Morrison’s not doing nearly enough to secure our future

It was obvious this time last week, but even more so a week later: Scott Morrison and Treasurer Josh Frydenberg are taking both the continuing threat from the coronavirus and the need to restore the economy far too cheaply. Figuratively and literally.

One thing another week of struggle by Victoria and NSW to contain the virus’s second wave has shown more clearly – plus the realisation of how vulnerable the neglect and misregulation of our aged care sector have left us – is the unreality of the government’s expectations about the effects of the pandemic.

Last week’s economic and budget update assumed Victoria would be back on track in six weeks and NSW’s struggles were too minor to matter. And also that we’ll start opening to international travel in January.

A more realistic assumption would be that the larger, virus-prone half of the economy (NSW and Victoria) will need to stay sealed off from the healthier, smaller half (the other states and the Northern Territory) indefinitely. Half a healthy economy is far from ideal, but it beats none.

Surely we should have realised by now that the pandemic will be a long-haul flight. Speaking of which, our barriers against the rest of the world are likely to stay up long after the 12th day of Christmas.

Economically, we must make the best of it we can – which won’t be anything like as good as we’d like. Forcing the pace on lifting the lockdown and removing the interstate barriers could easily end up setting us back rather than moving us forward.

What economists seem yet to understand is that, psychologically, what we have to do to keep the virus controlled is the opposite to what you’d do to hasten an economic recovery. To ensure people keep mask-wearing, hand-washing, sanitising, social-distancing and filling out a form every time they walk into a cafe for month after month, you keep them in a state of fear, afraid the virus may bite them at any moment.

How will this give them the confidence to get on with spending and investing? It won’t. Quite the opposite. But it’s the first indication Morrison and Frydenberg will need to spend more for longer.

The second thing that’s more obvious now than it was a week ago is that the setback in Victoria and NSW has put a question mark over the signs of an initial bounce-back in the economy as the lockdown has been lifted. The new payroll-based figures for the week to July 11 show jobs falling in all states, not just Victoria and NSW.

All this casts further doubt on the wisdom of the changes to the JobKeeper and JobSeeker programs announced last week. The initial reaction of relief that the government had not gone through with its original plan to end them abruptly in September has given way to the realisation that this threat of dropping the economy off a “fiscal cliff” has been delayed rather than averted.

The new boss of independent think tank the Grattan Institute, Danielle Wood, has estimated that the changes to the two job schemes will reduce the government’s support for the economy by close to $10 billion in the December quarter and thus “leave a substantial hole in the economy”.

In an earlier major report, Grattan argued that the government needed to spend a further $70 billion to $90 billion to secure a recovery. The measures announced last week amount to only about an additional $22 billion.

According to calculations by the ANZ bank’s economics team, the withdrawal of budgetary support amounts to the equivalent of about 10 per cent of quarterly gross domestic product during the December quarter.

In consequence, although the bank agrees with Treasury that real GDP will grow in the present September quarter, it sees the economy returning to contraction in the December quarter. What would that do for business and consumer confidence?

In its earlier report, Grattan said the government should aim to get the unemployment rate back down to 5 per cent or below by mid-2022. Why the hurry? To “reduce the long-term economic pain and avoid scarring people’s lives”.

Particularly young people’s lives – as this week’s report from the Productivity Commission has reminded us.

But the economic update last week forecast the unemployment rate would peak at 9.25 per cent in the December quarter and still be sitting at 8.75 per cent in the middle of next year.

That’s simply not good enough. It puts the interests of the budget deficit ahead of the interests of tens of thousands of Australians thrown out of work through “no fault of their own”, to quote a Mr S. Morrison.

Grattan’s Wood stresses that she has no problem with making the JobKeeper wage subsidy scheme better targeted. But that’s not all the government did. It cut back the size of payments and extended the scheme only for another six months.

After the cutback in income support for the jobless and potentially jobless was announced two days before the presentation of the budget update, she hoped the update would include announcements about the new spending programs that would fill the “substantial hole” the cutback left.

It didn’t. Not a sausage.

“The missing piece of the puzzle,” she now says, “remains a plan to stimulate the economy and jobs growth as the income supports are phased out and social distancing restrictions are eased in many parts of the country.”

So what should the government be spending on? She suggests measures that would both create jobs and meet social needs. “Social housing, mental health services, and tutoring to help disadvantaged students catch up on learning lost during the pandemic would deliver on this double dividend.

“Boosting the childcare subsidy to support family incomes and workforce participation should also be in the mix,” she says.

To that you could add fixing aged care, spending more on research and development and universities, not to mention renewable energy.

There’s no shortage of good things worth spending on.

Read more >>

Unions play their cards wrong in hopes for higher pay

You don't need to read much between the lines to suspect that Reserve Bank governor Dr Philip Lowe and his offsiders think the workers and their unions should be pushing harder for a decent pay rise.

Why else would he volunteer the opinion, in his testimony to a parliamentary committee on Friday, that average wage growth of 3.5 per cent a year would be no threat to the Reserve's inflation target?

This while employers are crying poor and Scott Morrison makes the extraordinary claim that big business needs a cut in company tax so it can afford to pay higher wages.

Why should Lowe care about how well the workers are doing? Because, as one of his assistant governors, Dr Luci Ellis, pointed out last week, our economic worries are shared by most of the other rich economies, except in one vital respect: they have reasonably strong growth in consumer spending, but we don't.

What's making our households especially parsimonious? No prize for remembering our world-beating level of household debt. Trouble is, consumer spending accounts for well over half the demand that drives economic growth.

Our economy won't be sparking on all four cylinders until consumption spending recovers, and that's not likely until our households return to annual wage growth that's a percent or more higher than inflation. That's why Lowe's encouraging workers to think bigger in their wage demands.

Even so, his proposed pay norm of 3.5 per cent, errs on the cautious side. That figure comes from 2.5 percentage points for the mid-point of the inflation target, plus 1 percentage point for the medium-term trend rate of improvement in the productivity of labour.

But 4 per cent a year would be nearer the mark because the trend rate of productivity improvement is nearer 1.5 per cent a year.

Even so, Lowe is acknowledging a point employers and conservative politicians have obfuscated for decades: national productivity improvement justifies pay rises above inflation, not just nominal increases to compensate for inflation (as is happening at present).

Lowe's concern that the present annual wage growth of about 2 per cent not be accepted as "the new norm" is an important point from behavioural economics: rather than calculate the appropriate size of pay rises based on the specific circumstances of the particular enterprise, as textbooks assume, there's a strong tendency for bargainers to settle for whatever rise most other people are getting.

That is, there's more psychology – more "animal spirits", as Lowe likes to say; more herd behaviour – and less objective assessment, in wage fixing than it suits many employers and mainstream economists to admit.

Which implies that, if the unions would prefer a wage norm closer to 4 per cent than 2 per cent, they should be doing a better job of managing their troops' fears and expectations.

In the Reserve's search for explanations of the four-year period of weak wage growth, it puts much emphasis on increased competitive pressure, present or prospective.

But in her speech last week, Ellis qualified her reference to the more challenging "competitive landscape" by adding ". . . or at least how it is perceived". Just so. It's about perceptions of reality.

It's easier for firms worried about a future of more intense competition to take the precaution of awarding minimal wage rises if they can play on their employees' own fears about losing their jobs to Asian sweatshops or robots or the internet.

There's little sign in the figures for business profitability that most firms couldn't afford much bigger pay rises than they're granting. But it's no skin off the employers' nose if their fears of future adversity prove exaggerated. Only their workers had to pay for the excessive fearfulness.

Workers - particularly those in industries with enterprise bargaining – are meekly accepting smaller pay rises than their employers' circumstances could sustain because the union movement has done too little to counter the alarmists telling their members they've lost the power to ask for more.

They've played along with the nonsense about 40 per cent of jobs being lost to robots, and that there's nothing to stop greedy businesses from making us all members of some imaginary "gig economy".

Worse, they've exaggerated the spread of "precarious employment" and encouraged the still-speculative belief that weak wage growth is explained almost exclusively by anti-union industrial relations "reform", which has stripped workers' bargaining power to the point where the right to strike has been lost.

Presumably, their game is to advantage their Labor mates by heightening disaffection with the Turnbull government, but this is coming at the expense of the economy's recovery, not to mention workers' pay packets.

Read more >>

How and Why we've escaped recession for so long

When Glenn Stevens took over from Ian Macfarlane as governor of the Reserve Bank in September 2006, both men knew the new boy was being handed a poison chalice.

By the time of the deep recession of the early 1990s, Australians – like the citizens of most developed economies – had got used to enduring a recession roughly every seven years.

But Macfarlane had been governor for 10 years, and had been extraordinary lucky to get through all that time without a severe downturn.

It was obvious to both men that Stevens wouldn't be as lucky. We were overdue for a recession and it was bound to occur sometime during Stevens' term, probably early on.

Except that it didn't. When, after his own 10-year stint, Stevens handed over to his government-chosen successor as governor, Dr Philip Lowe, in September last year, he was leaving the job with his record unsullied.

This time there were no forebodings about a doomed inheritance, even though it's only natural to fear that each successive quarter of this world record run must surely increase the likelihood of it coming to a sticky end.

Certainly, there would be few economists so foolhardy as to predict that their profession had finally conquered the booms and busts of the business cycle. Most remember that such bouts of hubris had afflicted – and in the end, mightily embarrassed – the dismal scientists before.

No one wants ultimately to be caught having made that stupid mistake a second time. So, a commercial message sponsored by your local friendly economist: rest assured, we'll have another bad recession sooner or later.

Human nature being what it is, keeping in the forefront of their minds the very real risk of another recession is the best way the managers of our economy can avoid the negligent overconfidence that could bring our record run to an ignominious end.

Of course, the politician with the strength of character to avoid complacency and self-congratulation for a remarkably good performance has probably yet to be born.

That's why this story began, and will continue, as a story about the people who have most say over the day-to-day management of the economy: not the politicians, but the bureaucrats in our central bank.

It's important to remember that Australia's run without a severe recession became a personal best, so to speak, many years ago, and for many years has exceeded the records achieved in all other developed countries – bar the Netherlands, with its freakish record of 103 quarters, almost 26 years, of continuous growth. Until now, as the world record passes to us.

An obvious question to ask is how Australia managed to avoid serious damage from the global financial crisis of 2008, when almost every other advanced economy was laid so low by the Great Recession.

The short answer is first that, thanks partly to the bureaucratic bum-kicking Peter Costello did after the collapse of the HIH insurance group in 2001, our bank regulators kept our banks under a tight rein, preventing them from doing all the risky things the American and European banks were allowed to.

Second, the Reserve Bank positively slashed interest rates the moment it realised the severity of the crisis, while the Rudd government ignored the dodgy advice it was getting from then-opposition leader Malcolm Turnbull and sections of the media, and splashed around a lot of cash.

Both the rate cuts and the cash splash had the intended effect of steadying the badly shaken confidence of businesses and consumers, thus quickly arresting the self-reinforcing downward spiral of fear and belt-tightening that causes all deep recessions.

Third, whereas many employers had previously responded to a downturn in demand for their product by laying off staff, this time many of them, hoping the downturn would be temporary, limited themselves to putting all their staff on a period of short-time working.

This restraint on the part of business proved a much less damaging approach for everyone.

But remember this: most advanced economies have suffered not one, but two or three deep recessions since the world recession of the early 1990s.

So there has to be more to our 26-year record than just our deft response to the GFC.

The deeper reasons for our success start with the factor already alluded to: our politicians' decision in the first half of the 1990s to hand control of interest rates to the central bank, acting independently of the elected government.

Turns out moving interests rates up and down in response to the business cycle, as opposed to the proximity of elections, is a big improvement in keeping the economy chugging steadily along.

The other beneficial change was all the "micro-economic reform" undertaken mainly during the term of the Hawke-Keating government, often with bipartisan support from the opposition, led by John Howard and Dr John Hewson.

Deregulating the financial system, floating the dollar, rolling back protection against imports, decentralising wage fixing and the deregulation of many particular industries had the combined effect of making the economy more flexible, less inflation-prone and better able to reduce unemployment.

The era of micro reform didn't achieve the hoped for continuing improvement in productivity, and had various adverse side-effects, but it did make it much easier for the central bankers to keep the economy on an even keel.

Read more >>

Depressed economists lose faith in capitalism

The nation's practicing economists are working themselves into a state over the future of the economy, convincing themselves the prospects for growth are dismal and the only answer is more "reform".

They're being rallied by former Treasury secretary Dr Martin Parkinson.

He told the National Reform Summit that Australia risked sacrificing as much as 5 percentage points of economic growth over the next 10 years, the equivalent of the production and income lost during a recession.

"Unless we grab this challenge by the horns and really get concrete about what are the priority issues, we are actually going to find ourselves sleepwalking into a real mess," he said.

There's a host of dubious assumptions hidden behind this stirring call to economic arms. For a start, how do we know we've got a problem? How do we know we're heading for a decade of slow growth unless the government acts?

We don't. We look at the below-trend growth in six of the past seven years and, as any economic illiterate would, simply extrapolate it for 10 years. But why stop at 10? Why not make it 40?

One of the shafts of enlightenment at the summit, we're told, came when a modeller from Victoria University challenged the inter-generational report's modelling that the productivity of labour would improve at an average annual rate of 1.4 per cent over the next 40 years. The rival modeller's modelling put it at less than 1 per cent.

Really? Talk about the biter bit. Rather than using their models to bamboozle the punters, economists are bamboozling themselves, mistaking an "exogenous" variable for an "endogenous" one.

Putting that in English, both the 1.4 per cent and the 1 per cent are merely assumptions, not a finding of the models. No economist knows what will happen to productivity over the next two years, let alone the next 40. And no model can tell them.

All the economists are doing is what any mug punter would do: relying on gut feel rather than science. You may be optimistic about the future, but I'm pessimistic.

They're making the economic illiterate's assumption that our recent weak growth is structural rather than cyclical. Sure, falling commodity prices are reducing our real income, but one day they'll stop falling.

Sure, we're making heavy weather of the transition from the resources boom, but one day it will have been made. Simple statistical theory should be telling economists that a protracted period of below-average growth is most likely to be followed by a period of above-average growth.

The next weird thing about the economists' bout of depression is their assumption that the economy will go nowhere without government intervention. It's as though they've lost their faith in capitalism.

The economy isn't a living organism whose growth and striving is driven by consumers' self-interest and producers' profit-seeking; it's more like a marionette whose animation depends on the Public Puppeteer continually jerking its strings.

Economic growth, it seems, is exogenous not endogenous. Really? What textbook did you read that in?

When you convince yourself, as many economists have, that the only way we'll see faster growth and further productivity improvement is for governments to engage in extensive reform, you've convinced yourself our economy is deeply dysfunctional.

Hugely inflexible and uncompetitive, highly protected, rife with cartels and lazy government-owned monopolies.

You're saying all the (unrepeatable) reform of the 1980s and '90s – floating the dollar, deregulating the financial system and a dozen industries, removing import protection, decentralising wage-fixing and privatising or corporatising public utilities – delivered a once-only productivity improvement but no lasting gain in efficiency, flexibility or dynamism.

There's nothing about those reforms that will help the economy grow in the future, you imply. Somehow in the intervening decade or so all those reforms have disappeared under a jungle of inefficiency; the jungle that's preventing us from ever returning to our former average growth rate.

So now you're threatening to slash your wrists unless the government trawls through all the second-string reforms not yet made and gets on with them.

Naturally, your best advice on how we can get productivity improving faster relies on the things economists think matter most: prices (including tax rates and the wage-fixing system) and intensifying competition (much of which would appal the Business Council and other industry lobbies).

And what do we get if we follow your advice? Another fleeting productivity improvement or something of continuing benefit?

Sorry, guys, but the propositions you're advancing are more like a high-pressure sales job than a rational analysis of our future opportunities and threats. Why don't you take a break and cheer up?

Read more >>

Debt-and-deficit brigade may bring us down

If the economy runs out of steam in the next year or two – and maybe even falls backwards – with unemployment climbing rapidly, there'll be plenty to share the blame: federal and state governments, federal and state Treasuries, and the utterly discredited credit-rating agencies.

The one outfit that will deserve little blame – but will get plenty – is the Reserve Bank. It shouldn't be criticised because it's had its monetary accelerator close to the floor for ages.

The official interest rate has been at or below 2.5 per cent for almost two years, but growth in real gross domestic product has remained stubbornly below trend.

If the economy does run out of puff it will be for a reason macro-economists have known was a significant risk for several years: the mining construction boom – which at its height accounted for about 8 per cent of GDP – is now rapidly coming to an end, with little likelihood that non-mining business investment (or anything else) will be strong enough to fill the vacuum it's leaving.

It's possible the Abbott government's surprisingly poor management of the economy is damaging business confidence, but the more powerful reason business isn't investing is simply that it has plenty of spare production capacity and doesn't see that expanding its capacity would be profitable.

So what can we do to reduce the risk of the economy losing momentum? It ought to be obvious. The Reserve has been dropping hints for months and earlier this month governor Glenn Stevens came right out and said it.

Fiscal policy – broadly defined to include state as well as federal budgets – needs to be pushing in the same direction as monetary policy (interest rates), not pulling against it. As Stevens pointedly noted, "public investment spending fell by 8 per cent over the past year".

Breaking down that contraction, it was caused by the states, not the Feds, with NSW by far the greatest offender. I suspect its poles-and-wires businesses have slashed their investment spending (no bad thing), with general government failing to take up the slack for fear of losing its precious AAA credit rating. So much for all last week's boasting about record infrastructure spending.

All this may have escaped the notice of Joe Hockey and his state counterparts – not to mention their federal and state Treasuries – but last week's statement by the International Monetary Fund's review team gave it top billing.

"The planned pace of [budgetary] consolidation nationally (Commonwealth and states combined) ... is somewhat more frontloaded than desirable, given the weakness of the economy, the size and uncertainty around the resource boom transition and the possible limits to monetary policy," the statement says.

"Increasing public investment (financed by more borrowing rather than offsetting measures) would support aggregate demand [GDP] and ensure against downside risks." Hint, hint.

"It would also employ [construction] resources released by the mining sector, catalyse private investment, boost productivity, take advantage of record-low borrowing rates, and maintain the government's net worth." Oh, that's all.

"Indeed, IMF research suggests that economies like Australia – with an output gap [spare production capacity], accommodative monetary policy and fiscal space – benefit most from debt-financed infrastructure investment, with the growth boost largely containing the impact on the (low) debt-to-GDP ratio."

The statement says the Feds should broaden the scope of investments they support – which may be, and certainly ought to be, a hint that they should be supporting urban public transport projects, not just yet more expressways.

And as well as direct funding, the statement says, the Feds could consider guaranteeing states' borrowing for additional investment, which "would keep accountability with the states but reduce their concerns about credit ratings".

That's one way to overcome the state governments' obsession with the credit ratings set by outfits that contributed greatly to the global financial crisis by granting AAA ratings to securities ultimately written off as "toxic debt".

State governments are letting these operators decide what's responsible and what's not? It's time state Treasuries stopped paying these characters to set arbitrary limits on borrowing for infrastructure spending, and state governments stopped putting retention or restoration of their AAA-rating status symbol ahead of their duty to provide their states with adequate infrastructure.

As for the Feds, Treasury should make it easier for its political masters to walk away from all their debt-and-deficit nonsense by abandoning its age-old objection to distinguishing between capital and recurrent spending.

These two artificial Treasury disciplinary devices – bulldust credit ratings and pretending all federal spending is recurrent – threaten to cause us to slip into an eminently avoidable recession. If that happens, we'll know who to blame.

Read more >>

Don't fix the budget while the economy is weak

We are hearing a lot of muddled thinking about how the Liberal Party's leadership ructions affect the budget and the economy, much of it coming from business people. For the sake of their businesses, they need to think more clearly.

There must be some truth to the idea that the political uncertainly is adding to the lack of business confidence, but the contention it's a big factor is dubious. "Confidence" is such an amorphous thing that you can say what you like about why it's up or down without anyone being able to prove you're wrong.

What's incontrovertible is that non-mining business investment spending isn't growing very strongly - not as fast as the Reserve Bank was hoping it would be by now, nor fast enough to offset the rapid slide in mining investment.

I think the main reason for this is simply that businesses don't see much need to expand at present: their sales aren't growing all that strongly and they're not about to run out of spare production capacity.

Any chief executive who has failed to take advantage of profitable investment opportunities because he's so worried about the instability in Canberra deserves the sack.

No, I think it works the other way round: because the economy's flat and you're waiting for an attractive investment opportunity to arise, you rationalise your inactivity by drawing attention to all the failings of the pollies supposed to be running the economy.

The danger with all this hand-wringing about "confidence" is that it's supposedly hard-headed business leaders resorting to wishful thinking: "if only we could have a change of prime minister, everything in the economy would be much better".

Part of the business angst has been worries about the budget: "it's vital we get the budget back to surplus to help the economy" and "it will be a terrible thing if Abbott tries to buy back some popularity by spending big in this year's budget".

Such comments reveal a weak understanding of the macro-economic basics. The budget isn't the economy. They're quite separate things and the fate of the economy matters far more that the fate of the budget and the size of the government's debt.

Getting the budget back to surplus within a year or two wouldn't make the economy grow any faster. In fact, it would make growth much slower. You'd have to let budget deficits roll on for at least another decade before you got to the point where it was damaging the economy.

Its main downside would be a level of public debt so high it made the government reluctant to add to it by using the budget to stimulate the economy out of a recession. At some point the government's credit rating might be downgraded, but the fear of downgrades is exaggerated. Its blow to the government's ego would be greater than the cost to taxpayers or the economy.

The budget and the economy are interrelated, of course, but it's a two-way relationship. People know the budget affects the economy: cut taxes and increase government spending and you'll make the economy expand faster; raise taxes and cut spending and you'll slow the economy down.

The bit many don't get is that the economy also affects the budget. Stronger growth in the economy leads to faster growth in tax collections and so reduces a budget deficit, whereas slow growth hits tax collections and so worsens a budget deficit.

That's where we are now. The prospective budget deficits over the coming three or four years are now much higher than they were when Joe Hockey took over as Treasurer. That's partly because of the budget measures blocked by the Senate, but mainly because commodity prices have fallen much more than expected and tax collections are growing much more slowly than expected.

The point is, to start slashing and burning in this year's budget would give the economy another kick in the guts, which would slow growth even further and probably make the deficit bigger rather than smaller.

This is precisely why, contrary to popular impression, the big cuts proposed in last year's budget weren't intended to really kick in until 2017, by which time it was hoped the economy would be back to growing strongly.

We now know the return to strong growth will be delayed. That's why the Reserve Bank cut interest rates again. But even the Reserve admits that, at such low levels, monetary policy isn't as effective as it was in stimulating growth.

That's why what we should be thinking about is whether the budget ought to be used to support the economy further by investing in more infrastructure projects.

Read more >>

Hockey risks scaring off consumers

You can never be sure what a fall in the measures of consumer confidence actually proves, but if I were Joe Hockey I'd be a bit worried. If he keeps on playing tough guy he may frighten people into clamping their purses shut.

We learnt last week that the Westpac-Melbourne Institute index of consumer sentiment fell by 3 per cent this month, down 9.5 per cent from its election-time high. Optimists now barely outnumber pessimists, the worst result since July.

I'm a great believer in the central role of business and consumer confidence - their alternating moods of optimism and pessimism - play in driving the ups and downs of the business cycle. As the Rudd government demonstrated with its remarkably deft response to the global financial crisis, managing psychology is probably more important that actual stimulus spending.

Trouble is, we don't seem able to measure consumer confidence with any accuracy. The index of consumer sentiment is an unreliable predictor of consumer spending. And there's reason to fear it tells us more about the state of politics than the state of the economy.

People who intend voting for the government of the day are invariably far more optimistic about the economy than people who intend voting for the opposition. This could mean people's views on how well the economy is being managed determine whether they intend to vote for government or opposition.

But Labor voters switched from pessimistic to optimistic and Coalition voters from optimistic to pessimistic the moment Kevin Rudd won the 2007 election, then the positions were reversed when Tony Abbott won in September. Seems clear it's people's political loyalties that drive their views about the state of the economy.

Even so, the fall in confidence since the election does seem to be explained by people's growing worries about losing their jobs. The related Westpac-Melbourne Institute unemployment expectations index worsened by 2.3 per cent this month, and by 9.2 per cent since September.

In a rational world people would judge their risk of unemployment from the monthly labour force figures, which, although they show unemployment worsening marginally to 6 per cent last month, aren't so frightening.

In the real world, however, the punters judge their risk of joblessness from the frequency of stories about factory layoffs on the TV news. All the fuss about the successive decisions of Ford, Holden and now Toyota to cease car-making in Australia, plus bad news about other manufacturers, Telstra and Qantas seems to have put the wind up a lot of people.

An Essential opinion poll shows respondents nominating unemployment as their greatest economic concern. Add all Hockey's efforts to soften us up for a tough budget and it's hardly surprising pessimism is spreading.

Note that, as part of this non-rational response, news that factories will close in three years' time is coded as jobs lost this week. Job losses in manufacturing get three times the publicity of jobs lost elsewhere, and jobs losses in the public sector worry no one in the private sector.

The Reserve Bank believes rising house prices are a helpful development, spurring people to get on with their housing plans before prices rise further, and also making home owners feel wealthier and so willing to lower their rate of saving and increase their rate of consumption spending.

This ''wealth effect'' would boost consumption even though incomes won't be rising strongly because growth in employment and wages will be weak.

But the proportion of consumer sentiment respondents believing it's a good time to buy a dwelling has fallen 10.8 per cent from its September peak. And Saul Eslake, of Bank of America Merrill Lynch, differs with the Reserve by believing house price rises are unhelpful.

He points out that renters are significantly less optimistic than mortgagers and outright home owners according to the consumer sentiment index, with tenants' confidence falling harder over the past year.

While it was true in the pre-GFC world that households responded to their rising (paper) wealth by slashing their rate of saving, Eslake doubts it will happen this time, mainly because household debt remains very high as a proportion of disposable income.

In the end, you can ''monetise'' rising paper wealth only by borrowing against it. And people with a lot of debt who are starting to worry about whether they'll keep their jobs are much less likely to resume borrowing.

This is something Hockey should remember when the econocrats tell him retail sales are growing more strongly since the election and that stronger home building approvals presage a rise in dwelling construction.

If Hockey's budget toughness - rhetorical and otherwise - adds to the punters' anxieties, his big political vindication could delay the return to strong employment growth.

Read more >>

Big change in party, little in policy

Coalition supporters rejoice! The evil incompetents have been banished and the good guys are back in charge. But don't get too excited because by the time we reached polling day many illusions about the difference a change of government would make had been shattered.

A standard delusion of election campaigns is that the Coalition portrays itself as standing for lower taxes, higher spending and lower budget deficits.

And Tony Abbott seemed to be cutting taxes big time, abolishing the carbon tax and the mining tax and cutting the company tax rate to 28.5 per cent.

But now we finally have the Coalition's full costings we see how far the reality falls short of the headline.

Its tax cuts will cost about $20 billion over four years (in cash terms), but its offsetting levy on big companies and reversal of Labor tax breaks - mainly on superannuation and small business - will claw back about $14 billion over four years.

And that's before you count the unlegislated Labor tax increases Abbott will put into law - including the increases in the Medicare levy and cigarette duty, and the new tax on bank accounts - worth about $28 million over four years.

Don't sound like lower taxes to me.

But surely the most disillusioning thing for Liberal true believers is the way five years of railing against Labor's utterly wasteful spending, never-ending budget deficits and soaring debt levels was simply cast aside over the course of a five-week campaign.

When, just before the campaign began, Labor was forced to reveal the deficit would be worse before we returned to surplus in another four years' time, the Libs proclaimed this a ''budget emergency''.

But then, just two days before polling day, they revealed their response to this emergency, which turned out to involve a net reduction in the cash deficit of just $6 billion over four years. On Treasury's projections, cumulative future deficits of a further $55 billion will now be a mere $49 billion and the return to surplus not a day earlier. Yippee.

Let me be clear: I wholeheartedly agree with the Liberals' last minute pull-back from resort to fiscal austerity. But then I was never taken in by their five years of frightening the fiscally illiterate.

What's supposed to be next on the agenda of a new government is a first look at the books, the amazed discovery it's all much worse than their predecessors let on, and the regretful announcement that this fiscal crisis necessitates a huge round of cost-cutting and the breaking of ''non-core'' promises.

Sorry, this ain't gunna happen, either. Why not? Mainly because Peter Costello's charter of budget honesty and, in particular, his instigation of the econocrats' pre-election economic and fiscal outlook statement was specifically designed to ensure he was the last treasurer able to pull that stunt.

If you've read the PEFO you've already seen the books.

But Abbott is further locked in by his repeated resolutions not to break his promises. He's even promised to let the deficit blow out rather than break a spending promise.

Labor claimed the planned ''commission of audit'' will be used as the vehicle for big spending cuts, but this was just its retaliatory scare campaign.

All past Coalition audits have been performed by purist economic rationalists who make radical recommendations no government would dream of accepting.

These and other promised inquiries (44 in Abbott's case) are just a device to get party hard-liners off a Coalition leader's back before elections.

There are just three main respects in which Abbott's policies are significantly different to Labor's.

First, the redistribution of the burden of taxation and the benefit of government spending against the Labor (and, for that matter, National Party) heartland and in favour of the Liberal heartland.

Second, the move from a market-based response to climate change to a pretend response. The campaign revealed a cap on ''direct action'' spending that means Abbott's professed bipartisan commitment to a 5 per cent reduction in emissions by 2020 is a sham.

Third, a marked improvement in business confidence now the socialist hordes have been vanquished.

This is the one delusion that remains from the rubble of an election campaign by the Liberals' most populist and least rationalist leader in a generation.

Fortunately, its delusory nature shouldn't stop it giving the economy a genuine boost as business ends its three-year-long dummy spit.

Today's return to real life will end one more illusion that accompanies every campaign: that it's governments who do most to manage the economy not the unchanging econocrats of the Reserve Bank.

There could be no more powerful reason why the change of government will change surprisingly little.

Read more >>

The jobs will come, as they always have

I can't make myself sleep on the long plane trip to or from Europe. These days I just keep myself distracted by the plane's entertainment system. Returning at the weekend from a walking holiday in England, I really enjoyed rewatching the Jack Nicholson movie As Good As It Gets, with its theme tune, an American-sanitised version of Always Look on the Bright Side of Life.

In Australia we're usually a land of bright-siders, though this hardly makes us unique. It's actually this optimism about the future that keeps our economy moving onwards and upwards.

At present, however, we're looking on the dark side. Until recently it was fashionable to complain that, whoever was benefiting from the resources boom, it wasn't you or me. These days, the worry is that with the initial stages of the resources boom passing its peak, it's hard to know where the growth and the jobs will be coming from.

Did you detect the logical inconsistency between those two worries? They can't both be true. If most of us gained nothing from the boom, most of us have little reason to mourn its departure. All the two positions have in common is their pessimism.
Advertisement

Yet despite all the political and economic commentary to which we're exposed, it took a speech last week from Reserve Bank governor Glenn Stevens to point out the contradiction.

The truth is you and I got plenty of benefit from the resources boom. The reason so few of us realise it is that most of those benefits were indirect. We often have trouble joining the economic dots.

One of the most easily detected indirect benefits of the boom is the high dollar which, among other things, has made it so much cheaper for us to take overseas holidays (and, until recently, left the world crawling with Aussie tourists).

Now, with the resources boom receding and the American economy finally picking up, the dollar is coming down again, allowing those who never acknowledged the high dollar's benefit to complain about its departure.

But the trick is that everything that happens in the economy - whether popularly judged to be good or bad - has both advantages and disadvantages. So to every seemingly good thing that happens there's always a downside, while to every bad thing there's an upside.

The disadvantage of the high dollar was that it made it harder for Australian businesses to compete on export markets and against imports in the domestic market. So the advantage of a lower dollar is that it takes pressure off a lot of Australian businesses - not least of which are our tourism operators - making it easier for them to expand their sales and employment.

When I was younger I used to dread times like this, where the economy was looking flat and everyone was demanding to know where the jobs would be coming from. How should I know?

Usually that question is asked in the later stages of a severe recession, when people are depressed and doubtful whether the economy has a future. We haven't had a severe recession for more than 20 years - a record for us and better than any other rich country can say - and yet we're feeling down. (Sometimes I think we're feeling down precisely because so many of us have no recollection of what genuine economic hardship feels like.)

By now, however, I no longer dread being asked where the jobs will be coming from. I know from the experience of three severe recessions that there's always a tomorrow. I don't know the precise details, but I do know the jobs will come. Always have in the past and no reason to doubt they will again.

What's more, in this case past performance does offer a reasonable guide to the future. As Stevens reminded us in last week's speech, over the 21 years to mid-2012, our production of goods and services roughly doubled. Only 3 percentage points of that 100 per cent increase came from manufacturing.

The largest contributions came from financial services (13 percentage points), mining (10 points), construction (9 points), professional services (8 points) and healthcare (7 points).

But though production and employment are related, they're not the same, with some industries being a lot more labour-intensive than others. Over the same period the number of jobs in the economy has increased by about half. About two-thirds of this increase is attributable to growing employment in the provision of various kinds of services to businesses and households.

There's been growth across the board in services sector employment, but healthcare accounts for 9 per cent of the increase and professional services for 7 per cent.

One beauty of the services sector is that it provides unskilled jobs - for waiters, cleaners, shop assistants and the like - but also, and increasingly, highly skilled jobs for managers, medicos, teachers, lawyers and all manner of professionals and para-professionals.

So that's where the jobs will come from, and come they will. It's not the government's job to ''create'' those jobs any more than it was its job to conjure up the resources boom. That's the job of business and, indirectly, households.

It will happen when businesses and householders get their confidence back - which we can be sure they will. What we can't be sure of is that this will happen on cue.

Read more >>

News on economy not as bad as it sounds

Good grief! It seems all the news about the economy this week has been terrible. Is the roof about to fall in?

First we heard consumer confidence took a 7 per cent hit after Treasurer Wayne Swan's all-bad-news budget, then we hear the sharemarket has taken a dive because the Americans can't decide whether things are getting better or still as bad as ever.

By now the dollar's down about US6c. New figures show the mining investment boom is no more and, to top it off, we hear Ford is ceasing production with up to 10,000 jobs to go.

So, is the roof falling in on the economy?

Fortunately, it's not as bad as it sounds. My guess is the economy will continue motoring along (sorry), not doing brilliantly but not doing too badly either.

Let's put the bad news in context. For a start, the ups and downs in measures of consumer confidence must mean something, but they are an unreliable guide to the prospects for consumer spending.

We all know the sharemarket goes up and down from one day to the next, and of late there has been more up days than down.

The fall in the dollar might be bad news for people planning overseas holidays or buying imported goods, but it's good news for our hard-pressed manufacturers and tourist operators. My fear is it won't last.

Ford might have announced its closure this week, but it won't actually happen for another three years. That gives its workers plenty of time to find new jobs.

In any case, our workforce of 11.6 million often grows by 10,000 or more in just a month. That might sound like a lot of jobs but, compared with the size of our economy, it's microscopic.

The economy's been growing at an average rate of 3 per cent a year. That's been enough to hold unemployment below 5.5 per cent, though it's true the budget expects the economy to slow a fraction in the coming financial year, thereby allowing unemployment to creep up to 5.75 per cent by next June.

It's true the end of the mining boom is likely soon to be reducing rather than adding to the economy's growth, but that is why the Reserve Bank has been cutting interest rates back to their lowest since the global financial crisis: to encourage borrowing and spending on consumer durables, housing and business investment.

And remember this: every time we get a new government hope springs eternal and people cheer up, with punters spending more and businesses investing in renewal and expansion.

How long the good mood lasts depends on the new government's performance, of course.

Read more >>

Why voters seen the economy as in bad shape

Despite last week's excitement, Julia Gillard's early announcement of the election date is unlikely to change much. It's certainly unlikely to change many voters' perceptions on a key election issue: her ability as an economic manager.

It's long been clear from polling that the electorate doesn't regard the government as good at managing the economy.

Why this should be so is a puzzle. As Gillard rightly claimed last week: "As the global economy still splutters, unlike the rest of the world we have managed our economy so we have low inflation, low interest rates, low unemployment, solid growth, strong public finances and a triple-A rating with a stable outlook from all three of the major ratings agencies."

I've said elsewhere that part of the reason for this yawning gap between perception and reality is that many people's perception of how well the economy's being managed proceeds not from independent observation but from their political alignment. Once I know who I'm voting for I then know whether or not the economy's travelling well.

But there's another part of the explanation: the public's inability to distinguish between cyclical and structural factors. Most of the bad news we heard last year was structural in nature, meaning it changed the shape of the economy rather than its overall size, adversely affecting some parts but favourably affecting others and having little effect on most.

But such analysis is too subtle for most punters. To them, all news is cyclical: good news means the economy's on the up and up; bad news means it's going down and downer.

Add the media's inevitable predilection for trumpeting bad news, underplaying good news and totally ignoring anything that doesn't change, and structural change can't help but be perceived as an economy in trouble.

The resources boom is the classic case of structural change. It's in the process of giving us a bigger mining sector and bigger non-tradeable services sector, but a relatively smaller manufacturing sector and internationally tradeable services sector.

The mechanism that brings much of this about is the high dollar. It harms all export- and import-competing industries, but benefits everyone who buys imports (which is all of us). It marginally benefits three-quarters of our industries, which are non-tradeable (they neither export nor compete against imports) but do buy imported supplies and equipment.

Now consider the recent performance of unemployment. Over the year to December, the unemployment rate rose from 5.2 to 5.4 per cent.

Admittedly, the rate at which people of working age were participating in the labour force by holding a job or actively seeking one fell from 65.3 to 65.1 per cent. This decline in participation is probably explained mainly by some people becoming discouraged in their search for a job.

Even so, it's surprising people became a lot more worried about unemployment last year. Why did they? Because they get their impressions about the state of the labour market not from the official statistics but from stories on the TV news about people being laid off from factories.

If voters were more economically literate they'd respond to this news by thinking, "Gosh, isn't manufacturing being hit hard by the high dollar - but fortunately I don't work in manufacturing and only 8 per cent of workers do." What many actually thought was: "Gosh, maybe I could lose my job, too."

Thus was a structural problem affecting only a small part of the economy taken to be a cyclical, economy-wide problem.

It's a similar story with the much-publicised tribulations of the retailers, which arise from their need to adjust to various structural problems, such as the inevitable end to the period in which household spending grew faster than household income, and the rise of internet shopping.

With all the silly talk about "the cautious consumer" and with punters blissfully unaware that retailing accounts for only about a third of consumer spending, all the highly publicised complaints of the Gerry Harveys helped convince the public not that the retailers have their own troubles but that the economy must be going down the tube.

Then there's the contribution of the unending fuss about "debt and deficit", in which the government has been completely outfoxed by the Liberals.

Although every economically literate person knows Australia doesn't have a significant level of public debt, the opposition has had great success exploiting the public's ignorance of public finance and of just how big the economy is ($1.5 trillion a year) by quoting seemingly mind-boggling levels of gross public debt.

With much of this argy bargy being reported by political rather than economic journalists - how many times have you heard talk of "the economy's deficit"? - it's hardly surprising the public has acquired an exaggerated impression of the economic significance of the budget deficit.

Ironically, the budget deficit is a case where a cyclical (temporary) problem has been taken to be a structural (long-lasting) one.

But Labor has to accept much of the blame for this bum rap. Rather than standing up to the nonsense the Libs were talking, it took the path of least resistance, purporting to be just as manic as they were. Then came Gillard's foolhardy decision to take a mere Treasury projection of the budget outcome in three years' time and elevate it to the status of a solemn promise.

By now, the voters' majority perception that the economy's in bad shape and Labor isn't good at managing it is deeply ingrained.

Read more >>

How the financial system works

It’s amazing to think the mighty, mysterious, overawing edifice of high finance - run by people much smarter and infinitely better-paid than us - is built on a pathetically simple, often fickle emotion: trust.

This is something economists and bankers understand in theory but, in their world of high-falutin’ mathematical models, keep forgetting in practice - to everyone’s cost. In this they exhibit the very human fallibility they so often assume away in their fancy calculations.

It’s also so elemental - and so humbling - they rarely talk about it. So when someone in authority spells it out for the benefit of mere mortals, it’s work taking note. An assistant governor of the Reserve Bank, Dr Guy Debelle, did so in a speech last week.

He started by explaining what banks and the financial sector do. They act as ‘intermediaries’ between savers and borrowers, taking the funds they raise from savers - through deposits, for instance - and lending them to those who wish to borrow, whether they’re businesses, governments or householders.

The financial sector is an intermediate sector, Debelle says. It’s not at the end of a production chain producing something that directly generates satisfaction. Rather, it’s a critical link along the way; the oil that keeps the economy ticking over. ‘When the oil dries up,’ he says, ‘the economic engine starts to malfunction and can ultimately grind to a halt.’

So the financial sector is different from other parts of the economy and its central role in keeping the rest of the economy functioning explains why it’s subject to considerably more government regulation and oversight than other industries (something many governments forgot in the years before the global financial crisis).

But why do we need financial intermediaries? Why don’t savers lend to borrowers directly? Mainly because of ‘asymmetric information’. This just means I know more about my affairs than you do. It’s hard for a saver to know whether the person or business to which they’re going to lend money will use the money wisely and be in a position to repay the loan when it falls due.

In contrast, a bank is practiced at making such an assessment of credit-worthiness and so can reduce (but never eliminate) the degree of asymmetry. The size of the interest rate charged by the bank should reflect its assessment of the degree risk of not being repaid.

The other main advantage of lending via intermediaries is their scope for ‘diversification’ - making a range of different loans to people or firms in different circumstances means the bank should not be overly exposed to a particular loan going bad.

So banks are able to ‘mutualise’ risk in a way individual savers can’t. ‘If there is a problem with one loan, the lender should be earning sufficient interest on the rest of its loan portfolio to cover the loss,’ Debelle says.

Now we see where trust comes into it. Largely because of the problem of asymmetric information, there has to be trust between depositors and the bank that their funds are safe. And there is trust between the bank and its borrower that the borrower has provided accurate information and will act in good faith.

Trust is needed to cover the asymmetry that remains despite the ‘due diligence’ of the depositor in assessing the riskiness of the bank and of the bank in assessing the riskiness of the borrower.

Trust is particularly important because banks engage in ‘maturity transformation’ - in the jargon, they ‘borrow short and lend long’. Banks will let you deposit your money ‘at call’ (you can withdraw it at any time) but, on the other hand, will lend this money for periods up to 30 years.

Were too many depositors to lose trust in their bank at the same time, it would not be able to call in all its loans and so would not be able to return the depositors’ money. To prevent such a thing occurring, central banks stand ready to lend to banks if they need it. The trust in these arrangements is almost always enough for them not to be needed, Debelle says.

Banks don’t always hold on their own books all the risk (debt) they’ve taken on, but use devices such as ‘securitisation’ (bundling many consumer loans into a bond, which is then sold to investors) to distribute the risk around the financial system.

This means the process of financial intermediation often has a number of links in the chain. This, in turn, means trust needs to be present at every stage in the chain. ‘One breakdown in this chain of trust between ‘counterparties’ can throw a spanner in the works of the whole process,’ he says.

Guess what? The global financial crisis can be explained as a consequence of the breakdown of trust.

The years leading up to the crisis were a period of what Debelle calls ‘lazy trust’. Things were going along fine, so too many people relaxed their due diligence. Too many borrowers were taken at their word, without checking.

‘Moreover, with long chains of intermediation involved, there was often too much distance between the ultimate holder of the risk and the source of the risk. Too many links means that details get lost or misheard. If the due diligence is necessarily incomplete by the very nature of financial transactions, then that incompleteness is likely to get magnified, the more chains there are in the transaction.

‘The due diligence gets dissipated along the chain. There is a presumption that someone further up the chain did the due diligence.’

Such behaviour was anything but rational. As Debelle concedes, ‘good times beget complacency’. ‘It does seem to be a trait of human behaviour that has been evidenced many times in financial history.’

Lazy trust evaporated. The financial system switched rapidly from complacency to deep mistrust. In particular, trust broke down between financial institutions. Knowing they had a lot of bad loans on their own books, institutions assumed the same was true of their competitors, though to an unknown extent.

Institutions stopped lending to each other, so intermediation broke down. Central banks had to step in and provide banks with the funds they needed. This is still true in Europe, and a lack of trust in the longevity of the euro has made people unwilling to lend even to some governments.

The trouble now is that trust can be quickly and easily shattered, but takes a long time to rebuild.

Read more >>

OK gloomsters, let's run some worst-case scenarios

In the long boom before the global financial crisis, when economists convinced themselves they'd achieved the Great Moderation and everyone was confident the good times would roll on forever, anyone who thought they saw a problem looming was either ignored or dismissed as a fool.

In the North Atlantic economies' continuing agonies since the crisis, it's been roughly the reverse. Excessive optimism has swung to excessive pessimism and anyone who thinks they see a problem looming gets a microphone and loud speaker stuck in front of their face.

Now it's the people who don't think the end is nigh who tend to be ignored. Our cyclical switch to pessimism is being compounded by the media's natural bias in favour of bad news and the tendency of people who dislike the Gillard government to believe everything in the economy has gone to hell.

One person who thinks things aren't as bad as they're being painted is Glenn Stevens, governor of the Reserve Bank. He gave a speech this week in which he begged to differ with the doomsayers. The cogent arguments he advanced deserve more attention than they've been given.

When it comes to dark forebodings, first prize goes to fears of a break-up of the euro. But worries about a hard landing in China are now coming second. Stevens examines the figures and concludes they show "Chinese growth in industrial output of something like 10 per cent, and gross domestic product growth in the 7 to 8 per cent range. To be sure, that is a significant moderation from the growth in GDP of 10 per cent or more that we have often seen in China in the past five to seven years."

But not even China can grow that fast indefinitely and there were clearly problems building up. It's far better the moderation occurs, he argues, if this increases the sustainability of future expansion.

What's more, the Chinese authorities have been taking well-calibrated steps in the direction of easing macro-economic policies, as their objectives for lower inflation look like being achieved and as the likelihood of slower global growth affecting China has increased.

Next he responds to the pessimists' greatest fear of disaster in the domestic economy: a collapse in house prices. He's not convinced they're overvalued by our historical standards. And while, expressed as multiples of annual household disposable income, they seem very high compared with American prices, they are within the pack of other developed countries. It's the US that seems out of line.

But Stevens emphasises he's not saying there's no possibility house prices will fall. "It is a very dangerous idea to think that dwelling prices cannot fall," he says. "They can, and they have." But the ingredients you'd look for as signalling an imminent crash seem even less in evidence now than five years ago.

"Even though we don't face immediate problems, we should ask: what if something went wrong?"

OK, so let's look at some worst-case scenarios. If the thing that goes wrong is a "major financial event" emanating from Europe, he says, the most damaging potential transmission channel would be if there were a complete retreat from risk, capital market closure and funding shortfalls for financial institutions.

This would be a problem for many countries, of course, not just us. But in that event the Aussie dollar might decline, perhaps significantly.

"We might find that, in an extreme case, the Reserve Bank - along with other central banks - would need to step in with domestic currency liquidity, in lieu of market funding. The vulnerability to this possibility is less than it was four years ago; our capacity to respond is undiminished and, if not actually unlimited, is not subject to any limit that seems likely to bind."

An alternative version of this scenario, if it involved the sort of euro break-up about which some people speculate, could be a flow of funds into Australian assets. In that case our problem might be not being able to absorb that capital. But that means the banks would be unlikely to have serious funding problems.

If the thing that went wrong was a serious slump in China's economy, the Aussie would probably fall, Stevens says, which would provide expansionary impetus to the Australian economy. But more importantly, we could expect the Chinese authorities to respond with stimulatory measures.

"Even if one is concerned about the extent of problems that may lurk beneath the surface in China - say in the financial sector - it is not clear why we should assume that the capacity of the Chinese authorities to respond to them is seriously impaired.

"And in the final analysis, a serious deterioration in international economic conditions would still see Australia with scope to use macroeconomic policy, if needed, as long as inflation did not become a concern, which would be unlikely in the scenario in question."

Next, what if house prices did slump after all? In such a scenario people typically worry about two consequences. The first is a long period of very weak construction activity, usually because an excess of housing stock resulting from previous over-construction needs to be worked off. But we've already had a long period of weak residential construction and it's hard to believe it could get much weaker at the national level.

The second common worry is about what a slump in house prices would do to the balance sheets of the banks and other lenders. But this scenario is regularly covered by the Australian Prudential Regulation Authority in its "stress-testing" of the banks.

"The results of such exercises always show that even with substantial falls in dwelling prices, much higher unemployment and associated higher levels of defaults, key financial institutions remain well and truly solvent."

Stevens points out that a lot of the adjustments we're complaining about at present - including households' higher and more normal rates of saving, a more sober attitude towards debt, the reorientation of the banks' funding away from short-term foreign borrowing, and weak house prices - are strengthening our resilience to possible future shocks.

"The years ahead will no doubt challenge us in various ways, including in ways we cannot predict. But what's new about that? Even if the pessimists turn out to be right on one or more counts, it doesn't follow that we would be unable to cope.

"Acting sensibly, with a long-term focus, has as good a chance as ever of seeing us through," Stevens concludes.

Read more >>

How our political prejudices affect confidence

I've realised we won't be satisfied with the state of the economy until the Liberals get back to power in Canberra. That's not because Labor's so bad, or because the Libs would be so much better, but because so many people have lost confidence in Labor as an economic manager.

The conundrum is why so many people could be so dissatisfied when almost all the objective indicators show us travelling well: the economy growing at about its trend rate, low unemployment, low inflation, rising real wages, low government debt - even a low current account deficit.

And yet the media are full of endless gloom, not to mention endless criticism of the Gillard government. Last week the NAB indicator of business confidence dropped to a 10-month low. And while the Westpac-Melbourne Institute index of consumer confidence recovered almost to par, that's a lot weaker than it ought to be.

Admittedly, the good macro-economic indicators do conceal a much greater than usual degree of structural adjustment going on. But these adjustments - which are generally good news for consumers - seem to be adding to the discontent rather than the root cause of it.

The Gillard government has been far from perfect in its economic policy, but you have to be pretty one-eyed to judge its performance as bad. Similarly, only the one-eyed could believe an Abbott government would have much better policies. It's likely to be less populist in government than it is opposition but, even so, Tony Abbott is no economic reformer.

Gillard's problem is not bad policies, it's Labor's chronic inability look and act like our leader and command the public's respect and comprehension. This is a government that doesn't believe in much beyond clinging to office, and the punters can smell its lack of principle.

To be fair, on the question of economic competence Labor always starts way behind the ball in the public's mind. Decades of polling reveals the electorate's deeply ingrained view the Libs are good at running the economy and Labor is bad.

This is what feeds both the Libs' born-to-rule complex - their utter assurance that all Labor governments lack legitimacy - and Labor's barely concealed inferiority complex.

The Hawke-Keating government did manage to turn the electorate's conventional wisdom on economic competence around for most of its 11-year term.

Labor in its present incarnation has never been able to pull this off. It's lost its race memory of how to govern. All this is compounded by the manner of Gillard's ascension, her non-maleness, her inability to make the punters warm to her and the uncertainties (and broken promises) of minority government. But the problem was apparent before Labor decided it could stomach Kevin Rudd no longer.

It's true the media environment is more unhelpful than it was in Hawke and Keating's day. Increased competition has made the media more relentlessly negative - more uninterested in anything but bad news - which must eventually have some effect on the public's state of mind.

In their search for a new audience in response to the challenge of the digital revolution, part of the media has become more partisan and more unashamedly hostile to all things Labor.

You see this in the radio shock jocks, but also in the national dailies, which have adopted the Fox News business model of telling a section of the potential audience what it wants to hear, not what it needs to know.

It seems a universal truth of the commercial media that the right-leaning audience is both more numerous and better lined than the left-leaning.

So, for instance, a favourite commercial tactic at present is to search for, and give false prominence to, all stories that portray our almost-dead union movement as a threatening monster about to engulf big business.

Boosting productivity equals making industrial relations law more anti-union. End of story. When Treasury people give speeches that fail to echo this infallible truth it's a clear sign they've been "politicised" and we need to find a few hyper-ideological economics professors to misrepresent what they said.

When Hawke and Keating were in power, business leaders judged it wise to keep their natural political sympathies to themselves and work with the elected government.

But with Gillard so far behind in the polls, so ineffective in maintaining relations with big business, with the general media so anxious to accentuate the negative and a significant part of the serious press telling them how badly they're being treated and holding out a microphone, it's not surprising big business people have become so unusually vocal in their criticism of Labor.

When God's in his heaven and the Libs rule in Canberra, business people jump on anyone they consider to be "talking the economy down". But so great is their loathing of the Gillard government that business is leading the chorus of negativity. How they see this as in their commercial interest I'm blowed if I know.

While John Howard was in power, the index of consumer sentiment showed respondents who intended voting for the Coalition to be significantly more confident about the economy than those intending to vote Labor. At the time of the 2007 election, however, the two lines crossed and Labor voters became significantly more confident than Coalition voters.

The latest figures show the overall confidence index at 99, while the Labor voters' index is up at 124 but the Coalition voters' index down at 79. Since Coalition voters far outnumber Labor voters, it's clear a change of government would do wonders for measured consumer confidence.

The same would probably be true for measured business confidence. Suddenly, business would be back talking the economy up, and the partisan media would revert to backing up our leaders rather than tearing them down.

But how much difference that would make to the objective economic indicators is another question.

Read more >>

Present gloom is more political than economic

The release of two downbeat indicators of business and consumer confidence last week serves only to deepen the puzzle over the gap between how we feel and what the objective indicators are saying about the state of the economy.

My theory is we have two-track minds. Many of us are thinking gloomier than we’re acting.

As you recall, the national accounts from the Bureau of Statistics show real gross domestic product growing by a remarkable 1.3 per cent in the March quarter and a rip-roaring 4.3 per cent over the year to March.

The bureau’s latest labour force figures, for May, show employment growing by an average of 25,000 a month over the first five months of this year, with much of the growth in the ‘non-mining’ states.

I never take the initial reading of frequently revised estimates too literally. The governor of the Reserve Bank, Glenn Stevens, has noted the annual growth figure is probably inflated by a catch-up effect following the disruption to economic activity caused by the Queensland floods early last year. He’s willing to say only that the economy’s travelling at about ‘trend’ (3.25 per cent a year).

Now Dr Chris Caton, of BT Financial Group, has advanced his own theory to explain the surprisingly strong 1.3 per cent growth in the March quarter. He notes the inclusion of a leap day in the quarter - so it contained 91 days rather than the usual 90 - may have thrown out the bureau’s seasonal adjustment process.

Some components of GDP would have been adjusted for this ‘trading-day effect’, but many may not have. Sounds far fetched? Caton looked back over the five previous leap years, finding the March quarter growth figure exceeded the average rate of growth for the three preceding and three subsequent quarters in four of those years, with the excess for the five years averaging 0.46 percentage points.

But even if you accept Stevens’s judgement the economy’s growing at about trend - which I do - you’re still left saying it’s doing a lot better than implied by the gloominess of business and consumer confidence as we conventionally measure them.

NAB’s business survey for May showed business conditions (the net balance of respondents regarding last month’s trading, profitability and employment performance as good) fell to their weakest level in three years.

To put this in context, the conditions index is now 5 points below its long-term average since 1989, but nothing like as bad as it got during the global financial crisis of 2008-09, let alone the recession of the early 1990s.

The index of business confidence (how the net balance of respondents expects conditions to change in the next month) is saying something roughly similar. NAB says the survey implies GDP growth will slow to an annualised 2 per cent in the June quarter.

The Westpac-Melbourne Institute index of consumer sentiment rose a fraction in June to 96, down almost 6 per cent on a year earlier. It’s pretty low, though at nothing like the depths to which it sank in 2008-09.

The overall index can be divided into two bits, the current conditions index and the expectations index. In June the conditions index rose by 6 per cent, whereas the expectations index fell by 4 per cent. And whereas the conditions index stands at 104, the expectations index is a 90.

I’m a great believer that the mood of consumers and business people does a lot more to drive the business cycle than it suits most economists to admit (because their theory tells them little about what drives confidence and, in any case, it’s not easy to be sure what you’re measuring).

So it pains me to admit that, at present - and not for the first time - the conventional confidence indicators seem to have been bad predictors of what HAS happened in the economy, and don’t look like reliable predictors of what WILL happen.

I think there’s a gap between how people are feeling and how they’re acting. How consumers and business people feel is a function of their direct experience and what their peers are saying and doing, but also of what the media is telling them about the wider world.

They probably give a lot more weight to the former than the latter. Direct experience tells them things aren’t too bad; interest rates have dropped a long way in the past six months and, despite all the media stories, they’ve seen little in the way of job losses close to them.

On the other hand, the media are bringing them a lot of worrying news about Europe and elsewhere. It seems pretty clear this is having a big effect on how they feel. It’s less clear how much it has affected their behaviour - so far, at least.

I suspect the present mood - as opposed to present behaviour - is also affected by political sentiment. A lot of people have decided - rightly or wrongly - the economy is being badly managed.

The NAB business survey showed 47 per cent of respondents believed the May budget would have a negative effect on their business. This seems a huge overreaction to the one piece of bad news for business in the budget: the cost of a cut in the company tax rate of a mere 1 percentage point was instead being paid into the pockets of business’s customers.

And consider this: when you divide the consumer sentiment index according to federal voting intention you find the index for Labor voters stands at 119, whereas the index for (the far greater number of) Coalition voters is down to 82.

Perhaps the main thing the confidence indicators are telling us is something we already know: the Gillard government is highly unpopular with consumers and business people.

Read more >>

Why we can't read the economy without help

The nation's economists, commentators and business people got caught with their pants down last week. They'd convinced themselves the economy was weak, but the Bureau of Statistics produced figures showing it was remarkably strong.

It's not the first time they've failed such a reality test. They prefer not to think about such embarrassing, humbling occurrences, but it's important to ask ourselves why we got it so wrong.

The bureau told us real gross domestic product grew by 1.3 per cent in the March quarter and by 4.3 per cent over the year to March. Then it produced labour force figures for May, showing employment has been growing at the rate of 25,000 a month this year, with much of that growth in NSW and Victoria.

So why is there such a yawning gap between what we thought was happening in the economy and what statistics say is happening?

Well, one possibility is the figures are wrong. That's likely to be true - to some extent. They're highly volatile from quarter to quarter and month to month, and much of that volatility is likely to be statistical "noise" rather than "signal".

But the financial markets, economists and media knowingly add to the noise by insisting on using the seasonally adjusted figures rather than the trend (smoothed seasonally adjusted) figures as the bureau urges them to. Truth is, both markets and media have a vested interest in volatility for its own sake - it makes for better bets and better stories.

However, even if the latest figures are likely to be revised down, their "back story" still contradicts the conventional wisdom. Cut March quarter growth back to the 0.6 per cent economists were forecasting and you're still left with above-trend annual growth of 3.6 per cent.

Consumer spending may not have grown by as much as 1.6 per cent in the March quarter, but - and notwithstanding all the retailers' complaints - it's been growing at above-trend rates for a year.

Another argument embarrassed economists are making is that the March quarter figures are "backward looking". All the news since March has been bad. They always use that excuse. But there's nothing out of date about job figures for May, and they, too, tell a story of strengthening growth.

If you accept, as you should, the figures are roughly right - especially viewed over a run of months or quarters - you have to ask how our perceptions of the economy have got so far astray from statistical reality.

It's less surprising business people's perceptions are off the mark. They're not students of economic theory or statistical indicators; their judgments are unashamedly subjective, based on direct experience and the anecdotes they hear from other business people, plus an overlay of what the media tell them.

More surprising is the evidence economists' judgments and forecasts aren't as rigorously objective and indicator-based as they like to imagine. They're affected by the mood of the business people they associate with and aren't immune to the distorted picture of reality spread by the media (because they highlight events that are interesting - and, hence, predominantly bad - rather than representative).

Like the punters, business people probably overestimate the macro-economic significance of falls in the sharemarket - particularly when our sharemarket is taking its lead from overseas markets reacting to economic news in the US and Europe that doesn't have much direct bearing on our economy.

Similarly, all the bad news from America and, particularly, Europe we're hearing from the media night after night can't help infecting our views about our economy. We're getting more economic news from China these days but we hear about the threats rather than the opportunities.

The familiar refrain about the alleged two-speed economy is tailor-made for the media but, as last week's figures make clear, an exaggeration of the truth. Consumer spending is reasonably strong in the non-mining states, as is employment growth this year.

In the absence of anything better, economists and the media persist in setting too much weight on the bureau's quarterly figures for state final demand, unaware they give an exaggerated picture of the differences in gross state product between the mining and non-mining states (because Western Australia and Queensland use much of their income to buy goods and services from NSW and Victoria).

The risk is the more we repeat the two-speed story to ourselves the more it becomes a self-fulfilling prophesy. This may be part of the explanation for the weakness in non-mining business investment spending, but as yet it doesn't seem to have affected consumer spending.

The media's highlighting of announced job lay-offs is a classic example of the way their inevitably selective reporting of job movements leaves the public, business people and maybe even economists with a falsely negative impression of the state of the labour market.

A recent list of 25 lay-off announcements showed total job losses of 17,000. When people wonder how the bureau's employment figures could be right when we know so many jobs are being lost, they're showing their ignorance of how selective media reporting is and how big the labour market is.

In a workforce of 11.5 million people, job losses of 17,000 are peanuts (though not, of course, to the individuals involved). Far more than 17,000 workers leave their jobs every month and far more take up jobs every month. The media tell us about just some of the job losses and about virtually none of the job gains.

The unvarnished truth - which none of us can admit, even to ourselves - is we think we know what's happening in the economy, but we don't. We're too fallible, and it's too big and complicated.

Read more >>

Europe has serious troubles, but we don’t

The economic news from Europe in recent days hasn’t been good. And it could get worse as the year progresses. Those guys have big problems. But let’s not spook ourselves by imagining it to be any worse than it is.

Unfortunately, there’s been a tendency in parts of the media to convey an exaggerated impression of how bad things are and of the extent to which Europe’s problems translate into problems for us.

Take last week’s downwardly revised forecast for the world economy in 2012 from the International Monetary Fund. We heard a lot about the fund’s dire warnings of what could happen if the Europeans didn’t get their act together, but what wasn’t made clear was that the fund’s actual forecast was for global recession to be avoided.

Though the forecast for growth in the world economy this year WAS cut significantly from the forecast in September, at 3.3 per cent it’s below the long-run average rate of about 4 per cent, but still comfortably above the 2 per cent level generally regarded as representing a world recession.

No one thought it necessary to tell us - even though Wayne Swan reminded journalists of it at his press conference - that, from our perspective, the fund’s revisions were old news. They were surprisingly similar to the revised forecasts the government adopted in its mid-year budget review last November.

The fund has the United States growing by 1.8 per cent this year; Treasury had it at 2 per cent. The fund has the euro area contracting by 0.5 per cent; Treasury had it contracting by 0.25 per cent. For China, the fund has growth of 8.2 per cent, whereas Treasury had 8.25 per cent. For India it’s the fund’s 7 per cent versus Treasury’s 6.5 per cent.

Bottom line? The fund has the world growing by 3.3 per cent, whereas Treasury had it at 3.5 per cent.

Journalists are always criticising politicians for repeatedly re-announcing new spending programs, thus leaving the public with an inflated impression of how much is being spent. But journos aren’t above doing much the same thing.

We get a fuss when the government revises down its forecasts in November, then another fuss when the fund announces essentially the same revisions. And in between we get a fuss when the World Bank announces its revisions. Three for the price of one.

Actually, you can understand why the uninitiated got excited about the bank’s revisions. Whereas Treasury had forecast world growth of 3.5 per cent, the bank revised its forecast down to just 2.5 per cent. But no one remarked on that, just as they didn’t seem to notice when, only a week later, the fund put its prediction at a seemingly healthier 3.3 per cent.

So which one is right? They all are. That’s to say, they’re all saying the same thing. I find it hard to understand how anyone who knew their business could bang on about how low the bank’s forecast was without pointing out that it does its forecasts on a different and inferior basis to everyone else.

Whereas our Reserve Bank and Treasury, and the fund, add each country’s gross domestic product together using exchange rates that take account of the US dollar’s widely differing purchasing power in each country, the World Bank doesn’t bother. It uses market exchange rates.

So it perpetually understates the rate of growth in the emerging economies of Asia, thereby understating world growth, since most of it has for quite some years come from Asia. But not to worry. If you took the fund’s country-by-country forecasts and added them together the same misleading way the bank does, what would you get? Growth of 2.5 per cent. Same forecast on either basis.

The trouble with all these forecasts and pronouncements from international agencies is it’s hard for the public to assess what they amount to by the time they reach our shores. These pronouncements rarely mention Australia. And shock waves from Europe have to come to us via China, India and the rest of Asia.

I think the media could try harder to bridge this gap rather than leaving us with the vague impression disaster for Europe means disaster for Australia. Actually, what matters for us is not world growth so much as the growth in our major trading partners, with each partner’s contribution weighted according to its share of our exports.

When Treasury did this sum in the mid-year review, growth in the world economy of 3.5 per cent translated to growth in our major trading partners of 4.25 per cent. All this despite Europe’s recession.

Fran Kelly of Radio Nation Breakfast did go to the trouble of asking the lead author of the fund’s World Economic Outlook, Jorg Decressin, what the revised forecasts meant for us. His reply deflated most of the hype we’ve been subjected to.

‘Australia will be affected by these downgrades only to a limited extent,’ he said. Oh. ‘At this stage, growth in output for Australia is still reasonably strong.

‘Growth in Australia is importantly driven by major investment projects that are in the pipeline and these are funded by strong multinationals that don’t have problems assessing funding.’ Oh.

‘There is no advanced economy - or maybe there are one or two - that is as well placed as Australia in order to combat a deeper slow down, were such a slowdown to materialise and that’s because, well, you still have room to cut interest rates if that was necessary and you also have a very strong fiscal [budgetary] position,’ he said.

Do you get the feeling you’ve heard all this before? Maybe it’s true.

Read more >>