community ideal outcomes ("optimisation").

But there's a basic fault in this contention, as Dominic Johnson, of Oxford University, Michael Price, of Britain's Brunel University, and Mark van Vugt, of Amsterdam's VU University, point out in their paper, Darwin's Invisible Hand.

In conventional economics, "economic actors" can be either individuals or firms, although the theory tends to treat firms as though they were individuals. In reality, however, firms are groups of individuals - in the case of big national and multinational companies, thousands of them in one firm.

So if Darwinian selection applies to competitive markets, this implies that selection pressure acts on groups, not individuals. And group selection, as opposed to conventional Darwinian selection at the individual level, leads to the emergence of traits that act against self-interest.

With group selection, "we should expect the suppression of self-interest among individuals, not its flourishing", the authors say.

"Firms with less self-interested workers will compete more effectively and spread at the expense of firms with more self-interested workers, which will compete less effectively and decline. In other words, the model predicts nasty firms but nice people.

"Firms vie for market share and profits, group selection would predict, while individuals within those firms sacrifice their own interests for the good of the group. They will work long hours, accept low status and low salaries, co-operate with each other, share resources, accept hierarchy, obey their bosses, volunteer for extra duties and never help - or move to - rival firms."

Does that sound realistic to you? No, me neither.

"In reality," the authors say, "firms are made up of individual human beings, with various goals and motives but, most importantly, considerable self-interest.

"Darwinian selection at the level of groups implies that the interests of group members are weaker or synonymous with the interests of the group as a whole. In the real world, they are not. There is often some overlap, of course: the boss will want his workers to perform well; the workers will want the firm to survive.

But we also have strong personal desires for salary, status, rank, reputation, free time and better jobs.
"In short, any evolutionary model must account for two opposing processes that operate simultaneously: competition between firms and competition between the individuals within them."

So the authors are adherents to a relatively new school of thought holding that selection occurs at both levels: "multi-level selection theory". And this leads them to conclude that taking account of the role of evolutionary selection doesn't really bolster the conclusions of the neoclassical model.

Economic actors are self-interested only sometimes. Self-interest promotes the public good only sometimes. And these things mean markets produce optimal results only sometimes.

Great. But where does that get us? The authors argue that being more realistic by integrating the factors at work at group level with those at work at the individual level allows us to make better predictions on which interests - individual or group - will dominate in particular circumstances.

"A one extreme, if selection among groups is frequent and severe, we may expect an increased alignment of individual and group interests resulting in successful firms with hard-working, groupish, highly committed employees," they say.

"At the other extreme, if selection among groups is rare and weak, we may expect increased conflicts of interest resulting in inefficient firms and lazy, self-interested workers."

By group selection they mean cultural selection - some ideas and practices beat others - not biological selection. And, because ideas can spread so quickly, not needing to wait for genetic evolution to occur generation by generation, cultural evolution is much faster and more powerful.

The authors say competition between firms may be a quintessential example of cultural selection.

A weakness of the neoclassical model is that it exalts competition between economic agents while ignoring the co-operation within firms that is such an important part of real-world competition in markets.
The evolutionary approach, however, does much to illuminate the role of co-operation.

"Individuals are adapted to co-operate in groups but do so in individually adaptive ways," they say. "That is, we are co-operative, but only so long as our own individual costs and benefits are taken into account."

People want to be rewarded for their contribution but also to see that their reward doesn't compare badly with the rewards fellow workers are getting relative to their contribution.

But whereas the conventional economic model focuses on only monetary rewards and punishments, the evolutionary approach predicts that individuals will be powerfully motivated to strive for social status and prestige within their firm, even at the expense of material rewards or the risk of punishment.

The evolutionary approach also offers a better explanation of why individuals would want to take on stressful and time-consuming leadership positions, which are not always compensated by higher salaries: higher social status rewards.

The key to improving the performance of firms, we're told, is not to strike some inefficient compromise between the interests of individuals and their group but to work with the grain of human nature to bring individual and group interests into alignment. If you know what you're doing, this can be achieved relatively easily and at low cost.

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Blame for budget worries widely shared

For months I've been having a nightmare: what if Australia's period of exemplary fiscal policy - which began with Paul Keating's return to budget surplus in 1987-88 - is already over and we've joined most of the other rich economies in running budget deficits every year, not just in the aftermath of major downturns?

That is, what if we've collectively lost the political will to make ourselves pay enough tax to cover the cost of all the things we require our governments to do for us?

The nightmare returned last week when Joe Hockey unveiled Treasury's projection of a further decade of budget deficits, assuming unchanged policies (including unending bracket creep).

On the other hand, it's worth remembering that even if this undisciplined scenario came to pass, the federal government's net debt would peak as a proportion of gross domestic product at 16.2 per cent in June 2019, then slowly fall as GDP grew faster than the debt grew. So the feds' triple-A credit rating would not be threatened.

With Hockey busily shifting all the blame for this daunting outlook onto Labor, it's worth examining its political antecedents. Since we've known we had a long-term ''fiscal gap'' problem at least since the first intergenerational report of 2002, the blame for making things worse must be shared not just by the former Labor government, but also by the Howard government and even the Abbott government.

The Howard government probably did most to add to the existing problem by the way it frittered away the proceeds of the first phase of the resources boom, which it treated as a permanent rather than temporary boost in tax collections.

It allowed government spending to grow very strongly - by real growth averaging 3.7 per cent a year in its last 10 years - instigated eight income-tax cuts in a row (with Kevin Rudd taking over responsibility for the last two) and greatly increased the concessional taxation of superannuation to the point where only one in five people over 60 pays income tax.

To this Labor added very strong real spending growth of 3.5 per cent a year over its last five years - including an unduly generous and ever-more expensive real increase in the age pension, now long-forgotten - and used Wayne Swan's ''fiscal bulldozer'' to push its spending commitments off beyond the forward estimates where they couldn't be seen.

Hockey's 10-year budget projections now reveal what Labor's bulldozer hid: a prospective real spending growth rate of 3.7 per cent. Specifically, on unchanged policy, spending on overseas aid, the national disability scheme and the Gonski education funding reforms positively shoots up after 2016-17 (see the remarkable graph on page 21 of the midyear review).

If anyone should have understood all this it was Hockey and Tony Abbott. But while making misleading claims about the ''budget emergency'' and promising to fix it painlessly, they added to the problem by promising to repeal the carbon tax and replace it with a more expensive solution to climate change; repeal the mining tax before it had a chance to raise significant revenue (after the accelerated depreciation allowances are used up); cut the rate of company tax by 2 percentage points and make paid parental leave absurdly more generous.

Now, Hockey will claim that since all those promises were fully funded by spending cuts and tax increases - which is true enough - his government has done nothing to add to the medium-term fiscal dysfunction it inherited.

But that makes him a Treasurer who doesn't understand opportunity cost. Had the Coalition not made all those expensive promises, it could have used its spending cuts and tax increases to reduce the fiscal imbalance it inherited.

Instead, it wasted them on vote-buying promises. And don't forget it also said ''me too'' on the disability scheme and the first four (cheap) years of Gonski.

All this on top of the underlying long-term budget problem that is no government's fault but which all governments have known about for at least a decade: the likelihood of never-ending strong growth in health spending - state as well as federal - caused not so much by ageing as by ever-more-expensive advances in health technology, to which the electorate demands immediate access.

What made the recurrence of my fiscal nightmare so scary was Hockey's fatuous statement that ''no country has ever taxed its way to prosperity'', which signalled his resolve to get the deficit down purely by cuts in government spending.

Seriously? That's a sign he still doesn't understand the nature and severity of his problem. No treasurer has ever purely cut his way to budget balance. Not an encouraging sign.

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Hockey's midyear budget forecasts are plausible

In this week's midyear budget review, Joe Hockey's claim to have found a black hole left by Labor was dishonest, but the revised forecasts for the economy and the budget deficit are credible and not the product of political spin.

In other words, there was nothing wrong with the document - it was prepared with Treasury's and the Finance Department's usual diligence and professionalism - just with what Hockey said about it.

Paradoxically, Hockey deserves credit for making the budget document a lot more transparent and informative than it was under Labor. Some of this is the result of the deal he did with the Greens to remove the silly Tea Party-style ceiling on government borrowing introduced by Labor and replace it with a lot more detail about the composition of the debt. But Hockey has included much more new information than that.

One innovation is that Treasury is now providing ''confidence intervals'' for its key forecasts. For instance, its forecast is for real gross domestic product to grow by just 2.5 per cent this financial year. This means that if Treasury's forecast errors are similar to those in the past 15 years, there is a 70 per cent probability the actual growth rate will prove to be somewhere between 1.5 per cent and 3.25 per cent.

With that sobering consumer warning, Treasury finds there has been a ''substantial deterioration'' in the outlook for the domestic economy just since the pre-election budget review in August. The economy's transition from resources to non-resource drivers of growth is now likely to be slower than previously forecast.

''Resources investment is expected to fall more sharply, while activity in the non-resources sectors has been subdued, with positive signs in those sectors thus far limited to the established housing market, above average measures of consumer sentiment and improving business sentiment,'' it says.

The forecast growth in real GDP of 2.5 per cent in the present financial year is unchanged since the election, but the composition of that growth has changed a lot. Forecasts for consumer spending, home building and business investment are all revised down to the point where growth in domestic demand (gross national expenditure) has been cut by 0.75 percentage points to 1.25 per cent.

But this is offset by an upward revision in the contribution to overall GDP growth made by external demand (''net exports'' - volume of exports minus volume of imports) of 0.75 percentage points to 1.25 percentage points.

The strong contribution from the external sector comes from strong growth in mineral exports as the resources boom moves to its production and export phase. But the upward revision arises because weaker domestic demand means weaker demand for imports.

Treasury has revised its forecast for growth in real GDP next financial year, 2014-15, down from 3 per cent (our medium-term trend rate of growth) to 2.5 per cent. That is, another year of clearly below-par growth, leading the unemployment rate to keep drifting up to 6.25 per cent.

This expected weaker performance is explained by downward revisions to forecasts for consumer spending and business investment. This time, however, it's not offset by an upward revision in the expected contribution from net exports.

Moving from the economy to the budget, it's obvious that slower than expected growth in real GDP and slowly rising unemployment mean slower growth in tax collections and faster growth in government spending on the dole.

But, as Wayne Swan used to say, we live and pay tax in the nominal economy, so it's what happens to nominal GDP that has more influence on the budget, not real GDP. And though the forecast for real GDP growth in this financial year hasn't changed, the forecast for nominal GDP growth has been cut by 0.25 percentage points to just 3.5 per cent.

And get this: the forecast for nominal GDP growth in 2014-15 has been cut by a huge 1 percentage point to 3.5 per cent.

Why? Remember, nominal GDP equals real GDP plus inflation. We already knew that the national accounts, production-oriented measure of inflation (known as the GDP ''deflator'') would be lower than other, consumption-oriented measures of inflation because the prices we get for mining exports are falling.

What's new is the greater weakness in the domestic economy, which should mean the prices of goods and services produced for domestic use rise more weakly than expected. In particular, wages growth is expected to be very low. This domestic weakness explains the big downward revision in GDP inflation.

Although most of the deterioration in the expected budget deficit for this financial year is explained by government policy decisions (the ones Hockey tried to blame on Labor), for the following three years the expected deterioration is almost wholly explained by Treasury's changed economic forecasts and projections.

At present, Treasury forecasts only the next two years. For the following two it uses mechanical projections based on the assumption the economy has returned to trend rates of growth. But this can look quite unreal when (as is expected in 2014-15) the economy is a long way from trend in the last forecast year.

This is why Treasury has changed its projection methodology a little, raising its projections for the unemployment rate in the last two years from 5 per cent to 6.25 per cent. It's likely to move to forecasting all four years.

Treasury has also moved to a much more detailed and careful method of guessing what will happen to mining export prices in future.

Some conspiracy theorists have claimed these changes were designed to make the outlook for the budget deficit worse than it really is, to soften us up for big cuts in May.

But the fine print shows the change to unemployment projections accounts for just $3.7 billion of the four-year total $68 billion worsening in the budget bottom line, while the export prices change contributes just $2 billion. No conspiracy.

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Why KPIs are a dangerous fad

You have heard of painting by numbers, but these days the great fad is management by numbers. I call it the metrification of business - although it's just as prevalent in the public sector. If you know what the initials KPI stand for, you'll know what I'm talking about.

I've been a bean-counter all my working life, first as an accountant, then as an economic journalist. So I've long believed in the importance of measurement, of getting the measurement as accurate as possible and of understanding the strengths and weaknesses of particular measures.

Much of my apprenticeship as an economic journalist was spent making sure I understood how all the economic statistics were put together. But as I've watched the enthusiasm for "key performance indicators" and other "metrics" grow, I've become increasingly sceptical about their usefulness.

The rise of metrification has been built on repetition of the seeming truism that what gets measured gets managed. It follows that what isn't measured isn't managed.

It's certainly true that what we measure affects what we do and the way we think about the phenomenon being measured. So in the drive to hold workers accountable - that is, to increase control over them - and improve their performance, it's become fashionable among managers - private and public sector - to measure key aspects of an organisation's performance.

It's only a small step to setting targets for the performance measures and, often, raising those targets from year to year. You might have targets for the performance of organisations, but also for the performance of individuals. And it's only another small step to link performance to remuneration. We pay for results - what could be fairer?

The rapid escalation of executive remuneration over the past 20 years has occurred not so much because of the rise in basic salaries as the proliferation of "performance pay". A study by Mihir Desai, of the Harvard Business School, found that, in America, the proportion of the total pay of senior managers that is based on share prices rose from 20 per cent in 1990 to 70 per cent in 2007.

But, as The Economist reported last year, Desai found this had warped incentives and fostered malfeasance. Managers had won huge payouts simply because the share market had gone up, regardless of whether they had personally added value.

"They have also gamed the system, sometimes illegally, to hit targets that put fat sums in their pockets," it said.

The trouble with this measurement approach to accountability and reward is that, as the American psychologist Martin Seligman has said, "If you don't measure the right thing, you don't get the right thing."

When the push for micro-economic reform was at its height, someone got the bright idea that if you calculated and made public the equivalent of key performance indicators for all the many responsibilities of the state governments, you'd encourage them to compete among themselves to improve their standing in the league tables.

The Productivity Commission has now compiled and published these indicators for many years. But someone who should know warned me they'd become completely unreliable. Why? Because managers in each state had manipulated their results to make them look good against the competition.

In 2005 the website Crikey.com.au ran a letter from an anonymous public servant reporting their experience with management by KPI.

"Early in June our manager discovered we were a few percentage points away from meeting operational requirements for the financial year. Rather than explain to his boss that staff cannot perform well when there are continual computer problems and weekly changes in procedures and priorities, he instituted a series of ludicrous schemes to improve the statistics," the person wrote.

"Any work that was already out of time was placed on the backburner, not to be touched until after July 1, when it would be counted in the next year's statistics. In other words, work that was overdue would not even be looked at for another fortnight.

"For two days staff did nothing but go through their files searching for cases that could be closed without further action or referred to another area. We achieved absolutely nothing in terms of genuine output for those two days, but our percentage of resolved cases sky-rocketed. We then started on the new work, but only worked on simple cases that could be closed well within the acceptable operational time frame...

"On June 30 our manager proudly announced that we had achieved operational requirements."

I've been around long enough to know that measurement can be a trap. People can be mesmerised by numbers. Because they're objective, people take them to be infallible. They forget (if they ever knew) the assumptions and other limitations on which they're based, they take them to be measuring something they're not and they forget how easily others can manipulate them for their own purposes.

It's easy to measure quantity, but much harder to measure quality. Most jobs are multi-dimensional, but you can't have a KPI covering every dimension. In which case, I can always meet my KPIs by cannibalising some dimension - some aspect of quality - not covered by a KPI.

Einstein said "not everything that counts can be counted". The modern preoccupation with metrics is an attempt to over-simplify the managerial task by confusing quantity with quality.

Sorry, life wasn't meant to be that easy.

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Budget deterioration is real, but Labor not to blame

How on earth did we convince ourselves this bunch would be miles better at fixing the budget than the last lot?

Joe Hockey claims his midyear budget update is an honest assessment of the state of fiscal affairs he inherited from Labor. It isn't.

Rather, it is an attempt to lower our expectations about the speed and ease with which the Coalition will be able to get the budget back on track. He won't be able to achieve it for many years - he's not saying when - and not without significant and painful, but as yet unidentified, cuts in government spending.

In short, he is unlikely to be able to do it much faster than Labor would have. What's likely to differ is who will bear most pain. Labor would have erred in the direction of higher taxes, particularly on the better-off. Hockey has ruled out higher taxes and is hinting at cuts in government spending on "welfare, education and health".

Contrast this grim slog with all the Coalition said in opposition about the budget deficit being purely the result of Labor mismanagement, which it could quickly put right if only it was in government.

This time last year Tony Abbott and Hockey were promising to deliver a budget surplus in each year of their first term. By the election campaign the return to surplus had been delayed until the first year after the next election. Now even that's in doubt.

Hockey claims the midyear review and the latest deficit estimates it contains draw "a line in the sand". From now on, he says, he will take responsibility for budget estimates. In truth, he is trying to shift the goalposts in his favour.

Although the pre-election budget statement, certified by the most senior econocrats, was specifically instigated by the Howard government to remove all doubt about the true state of the budget at election time, Hockey is claiming to have uncovered a budget black hole.

This financial year's budget deficit is now expected to be $17 billion bigger, while the cumulative deficits for the next four years are expected to be $68 billion bigger. Little of this can be fairly attributed to the previous government.

More than 60 per cent of the expected worsening in this year's deficit is attributed to decisions made by the Abbott government, most particularly the capital grant of almost $9 billion to the Reserve Bank, which the Reserve didn't ask for and Treasury recommended against.

It represents a piece of creative accounting, loading up the deficit in the year for which Labor can be blamed so as to improve the deficit in the years for which the Coalition will be responsible.

When you look at the expected deterioration over four years, however, 80 per cent of it is attributable to the worsening in the outlook for the economy just since the election. Hockey is trying to shift the blame for this deterioration on to Labor but, in truth, if it comes to pass it will be caused by factors largely beyond the control of any government.

Hockey is right in his claim that government spending grew a lot faster under Labor than it tried to have us believe. He is right, too, in saying the present prospect of another decade of deficits cannot be accepted.

We are being softened up for a tough budget in May. What remains to be seen, however, is whether Hockey and Abbott have the toughness needed to get the budget back on track and do so without damaging the economy in the short term or sharing the pain unfairly.

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How six states became one economy

It's been a year of anniversaries: 50 years since The Australian Financial Review became a daily, 30 years since the floating of the dollar, 21 years since the Council of Australian Governments replaced the special premiers' conference and 15 years since the start of the national electricity market.

In the Fin Review's self-congratulatory anniversary edition - apparently, the paper brought about micro-economic reform single-handedly - one of my old bosses, Vic Carroll, made a point most of us have forgotten, if we ever knew.

Before Paul Keating began opening Australia to the world in the 1980s, we first needed to break down the barriers between the six states to get one national market. In theory we've had a common market since Federation; in practice it didn't start until the 1960s.

We had separate stock exchanges and even big companies tended to stick to their own state. Coles and Woolworths didn't start to invade each other's home states until the 1960s. The big banks were concentrated in their home states until eight merged to become four in the early 1980s.

For many years the brewers defined much of the Riverina as part of Victoria and thus out of bounds to Sydney-based Tooth and Co. It took the Trade Practices Act of 1974 to make agreements on competition-reducing territorial carve-ups illegal.

A main role of COAG has been to gain agreement between the states to align their regulation of markets and in other ways facilitate cross-border trade. Progress has been painfully slow and at Friday's meeting it gave up trying to introduce a national occupational licensing scheme.

But that makes COAG's initiative of establishing a national electricity market (covering all states bar WA) in 1998 the more remarkable. Before then, we had six separate, state-owned vertically integrated monopolies.

The Australian Energy Market Commission has celebrated the national market's 15th anniversary by commissioning KPMG consultants to prepare "a case study in successful micro-economic reform". The idea was to record the insights of key players before they were carted off to retirement homes.

It took eight years of preparation before the market began. Step one was for each state to break its monopoly electricity commission into separately owned power generators and separately owned electricity retailers, leaving the transmission and distribution network ("poles and wires") as the irreducible natural monopoly.

The generators could be made to compete with each other (and probably privatised) and the retailers made to compete with each other (and privatised) by giving them equal access to the network.

The hard part was setting up the continuously trading wholesale auction market in which competing generators supply power to competing retailers. Once the state networks had been physically connected to a single grid, this was made possible by the "fungibility" of electricity. If one unit of power is identical to any other, I don't have to actually generate the power I end up selling you.

That's handy, but it makes the market, with all its derivative contracts, horrendously complex. Its smooth operation is a notable tribute to the economist's art: it's a quite artificial, geek-designed, government initiated and regulated market. T. Abbott and other sceptics please note.

The case study should prove a useful guide to would-be reformers. One tip is that this radical change was achieved through many small steps. Each state set up its own market before they merged into one after many trial simulations.

Though the federal government had no responsibility for electricity, it was deeply committed to micro reform and, since it would benefit from higher tax collections, transferred these to the states as incentive payments for reforms achieved.

No business people or economists need telling that many people find money highly motivating. Premiers more than most. But the study warns "there are risks that the incentive becomes payment maximisation rather than policy optimisation".

Likewise, establishing a competitive industry structure must take precedence over doing things to maximise the proceeds from privatisation. "Incentive payments are not a substitute for mutual commitment to policy outcomes," we're told.

Careful planning, widespread consultation and good processes are all necessary, but the study emphasises the key role of committed leaders. At the political level, reform was pushed by Bob Hawke and Nick Greiner, by Paul Keating and Jeff Kennett, then by John Howard.

But the person who deserves greatest approbation was the chairman of the National Grid Management Council, John Landels, formerly of Caltex. His strengths were he was beholden to no one, kept the board focused while letting the technocrats get on with the details, and he had pull with prime ministers and premiers. And I doubt he was doing it for the money.

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Holden's fate will have little effect on economy

Contrary to appearances, the economy is not falling apart nor has the Abbott government taken leave of its senses.

The threat to the economy from Holden's decision to cease making cars has been greatly exaggerated by those with axes to grind - the opposition, the motor vehicle union and other industry apologists, plus the overexcited media.

The greatest threat comes not from what happens to the car industry - nor from Qantas' plan to lay off 1000 workers - but from the risk that all the talk of job losses could leave people in industries far removed from the troubled sector with an exaggerated impression of their chances of losing their own jobs, prompting them to become more cautious in their spending and housing decisions.

There is no denying the Abbott government is off to a rocky start, with its backing and filling over the Gonski education reforms, its ruminations over continued Australian ownership of Qantas, and its refusal to permit the foreign takeover of GrainCorp casting doubt over Tony Abbott's election-night claim that Australia is now ''open for business''.

What we have had from Abbott is clunkiness. It's been hard to detect the hand of a government that knows what it is doing and where it is heading, let alone one that can articulate its destination and reasons for wanting to take us there.

But its most controversial decision so far - to decline to keep paying the protection money demanded to defer General Motors' departure from production in Australia - offers hope that this is a government with the courage to give genuine leadership, to make the unpopular decisions needed to secure our economic future.

If we want the economy to return to a healthier rate of growth, with rising job opportunities, the answer is for our businesses to find new and better ways to make profits, not for them to become ever more reliant on government subsidies.

It is for us to face up to, and adapt to, a rapidly changing world economy, not use taxpayers' money to try to prevent change, eventually turning our economy into an industrial museum.

If we want the federal budget to be returned to balance without huge hikes in taxation, part of the answer is to stop providing welfare to industries as well as people.

It is understandable for older Australians to be sentimental about the end of car making by our first car maker - even though most of us stopped buying locally made Holdens many moons ago, just as most of us have stopped using Qantas to fly overseas.

How much tax are you prepared to pay for sentimental reasons?

It is also understandable for older Australians to worry about the decline of manufacturing. If we stop making things, where will the jobs come from?

Employment in manufacturing has been falling since the early 1970s, during which time the workforce has doubled. Manufacturing now accounts for only about 8 per cent of total employment.

Do you really believe the remaining 92 per cent of us have phoney, inconsequential jobs? The big jobs growth has been in education, health, community and business services. Where will the jobs come from? That's where. The same thing is happening in all the rich countries.

The prospect is for the rate of unemployment to keep creeping up next year until the effect of record low interest rates causes spending on consumption, home building and business investment to recover and take the place of the now-declining investment in new mines.

What happens in car-making will have a negligible effect on what happens to unemployment everywhere except Adelaide. For a start, few jobs will be lost until the plants close in 2016 and 2017.

It's planned that 2900 jobs will go from Holden, with a greater flow-on to the parts-makers. But car and component manufacturing account for only about 0.4 per cent of total employment.

Even the end of local car-making wouldn't mean the end of cars. Saul Eslake of Bank of America Merrill Lynch reminds us there are five times as many people employed in the wholesaling, retailing and maintenance of cars as are employed building them.

Car-making ended in Sydney in the 1980s. Steel-making ended in Newcastle in 1999. Since then, both cities have not only survived, but prospered.

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Multi-factor productivity not what it's cracked up to be

Figures for the economy's productivity performance haven't looked good for the past decade, causing consternation among economists and business people. But a careful study by the Productivity Commission has failed to find any particular problem, nor anything we could do to make the figures look better.

Productivity is a measure of the efficiency with which the economy turns inputs of labour and capital into outputs of goods and services. Thus productivity is measured as output per unit of input.

The more we can improve productivity the better off we are. We have in fact being increasing it a little almost every year since the Industrial Revolution, and this is what has made us so much more prosperous. So if you believe the goal of economic management should be to increase our material standard of living (which I don't), nothing is more important than ever-improving productivity.

The simplest (and probably least inaccurate) way to measure productivity is to take the quantity of goods and services produced during a period (real gross domestic product) and divide it by the number of hours of labour required to achieve that production.

Doing this each year shows that our "productivity of labour" improved unusually rapidly in the second half of the 1990s, but then showed little further improvement during most of the noughties. Over the past two or three years, however, it has returned to a reasonably healthy rate of improvement.

But you can improve the productivity of labour simply by giving workers more machines to work with. And this tells us nothing about the efficiency with which the economy's physical capital is being used. So in recent years it has become fashionable to focus on a more sophisticated measure called "multi-factor productivity".

This is the growth in real GDP (output) that can't be explained by any increase in inputs of both labour and physical capital. So, in principle, multi-factor productivity represents "technological progress" - the invention of better physical technology and the discovery of better ways to organise the production of goods and services. It's technological advance that does most to raise material living standards.

When you look at our performance over the past few years you find that, though the productivity of labour has been improving at a reasonable rate, multi-factor productivity hasn't improved. It was this that staff at the aptly named Productivity Commission set out to investigate in a study published last week.

They found that the flat performance of multi-factor productivity in the market economy was explained mainly by an actual decline in the multi-factor performance of manufacturing. So they focused their investigation on manufacturing.

Estimates by the Bureau of Statistics show that between 1998-99 and 2003-04 multi-factor productivity in manufacturing improved at a rate of 1.3 per cent a year. But between 2003-04 and 2007-08 it fell by 1.4 per cent a year. Since then (up to 2010-11) it has deteriorated at the slower rate of 0.8 per cent.

Delving further, the researchers found that two-thirds of the deterioration between the first two periods could be explained by just three of manufacturing's eight sub-sectors. From worst to least worse: petrol and chemicals, food and beverages, and metal products.

Trouble is, they could find "no overarching systemic reason for the decline". That is, no problem or problems you could tell the government it needed to fix.

What they found were several factors that made the figures look bad but weren't actually bad themselves, plus one factor we all know about, can't do much about, but have reason to hope will improve soon: the high dollar.

The metal products industry's poor performance was explained mainly by a big expansion in alumina refining capacity which had yet to come on line. Obviously a temporary problem.

The petroleum and chemicals industry's poor performance was explained to a significant extent by increased investment by petroleum refineries to meet new environmental standards. That is, there was an improvement in the quality of their output which the figures didn't pick up.

The food and beverages industry's poor performance was partly explained by a change in consumer preferences in favour of products made in smaller-scale, more labour-intensive bakeries. No probs if that's what the punters want.

In both petroleum and chemicals and food and beverages the poor performance was explained also by reduced use of production capacity, caused largely by the effect of the high dollar in reducing exports and increasing competition from imports.

But now I must give you the product warning economists keep forgetting. Like so many other concepts in economics, multi-factor productivity is simple in principle but as ropey as hell in practice. Putting a number on the concept requires you to make a lot of unrealistic assumptions (perfect competition, equilibrium, for instance) and use statistics that don't accurately measure what they're supposed to measure.

As the researchers acknowledge, multi-factor productivity is measured as a residual: after you estimate the amount of production you subtract an estimate of the amount of labour used and an estimate of the amount of capital used (particularly dodgy) and what's left is multi-factor productivity.

It's what a modeller would call an "error term" - the net result of all the mismeasurement of output, labour input and capital input. So, as the researchers acknowledge, the figures they have used can't be taken as a reliable measure of technological progress.

My word for it is ragbag: technological progress may be in there somewhere, but so will be a lot of other things, real and non-existent.

You can work out the figures for multi-factor productivity, but if they look good you don't know whether they really are, nor why they are. If they look bad it's the same.

What the Productivity Commission's study tells me is that even with figures that look really bad, it can find nothing amiss. Worrying about measures of multi-factor productivity is jumping at shadows.

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AN ECONOMIC RESPONSE TO THE LIMITS TO GROWTH

Mathematics of Planet Earth, Limits to Growth symposium, Parade Theatre, University of NSW, Wednesday, December 11, 2013

Virtually all our business people, economists and politicians have long rejected the contention there are ‘limits to growth’. They are able to do this primarily because their way of thinking about the economy is based on a model of the economy that excludes a role for the natural environment except as a passive supplier of natural resources. This model was developed in the late 19th century at a time when economic activity wasn’t doing much obvious damage to the natural environment and ecosystem services could be regarded as ‘free goods’. More recently, economists have refused to accept that there are limits to growth on the grounds of ‘technological optimism’: should any shortages of particular natural resources emerge, market forces - in the form of very high prices - would call forth technological solutions to the problem.

There is, however, a large element of denial in their reaction because they are so conscious of the material benefits that flow from economic growth. When the economy’s generation of income - and its production of goods and services, which is the same thing, and is conventionally measured by the growth in real gross domestic product - grows faster than the population is growing, income per person is rising, meaning that, on average, our material standard of living is rising. Doesn’t that sound good to you?

But the advocates of growth believe it brings with it many other advantages. They argue that the richer we get, the more easily we can afford to spend money on fixing the environment. They argue that rising real incomes should also directly benefit the poor and, as well, that when incomes are rising it’s easier to get agreement to redistributing income in favour of the poor. They further argue that growth in the economy is necessary to create the additional jobs needed to provide employment for a growing population of working age.

So why do an increasing minority of people oppose continuing economic growth? Because of their belief that unending economic growth is ecologically unsustainable and, indeed, physically impossible. They see the global economy as a sub-system of the global ecosystem, which is of fixed size. If the ecosystem can’t grow, then there must be a limit to the extent to which the economy can grow within it. They look at all the damage economic activity has done and is doing to the natural environment - the damage to soil, forests, waterways and fish stocks, the destruction of species and, most obvious and pressing, the emission of greenhouse gases - and they conclude we must be close to the ‘limits to growth’. To press up to those limits or even exceed them must surely damage the natural environment to such an extent that huge, possibly irreparable damage is done to the economy, not just the environment.

The growth imperative is so deeply ingrained in our thinking, so much an assumption underlying so much of what we say - even what I say - that many people imagine the economy is like a bicycle: if you stop going forward you lose your balance and fall off. Fortunately, the analogy isn’t apt. Though many people would have to adjust their thinking in what some economists have called a ‘steady-state’ economy, it wouldn’t collapse just because it wasn’t growing. What would cause deep problems, however, is if the economy was steadily shrinking, particularly if prices were falling.

There’s obvious truth to the argument that when incomes are growing it’s easier to afford to repair the environment. But that argument becomes dubious when we reach the point where the growth itself is adding to the environmental damage. We have to destroy the environment to afford to save it? It’s hard to imagine how the environment could end up ahead on that deal.

There’s more truth to the argument that when incomes are growing it’s easier to give the poor a better deal, including by redistributing income from the better-off to the less well-off.  It’s factually correct - in Australia, though not in America - that real growth in national income over the years has led to real growth in the incomes of households at the bottom of the distribution, as well as in the middle and at the top. What’s also true, however, is that incomes at the very top have been growing much faster than all other incomes. I think advocates of a steady-state economy have to accept that, yes, the absence of growth would increase the political resistance to greater redistribution in favour of those at the bottom. But just because growth makes greater redistribution easier doesn’t necessarily mean redistribution happens. It hasn’t happened sufficiently to prevent the gap between rich and poor widening significantly over the past 30 years or so, notwithstanding all the growth we’ve enjoyed.

The strongest anti-steady-state argument is that we need economic growth to provide employment for our growing population of working age. It’s pretty much the only argument I get from the ecologically aware economists I talk to. But I don’t think it’s insurmountable. The first reservation is that, were it not for immigration, our working-age population wouldn’t be growing (as is the case for most of the advanced economies and will soon be the case for China).  We could adjust our net migration to keep the working-age population steady. The second reservation is that, even if our working-age population was growing, we could respond to the problem by job-sharing. Here I’m not only referring to the idea of two or more part-time workers sharing the one full-time job, but to the more fundamental solution that rather than continuing to take the continuing improvement in the productivity of labour in the form of ever-higher real wages, we could do what the futurists of the 1960s and 70s expected we’d do and take it in the form of shorter working hours.

Before I turn to the more positive question of how we’d go about achieving a steady-state economy, we should clarify an issue I probably should have raised much earlier. In all that follows I’ll be leaning heavily on the leading thinker in the area of steady-state economics, Professor Herman Daly of the University of Maryland. There’s enormous terminological confusion between scientists and economists on what exactly they mean by the word ‘growth’. Scientists take it to mean something very different from what economists do, which means much of what little debate passes between them flies over the heads of the other side. I’m sure the ground of disagreement between them would be greatly reduced if only this terminological confusion could be ended.

What ecologists want is an end to growth in the ‘throughput’ of natural resources. If you think of the economy as a machine, we put inputs in one end of the machine, and take outputs out of the other end. To an ecologist, the inputs of concern to them are natural resources and ‘ecosystem services’; the outputs of concern to them are an equivalent amount of waste - in the form of landfill, sewage and all the many types of pollution, including greenhouse gases. In conformity with the laws of thermodynamics, the ecologists worry as much about the emission of waste - and the ecosystem’s ability to absorb that waste - as they do about the using up of natural resources. This is why what they seek is an end to growth in the throughput of such resources. I think many of them imagine this would be achieved if GDP ceased to grow.

But the economists conceptualise things very differently. To them, the inputs to the economic machine aren’t just natural resources, but also the other economic resources: labour and capital - physical capital in the form of machines, structures and infrastructure. (The input from ecosystem services is ignored.) To their eyes, the output from the economic machine isn’t waste (it gets ignored) but all manner of goods and services. What real GDP measures is the growth in the output of goods and services over time. (Since those of us who work earn our income from our contribution to the output of goods and services, real GDP also measures the growth in real income.)

So what is it that causes GDP - output of goods and services - to grow? Two things. First, any increase in the throughput of economic resources: natural resources, but also labour and capital. But, second - and this is the bit that goes straight over the heads of most ecologists - any increase in the efficiency of the economic machine at turning inputs into outputs. Economists call this ‘productivity’, which they define as output per unit of input. The productivity of the economic machine increases almost continuously each year, and has done since the start of the industrial revolution. What causes ‘multi-factor’ productivity to improve is the continuing pursuit of economies of scale, the increasing specialisation of labour, the rising knowledge and skill of the workforce, and technological advance: the invention of better machines and better ways of doing things. Now get this: over the long term, productivity improvement accounts for the lion’s share of our rising real income per person and our rising material standard of living.

The point is that when economists hear people say they want an end to growth, they assume that means they want an end to productivity improvement. They find this prospect appalling. But this is not what ecologists want. All they want to stop is growth in the throughput of natural resources - which isn’t something most economists would relish, but isn’t nearly as frightening. And this means GDP could still increase, provided that increase came from improved productivity, not increased use of natural resources.

Clearing up this misunderstanding allows us to envisage more clearly what a steady-state economy would look like. It would be an economy that didn’t get bigger in its impact on the environment - that was ecologically sustainable - but did get better, in terms of the quality of our lives. It would be an economy that didn’t grow, but it wouldn’t be an economy that was stagnant, that never changed. It wouldn’t be an economy where people had to stop striving - to build a better mousetrap, write a symphony or find the cure for cancer. Many economists instinctively fear a steady-state economy would stifle the incentive to innovate. But that fear’s not justified. Indeed, you could argue that, with the quantitative route to improvement blocked off, the qualitative route would gain more attention. Herman Daly’s way of making the distinction is to say economic growth (pushing more resources through a physically larger economy) is bad, but economic development (squeezing more welfare from the same throughput of resources) is fine.

But how would we go about reorganising the economy so that we no longer increased the throughput of natural resources? It wouldn’t be easy, but nor would it be terrifically hard. It actually represents nothing more than a design problem - one the economics profession is well-equipped to solve, should we decide to give it that task. We’d still have a capitalist, market economy where market forces continued to determine economic outcomes and to drive the push for greater efficiency in resource use, within the framework set by government. The big difference would be the government adding one new constraint to the operation of market forces: a limit on the consumption of natural resources.

How would we achieve that limit? By using the same ‘economic instrument’ we’ve already begun using to limit the burning of fossil fuels: a system of tradable permits. You impose a cap on the total quantity of a certain class of natural resource permitted to be consumed in a year, and auction to producers permits to use the resource up to the cap. The more efficient firms are at doing what they want to do while using fewer natural resources to do it, the less they have to spend on permits - thus harnessing market forces to help reduce the use of those resources. Firms that discover they have more permits than they need are able to trade them for money with firms that discover they need more permits than they have. By such means the burden of limiting resource use to the cap is transferred to those firms able to reduce their resource use most cheaply, thereby limiting the loss of income to the community involved in achieving the limit on resource use. As firms became more efficient at reducing their natural resource use - including by the invention of new technological solutions to the problem - it would possible, if desired, to lower the cap and, hence, the quantity of resources used, at no increased cost to the community.

The purpose of such a cap-and-trade scheme would be, of course, to raise the price of natural resources - and the prices of goods with a high natural-resource component - relative to the prices of all other goods and services. In line with the most orthodox economics, it’s this change in relative prices which would motivate producers and consumers to reduce their resource use, and do so with minimum loss of economic efficiency. Economists believe changes in relative prices are very effective in bringing about changes in the behaviour of producers and consumers.

Raising the prices of natural resources relative to the prices of other resources - labour and capital - could be expected to have various desirable side-effects. First, it would increase the economic incentive for people to recycle natural resources and repair rather than replace appliances with a high materials-component.

Second, changing the relative prices of economic resources could be expected to change the focus of the private sector’s continuing search for greater efficiency - economising, if you like - in the use of economic resources and, hence, improved productivity. For all the time since the Industrial Revolution, most of the economising effort - including most technological advance - has been, quite logically, directed towards economising in the use of the most expensive resource: labour. But if we were to make natural resources more expensive than labour - particularly if the scheme involved a fall in the main tax on labour, income tax, thereby lowering its effective cost - this should mean a lot more entrepreneurial effort would be directed towards reducing the economy’s despoiling of the natural environment.

An economic response that accepts there are indeed limits to growth in the throughput of natural resources says, don’t worry, we could rejig economic incentives in a way that discouraged further growth in natural resource use while minimising the economic disruption and loss of livelihood. And this would be vastly preferable to waiting for the economic destruction that would occur if we blindly sought to exceed those limits.

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Trans-Pacific Partnership: we pay more for longer

According to someone called Oscar Ameringer, politics is the gentle art of getting votes from the poor and campaign funds from the rich, by promising to protect each from the other. However, when Tony Abbott spoke at the Business Council's 30th anniversary dinner last week, he was very much in protecting-big-business mode.

"On election night, not quite three months ago, I declared that Australia is under new management and once more open for business," he told the captains of industry. "My business - the business of government - should be making it easier for you to do your business because government doesn't create prosperity, business does.

"Governments' job is to make it easier for good businesses to do their best ... that's why almost everything we've done over the past three months has been to make it easier for Australians to do business."

It's possible, of course, that Abbott didn't really mean all that. Perhaps he was just greasing up business people because they were who he happened to be speaking to. Maybe next week he'll tell a bunch of consumers he's doing it all for them.

It's too early to tell just whose interests the Abbott government is seeking to advance. Maybe it doesn't yet know itself.

But I get a bit twitchy when I hear politicians running the line that what's good for General Motors is good for America.

I worry when I hear allegations that Australia bugged the cabinet room of a friendly nation not in the national interest but in the interest of a particular Australian company. Then that one of the politicians at the time has since become an adviser to the company.

I confess to being concerned about what deal Trade Minister Andrew Robb is doing in our name at the Trans-Pacific Partnership negotiations in Singapore this week.

The partnership is a trade treaty the US wants with 11 other Pacific rim countries: Canada and Mexico, Chile and Peru, Australia and New Zealand, Japan and Malaysia, Singapore, Brunei and Vietnam.

The US has been negotiating the treaty since 2006 in what it has insisted be complete secrecy. Although it has no doubt been consulting with its own big companies, and it's a safe bet our business lobby groups have been briefed about the contents of the treaty and have advised our government on their views and goals, the rest of us aren't meant to know what's going on.

Parliament will have to be told the content of the done deal before it votes to ratify any treaty the government has agreed to, but that's all. It's "need to know" and you, dear voter, don't need to know. Leave it to the adults.

Well, not quite. Last month one of the draft treaty's 29 chapters, on intellectual property, was published by WikiLeaks.

This week one country's detailed description of the state of negotiations was leaked. So we know a fair bit about what we're not supposed to know. And what we know isn't terribly reassuring.

What I know about the US government's approach to trade agreements - which doesn't seem to have changed since the deceptively named free-trade agreement we made with it in 2004 - is that its primary objective is to make the world a kinder, safer place for America's chief export, intellectual property: patents, copyright and trademarks - in the form of pharmaceuticals, films, books, software, music and much else.

To this end, the length of copyright would be extended beyond the 70 years to which it has already been extended, and copyright infringement would be made a criminal offence. It would be made easier for pharmaceutical companies to artificially extend the life of their patents and frustrate the activities of others wishing to produce generic versions.

It is clear this would greatly benefit America's big entertainment, software and drug companies.
What's equally clear is that it has no economic justification, being simple "rent-seeking"; government intervention in markets to enhance the profits of particular companies.Rupert Murdoch's 21st Century Fox would be a prime beneficiary.

Since Australia is a net importer of intellectual property, our government ought to be in no doubt the Americans' demands are contrary to our economic interests.

The leaks reveal many dubious demands by the US, but none more so than its promotion of "investor-state dispute settlement" provisions, which would allow foreign companies to pursue legal actions against our government in foreign tribunals if, for example, it were to introduce policies they considered contrary to their interests.

This would give foreign companies an advantage local companies didn't have. The Productivity Commission found such provisions offered few benefits, but considerable policy and financials risks. The former Labor government had a blanket ban on agreeing to such clauses, but Robb's approach is more flexible.

Why would any country agree to such unreasonable demands? Because, in exchange, the Americans are holding out the promise of greatly enhanced access to their markets - in our case, for sugar and beef.

So what we're not supposed to know is that, if the rest of us get sold out, it will all be in aid of Australian farmers. The trouble with running the economy to benefit business is you end up harming some to help others.

But not to worry. The leaks suggest agreement on the treaty is a long way off.

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Keating gives Abbott a masterclass

With our neophyte Prime Minister and his Treasurer struggling to find their feet - and a direction to travel in - let's hope they've been watching the ABC's interviews with Paul Keating. If not, they're out on DVD this week.

For those of us who lived through the Hawke-Keating government's extraordinary 13 years - and those who didn't - Kerry O'Brien's four interviews are a reminder of Keating's indisputable claim to be our greatest, most reforming, treasurer.

If you're tempted to doubt that, consider Business Council president Tony Shepherd's description of our economy in the early 1980s. Keating had described it as a "moribund, inward-looking industrial graveyard" and he'd been right, Shepherd said.

"We had a fixed exchange rate, tariffs [on imports] were still high, we were frightened of Japanese investment ... our financial system was tightly regulated, our industrial relations system was centralised, complex and unproductive, and just about every service was provided by the public sector. State ownership extended to banks, insurance, telecommunications, airlines, ports, shipping, dockyards, electricity, gas etc," Shepherd said.

Keating was the instigator of virtually all those reforms. And though many of them weren't opposed by the Coalition opposition, they were radical reforms - brave steps into the unknown - controversial in the community, including among many Labor voters.

O'Brien's interviews reveal Keating in all his strengths and weaknesses. His self-congratulation ("there's nothing there to be humble about"), bravado ("what I love about the Road Runner is he runs that fast he burns up the road behind him; there's no road left for the others"), colourful language ("a pimple on the backside of progress"), disposal of people who got in his way (Bob Hawke, for instance) and revenge against supposed enemies ("don't get mad, get even" - including with Fairfax).

But no leader of this country since John Curtin has more cause for self-congratulation than Keating. No leader is without character failings and Keating's were outweighed by his contribution.

If Tony Abbott and Joe Hockey want their chapter in Australia's economic history to be half as glorious as Keating's there's much they could learn from him, starting with his clear sense of purpose. "I had to make sure this slothful, locked-up place finally became an open, competitive economy."

His vision was of "an efficient, competitive, open, cosmopolitan republic, integrating itself with the Asian region".

"To do what's right and good gives you the surge. Without the surge, what are you? You're just mucking around with tricky press statements, appearances and 'doorstops'." - "You make the political strategy around good policy rather than around trickery."

Keating was a man of courage. "I always believed in burning up the government's political capital, not being Mr Safe Guy." - "You're nobody until you attract a good set of enemies." - "If you run hard enough and fast enough for a great change you'll get it." - "Statecraft and nation building are about taking the risks and moving the country on."

And a man of toughness. "Nations get made the hard way; nation building is a hard caper." - "You've got to elbow your way through." - "In the end, if you want to get the changes through you've got to hold your nerve and squeeze the system."

Does that sound like any present politician? Last week Hockey said he had an "economic plan" focused on building economic growth. Great. At last. What is it?

"It is focused on getting rid of inhibitive taxes and inhibitive regulation that undermines our capacity to be at our best. We need to speed up the Australian economy and ... if we repeal the carbon tax, it will add to economic growth ... when we get rid of the mining tax it sends a clear message to the world that we need mining investment."

Really? That's the best you've got - to undo the reforms of the previous government? To move to a less economically efficient instrument against climate change and undercharge mainly foreign-owned mining companies for their appropriation of our non-renewable resources? That will balance the budget? That's what will lift productivity? Seriously?

According to Abbott last week, "the challenge is always the same: to build the strongest possible economy with lower taxes and less red tape leading to higher productivity and stronger economic growth ... my business - the business of government - should be making it easier for you to do your business".

Really? Easy as that, eh? No need for courage or toughness. No need to do anything that won't win a vote of thanks from the Business Council.

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Mining still driving economy - slowly

The economy performed poorly in the September quarter, but that's OK. It was all Labor's fault, but now Labor is out. From here on it will be the Coalition's watch and everything will be much better. Or not. At least from here on Joe Hockey will be talking the economy up - as a treasurer should - not talking it down.

The national accounts we got this week show the economy grew by only 0.6 per cent in the quarter and by 2.3 per cent over the year to September. According to Hockey this shows "an economy that is growing below trend, with a soft labour market, cautious consumers and plateauing business investment".

That's the frankest assessment we're ever likely to get from the man. Although no one can say with confidence what the future holds, the best guess is that, this time next year, the economy won't be growing much faster than it is now. The non-mining economy should have picked up a bit by then, but this may be offset by big falls in mining investment spending.

As it is now, the national accounts show little strength in the rest of the economy, leaving mining accounting for what growth we did get. Starting with consumer spending, it grew by just 0.4 per cent in the quarter and by 1.8 per cent over the year to September.

That's well below its trend rate of about 3 per cent and is explained mainly by weak growth in employment (a smaller increase in the members of households earning incomes) and slower growth in wage rates. Households saved 11 per cent of their disposable income, roughly what they've been saving for three years.

Overall, home building activity fell by 0.5 per cent in the quarter to grow by just 1.7 per cent over the year, but this was because another fall in spending on renovations outweighed weak growth in the building of new homes.

The fall in renovations is surprising: usually when the buying and selling of homes picks up - as it has - renovations pick up as sellers tidy up for a sale and new buyers undertake more extensive changes.
We've seen an increase in council building approvals that's yet to show up in actual building activity, so perhaps housing will make a bigger contribution to growth in the coming year.

Overall, business investment spending increased by 1.1 per cent, but fell by 2.5 per cent over the year. Within this, mining investment rebounded in the quarter, but still looks like it reached its peak last year. Kieran Davies, of Barclays bank, says he expects mining investment to make a major subtraction from growth as it returns to a more normal level over the next few years.

Non-mining investment spending was broadly unchanged during the quarter and down about 4 per cent over the year. Davies says business confidence has picked up sharply, and this normally leads to increased investment, but the delay varies and at this stage he's not expecting much of a pick-up until later next year.
"This is because relatively low levels of capacity utilisation suggest companies are in no rush to expand, even though they can borrow at record low interest rates and many firms are cashed up," he says.

Public demand - spending by governments and their authorities - was broadly unchanged in the quarter, after rising by 0.7 per cent the previous quarter. Within the lack of change overall, however, a 5.5 per cent fall in public investment spending was negated by a 1.1 per cent rise in public consumption spending (mainly public service wages).

Davies says the fall in investment was driven by lower state capital works spending, but this "could turn around later next year and into 2015" because Hockey is encouraging the states to spend more on infrastructure and may introduce some new arrangements to help the states fund this investment.

The volume of exports grew by 0.3 per cent during the quarter and by 6.1 per cent over the year, while the volume of imports fell by 3.3 per cent during the quarter and 3.7 per cent over the year.

Most of this is explained by mining. Bulk commodity exports are up about 15 per cent over the year, while the fall in mining investment - which is "import-intensive" - accounts for the fall in import volumes.

This means "net exports" (exports minus imports) account for more than all the growth in the quarter, and contributed 2.1 percentage points of the 2.3 per cent growth in real gross domestic product over the year.

Who said the resources boom was over? Developments in the mining industry will go on having big effects on the economy for a long time yet. It won't be long, however, before the negatives exceed the positives. That is, before the decline in mining investment spending (even net of the helpful decline in imports of capital equipment) exceeds the gain from increasing exports of minerals and energy as the new mines and natural gas facilities come on line.

And don't forget the quarter saw a further, mining-driven deterioration in our terms of trade - export prices relative to import prices - of 3.3 per cent, taking the total deterioration since the peak in 2011 to 17.7 per cent. This reduction in our real income contributes to the explanation of why consumer spending has been weak.

Hockey is right when he says other indicators - retail sales, building approvals, business and consumer confidence - have improved since September. And it's reasonable to hope this will lead to a modest improvement in consumption, home building, business investment and other aspects of the non-mining economy.

But we know there will be big falls in mining investment, which could offset most of the gain. There's not a lot Hockey can do about that between now and then. Even infrastructure spending takes a long time to get going.

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How patients and taxpayers lose out to chemists

Sometimes the good news just doesn't get through. Did you know, for instance, that the prices of three widely used medicines fell from the start of this month, meaning more than 850,000 Australians will be paying less? As federal Health Minister Peter Dutton announced, this is happening because of a wise policy instituted by the Howard government in 2007.

The saving on the most frequently prescribed medication on the pharmaceutical benefits scheme - the anti-cholesterol drug atorvastatin (known as Lipitor before its patent expired) - will range between $5.58 and $12.51 a script, depending on which brand the chemist gives you.

For olanzapine - used for schizophrenia and bipolar disorder - the saving will be up to $6.69 a script. For venlafaxine - used for major depressive disorders - the saving will be $7.03 to $10.60 a script.

But Dutton is too modest. He didn't mention that the wholesale prices of four other drugs have also fallen, reducing the cost to the taxpayer but not the direct cost to patients.

The pharmaceutical scheme requires patients to make a co-payment of up to $36.10 a script (or up to $5.90 for people with concession cards), with the government paying any amount above the co-payment. So the more the price falls below $36.10, the greater the direct saving to patients.

There's just one problem with all this good news. As Dr Stephen Duckett points out in a report for the Grattan Institute, it's not nearly as good as it should be. The price cuts the government has extracted from the drug companies still leave Australian taxpayers and patients paying about 14 times more for those seven medicines than are paid in New Zealand, Britain and parts of Canada.

Duckett - a hugely experienced health economist - estimates that, had our government driven a deal as tough as other governments, patients would be paying less for all seven of them, not just three. The out-of-pocket saving would average about $21 a drug.

Take atorvastatin (a medicine close to my heart; as close as my blood vessels, in fact). The wholesale price of a box of 30, 40-milligram pills has fallen to $19.32 (the price from the chemist would be a bit higher). The equivalent price in Britain is $2.84 and across the Tasman it's $2.01.

If our price came down that far it wouldn't only be ordinary patients who made savings, pensioners and other concession card holders would too.

Remember, even with our subsidy scheme, plenty of people don't take the pills they should because they find it too expensive. (I'm on seven prescription pills; I can afford it, but plenty of people my age can't.)

There was a time when Australians paid less for medicine than most people in developed economies. Now we pay high prices because John Howard decided to go easy on the international drug companies. In its six years in office Labor did little to remove this rort. Why not? Keep reading.

The change came when a lot of widely used medicines came to the end of their patents. A patent gives its holder a monopoly over production of that drug. It can charge a very high price for the drug, one far above its cost of production.

Governments choose to grant patents and so allow overcharging to encourage companies to incur the high costs and risks of developing new medicines.

But when the patent expires, other companies start producing generic versions (all of them still required to meet standards set by the Therapeutic Goods Administration) at very much lower prices.

Governments in other countries determine the lowest price being charged and that is what they pay when buying for their pharmaceutical subsidy schemes. In Australia, however, we decided to go easy on the drug companies. When the drugs first came off patent, we cut the price by only about 30 per cent.

Then Howard introduced a complicated "price disclosure" system, which has the effect of lowering the prices of generic equivalent drugs very slowly. Presumably, if we wait long enough, prices will get down to where they already are in countries that do a better job of protecting their citizens. In the meantime, our government has required us - as taxpayers and patients - to pay far more for our medicines than we need to.

But why? Well, I don't believe it's because many of the drug companies had their headquarters in Howard's electorate. Nor are many of the pills manufactured in Australia. No, it's because the drug companies cut our chemists in on the deal.

Because so many of their patients trust them, chemists are politically powerful. If any government were to cut too far into the taxpayer subsidy our chemists have long enjoyed, the chemists would go on the war path against that government.

Duckett - who knows where the bodies are buried - estimates we are paying more than $1 billion a year too much for generic drugs, with most of that picked up by the taxpayer.

Soon we will get the midyear economic statement with its cuts in government spending. There will be more cuts in the budget in May. Some will affect you.

Joe Hockey will assure you he had no choice. What he will mean is that he's less afraid of you than your chemist.

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