Cost-of-living crisis? Why only some of us are feeling the pinch

If you believe the opinion polls, we’re all groaning under the weight of the cost-of-living crisis. And Treasurer Jim Chalmers confirms we’ve all been “under the pump”. But it’s not that simple. Some of us are doing it a lot tougher than others. And some of us are actually ahead on the deal.

In any case, where did the living-cost crisis come from? That bit’s simple. The economy’s been on a rollercoaster for the past four and a half years. COVID and the lockdowns may seem a distant memory, but almost everything that’s happened in the economy since the end of 2019 has been the direct or indirect consequence of the pandemic.

The surge in consumer prices that began in early 2022 stemmed from a combination of temporary disruptions to supply caused by the pandemic, and excess demand for goods and services as people spent the money they’d earned but couldn’t spend during the lockdowns.

The tax cuts that began this month had been planned for six years, but Chalmers changed their intended shape radically to help people most affected by the cost of living. They mean that, by the end of this year, overall living standards should be just a little up on where they were five years ago.

Just as the media focus on bad news more than good news, so you and I focus more on what’s been happening to the cost of living than what’s been happening to our after-tax income. But it’s the difference between the two – our standard of living – that matters most.

Two economists at the Australian National University’s Centre for Social Policy Research, Associate Professor Ben Phillips and Professor Matthew Gray, have been crunching the numbers, and their results may surprise you.

They’ve examined the change in our standard of living since the end of 2019, and included a forecast up to the end of this year, to take account of the latest tax cuts and changes in the May budget.

Lumping all households together, they find that we did quite well in 2020 and 2021 as the Reserve Bank cut interest rates and governments spent billions on such things as the JobKeeper scheme and temporary doubling of JobSeeker unemployment benefits. But then living standards fell sharply in 2022 as consumer prices took off and housing costs rose. Living standards fell a little further last year, taking them to 0.6 per cent lower than they were before COVID arrived.

The authors estimate that, this year, the tax cuts and continuing pay rises will lift living standards to a princely 1.6 per cent above what they were in December 2019.

But those national averages conceal much variation. When the authors ranked all households by their disposable income, then divided them into five “quintiles”, the poorest 20 per cent are expected to end the five years with their living standard 3.5 per cent higher.

Huh? They did well partly because their pensions and benefits are indexed to inflation.

At the same time, the top 20 per cent of households are expected to be 2.7 per cent ahead. Why? Partly because they did well on their investments.

So it’s the middle 60 per cent of households that have been hit the hardest by the cost of living. The second lowest 20 per cent barely broke even, while the middle and upper-middle quintiles suffered a fall in their living standards.

But now we get to the pointy bit. Why did the middle do so much worse than the rest? Because that’s where you find most of the people with mortgages. Turns out all those households with mortgages are expected to see their living standards fall by 5.6 per cent over the five years to December 2024.

What about renters? Their living standards should rise by 2.9 per cent over the period. Huh? How could that be? It’s true that shortages of rental accommodation have caused rents to rise hugely this year and last. But much of that can be seen as catch-up for the lockdown-caused falls in rents in 2020 and 2021, and the small increases in 2022.

If you’re sitting down, I’ll tell you that the living standards of people who own their homes outright are expected to rise by … 8.5 per cent.

But here’s an even bigger shock: if you divide all the households by their main source of income, those in the “other” category – that is, not reliant on either wages or pensions – should see their standard of living rise by what the authors call “an astounding 15.8 per cent”.

Penny dropped yet? Yes, we’re talking about the group that always has its hand out for a handout to thank it for being too well-off to get the age pension: the self-described, so-called self-funded retirees.

But while you’re feeling sorry for all those poor souls (whose company I’ll be joining one day), spare a kick for the economists who, several decades ago, had the bright idea of using only interest rates to control inflation. They must have had a fairness bypass.

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Construction industry a honeypot that capital and labour fight over

Don’t fall for the bogeyman theory of our troubled major constructions industry: its union has gone rogue, been infiltrated by criminal elements, and must be cleaned out, so life can return to normal. There’s much more to it than that.

But first, let’s be clear. I’m trying to explain the phenomenon, not make excuses for thuggery and lawbreaking – even if perpetrated by the union movement, with successive Labor governments pretending not to have noticed.

Anyone who remembers the exploits of Eddie Obeid in NSW knows Labor has form when it comes to turning a blind eye to illegality. Like the ACTU, Labor does need to clean up its act. And as always, lawbreaking should be punished.

Like every prime minister, premier, politician and union secretary in the country, I’ve long known that the construction union engages in thuggish, often illegal behaviour (see three royal commissions below). When my superannuation fund merged with the huge construction industry fund, I moved my money elsewhere.

But if it’s just a matter of Labor governments failing to punish the crimes of their union mates, ask yourself this: how come the Liberals haven’t fixed it? John Howard had almost a decade to do so, but the Australian Building and Construction Commission he set up in 2005 didn’t get far in the seven years before Labor abolished it.

Likewise, the Abbott government’s re-established commission didn’t get far in the seven or so years before the Albanese government re-abolished it last year.

This problem’s been around for at least 40 years. The Hawke government deregistered the Builders Labourers Federation in the 1980s, but that didn’t work. Liberal federal and NSW governments have set up three royal commissions – in 1992, 2003 and 2015 – to no avail.

All of which should make you wonder why it’s so hard to fix such a seemingly simple problem. Could it be that the Libs aren’t fair dinkum either? Could it be that the big construction companies aren’t all that fussed about their union’s bad behaviour?

If so, could it be that they’re not privately pressing the Libs actually to fix the problem rather than just score political points against Labor?

We’re hearing about small contractors who aren’t game to stand up to union bullies for fear of retribution. I don’t doubt it’s true. But the construction companies running the show are huge. I don’t believe that, if they really wanted to rid themselves of union thugs, they lack the brains or the wherewithal to make it happen.

Remember too that when it comes to industrial relations, it’s always the unions that look bad, never the employers. That’s because the world is run by bosses. When everyone does what the boss tells them to, there’s never a problem.

But when the workers form a union to challenge the boss’s decision to pay them peanuts – or to run worksites where you could lose your life – it’s always the union that’s making trouble. It’s always greedy workers who strike and make you walk to work, never intransigent bosses. The media almost invariably fall for this characterisation.

We’re hearing that the rogue union’s disruptions and success in extracting excessive wages and conditions have forced up the cost of big city buildings, railways and motorways. It may look that way, but I’m not sure that it’s true.

Nor am I persuaded by the claim that high wages in the construction sector have flowed through to home building, and so explain why it’s so hard to afford to buy a place. This is a tricky way of claiming that employed carpenters, sparkies, plumbers, tilers and all the rest are grossly overpaid. Bulldust.

And Peter Dutton’s attempt to link union thuggery to the cost-of-living crisis is laughable. Whatever the union’s doing to construction costs, it’s been doing for 40 years, not just the past two.

Next they’ll be telling us the bullying will force the Reserve Bank to raise interest rates again.

But consider this thought experiment. I reckon that if Anthony Albanese could wave a wand and remove all union presence from the construction industry, the effect on the cost of major constructions would be minor.

Why? Because, although the untrained don’t know it, and some economists seem to have forgotten it, the biggest single message of conventional economics is that market prices aren’t just set by the cost of production – supply – but by the interaction of supply with demand.

If it’s true that a rogue union’s demands have been able to push up the costs of constructing office towers and all the rest quite excessively, how come employers have had no trouble passing those excessive costs on to their customers?

Partly because the union has imposed the higher cost on all the businesses in the industry, but mainly because any outfit that wants a city building, or government that wants a motorway, has no choice but to pay up. When economists say that the demand for the output of the construction industry is highly “price inelastic”, that’s what they mean.

But why can the industry get away with high costs? Why do its customers have no choice but to pay? Two reasons. First, the industry enjoys “natural protection”. That is, you can’t import office blocks.

Second, the industry is dominated by a just few big companies. It’s an oligopoly. It lacks effective competition between the local players.

Point is, magically remove the unions and none of that changes. If so, why would the big companies lower their prices? Why wouldn’t they keep charging the prices they know the market will bear?

Not enough people understand the unions’ role in the economy and how they go about advancing their members’ interests. The mistake is to imagine that the bosses represent capitalism, whereas the unions represent anti-capitalism.

No. Union bosses are capitalists too. The true contest is between the representatives of the two main “factors of production”: capital and labour. So unions are an integral part of the modern capitalist system. They’re a countervailing force that helps keep the system in balance.

Take out the unions, and capital ends up with almost all the money, and the households whose income comes from selling their labour have very little. In which case, the capitalists have no one to buy their products. Unions save the capitalists from their own excesses.

But get this: the unions are rogue capitalists who try to beat the real capitalists at their own game. The most successful capitalism comes from finding a business where it’s possible to make super-profits (in the jargon, to earn “economic rent”).

Turns out that’s also what the most successful unions do: find an industry whose circumstances allow it to earn super-profits and then demand a generous share for the workers. Guess what? A good example of an industry earning economic rent is construction.

And my guess is that the construction industry oligopoly finds it quite convenient to have a union that goes around bullying smaller businesses. Why? Because what they’re doing is policing the industry’s “barriers to entry”.

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Unthinking privatisation leaves much mess to be cleaned up

It’s been a week of facing up to the various troubles caused by the fad of governments trying to solve their problems with help from the private sector.

All governments have indulged in the fashion of privatising their businesses and outsourcing the provision of public services to a greater or lesser extent, with varying degrees of success. Victoria was first with the idea of selling off its electricity monopoly, and it’s had its own adventures with private toll roads.

But this week it was NSW’s turn to grapple with the almighty mess it’s made of its toll roads, guided by two visiting Victorians – Professor Allan Fels and Dr David Cousins. There is much for Victorians to learn from the northerners’ travails, as they struggle to keep the schadenfreude off their face.

First, how did this supposed “reform” push get started? Partly, it was ideological – many people believe private businesses are always efficient, whereas governments are always inefficient.

But mainly it was politicians trying to do the impossible – or look like they’d done it. How can the government do more without getting bigger? How can we respond to the voters’ unceasing demand for us to provide more without increasing taxes or adding to government debt?

I know, let’s use “public-private partnerships” to work their magic. This thinking has left Sydney ringed by 13 toll roads, 11 of which are majority-controlled by the ASX-listed giant tolling company Transurban, along with many minority partners.

Toll roads now make up almost half of Sydney’s motorway network. It has more toll roads than any other Australian capital city, which hasn’t stopped it from being the most congested. These toll roads have grown like Topsy, each with differing tolls and rules about how the toll is regularly increased.

Taken together, the toll road system is regarded as inefficient, unfair and lacking transparency.

This week’s final report of Fells’ and Cousins’ independent review found that tolls are higher than they need to be and higher than they should be. Unless something is done, they’ll increase too quickly in coming decades.

Tolls are too high in the sense that they probably encourage trucks to use less suitable roads, and lead to greater congestion on other roads as motorists try to save money. There is no provision for pricing rules set to run for decades to be reviewed to ensure they still make sense.

A toll road contract is a natural monopoly, but not all the contracts were awarded after competitive bidding. Where bidding did occur, contracts weren’t necessarily awarded to the firm offering to charge the lowest toll.

Often, the government set what the toll would be, with the contract awarded to the firm offering to take on the most of the government’s obligation. This was a way of shifting costs that should have been covered by the taxpayer onto motorists, thereby making budgets look better and taxes lower.

Sometimes the cost to motorists was disguised by contracts where the toll started low but rose excessively over time.

All the contracts involved the private firms borrowing the money to pay for the motorway, even though governments can borrow much more cheaply than businesses can. This made government debt look lower, but hid the higher interest costs in higher tolls.

All the contracts involved the company accepting “traffic risk”. When fewer cars use the road than had been predicted, the company’s out of pocket, but when there are more cars than predicted, the company makes a windfall gain.

By now, windfall gains are common, and the companies are cleaning up. But this is an unnecessary burden on motorists. Why? Because companies have to be paid to take on the risk, whereas governments are much better at bearing such risks. They can spread any costs over millions of taxpayers so that they become trivial.

The system of tolls is biased against motorists who live in the outer western suburbs, and biased in favour of those in better-off northern suburbs using long-established, government-owned toll roads crossing Sydney Harbour.

For some years NSW governments have sought to reduce this unfairness by paying subsidies to western suburbs motorists with excessive weekly toll bills. This makes the system less unfair by adding a cost to taxpayers with no loss to the toll companies. They actually benefit because more motorists can now afford to pay their high prices.

The Minns Labor government has vowed to bite the bullet and renegotiate the contracts. This week’s final report recommends that it replace the hodgepodge array of tolls with a uniform system where the price is based on distance travelled, with those travelling longer distances charged less per kilometre.

The Harbour Bridge and Harbour Tunnel tolls would be included in the pricing mechanism, so that northern suburbs motorists paid more, while western suburbs motorists paid less.

The government says it will compensate the toll companies for losses from changes to their contract arrangements, but would transfer “traffic risk” and its windfall gains to the government. This would help cover lower tolls in the west.

Transurban has belatedly agreed to renegotiate, but proposes setting the toll on a different basis, suggesting the negotiations may be long and hard. But getting agreement from all Transurban’s many minor partners could take an eternity. The government wants a deal by Christmas.

To this end, the report recommends that the NSW government take back control of tolls by setting up a state-owned entity, NSW Motorways. Its changes to tolling arrangements would be overseen by the NSW Independent Pricing and Regulatory Tribunal. The new entity should look for opportunities to add competition to the system, especially for any new roads.

The existence of the new tolling entity would allow the government to act should it take Transurban and its many partners too long to agree to a satisfactory deal.

The private companies have rights, but they don’t have the right to impose on the people of NSW and their government an unfair and unsustainable arrangement lasting forever and a day.

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Take heart! Australia is still better and fairer than most

Don’t be disheartened by recent events. Things in the Land of Oz are far from perfect, and we have our share of problems. But don’t be tempted by the thought that if America’s going to the dogs, we won’t be far behind. No, we’re holding things together much better than the Yanks are.

With the US reverting to its traditional practice of taking shots at presidents and presidential candidates, this week of all weeks is the time to say, “Only in America”. Thanks to the courage and quick thinking of John Howard after the Port Arthur massacre in 1996, our access to guns is well controlled.

Of late, it’s been tempting to think that the goal of every generation being better off than their parents has been lost. It’s not true. Not yet, anyway. And there’s still time to ensure that Gen Z – youngsters in their teens and early 20s – get a fair shake.

It’s not easy to compare generations with statistical accuracy. But lately, statisticians have made progress in linking information from the census and official surveys with banks of data held by government departments. And last week, the Productivity Commission used this advance to publish a much more authoritative study on economic mobility.

It confirms that, on average, each generation earns more than its parents did at the same age. That’s because the economy has grown almost continuously over the decades, raising material standards of living. This would be true of all the developed economies.

Of course, it’s also true that it’s easier for children born into poorer families to do better than their parents than it is for children born into well-off families.

However, living standards haven’t grown much over the past decade or so. Were this to continue for a further decade or more, it could become true that Gen Z isn’t doing better than its parents.

A different question as to whether overall living standards are continuing to rise in real terms over the years is how easy it is for people to change where they stand in the distribution of incomes as their lives progress.

How easy is it for people starting out towards the bottom of the ladder to climb to a higher rung?

This is the meaning of income mobility. Can you better yourself if you try hard enough?

Now, this is where the Americans keep telling themselves they’re the land of opportunity. Log cabin to the White House and all that. Well, it may have been true in Abraham Lincoln’s day, but it hasn’t been true for decades. As a general rule, the more unequal incomes are, the harder it is for people’s positions on the ladder to change.

America’s incomes are highly unequal, and it’s one of the countries where changing your income status is hardest.

But this is where the Productivity Commission’s research brings good news. On income inequality, Australia is in the middle of the pack of rich countries. But when it comes to income mobility, we do what Australians love to think of themselves as doing: punching above our weight.

We pride ourselves on being the land of the fair go. Or, as dear departed Scott Morrison preferred to put it: if you have a go, you get a go. Well, guess what? We now have documentary evidence that it’s still true. According to the commission’s calculations, Australia is among the most income-mobile countries, scoring better than even the fabled Scandinavians.

Two qualifications. First, people in the middle 60 per cent of the distribution enjoy the most opportunity to move. If you start in the bottom 20 per cent of personal incomes, you have less ability to improve. And if you’re already in the top 20 per cent, it’s harder to go higher.

Second, although the commission doesn’t spell this out, mobility cuts both ways. Remember, we’re talking about relative incomes, not absolute incomes. So, if it’s easier for me to pass you on the ladder, it’s easier for you to fall below me.

How do people seek to improve their earning potential? The obvious way is to get a better education. On average, people with a uni degree or higher earn 23 per cent more over their lifetime than those who only complete year 12. And those who complete high school earn significantly more than those who don’t.

Mobility is adversely affected by significant life events, such as unemployment, serious health problems and relationship breakdowns.

So far, we’ve been focusing just on income. But wealth – the assets you own – also affects your mobility. Unsurprisingly, the less wealth you have, the harder it is to move up, and the more wealth you have, the easier it is to stay up.

The rich have always been with us, but I think the inordinate rise in the cost – and value – of homes, which is already handicapping young people without access to parental help, will also make inheritance a bigger influence on people’s income mobility.

As Australians, we have a lot to be pleased about and proud of. But we have no cause for complacency.

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OECD’s message to our inflation warriors: calm down, she’ll be right

Last week a bunch of international public servants in Paris launched a rocket that landed in Sydney’s Martin Place, near the Reserve Bank’s head office and the centre of our financial markets. It carried a message we should already know. Australia has a big problem with real wages: they’re too low. In which case, why are you guys so anxious about continuing high inflation?

The Organisation for Economic Co-operation and Development’s annual Employment Outlook says Australia’s real wages in May this year are still 4.8 per cent lower than they were in December 2019, just before the pandemic.

This is one of the largest drops among OECD countries. It compares with real falls of 2 per cent in Germany and Japan, and 0.8 per cent in the United States. Real wages have risen by 2.4 per cent in Canada and 3.1 per cent in Britain.

The organisation observes that, “as real wages are [now] recovering some of the lost ground, profits are beginning to buffer some of the increase in labour costs. In many countries, there is room for profits to absorb further wage increases, especially as there are no signs of a price-wage spiral”.

Just so. But this isn’t something you’re allowed to say out loud in Martin Place. When the Australia Institute copied various overseas authorities in calculating the contribution that rising profits had made to our rising prices, it was dismissed by the Reserve Bank and the financial press.

Apparently, it’s OK for the Reserve to say it must increase interest rates because demand is growing faster than supply and adding to inflation, but it’s not OK to say that businesses have used the opportunity to raise their prices and this has increased their profits.

No, in the Reserve’s eyes, the problem with prices soaring way above its inflation target has never been greedy bosses, but always the risk of greedy workers using their industrial muscle to prevent their real wages from falling and thus causing a price-wage spiral that perpetuates high inflation.

It was a worry that anyone who knew anything about the changed power balance between employers and workers and their unions – anyone who wasn’t still living in the 1970s – could never have entertained.

For many years, the Reserve Bank benefited greatly from having a senior union official appointed to its board along with the many business people. But John Howard soon put a stop to that.

Since then, the Reserve has had to fall back on the primitive understanding of how labour markets work that you gain from a degree in neoclassical economics. Fortunately, since last year the board has included Iain Ross, former president of the Fair Work Commission.

The Reserve’s great sense of urgency in getting the inflation rate back down since it began raising interest rates in May 2022 has been driven by two worries about wages. First, when excessive monetary and budgetary stimulus caused the post-lockdown economy to boom while our borders were closed to imported labour, it worried that shortages of skilled and even unskilled labour would cause wages to leap as employers sought to bid workers away from other firms.

Although job vacancies more than doubled, reaching a peak in May 2022, annual wage growth had risen no higher than 4.2 per cent in December last year, even though consumer price inflation had peaked at 7.8 per cent a year earlier.

So, though no one’s bothered to mention it, our first period of acute labour shortages in decades hardly caused a ripple. It’s probably fair to say, however, that had the shortages not occurred, wages would have fallen even further behind prices than they did.

The Reserve’s second reason for feeling a sense of urgency in getting inflation back down to the target range is its fear that, should we leave it too long, inflation expectations may rise, causing actual inflation to move to a permanently higher level.

Indeed, the signs that our return to target will be slow have been used by the Reserve’s urgers in the financial markets to call for another rate rise or two. Apparently, every week’s delay in getting inflation down could see inflation expectations jump.

But this is mere pop psychology. Even if the nation’s workers and unions were to expect that inflation will stay high, they lack the industrial muscle to raise wage rates accordingly. If you didn’t already know that, our outsized fall in real wages should be all the proof you need.

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Forget smaller government, let's shoot for better government

We pay our taxes, then governments spend them. But where does all that money go? And how much of it is wasted? Well, where it goes is no secret, but how much of it does little to benefit us is something we don’t really know. Why not? Because we put so little effort into finding out.

In 2022-23, the federal and state governments spent almost $890 billion. Nearly 33 per cent of that went on social security payments; 21 per cent on healthcare (hospitals, doctors, medicines); 15 per cent on education (from pre-primary to university); 5 per cent each on defence and law and order; plus transport, the environment, housing, recreation and culture, and much else.

People who resent the taxes they pay like to think it goes to council workers leaning on shovels and public servants sitting around drinking tea, but really, they should be thinking of doctors, nurses and ambos; teachers and lecturers; soldiers, sailors and fliers, coppers, firies and garbos.

Those people are busy almost all the time doing what they’re paid to do. If some government departments once were overstaffed, years of cost-cutting should have fixed that.

No, the trouble isn’t that workers in the public sector aren’t working hard. It’s that they can be working away on programs that seem like they should be delivering for taxpayers, but aren’t.

Consider these four plausible propositions. First, parents are more likely to get their kids to school if threatened with the loss of government payments. Second, testing students’ literacy is an accurate way to assess their ability.

Third, early childhood staff have all the skills they need. Fourth, a health program designed by both educators and their students will be more likely to discourage risky behaviours.

Sorry, turns out none of those programs worked.

In 2016, researchers discovered that the Northern Territory’s efforts to improve school attendance by making welfare payments conditional on getting kids to show up had no effect on attendance.

In Dubbo, other researchers found that if you made a literacy test more culturally relevant by changing a story about lighthouses to one about the dish-shaped telescope in Parkes, you halved the gap between the scores of Indigenous and non-Indigenous kids.

In NSW, researchers found that giving early childhood staff a half-year professional development program boosted the achievement of their kids, especially their literacy.

Yet more researchers – in Brisbane, Perth and Sydney – found that, despite the students’ involvement in designing the Health4Life program, it had no effect on alcohol use, smoking, screen time, physical inactivity, poor diet or poor sleep.

What all these research efforts had in common was that they evaluated these programs using RCTs – randomised controlled trials. This involves using the toss of a coin to divide similar participants in the trial into two groups. One group gets the treatment and the other “control” group doesn’t. You then compare the two, confident that any differences between them have been caused by your intervention.

Point is, this is a far more rigorous way of judging whether government spending programs achieve the benefits you were hoping for, rather than just doing a pilot program and deciding whether it seems to have worked.

But these four careful trials are the exception, not the rule. A study by the Committee for Economic Development of Australia examined a sample of 20 federal government programs worth more than $200 billion. It found that 95 per cent of them hadn’t been properly evaluated. The committee’s examination of state and territory government evaluations reported similar results.

“The problems with evaluation start from the outset of program and policy design,” it said. Across the board, the committee estimated that fewer than 1.5 per cent of government evaluations use a randomised design.

Similarly, a Productivity Commission report in 2020 into the evaluation of Indigenous programs concluded that “both the quality and usefulness of evaluations of policies and programs … are lacking”.

This is in marked contrast to the medical profession, where controlled trials are standard in the evaluation of medical operations. These have demonstrated that the treatments preferred by experts were often worse for patients.

For instance, radical mastectomies for breast cancer disfigured 500,000 women while doing nothing to increase their odds of survival. Many treatments found to be harmful had been supported by expert opinion and low-quality before-and-after studies.

If you can feel a commercial message coming on, you’re right. Dr Andrew Leigh, former economics professor and now Assistant Minister for Treasury and many other bits and bobs, has been championing the use of randomised controlled trials in government program evaluation for years.

And last year the Albanese government set up within Treasury the Australian Centre for Evaluation, with Leigh responsible. It aims to expand the quality and quantity of program evaluation in co-operation with other government departments. Its leader, Eleanor Williams, has a modest budget and a staff of more than a dozen. A key principle is that high-quality evaluation of a program’s impact needs to be built into the design of the program from the get-go. The centre will also collaborate with evaluation researchers outside government.

And now the Paul Ramsay Foundation, Australia’s largest charitable foundation, is providing a $2.1 million round of grants for people to run randomised trials on important social problems. The centre, which has been given access to a wealth of “administrative data” – statistical information collected by government departments – will make this available to academics and others receiving grants.

I think this is all to the good. And about time. Econocrats went for decades supporting the push for smaller government, which led to the privatising of many government-owned businesses (including a national electricity market now dominated by three big companies) and much outsourcing of government services to private businesses – which, as should have been expected, have proved highly efficient at increasing their profits.

Great. What we could use now is a lot more attention to achieving better government.

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The moribund political duopoly is rapidly self-destructing

Why do we have so many economic problems, and why do our governments make so little progress in fixing them? Because the two main parties just play politics and by now have boxed each other in. Neither side is game to make tough decisions for fear of what the other side will do to them.

Our tax system needs repair, but neither side dares to make changes somebody somewhere might not like. So we put up with poor government services, growing waiting lists, tax avoidance by the highly paid, bracket creep and phony tax cuts.

We have a system where people with mortgages get squeezed unmercifully whenever inflation gets too high. There are fairer and less painful ways to fix the problem, but neither side has the courage to change.

When occasionally the two sides agree on some policy, it’s often a bad one. Many defence experts quietly doubt the wisdom of AUKUS. By the time the nuclear subs arrive in many years’ time – if they ever do – they’ll probably have been superseded.

But the political duopoly’s most egregious failing is its inaction on climate change. For a while, it looked like the climate wars had ended, with the Albanese government making very cautious progress towards net-zero emissions.

Now, however, Peter Dutton has come up with a new reason for delay: let’s go nuclear instead. And we don’t have to do anything unpleasant for a decade or two. It will probably never happen, but what it has done is rob commercial investors of the certainty they need to keep investing in solar and wind farms at the rapid rate we need them to. With our ageing coal-fired power stations so close to the grave, our transition to renewable energy could be very bumpy.

So, what can we do to free ourselves from the clutches of a two-party political system that’s stopped working? Well, we’re already doing it. Voters are increasingly taking the law into their own hands by opting for the minor parties and independents. We saw this at the last federal election, in 2022, where the two big parties’ combined share of first-preference votes – which has been declining since World War II – fell to 68.3 per cent, its lowest level since the Great Depression.

So, the share of first-preference votes going to minor parties and independents is now just a little short of a third. In consequence, the number of crossbenchers in the House of Representatives rose to a record 16.

It’s not difficult to judge that the duopoly’s poor performance on climate change explains much of their decline. Labor loses votes to the Greens while, for the first time, teal independents took six previously safe seats from the Liberals.

Nor is it hard to believe that Labor’s caution and the Liberals’ nuclear red herring may add to the big parties’ loss of first preferences at next year’s election.

New research by Bill Browne and Dr Richard Denniss, of the Australia Institute, finds there are now no safe seats in House of Representatives. While some Labor seats are safe from being taken by the Liberals, and some Liberal seats are safe from Labor, such seats aren’t safe from the Greens or an attractive independent candidate.

In the supposedly safe Liberal seat of Mackellar on Sydney’s northern beaches, the teal independent Dr Sophie Scamps won the seat with a two-candidate preferred swing of more than 15 per cent. A strong independent candidate’s advantage is that they can pick up the preferences of the minor parties, plus those of the other big-party candidate who was never going to win.

It’s usual for the big parties to focus on the “marginal seats” that could be won or lost if a few “swinging voters” change their votes. And it’s mainly these marginals that one big party loses to the other.

But it’s not usual for the minor parties and independents to pick up such marginal seats. No, they’re much more likely to win supposedly safe seats.

So while the big guys focus on winning or retaining the marginals, they leave themselves open to the small guys when they neglect the concerns of voters in their heartland seats. Again, climate change would be the classic concern.

The standard way of predicting the results of elections using the psephologist Malcolm Mackerras’ famous pendulum has been overtaken not just by the lack of a uniform national swing between the two majors, but by the rise of the minors and independents.

I think it will be rare for governments to be elected with big majorities in future. Wafer-thin majorities will be the norm, with “hung” parliaments common. The big guys will warn us this will lead to chaos and inaction.

Don’t you believe it! It’s never been true at the state level where, at present, only five of the eight state and territory parliaments are dominated by a majority party.

I think a move to more power for crossbenchers at the federal level could be a good way to break the big-party logjam. It’s hard to see how it could be worse than what we’ve got.

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Yes, we need tax reform, but it offers no easy answers

When we’re reminded that income tax cuts represent merely the partial return of the proceeds of earlier bracket creep, and that the process of clawing back the latest tax cut starts the same day it arrives, it’s easy to join the impassioned cry for tax reform. Sorry, it ain’t that simple.

Surely if we could end the crazy business of bracket creep, we’d pay less tax? Well, yes – but no.

Bracket creep occurs because our income tax scales ignore the reality of inflation. When our wages rise to take account of inflation, we’re no better off in real terms, but we’re often pushed into a higher tax bracket, which raises the average rate of tax we pay on the whole of our income. (If we’re not literally pushed into a higher bracket, our average tax rate still goes up because a higher proportion of our income is now taxed at a higher rate.)

So we’ve long known how to (largely) end bracket creep: do what the Americans do and increase all the bracket limits once a year, in line with the annual increase in the inflation rate. Then, it would only be rises in your real income that pushed up your average tax rate, which is fair enough.

Mission accomplished. Now we’ll all be paying less tax.

Except that the net profit the taxman makes after all the to-ing and fro-ing on bracket creep isn’t just kept in a jam jar somewhere. It’s used to help cover the ever-growing cost of all the services the government gives us, and thus to limit the size of budget deficits and government debt.

So, without the benefit of bracket creep, governments would be forced to keep making explicit increases in the rates of income tax, or to announce new taxes.

Wouldn’t that be an improvement? In principle, yes. In practice, our (politician-fed) aversion to paying higher taxes would just make politics an even bigger shoot-fight than it already is. The pollies would spend more time abusing each other and less time getting on with fixing our problems.

One thing we can be sure of is that it wouldn’t do much to slow the growth in government spending. Why not? Because our demand for more and better government services is insatiable. Because both sides of politics fight every election campaign promising more and better services – and by never showing us the tax price tag on whatever it is they are selling.

How can I be sure tax indexation would do little to slow the growth in government spending? Because that’s what happens in America. They keep running bigger budget deficits and amassing more government debt than the other rich countries (except Japan).

But they get away with it because their economy’s so big, and they’re the centre of the world financial system. A middle-level economy like ours could never pull it off.

So tax indexation isn’t high on my list of desired tax reforms. Bracket creep turns out to be just one of the dirty little tricks by which the politicians who’ve done so much to make our political system almost unworkable keep it staggering along.

It’s easy to agree on the need for tax reform, but its advocates want to reform differing things and have differing motives. “Reform” is a lovely, positive word, but you need to beware of people whose idea of reform is: I pay less, you pay more.

All the alleged reform advocated by the (big) Business Council, for instance, takes that form. They want a lower rate of company tax and a lower top rate of personal income tax – all paid for by a higher goods and services tax.

Spruikers for the highly paid make a big fuss about the government’s heavy reliance on income tax – which they exaggerate – and always claim discourages them from working and investing.

But economic theory doesn’t support these claims, and the empirical evidence – which would be more persuasive – doesn’t either. The people whose behaviour is influenced by the rate of tax on additional earnings are “secondary earners”, who have more ability to increase or decrease the hours they work because they have part-time jobs. But the nation’s executives don’t worry much about them.

No, the tax reform I think we need is higher tax on capital gains, less concessional tax on the superannuation of people such as me, a decent tax on highly profitable mining companies and, probably, a tax on big inheritances.

But don’t hold your breath waiting for that to happen.

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If you care about your offspring, you should support 'nature positive'

The most pressing problem we face is climate change. It’s even more important than – dare I say it – getting inflation down to 2 per cent by last Friday. But we mustn’t forget that climate change is just the most glaring symptom of the ultimate threat to human existence: our continuing destruction of the natural environment.

Economists are often accused of being too narrowly focused on markets and the market prices that move up or down to bring supply and demand into balance.

But one way they’ve widened their scope is by broadening the meaning of “capital”. Capital refers to anything that helps us produce the many goods and services we consume as part of our standard of living.

Historically, it has meant “physical” capital: the human-made tools, machines, factories, shops, offices and other buildings, as well as infrastructure such as roads and bridges.

To this, economists have added the “human” capital we have in our brains: the education, training and on-the-job knowledge that adds to the productive value of our labour.

And then they took account of “social” capital: the human relationships and networks, norms of acceptable behaviour and, particularly, the trust between people that make markets work more smoothly and lower the costs of doing business.

Finally, economists have recognised the importance of “natural capital”: the world’s stocks of natural assets, such as geology, soil, air, water and all living things. These natural assets deliver to us “ecosystem services” ranging from pollinating birds and insects, sources of fresh water, forests, marine life, arable soils and various absorbers of wastes.

As a former Treasury secretary, Dr Ken Henry, reminded us in a speech last week, human progress has relied on forms of industrial production, including modern agricultural practices, involving extracting non-renewable raw materials, such as iron ore, coal and gas, and making extensive use of ecosystem services.

Two hundred years ago it was possible to believe that all this economic activity was having no significant impact on our stocks of natural assets and their ecosystem services to us. Today, scientists tell us a very different story – and it’s much easier to see with our own eyes the damage we’ve done.

As Henry puts it, the extraction of non-renewable natural resources for industry has depleted the stock of natural capital directly. But it has also had an indirect impact. Most obviously, the burning of fossil fuels has damaged the atmosphere, the total supply of water in all its forms, and the earth’s surface, in a set of complex processes we call climate change.

But that’s not our only contribution to the degradation of natural capital. Because the industrial rate of use of ecosystem services has exceeded nature’s capacity to regenerate for at least several centuries, the stock of natural capital has been depleted – just as machines used in production depreciate more rapidly if worked harder and not properly maintained.

The depletion of natural capital over time reduces its capacity to supply ecosystem services that are critical to production. For example, soil fertility, the availability of well-watered farming land, and capacity of the atmosphere and the land to absorb the waste left by economic activity have all fallen over time.

“A degraded biosphere [of land and air] affords less protection from fire, droughts, floods and storms, all of which are growing in incidence and severity because of human-induced atmospheric change,” Henry says.

Wait, there’s more. The depletion of natural capital also reduces “environmental amenity” – our enjoyment of being out in nature. It also imposes adverse cultural impacts on indigenous peoples.

Economists are very aware that, to some extent, labour and physical capital can be substituted for each, one source of energy can be used to replace another, and resources can be used to produce machines that increase what we have available to consume.

These are the reason some economists have dismissed the fear that we have, or could ever, approach the “limits to [economic] growth”.

But Henry’s not convinced. “None of this human ingenuity, nor [physical] capital accumulation, nor increasing work effort has, thus far, done anything to halt the rate at which the stock of natural capital is being depleted,” he says.

“To the contrary, new technologies and more [physical] capital-intensive modes of production have accelerated its rate of depletion. And they have done little to reduce the dependence of industry upon the stock of natural capital.”

The distinguished American economist Robert Solow argued that for economic growth to be sustainable, the present generation has a moral obligation to “conduct ourselves so that we leave to the future the option or the capacity to be as well-off as we are”.

But Henry responds that: “The historical loss of natural capital denies us reason to believe that future generations will have the capacity to achieve our level of wellbeing. To put it another way, it would be irrational of us to suppose that we, in this generation, are custodians of sustainable development.”

Wow. He goes on to argue that so much has been lost, and with such serious consequences, a consensus has emerged that we must now commit to nature repair.

Have you heard of “nature positive”? It means halting and reversing nature loss, so that species and ecosystems start to recover.

Henry says the nature positive position “argues that for some time, perhaps generations, we must seek to restore environmental condition, understanding that without doing so, we cannot be confident that future generations will have the capacity to be as well-off”.

Wow. This is radical stuff. And it’s coming not from some Greens senator, but from a former Treasury secretary and former chair of the National Australia Bank.

In an interview in April, Henry said the Albanese government should establish a public fund to spur corporate involvement in nature positive protection and repair. The cost would be enormous, he admitted.

A last thing to surprise you. The world’s first global nature positive summit will be held in Sydney in early October. It will be hosted by the federal Minister for the Environment, Tanya Plibersek.

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Despite what we're led to believe, tax cuts are no free lunch

Isn’t it wonderful that the Albanese government – like all its predecessors – has been willing to spend so many of our taxpayers’ dollars on advertising intended to ensure no adult in the land hasn’t been reminded, repeatedly, about the income tax cuts that took effect on Monday, first day of the new financial year?

But believe me, if you rely only on advertising to tell you what the government’s up to with the taxes you pay – or anything else, for that matter – you won’t be terribly well-informed. The sad truth is there’s a lot of illusion in the impressions the pollies want to leave us with when it comes to tax and tax cuts.

For instance, none of those ads mentioned the eternal truth that, when we have income tax scales that aren’t indexed annually to take account of inflation, the taxman gradually claws back any and every tax cut the pollies deign to give us. And this slow clawback process – known somewhat misleadingly as “bracket creep” – begins on the same day the tax cuts begin.

So readers of this august organ are indebted to my eagle-eyed colleague Shane Wright, who asked economists at the Australian National University to estimate how long it would take these tax cuts to be fully clawed back, using plausible assumptions about future increases in prices and wages.

A tax cut reduces the average rate of income tax we pay on the whole of our taxable income. A middle-income earner’s average tax rate will fall from 16.9 cents in every dollar to 15.5¢. The economists calculate it will take only two or three years for inflation to have lifted most taxpayers’ average tax rate back up to where it was last Sunday.

So that’s the terrible truth the pollies rarely mention. But don’t let that make you too cynical about the tax-cut game. Just because this week’s tax cut will have evaporated in a few years’ time doesn’t mean it’s worthless today. Actually, as tax cuts go, this is quite a big one. Someone earning $50,000 a year is getting a cut worth almost $18 a week. At $100,000 a year, it’s worth almost $42 a week. And on $190,000 and above, it’s worth $72 a week.

Is that enough to completely fix your cost-of-living problem? No, of course not. But if you think it’s hardly worth having, please feel free to send your saving my way. I’m not too proud to take another $18 no one wants.

Remember, too, that had Anthony Albanese not broken his promise in January and fiddled with the stage 3 tax cuts he inherited from Scott Morrison, most people’s saving would have been a lot smaller, even non-existent.

Everyone earning less than $150,000 a year got more, while those of us struggling to make ends meet on incomes above that got a lot less. In my case, about half what I’d been led to expect.

But the politicians’ illusions are built on our self-delusions. Our biggest delusion is that government works quite differently to normal commercial life. We know that when you walk into a shop you have to pay for anything you want. If you want the better model, you pay more.

Somehow, however, we delude ourselves that governments work completely differently. That the cost of the services we demand from the government need to bear no relationship to the tax we have to pay.

The politicians actively encourage this delusion in every election campaign by promising us this or that new or better service without any mention that we might have to pay more tax to cover the cost of the improvement.

Any party foolish enough to mention higher taxes gets monstered – first by the other side and then by the voters. No one wants to admit that what we get can never be too far away from what we pay.

For the near-decade of the Liberals’ time in government, they drew many votes by branding Labor as “the party of tax and spend” while claiming they could deliver us the services we want while keeping taxes low.

This was always a delusion. So they squared the circle by using various tricks they hoped we wouldn’t notice, such as underspending on aged care, allowing waiting lists to build up and secretly ending the low- and middle-income tax offset, thus giving many people an invisible tax increase of up to $1500 a year.

But the main trick they relied on was the pollies’ old favourite: bracket creep.

Get it? When we delude ourselves that we can have the free lunch of new and better services without having to pay more tax, they resort to the illusion that income tax isn’t increasing by letting inflation imperceptibly increase our average tax rate.

This is the tax-cut game. As an economist would say, our “revealed preference” is for no explicit tax increases, but for tax to be increased in ways we don’t really notice and for tax cuts to be only temporary.

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Interest rate speculators should get back in their box

There’s nothing the financial markets and the media enjoy more than speculating about the future of interest rates. And with last week’s news that consumer prices rose by 4 per cent over the year to May, they’re having a field day.

Trouble is, the two sides of the peanut gallery tend to egg each other on. They have similar ulterior motives: the money market players lay bets on what will happen, while the media can’t resist a good scare story – even one that turns out to have scared their customers unnecessarily, thus eroding their credibility.

But the more the two sides work themselves up, the greater the risk they create such strong expectations of a rate rise that the Reserve Bank fears it will lose credibility as an inflation fighter unless it acts on those expectations.

Fortunately, the Reserve’s newly imported deputy governor, Andrew Hauser, has put the speculators back in their box with his statement that “it would be a bad mistake to set policy on the basis of one number, and we don’t intend to do that”.

He added that there was “a lot to reflect on” before the Reserve board next meets to decide interest rates early next month. Just so. So, let’s move from idle speculation to reflection.

For a start, we should reflect on the wisdom of the relatively recent decision to supplement the quarterly figures for the consumer price index with monthly figures.

This has proved an expensive disaster, having added at least as much “noise” as “signal” to the public debate about what’s happening to inflation. Why? Because many of the prices the index includes aren’t actually measured monthly.

Many are measured quarterly, and some only annually. In consequence, the monthly results can be quite misleading. Do you realise that, at a time when we’re supposedly so worried that prices are rising so strongly, every so often the monthly figures tell us prices overall have fallen during the month?

In an ideal world, the people managing the macroeconomy need as much statistical information as possible, as frequently as possible. But in the hugely imperfect world we live in, paying good taxpayers’ money to produce such dodgy numbers just encourages the speculators to run around fearing the sky is falling.

The Reserve has made it clear it’s only the less-unreliable quarterly figures it takes seriously but, as last week reminded us, that hasn’t stopped the people who make their living from speculation.

The next thing we need to reflect on is that our one great benefit from the pandemic – our accidental return to full employment after 50 years wandering in the wilderness – has changed the way our economy works.

I think what’s worrying a lot of the people urging further increases in interest rates is that, as yet, they’re not seeing the amount of blood on the street they’re used to seeing. Why is total employment still increasing? Why isn’t unemployment shooting up?

One part of the answer is that net overseas migration is still being affected by the post-pandemic reopening of our borders – especially as it affects overseas students – which means our population has been growing a lot faster than has been usual after more than a year of economic slowdown.

But the other reason the labour market remains relatively strong is our return to full employment and, in particular, the now-passed period of “over-full employment” – with job vacancies far exceeding the number of unemployed workers.

With the shortage of skilled workers still so fresh in their mind, it should be no surprise that employers aren’t rushing to lay off workers the way they did in earlier downturns. As we saw during the global financial crisis of 2008-09, they prefer to reduce hours rather than bodies.

It’s the changing shares of full-time and part-time workers – and thus the rising rate of underemployment – that become the better indicators of labour market slack in a fully employed economy.

The other thing to remember is the Albanese government’s resolve not to let the ups and downs of the business cycle stop us from staying close to the full employment all economists profess to accept as the goal macroeconomic management.

This resolve is reflected in the Reserve Bank review committee’s recommendation that the goal of full employment be given equal status with price stability, which the Reserve professes to have accepted.

This doesn’t mean the business cycle has been abolished, nor that the rate of unemployment must never be allowed to rise during a period in which we’re seeking to regain control over inflation.

What it does mean is that we can’t return to the many decades where the commitment to full employment was merely nominal, and central banks and their urgers found it easier to meet their inflation targets by running the economy with permanently high unemployment.

The financial markets may persist in their view that high inflation matters and high unemployment doesn’t, but that shouldn’t leave them surprised and dissatisfied with a central bank that’s not whacking up interest rates with the gay abandon they’ve seen in previous episodes.

But there’s one further issue to reflect on. It’s former Reserve Bank governor Dr Philip Lowe’s prediction in late 2022 that we’d be seeing “developments that are likely to create more variability in inflation than we have become used to”. As someone put it: shock after shock after stock.

The point is, it’s all very well for people to say we should keep raising interest rates until the inflation rate is down to 2 per cent or so, but what if price rises are being caused by problems on the supply (production) side of the economy, not by excessive demand?

High interest rates have already demonstrated their ability to end excessive demand, as quarter after quarter of weak consumer spending, and a collapse in the rate of household saving, bear witness. But if high prices are coming from factors other than excess demand, there’s nothing an increase in interest rates can do to fix the problem.

What surprises me is how little attention market economists have been paying to what’s causing the seeming end to the inflation rate’s fall to the target range.

Look at the big price increases that have contributed most to the 4 per cent rise over the year to May – in rents, newly built homes, petrol, insurance, alcohol and tobacco – and what you don’t see is booming demand.

Right now, all we can do to push inflation down is attempt to hide the effect of supply-side problems on the price index by putting the economy into such a deep recession that other prices are actually falling.

This was never a sensible idea, and it’s now ruled out by the government and the Reserve’s commitment never to stray too far from full employment.

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