Sorry, it's not gallantry that wins wars, it's economic might

Welcome to the Anzac long weekend (sort of). This column is brought to you by your friendly economists, who want to get one thing straight: whatever their causes, wars are usually won by the side with the most economic resources.

This is just one of the many fascinating things you learn from a new book, The Shortest History of Economics, written by Dr Andrew Leigh, former economics professor turned minister in the Albanese government. (The book’s name is misleading. It’s really the shortest account of the part the economy has played in the world’s history. Well worth a read.)

Leigh says the first industrial-scale war following the Industrial Revolution was America’s Civil War during the first half of the 1860s.

“With the use of mass-produced weapons, railroads, steamships and telegraphs, the Civil War was industrial in its scale, and in its carnage,” he says. More than 600,000 combatants – one in five soldiers – lost their lives.

A striking thing about that war was the imbalance of resources between the two sides, strong support for the saying that God is usually on the side with the bigger battalions.

At the outset, the North had a population of 21 million – more than twice the South’s. The South was primarily an agricultural economy, with the North producing 90 per cent of the country’s manufactured goods, including 97 per cent of its firearms.

What’s surprising is that the South held out as long as it did. The war was prolonged by the North’s poor military tactics.

From an economic perspective, wars are often financed by printing money, with ultimate inflationary consequences. The South used this to fund 60 per cent of its costs, whereas the North needed only 13 per cent.

To economists, a significant effect of World War I was that it brought a hasty end to the world’s first experience of globalisation, with greatly increased trade and migration between Europe and the “new world”, fostered by the advent of steel-hulled steamships and the telegraph, and the absence of boring things like passports and visas.

Not until after the Great Depression and World War II did the barriers keeping countries apart begin falling back, thanks to advances in air travel, shipping, containerisation and telecommunications, plus reductions in import protection and banking regulations.

Today, many people believe that greater trade, tourism and other economic contact between countries reduce the likelihood of war. I think there’s truth to this, but the strong commercial ties between the combatants in World War I didn’t stop it happening.

Did you know that, at the outbreak of war in 1914, most of Germany’s shipping trade was insured by Lloyd’s of London?

The Allied powers (Britain, France, Russia and their allies) had far more resources than the Central powers (the German Empire, the Austro-Hungarian Empire and their allies). The Allied powers had five times the population, 11 times the territory and three times the income, according to Leigh.

That the conflict took four years and claimed about 20 million lives reflects the ineptitude of the generals and the intransigence of the political leaders, he says. But the side with the larger economic base won.

Moving on to World War II, which started in 1939 and ran for six years, its outcome, too, could have been predicted from the economic fundamentals.

Compared with the Axis powers (Germany, Italy, Japan and their allies), the Allied powers (Britain, France and their allies) had more than twice as many people, more than seven times as much territory, and a combined income that was 40 per cent higher, Leigh tells us.

Germany did well at first, thanks to the skill of its generals, such as Erwin Rommel, but the war proved primarily a contest of industrial production, Leigh says, and the Allied powers had more resources at their disposal.

This was true even midway through the war because, although Germany had annexed much of Europe, the United States and the Soviet Union had joined the conflict on the side of the Allies. In 1942, the Allied powers still retained a decisive advantage in people, territory and income, he says.

Consider aircraft carriers. Although Japan fully understood their great strategic value, the Allies built nine-tenths of the carriers produced during the war.

The combatant nations differed in how much of their economies they devoted to the war effort. Italy never devoted more than a quarter of its gross domestic product to the war, whereas, at its peak, Japan was devoting more than three-quarters. Britain and Russia managed to deliver more than half their national output to the war, while the US devoted two-fifths.

Together, this gave the Allies a substantial advantage. They produced at least twice as many rifles, tanks, aircraft, mortars and warships. According to Leigh, the Axis powers were literally outgunned.

The overall damage to economies done by World War II was more devastating than in World War I, largely because the technology of killing had advanced so much in the intervening years.

In the air, the first war’s biplanes and zeppelins played a relatively minor role, whereas the second war saw squadrons of bombers devastating cities with incendiary – and ultimately atomic – bombs.

All up, World War II claimed three times as many lives as World War I had done.

But let’s finish on a more positive note. Leigh says the peace that followed World War II was more enduring, partly because countries learnt the lessons of the previous conflict. Through the Marshall Plan, the US provided $US13 billion to Western Europe, equivalent to about 3 per cent of the region’s annual economic output.

In Germany and Japan, the occupying powers put great emphasis on restoration, with the result that both became major industrial powers within a generation.

And economists, including Keynes, played a central role in building international economic institutions – including the Bretton Woods system of fixed exchange rates, the International Monetary Fund, the World Bank and the forerunner to the World Trade Organisation – that would sustain peace.

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'Planetary boundaries' set the limits of economic freedom

One of the most important developments in economics is something in which economists had no hand: the identification of the environmental limits which humans, busily producing and consuming, cross at their peril.

Earth has existed for about 4 billion years and humans have lived on Earth for about 200,000 years. For almost all of that time we were hunters and gatherers, but 10,000 to 12,000 years ago we settled down, to farm and create civilisation.

It’s probably no coincidence that, for about that time, Earth has enjoyed a stable climate, with no more ice ages nor period of great heat, in which palms grew in Antarctica. This is the geological epoch called the Holocene, in which we live – although it may be ruled that we’ve moved to the Anthropocene, a new epoch in which the human species has made major alterations to the planet.

In its modern form, economics can be dated to 1776, when Adam Smith published The Wealth of Nations. Beliefs about how the economy works were well-defined by the time Alfred Marshall published Principles of Economics in 1890.

The point is that all economic activity – all the efforts of humans to earn a living – both depends on the natural environment and adversely affects it. By 1900, there were only about 1.6 billion humans on the planet, not enough to do much damage.

If we wrecked some area, we could just move to somewhere that hadn’t been wrecked, while the first bit gradually recovered.

So, at the time conventional economics was established, it was perfectly sensible to assume that the environment’s role in economic activity could be taken for granted. It was just there and it always would be. It was, as economists say, a “free good”.

When, from the 1700s, we started burning fossil fuel – coal, oil and gas – for heat, light and energy, we had no reason to worry that one day it might run out. It certainly never occurred to us that this might end up having an effect on the climate.

It took many decades before scientists began telling us that all the things we were doing to improve our lives – cutting down forests, damming rivers, drilling for water, ploughing, fertilising crops, fishing with nets – were damaging the soil, causing erosion, killing species, lowering the water table, and damaging the environment in other ways.

However, in just the past century or so, the world’s population has gone from 1.6 billion to 8 billion. Every extra human does a bit more damage to the environment. But that’s not the main thing. The main thing that’s changed is our use of advances in technology to hugely increase our standard of living and, in the process, massively increase the damage we’re doing to the environment.

Which brings us to “planetary boundaries”. In 2009, the Swedish scientist Johan Rockstrom and a scientist from the Australian National University, the late Will Steffen, with many helpers, established a framework listing the key categories of environmental damage, and estimating the amount of damage that could be done to each before the risk increased that “the Earth system” could no longer recover.

A second update of these estimates, led by an American oceanographer based in Copenhagen, Katherine Richardson, was released last month. With the ANU’s Professor Xuemei Bai, Richardson has written an article explaining the planetary boundaries.

There are nine boundaries. Three of them cover what we take from the ecological system: loss of biodiversity (extinction of species), loss of fresh water (pumping too much water from rivers and aquifers) and land use (deforestation).

Something economists didn’t know – or didn’t realise affected them – is that the laws of physics say we can never truly get rid of anything that exists on Earth.

All we – or the ecosystem – can do is change the form of the thing. Water can evaporate, but it’s still up in the clouds, for instance. We can cut down a tree, but as it slowly sinks into the dirt, it releases the carbon dioxide it had previously taken up.

This means that all our economic activity leaves in its wake a lot of waste. Not just landfill, but in many other forms.

So, the remaining six boundaries concern the waste our activity greatly adds to what would have occurred naturally. They are: greenhouse gases which cause climate change, ocean acidification (carbon absorbed by the sea), emission of chemicals that deplete the Earth’s ozone layer, “novel entities” (synthetic chemicals such as plastics, DDT and concrete), aerosols, and nutrient overload (nitrogen and phosphorus from fertilisers that wash into rivers and the sea, causing algae blooms, killing fish and coral).

Crossing any of these boundaries doesn’t trigger immediate disaster. But it does mean we’ve moved from the safe zone into dangerous territory. And the nine boundaries are interrelated and interacting, in ways we don’t yet fully understand.

In 2009, the scientists found we’d already crossed three boundaries: biodiversity, climate change and nutrient overload. By the 2015 update, a fourth boundary had been crossed: land use.

And by this year’s update, only three boundaries hadn’t been crossed: ocean acidification (but only just), aerosol pollution, and stratospheric ozone depletion – where an international agreement banning CFCs is slowly reducing the ozone hole we created.

Richardson and Bai say we’re now well into the danger zone, “where we – as well as every other species – are now at risk”. “We are eating away at our own life support systems,” they say.

One thing to be said for economists is that, unlike some, they don’t try to tell scientists how to do their job. Very few economists dispute the scientists’ evidence that climate change has been caused by human activities.

It was economists who developed the best means to reduce carbon emissions – emission trading schemes – which other countries have adopted, but Australia rejected.

When our governments decide to act on the other planetary boundaries, it will be economists who work out the best way to do it.

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Inflation is too tricky to be left to the Reserve Bank

The higher the world’s central banks lift interest rates, and the more they risk pushing us into recession, the more our smarter economists are thinking there has to be a better way to control inflation.

Unsurprisingly, one of the first Australian economists to start thinking this way is our most visionary economist, Professor Ross Garnaut. He expressed his concerns in his book Reset, published in early 2021.

Then, just before last year’s job summit, he gave a little-noticed lecture, “The Economic Consequences of Mr Lowe” – a play on a famous essay by Keynes, “The Economic Consequences of Mr Churchill”.

Academic economists are rewarded by their peers for thinking orthodox thoughts, and have trouble getting unorthodox thoughts published. Trick is, it’s the people who successfully challenge the old orthodoxy who establish the new orthodoxy and become famous. John Maynard Keynes, for instance.

In his lecture, Garnaut praised the Australian econocrats who, in the late 1940s, supervised the “postwar reconstruction”. They articulated “an inclusive vision of a prosperous and fair society, in which equitable distribution [of income] was a centrally important objective”.

The then econocrats’ vision “was based on sound economic analysis, prepared to break the boundaries of orthodoxy if an alternative path was shown to be better”.

It culminated in the then-radical White Paper on full employment, of 1945, under which policy the rate of unemployment stayed below 2 per cent until the early 1970s.

Garnaut’s earlier criticism of the Reserve was its unwillingness to keep the economy growing strongly to see how far unemployment could fall before this led to rising inflation. “We haven’t reached full employment [because] the Reserve Bank gave up on full employment before we got there.”

Now, Garnaut’s worry is that “monetary orthodoxy could lead us to rising unemployment without good purpose”.

“Monetary orthodoxy as it has developed in the 21st century leads to a knee-jerk tendency towards increased interest rates when the rate of inflation... rises.

“I have been worried about the rigidity of the new monetary orthodoxy since the early days of the China resources boom.” He had “expressed concern that an inflation standard was replacing the gold standard as a source of rigidity in monetary policy”.

Ah. That’s where his allusion to Churchill comes in. In 1925, when he was Britain’s chancellor of the exchequer, Churchill made “the worst-ever error of British monetary policy” by following conventional advice to suppress the inflationary consequences of Britain’s massive spending on World War I by returning sterling to the “gold standard” (Google it) at its prewar parity.

The consequence was to plunge Britain into deep depression years before the Great Depression arrived.

“If we continue to tighten monetary policy – raise interest rates – because inflation is higher that the target range, then we will diminish demand... in ways that seriously disrupt the economy.

“High inflation is undesirable, and it is important to avoid entrenched high inflation. But not all inflation is entrenched at high levels. And inflation is not the only undesirable economic condition.

“There is a danger that we will replace continuing improvement to full employment with rising unemployment – perhaps sustained unnecessarily high unemployment.

“That would be a dreadful mistake. A mistake to be avoided with thoughtful policy.”

Such as? Garnaut has two big alternative ways of reducing inflation.

First, whereas in the early 1990s there was a case for independence of the Reserve Bank because, with high inflation entrenched, it needed to do some very hard things, he said, “what we now need is an independent authority looking at overall demand, and not just monetary policy.

“We need an independent body playing a role in both fiscal and monetary policy... It would be able to raise or lower overall tax rates in response to the macroeconomic situation.”

Second, we shouldn’t be using higher interest rates to respond to the surge in electricity and gas prices caused by the invasion of Ukraine.

Because of the way we’ve set up our energy markets, the increases in international prices came directly back into Australian prices. This put us in the paradoxical position of being the world’s biggest exporter of liquified natural gas and coal, taken together, but most Australians became poorer when gas and coal prices increased.

“Many Australians find this difficult to understand. If they understand it, they find it difficult to accept.

“Actually, it’s reasonable for them to find it unacceptable,” he said.

So, what to do? We must “insulate the Australian standard of living from those very large increases in coal, gas and therefore electricity”.

How? One way is to cause domestic energy prices to be lower than world prices. The other is to leave prices as they are, but tax the “windfall profits” to Australian producers caused by the war, then use those profits to make payments to Australian households – and, where appropriate, businesses – to insulate them from this price increase.

By causing actual prices to be lower, the first way leaves the Reserve less tempted to keep raising interest rates. Which, in turn, should avoid some unnecessary increase in unemployment.

There are two ways to keep domestic prices lower than world (and export) prices. One is to limit exports of gas and coal to the extent needed to stop domestic prices rising above what they were before the invasion.

The other way is to put an export levy (tax) on coal and gas, set to absorb the war-cause price increase.

Either of these methods could work, Garnaut said. Western Australia’s “domestic reservation requirement” specifying the amount of gas exporters must supply to the local WA market, has worked well – but this would be hard to do for coal.

This week Treasury secretary Dr Steven Kennedy said the measures the government actually decided on could reduce the inflation rate by three-quarters of a percentage point over this year.

Garnaut’s point is that we’ll end up with less unemployment if we don’t continue leaving the whole responsibility for inflation to an institution whose only tool is to wack up interest rates.

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Globalisation has stopped, but it's not actually reversing - yet

In case you’ve been too worried about your mortgage to notice, the era of ever-increasing globalisation has ended. There’s a backlash against greater economic integration and a risk it will start going backwards, causing the global economy to “fragment”.

The process of globalisation involves the free flow of ideas, people, goods, services and financial capital across national borders, leading to economic integration. But, as a new post on the International Monetary Fund’s blog site reminds us, globalisation is not new, and the process has ebbed and flowed over many decades.

The post charts the progress of globalisation back more than 150 years. Using openness to international trade – measured as global exports plus imports as a proportion of world gross domestic product – it divides that period into five successive eras.

First came the era of industrialisation between 1870 and 1914, when increasing trade between Europe and the “new world” of North America, Argentina and Australia was driven largely by technological advances in transportation – including steel-hulled, steam-driven ships and refrigeration for shipping meat – which lowered the cost of trade.

The laying of undersea cables to improve communication between countries also helped.

Then came the era of wars and protectionism, beginning with the start of World War I in 1914 and finishing with the end of World War II in 1945.

In between came the Great Depression of the 1930s, which was made much worse than it needed to have been by governments trying to protect their domestic industries by using high import duties (“tariffs”) to keep people buying local.

It sounds like a great idea when you do it to other countries. It turns into a stupid idea when they retaliate and do it to you, leaving everyone worse off.

After trade had increased from 30 per cent of world GDP to more than 40 per cent during the era of industrialisation, it had fallen back to about 15 per cent by the end of World War II.

Third came the era of tariff reform between 1945 and 1980. Even before the war had ended, the Allies knew they’d have to fix the world economy. They decided to move to a system of fixed exchange rates and establish the IMF and the World Bank. Most importantly, they set up the General Agreement on Tariffs and Trade (now the World Trade Organisation).

The GATT arranged eight successive “rounds” of multilateral trade negotiations, in which the developed countries agreed to big reductions in their barriers to imports. Thanks to all this, trade doubled from 15 per cent of world GDP to 30 per cent.

This led on to the era of “hyperglobalisation” between 1980 and 2008, with the fall of the Berlin Wall in 1989 and collapse of the Soviet Union, bringing the Cold War to an end.

The eighth, biggest and final, “Uruguay” round of the GATT, in 1994, focused on increasing trade between the developed and developing countries, with many poor economies joining the WTO.

China’s economy began growing rapidly after it was opened up in the late 1970s, and in 2001 it was permitted to join the WTO, hugely increasing its trade.

The era also brought a move to floating exchange rates and deregulation of banking systems, leading to much increased investment between rich and poor countries.

As well, big advances in telecommunications, computerisation and the advent of the internet allowed a surge of trade in digital services, including data processing.

Resulting from all this, trade reached a peak of more than 55 per cent of world GDP in 2008, on the eve of the global financial crisis and the ensuing Great Recession.

The IMF bloggers label the present period, with figures from 2008 up to 2021, the era of “slowbalisation”. To date, those figures bear this out: trade has reached a plateau of about 55 per cent. More recent figures show world trade has largely bounced back from the initial effects of the pandemic’s global coronacession.

It seems the combined effect of the Great Recession and rising protectionist sentiment has stopped trade from continuing to shoot up relative to world GDP, but not caused it to fall back – or not yet.

Less optimistic observers, however, refer to present as the era of “deglobalisation”. They worry that we’re in the early stages of a period of “policy-induced geoeconomic fragmentation”.

It’s not hard to see what’s worrying them. First we had Britain deciding to leave the European Union, then the election of Donald Trump, vowing to “make America great again” by whacking up tariff barriers against the exports of friend and foe alike, and starting a trade war with China.

Now we have the use of trade and other economic sanctions by many countries to punish Russia in its war against Ukraine, which is fragmenting world trade.

US President Joe Biden has toned down his predecessor’s excesses, but not abandoned the trade war. This doesn’t seem to be about protectionism so much as America’s desire not to be overtaken by China as the world’s dominant superpower. In particular, the US wants to stay ahead of the Chinese in advanced digital technology, by denying them access to the latest and best semiconductors.

The risk is that the two could end up dividing the global economy into separate trading blocs, America and its democratic friends versus China and its autocratic friends. This would almost certainly slow the economic growth of both groupings.

And, as economist Dr John Edwards has written, dividing the trading world into good guys and bad guys would not suit us, nor our region. Our exports to China greatly exceed our exports to the US and other close security allies.

And all the East Asian economies – including Japan and South Korea – have China as a major trading partner. For that matter, China and the US are major trading partners of each other.

Fortunately, and despite all the sparring we’ve seen, Edwards and others find no evidence that the US and China have yet started to “decouple”.

Let’s hope economic sense prevails, and it stays that way.

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Creative destruction: Even pandemics have their upside

There’s nothing new about pandemics. Over the centuries, they’ve killed millions upon millions. But economic historians are discovering they can also have benefits for those who live to tell the tale. Take the Black Death of the 14th century.

In October 1347, ships arrived in Messina, Sicily, carrying Genoese merchants coming from Kaffa in Crimea. They also carried a deadly new disease. Over the next five years, the Black Death spread across Europe and the Middle East, killing between 30 and 50 per cent of the population.

What happened after that is traced in a recent study, The Economic Impact of the Black Death, by three American academics, Remi Jedwab, Noel Johnson and Mark Koyama, and summarised by Timothy Taylor in his popular blog, the Conversable Economist.

The immediate consequences of all the deaths were severe disruptions of agriculture and trade between cities. There were shortages of goods and shortages of workers, so those who did survive had to be paid well. This will ring a bell: with shortages of supply but strong demand, inflation took off.

In England, the Statute of Labourers, passed in 1349, imposed caps on wages. It was highly effective during the 1350s, but less so after that. Similar restrictions were imposed elsewhere in Europe.

Over the next few decades, after economies had adjusted to the worst of the disruptions, the continuing shortage of workers resulted in many rural labourers moving to the cities, which had vacant houses as well as jobs. Farmers had to pay a lot to keep their workers, so real wages had grown substantially by the end of the century.

Since many noblemen had died, the distribution of income became less unequal. Ordinary people could afford better clothing. So, many countries passed “sumptuary” laws under which only the nobility were allowed to wear silk, gold buttons or certain colours. Nor could the punters serve two meat courses at dinner.

Sumptuary laws were an attempt by elites to repress status competition from below.

The authors say the economic effects of the Black Death interacted with changes in social and cultural institutions – accepted beliefs about how people should behave. Serfdom went into decline in Western Europe because of the fewer labourers available.

People became even more inclined to marry later and so have fewer children. Stronger, more cohesive states emerged and the political power of the church was weakened.

It’s widely believed that all these developments played a role in the economic rise of Europe, particularly north-western Europe.

Taylor notes that one of the great puzzles of world economic history is the Great Divergence - the way the economies of Europe began to grow significantly faster than the economies of Asia and the Middle East, which had previously been the world leaders.

This divergence began soon after the Black Death.

“Of course, many factors were at work. But ironically, one contributor seems to have been the disruptions in economic, social and political patterns caused by the Black Death,” he concludes.

Fortunately, advances in medical science mean our pandemic has cost the lives of a much smaller proportion of the population. And believe it or not, advances in economic understanding mean governments have known what to do to limit the economic fallout – even if we didn’t see the inflation coming.

Governments knew to spare no taxpayer expense in funding drug companies to develop effective vaccines and medicines in record time.

One consequence of our greater understanding of what to do may be that this pandemic won’t alter the course of world economic history the way the Black Death did.

Even so, it’s still far too soon to be sure what the wider economic consequences will be. Changing China’s economic future is one possibility. Come back in 50 years and whoever’s doing my job will tell you.

Even at this early stage, however, it’s clear the pandemic has led to changes in our behaviour. Necessity’s been the mother of invention. Or rather, it’s obliged us to get on with exploiting benefits from the digital revolution we’d been hesitating over.

Who knew it was so easy and so attractive for people to work from home – with a fair bit of the saving in commuting time going into working longer. And these days many more of us know the convenience of shopping online – and the downside of sending back clothes that don’t fit.

Doctors were holding back on exploiting the benefits of telehealth, but no more. Prescriptions are now just another thing on your phone. And I doubt if the number of business flights between Sydney and Melbourne will ever recover.

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Digital revolution is leaving economists scratching their heads

There should be a law against holding election campaigns while people are trying to enjoy their Easter break. So let’s forget politics and think about the strange ways the economy is changing as the old industrial era gives way to the post-industrial, digital era.

The revolution in information and communications technology is working its way through the economy, changing the way it works. The markets for digital products now work very differently from the markets for conventional products.

So a growing part of the economy consists of markets that don’t fit the assumptions economists make in their basic model of markets, as Diane Coyle, an economics professor at Cambridge University, explains in her book, Cogs and Monsters.

And the way we measure the industrial economy – using the “national accounts” and gross domestic product – isn’t designed to capture the new range of benefits that flow from digital markets.

Starting at the beginning, the great attraction of the capitalist, market economy is its almost magical ability to increase its productivity – its ability to produce an increased quantity of goods and services from an unchanged quantity of raw materials, capital equipment and human labour.

It’s this increased productivity – not so much the increase in resources used – that explains most of the improvement in our standard of living over the past two centuries.

Where did the greater productivity come from? From advances in technology. From bigger and better machines, and more efficiently organised factories, mines, farms, offices and shops, not to mention better educated and skilled workers.

Particularly in the past 70 years, we benefited hugely from the advent of mass-produced consumer goods on production lines. Economists call this “economies of scale” – the bigger the factory and the more you could produce, the lower the cost of each item.

Although each extra unit produced added marginally to raw material and labour costs, the more you produced, the more the “fixed cost” of building and equipping the factory was averaged over a larger number of items, thus reducing the “average cost” per item.

Decades of exploiting the benefit of economies of scale explain why so many of our industries are dominated by just a few big firms.

But the new economy of digital production has put scale economies on steroids. Coyle says software – and movies, news mastheads and much, much else – is costly to write (high fixed cost) but virtually costless to reproduce and distribute (no marginal cost).

So, production of digital products involves “increasing returns to scale”, which is good news for both producers and consumers - everyone except economists because their standard model assumes returns are either constant or declining.

But another thing that makes the digital economy different is “network effects”, starting with the greatest network, the network of networks, the internet. The basic network effect is that the more users of the network there are, the greater the benefit to the individual user. More increasing returns to scale.

Then, Coyle says, there are indirect network effects. Many digital markets involve “matching” suppliers with consumers – such as Airbnb, Uber and Amazon Marketplace. For consumers, the more suppliers the network attracts, the better the chance of quickly finding what you want. But, equally, for suppliers, the more customers the network attracts, the easier it is to make a sale. Economists call these digital networks “two-sided platforms”. The owner of the platform sits in the middle, dealing with both sides.

So, yet more benefits from bigness. And that’s before you get to the benefits of building, mining and sharing large collections of data.

All these benefits being so great, it’s not hard to see why you could end up with only a couple – maybe just one – giant network dominating a market. Welcome to the world of Google, Facebook, Apple, Amazon and Microsoft.

In their forthcoming book, From Free to Fair Markets, Richard Holden, an economics professor at the University of NSW, and Rosalind Dixon, a law professor at the same place, note that a number of leading lights have proposed breaking up these huge tech companies, in the same way America’s big telephone monopoly and interlocking oil companies were broken up last century.

But, the authors object, in most of these markets the power of these giants stems from the “network externalities” we’ve just discussed.

“Unlike traditional markets, when the source of market power is also the source of consumer harm, in these markets the source of market power is also what consumers (and producers, in the case of two-sided platforms) value – being connected with other consumers and producers,” they write.

“The key driver of the value that these firms create is precisely the network externalities that they bring about. Facebook is valuable to users because lots of other users are on Facebook . . .

“Google is a superior search engine because in performing so many searches, machine learning allows its algorithm to get better and better, making it a more desirable search engine.”

So, the driving force that leads to these markets having one dominant player is also the force that creates economic value. “Breaking up the large players will stop there being just a few large players, but it will also stop there being nearly as much economic value created,” they say.

Research by Holden, Professor Luis Rayo and the Nobel laureate Robert Akerlof has found that markets with network externalities tend to have three features. First, the firm that wins the initial competition in the market ends up with most of the market.

Second, it’s difficult to become a winning firm, and success is fragile. For instance, Microsoft has had little success getting its search engine Bing to take business from Google. And Netscape was once dominant in the browser market, but suddenly got supplanted.

Third, winners can’t go to sleep. They must constantly innovate and seek to raise their quality.

This makes the tech markets quite different from conventional markets like oil or even old-style networks like railways.

Economists’ efforts to get a handle on the new economy continue.

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Wars, floods and pestilence: these horrors have an economic upside

By profession, economists are hard-nosed and cold-blooded. The pictures we’re seeing of the death and destruction wreaked by Russia in its invasion of Ukraine are heart-wrenching. At home, seeing people perched on their roofs as floodwaters surge, or piling up the ruined contents of their homes on the footpath, makes your heart go out. But what economists see is that every disaster has its upside.

Once they’ve put on their professional’s hat, economists don’t see evil, or pain or any emotion. Feelings must be suppressed when what they need is objectivity.

They simply size up wars and natural disasters for the effect they’ll have on the economy, measured by inflation, unemployment and, above all, gross domestic product. And since GDP often ignores the destruction of buildings and other assets, but plays close attention to the building of new assets, it tends to paint an overly favourable view of events we see as disastrous.

This doesn’t make GDP an instrument of evil that should be banished. It’s simply mono-dimensional. It focuses on a vital, but narrow aspect of our lives – how much we produce, how much income we generate – while studiously ignoring all the other aspects.

When someone’s house has been declared uninhabitable, you and I see how painful and disorienting that must be for them. What an economist sees is all the jobs that will be created and income generated to build them a new one.

But until then, the family will be homeless! That’s OK. Those who provide them with somewhere to live will be earning income and employing people – provided they don’t just stay with family or neighbours. It’s not counted in GDP if no money changes hands.

GDP doesn’t measure wellbeing – and was never designed to. This is only a problem when people fall into the trap of thinking GDP is all that matters – an occupational hazard for economists.

Last week’s budget papers discussed the economic consequence of the war in Ukraine and the floods in NSW and Queensland. For such terrible events, the tone was surprisingly upbeat.

Combined, “the Russian and Ukrainian economies comprise less than 3 per cent of global GDP and less than 2.5 per cent of global trade.

“Foreign financial exposures to Russia are small, and the International Monetary Fund has assessed that sovereign [government] or bank default is not a systemic risk to global financial stability.”

Russia is, however, an important global supplier of rural, mineral and energy commodities. So the invasion has caused substantial disruption in global commodity markets, the papers say, and has the potential to significantly raise inflation and lower global growth.

“Russia produces 18 per cent of the world’s gas and 12 per cent of the world’s oil supply and, together with Ukraine, accounts for around 25 per cent of world wheat exports.” The invasion has increased the risk of supply disruptions, pushing up energy, agricultural and metals prices.

“Global supply chains are also reliant on Russian metals exports, especially palladium [a rare metal used in catalytic converters of exhaust fumes, and fuel cells], so significant supply disruption could have flow-on effects for global manufacturing supply chains.”

All economies will be affected by the rise in global commodity prices. Among the worst affected will be Europe, Japan and South Korea, which are highly dependent on imports of energy. These and other countries will suffer what economists call a “negative terms-of-trade shock” – that is, the prices of their energy imports will rise relative to the prices they get for their exports.

But, the papers say, a smaller set of countries will benefit from a “positive terms-of-trade shock” – because they are net exporters of the higher-priced energy commodities. Their consumers and businesses will pay the higher world price for the petrol and other fuels they use, but this will be greatly offset by the higher prices their producers of energy exports will be receiving.

Among this small group is one lucky country whose net energy exports are twice as great as its domestic energy use. It’s Austria. Sorry, make that Australia. As the economist Chris Richardson might say, you may be paying a lot more for your petrol, but the economy’s been kicked in the backside by a rainbow.

Turning to our floods, although it’s still raining and too soon for final figures, last week’s budget papers say that, under an arrangement where the federal government funds up to 75 per cent of the assistance provided by the state governments, the feds expect to pay more than $2 billion for income support to households, temporary accommodation and social services, about $600 million for community clean-up and recovery, and almost $700 million to businesses and farmers for repairs, new equipment and support services.

As well, the budget makes provision for $3 billion in further federal spending over the coming four years.

Moving from the budget to the economy, we’re told that the “direct economic cost” – that is, those purely monetary costs that show up in GDP – are expected to subtract about 0.5 percentage points from the growth in the nation’s real GDP during the March quarter.

What are the costs that show up in GDP? They’re mainly reduced production in the mining, agriculture, accommodation and food services, retail trade and construction industries.

You’ll be relieved to hear, however, that this 0.5 per cent overstates the net impact of the floods on real GDP over the longer term.

Why? Because “this direct cost will be partially offset by increased investment to replace and rebuild damaged housing, infrastructure and household goods”.

And here’s some good news: the reduced exports of coal caused by rain in the March quarter aren’t expected to be as bad as previous weather events, such as the floods and Cyclone Yasi in 2011.

If you find all this mercenary and distasteful, it’s not new. The arrival of World War II helped end the Great Depression. And rebuilding bombed out Europe and Japan after the war helped the rich countries grow faster than ever before – or since.

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Working from home would be back to the future

By now it seems cut and dried. The pandemic has taught us to love the benefits of working from home and stopped bosses fearing it, so we’ll keep doing it once the virus has receded and the kids are back at school. Well, maybe, maybe not. Any lasting change in the way we work is likely to be evolutionary rather than revolutionary.

Productivity Commission boss Michael Brennan and his troops have been giving the matter much thought and, as he revealed in a speech last week, such a radical change in the way we work would be produced by the interaction of various conflicting but powerful forces.

After all, it would be a return to the way we worked 300 years ago before the Industrial Revolution. Then, most people worked from home as farmers, weavers and blacksmiths and other skilled artisans. And, don’t forget, by today’s standards we were extremely poor.

What’s made us so much more prosperous? Advances in technology. But technology is the product of human invention. That invention could have pushed our lives in other directions.

What underlying force pushed us in the direction it did? As the Productivity Commission boss was too subtle to say, our pursuit of improved productivity.

Productivity isn’t producing more, it’s producing more with less. In particular, producing more of the goods and services we love to consume using less labour. Why among the three “factors of production” – land and its raw materials, capital equipment and labour – is it labour we’ve always sought to minimise?

Because we run the economy to benefit ourselves, and it’s humans who do the labour. We’ve reduced physical labour, but now automation allows us to reduce routine mental labour.

(While we’re on the subject, note this. Many people think automation destroys jobs. But in 250 years of installing ever-better “labour-saving technology” we’ve managed to increase unemployment only to 6 per cent or so. That’s because automation doesn’t destroy jobs, it changes and moves them. From the production of physical goods to the delivery of human services. In the process, it’s made us hugely better off.)

It was the Industrial Revolution that increasingly drove us to the centralised workplace. Initially, the factory and the mine, then the office.

The move to most people working in a central location was driven by economic forces. Businesses saw the benefits – to them and their customers – of combining labour with large and expensive machinery, powered by a single source. Initially, steam.

“The factory provided a means for bosses to co-ordinate activity in real time, supervise workers and it also provided an efficient way to share knowledge – as did the office,” Brennan says.

So the central workplace reduced the cost of combining labour and capital, but did so by imposing transport costs – mainly on workers who had to get themselves from home to the central location and back.

For most of the 20th century, however, it got ever-cheaper to move people around, via steam, electricity, the internal-combustion engine and the aeroplane. So advances in transport technology reinforced the role of the central workplace.

For about the past 30 years, however, the cost of moving people around has stopped falling. “We seem to have hit physical limits on speed; and congestion has meant that today it takes longer to move around our cities than was the case a few decades ago,” Brennan says.

This, of course, is why we fancy the idea of continuing to work from home. It’s only advances in computing and telecommunications technology that have made this possible. The cost of moving information has plummeted, while the cost of moving workers – in time and discomfort – has gone up.

So, could it be that modern communications technology is set to drive us back to our homes?

Perhaps. But remember this. While the tiny proportion of people working from home has hardly budged over the past two decades, our capital city CBDs have become more significant as centres of economic activity and as engines of productivity improvement.

Here’s the catch. At the same time as information technology was improving, and the cost of communicating over distance was falling, the nature of work was changing. As machines have replaced routine tasks, modern jobs have come to require more open-ended decision-making, critical thinking and adaptability.

Experts think these quintessentially human skills are best developed and honed through face-to-face interactions, such as the serendipitous encounter or the tacit knowledge we absorb through observing those around us.

Get it? That many of us have come to prefer working from home (I’ve been doing it since 1990) is just one factor that happens to be pulling us in the direction of home. Other factors will keep pulling us into the office. Expect a lot of businesses experimenting with different mixes of the two.

Economic history suggests that what evolves will be the combination that maximises our productivity. Not just because bosses want to make bigger profits, but also because most people like a rising standard of living.

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Why people can be much nicer than economists assume

There’s a lot you can learn about the world of work – and human nature in general – from studying economics. Then again, there’s a lot you can’t learn from conventional economics – and, indeed, from the bum steers it can give you.

Consider this. The 18th century Scottish philosopher Adam Smith is said to be the father of economics. He wrote two monumental books, the second of which, The Wealth of Nations, contained the famous observation that “it is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest”.

The worthies who developed conventional economics – and its “neo-classical” model of how markets work, the main thing taught in economics courses – seized on this idea to describe an economy populated by profit-maximising firms and self-interested consumers, all of them competing with each other to get the best deal.

They developed Smith’s reference to the “invisible hand” of competition in markets to show how this self-interest on all sides miraculously ends up satisfying everyone’s wants. Hence modern economists’ eternal banging on about the benefits of competition.

But Smith’s first book, The Theory of Moral Sentiments, said something quite different: “How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, thought he derives nothing from it, except the pleasure of seeing it”.

So what’s it to be? Are we totally self-interested, or do we care about the wellbeing of others? Are we individuals competing against each other for the biggest bit, or are we caring souls who co-operate with others to ensure everyone gets looked after?

Short answer: we’re both. But study conventional economics and you’re told only about the selfish, individualistic, competitive side of our nature. The moral, collective, co-operative side is assumed away. Government is seen not as a force for good, but as an alien force whose intervention in the market risks stuffing things up.

If you wonder why so many of the predictions economists make prove astray, that’s part of the reason. But some years back, two American economists associated with the Santa Fe Institute in New Mexico, Samuel Bowles and Herbert Gintis, wrote A Cooperative Species, to try to balance the story.

In the process, they provide a more convincing explanation of why humans have become the dominant species on Earth – for good and ill.

They focus on the way humans co-operate with each other in many circumstances – including when hundreds of us work for a single business, which competes with other big businesses - and argue that we co-operate not only for self-interested reasons, but also because we are genuinely concerned about the wellbeing of others.

We try to uphold “social norms” of acceptable behaviour, and value behaving ethically for its own sake. For the same reasons, we punish those who exploit the co-operative behaviour of others.

“Contributing to the success of a joint project for the benefit of [your] group, even at a personal cost, evokes feelings of satisfaction, pride, even elation,” they say. “Failing to do so is often a source of shame or guilt.”

We came to have these “moral sentiments,” in Smith’s words, because our ancestors lived in environments, both natural and as constructed by humans, in which groups of individuals who were predisposed to co-operate and uphold ethical norms tended to survive and expand relative to other groups, thereby allowing these “pro-social” motivations to proliferate.

So they explain our motivations for caring about the wellbeing of others: we do it because it makes us feel good. But they also explain the distant evolutionary origins of our disposition to co-operate and its perpetuation to the present day.

Co-operation – engaging with others in a mutually beneficial activity - was part of the behaviour of homo sapiens when we were still living on the African savannah. We formed bands to make us more successful in hunting big animals.

But though co-operation is common in many species, human co-operation is exceptional in that it extends beyond our close relatives – whom we look after in obedience to our evolutionary urge to replicate our species – to include even total strangers. And we co-operate on a much larger scale than other species except the social insects, such as ants and bees.

We co-operate in political and military objectives as well as more prosaic everyday activities: collaboration among the employees in a firm, exchanges between buyers and sellers, and the maintenance of local amenities among neighbours.

So, though they don’t see it in these terms, economists focus on a form of co-operation that involves “reciprocal altruism”. Buyers benefit sellers; sellers benefit buyers.

But human co-operation goes much further, in that it takes place in much larger groups and in circumstances that are unlikely to be repeated. Why do people tip while passing through a country town? In my own town I have reason to care about my reputation. But if I’m in your town, why does it not occur to me to cheat you in some way?

Much experimental and other evidence shows that people gain pleasure from co-operating, or feel morally obliged to. On the other hand, people enjoy punishing those who exploit the co-operation of others, or feel morally obligated to do so.

“Free-riders,” as economists call them, frequently feel guilty and, if they are sanctioned by others, they may feel ashamed.

We may have started out co-operating to hunt wild animals and mind other people’s children, but today we co-operate to enjoy the benefits of “the division of labour” (we each specialise in something we’re good at), of market exchange and the pursuit of economies of scale (in irrigation, factories, information networks) and even warfare.

And we made all this work better by inventing governments capable of enforcing the rights to property and providing incentives for the self-interested to contribute to common projects.

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My love letter to The Sydney Morning Herald

It’s not something any hard-bitten journalist should admit, but I’m in love with The Sydney Morning Herald. Have been since, at the age of 26, I quit chartered accounting in disillusionment and stumbled into a cadetship at the Herald. I quickly realised I’d found the only place I wanted to be.

After four years they gave me the title of economics editor and sat me in an armchair with a licence to air my opinions about anything economic. It’s probably the only job I’m capable of doing with any competence. I’ve been so fulfilled by my work that, in 47 years, I’ve never wanted another job on the paper and, certainly, never wanted to move to another paper.

I suspect that by now I’m actually addicted to column-writing and to staying one of the Herald‘s roosters rather than one of its many feather-dusters. When my designated retirement date arrived, I had no desire to hang up my boots and luxuriate on the Herald’s more-than-generous super scheme. And, apart from Jessica Irvine, detected no desire by my colleagues to wave me off.

But I promise you (and Jessica) this: I’ll be out of here the moment I find I’ve worn out my welcome with our readers or my bosses, or realise I’m starting to lose my marbles. That I’m still keen to learn more about the economy and to work rather than play, I credit mainly to three gym sessions a week with my physio trainer, Martin Doyle. Exercise is good for mental as well as physical fitness.

I did feel I should at least stay on to do my bit in helping the Herald make the seemingly improbable “transition” – what a fashionable word that’s become – from “legacy asset” to successful digital “masthead”. Fortunately – and touch wood – we’ve passed that test now we’ve switched from chasing clicks to seeking digital subscriptions.

The thought of the Herald ceasing to be appalled me. As Australia’s oldest metropolitan daily newspaper, for 190 years it’s been one of the pillars on which Sydney rests. I get an enormous kick from being a tiny part of that grand history – for, I realise to my amazement, almost a quarter of its existence. It tickles me that, in the days when governors of NSW and Anglican archbishops of Sydney were recruited from England, so were editors of the Herald.

I’m proud of the many big names to have worked for the Herald at some point in their career. Banjo Paterson was our correspondent covering the Boer War. C.E.W. Bean was a Herald writer before becoming the federal government’s official war correspondent in World War I. Angus Maude, one of our last English-export editors, became Maggie Thatcher’s Paymaster General. I remember Thatcher’s daughter Carol working for a few months in our newsroom.

The playwright and speech writer Bob Ellis’ Herald career lasted 11 days. Columnist and poet Clive James lasted longer before he went off to England to make his name. I remember author Geraldine Brooks cutting a swathe through our feature writers’ room before she went off to New York to make her name. The others wrote one feature a week; she wrote one a day.

Together with her journalist husband George Johnston, Charmian Clift was a celebrity in 1960s Sydney before the word had been invented. This was explained by the years they’d spent living on a Greek island, where (we’ve learnt only recently) they were friendly with some Canadian singer named Leonard and his girlfriend Marianne. Charmian wrote a highly popular weekly column in the Herald, before ending her life.

William Stanley Jevons, a celebrated English neo-classical economist and polymath of the 19th century, discoverer of the Jevons paradox, spent part of his early career working at the Sydney Mint. He didn’t work for the Herald, but he did write letters to the editor. Hearing that made me proud to work where I did.

The Herald has changed greatly over the years I’ve been here and, leaving aside the many journalists we lost as we made our painful adjustment to the digital revolution, mainly for the better. Some years ago, someone got the idea of honouring our longest-serving journos by presenting them with a framed copy of our front page from the day they joined the paper. I was shocked by how dreary mine was. We were busy sticking to traditional standards as the world around us was changing without us noticing.

These days we cover a wider range of subjects – crime and lifestyle interests – all in a livelier, brighter, cleaner, more cleverly written way. I like to think I’ve been part of our move to a less formal, more relaxed and conversational writing style. The old-timers would be appalled to see us saying “kids” rather than “children”.

The Herald is far from perfect – no “first draft of history” ever is – but I value being at the more careful, intellectually respectable and, dare I say, gentlepersonly end of the news media. I feel privileged to write for such a well-educated audience.

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Hard lessons on how recessions work and why we hate them

Forgive me for boasting about how old I am, but this coronacession – aka the Great Lockdown – will be the fourth severe recession of my career as an economic journalist. That makes recessions my special subject, though I’ve not had much call to talk about them for almost 30 years.

I was too young to remember much of Bob Menzies’ Credit Squeeze, which came within a whisker of tossing him out of office in 1961. But I was established in journalism before I saw the recession of the mid-1970s add the last nail to the coffin of the Whitlam government.

Malcolm Fraser’s prime ministership was cut short by the recession of the early 1980s. Bob Hawke’s successor, Paul Keating, should have been dispensed with at the 1993 election after the recession of the early 1990s, but was saved by our inordinate fear of Dr John Hewson’s proposed goods and services tax. By the next election in 1996, however, voters were on their verandahs with baseball bats waiting for Keating.

So, lesson No. 1: governments that preside over recessions usually get the blame for them. Lesson No. 2: in Australia, recessions happen roughly every seven years – or so I imagined at the time.

When the financial crisis of 2008 failed to sweep us into the world’s Great Recession, I was denied what I fondly assumed would be the biggest recession of my career. Why? Because Kevin Rudd did exactly what his econocrats told him to – and it worked.

In truth, we did have a recession, but one too small to remember. Another truth: more than a decade later, our economy had still not got back fully to normal and was in a weak state when the virus hit us some weeks ago.

In the decades since our last experience of severe recession, silly people in the financial markets and the media have given us the impression that a recession consists of real gross domestic product falling for two quarters in succession.

If you haven’t already, you’ll soon realise what nonsense that is. Lesson No. 3: the defining, terrible characteristic of recessions is soaring unemployment. That’s what makes people fear them so much. “What if I lost my job? How would I pay the mortgage? What about my kids? I’ve got one just finishing uni. Oh, what an appalling stuff-up. Those politicians are hopeless.”

Recessions inflict great harm on those who lose their jobs or their businesses. They make people terribly anxious. They heighten money worries and fights between spouses. They kill off any optimism about the future, leaving the public depressed and surly for month after month. They bark at every economist.

Lesson No. 4: unemployment shoots up, but crawls back down. I remember how much fuss there was when the number on unemployment benefits hit a million under the Hawke government. Last week Scott Morrison announced that, in just a few weeks, the number of people on the JobSeeker allowance (the latest in a long list of bureaucratic euphemisms for the dole) had topped 1.3 million – with a further 300,000 applications to be processed.

After the Hawke-Keating recession (the one we didn’t really have to have), it took almost 14 years for the rate of unemployment to get back down to the 5.9 per cent it was in November 1989.

And research by Professor Bob Gregory, of the Australian National University, suggests that people who’ve been unable to find a job for two years are unlikely to find one again. In recessions past, governments have hidden away some of these people by putting them on the disability pension.

In this recession, the new JobKeeper payment – a worthy measure – is helping to understate the number of workers counted as unemployed.

Lesson No. 5: though economic journalists make much of unemployment statistics, what brings the reality of high unemployment home to the public is TV footage of ashen-faced workers streaming out of factory gates after being laid off.

What did it this time was footage of all those young people queuing up the street and around the corner from Centrelink. Lesson No. 6: this recession, like all of them, will hit the young hardest, particularly those leaving the education system to start working. As part of this, the low-skilled are always hit harder.

What’s different this time – due to the recession’s unique cause: the government hitting the economy on the head with a hammer – is that job losses are so heavily concentrated in a few sectors: tourism and hospitality, arts and entertainment, and universities.

My final lesson is that public attitudes towards the unemployed are cyclical. Between recessions, many people see them as too lazy to work. Come the next recession, however, and we ooze sympathy. We know people who’ve lost their jobs and we’re hoping neither we nor our kids will be joining them.

So, give the jobless a hard time with pettifogging officiousness, robo-debt, payment by card not cash, Work for the Dole, drug testing, reverting to $40 a day? No, wouldn’t dream of it. Not if you’re hoping to be re-elected.

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Sidney Kidman: how to make a buck out of a terrible climate

You may not have heard of Sir Sidney Kidman, once known as Australia’s Cattle King. He died in 1935. But when it comes to using “innovation” to get rich, he was tops – certainly, the most amazing. And he’s about to become our patron saint of climate change adaptation.

He chose to farm in the most arid, unpredictable and unforgiving part of Australia, and he made his pile. His company, S. Kidman & Co, exists to this day, and in 2016 was acquired by Hancock Prospecting, owned by Gina Rinehart, with Shanghai CRED as junior partner.

There are two ways to respond to climate change. Plan A is mitigation: do things to stop it happening. Plan B is adaptation: learn to live with a much hotter world where, apart from the rising sea level, extreme weather events are more frequent and bigger.

Since we’re making such a hash of Plan A – not just us, but the world in general – it may not be long before we have no choice but to get on with Plan B. Innovation – finding new ways to do things – will be king and Kidman will be recognised as the forerunner he was.

As any climate-change denier will tell you, there’s nothing new about drought. These days, all our good farmers have learnt that, though you can never tell when, another drought is always coming, so you have to be ready for it.

But Kidman was on quite another level: he found a way to make money out of drought. Dr Leo Dobes, an economist from the Crawford School of Public Policy at the Australian National University, has written a paper attempting to uncover the secret of what Kidman would never have called his “business model”.

From the turn of the previous century, Kidman, born in modest circumstances, built up a collection of cattle properties in the most marginal country in Australia’s Dead Heart – the area around the Simpson Desert, to the north of Lake Eyre – and in the “corner country” where the borders of the Northern Territory, Queensland, South Australia and NSW meet.

In this arid core of Australia, rain was very irregular and occurred mainly through thunderstorms after very hot weather. Kidman said his South Australian properties generally got less than 100 to 200 millimetres a year.

Kidman was always buying and selling properties, ending up with properties extending across the whole continent.

There was an underlying rationale to his acquisitions, however. He had several breeding properties in the north, including Newcastle Waters in the NT and Augustus Downs and Fiery Downs in Queensland, which had a tropical climate with a short rainy season.

Further north in the Gulf country, the summer rainfall seasons were more prolonged, and Kidman also used his properties there to source cattle for southern markets. Properties in the Channel country of south-western Queensland, where the grasses where softer, were used to fatten cattle for market.

A second characteristic of his holdings was the concentration of adjoining properties, running from west of the Darling River to the SA border, along the Diamantina and Georgina rivers and Cooper’s Creek in the Channel country, and along the stock route to the west of Lake Eyre via Charlotte Waters to Marree and Farina. This amounted to two major chains of properties.

“Because the holdings were on, or in close proximity to, major stock routes (and associated watercourses), they afforded easy access to rail heads connected to southern markets” in Sydney, Melbourne and Adelaide, Dobes says.

So, what was the business model that allowed Kidman to succeed where so many others failed? You can see signs of a supply-chain model – a vertically integrated business, from properties that bred cattle, to fattening properties and final sale in capital city markets.

Also signs of spatial diversification. Lack of rain or feed on one property could be compensated by moving cattle to a property with sufficient feed.

“Kidman’s drovers were shifting, shifting, shifting all the time. There was no such thing as starving or dying stock on Kidman’s stations. They just shifted them.”

But Dobes sees Kidman’s business model as captured by his creation of three “real options”. In financial markets, buying an “option” gives you the right, but not the obligation, to buy (or, in other cases, sell) a parcel of shares at a set price at a specified date in the future. It’s a way of trying to protect yourself from uncertain future developments.

In Kidman’s case, however, the options weren’t financial, they were real – physical. Kidman could easily move his stock to better conditions because his properties were adjacent and because he kept those properties understocked. The opportunity cost of understocking was the price of the option.

Second, because his properties followed stock routes and waterways, Kidman could move his stock towards better conditions – and towards the market – in a way that gave his cattle priority over other people’s herds on the route. Again, understocking was the price of this option.

Third, Kidman’s practice of holding properties near rail heads, plus his maintenance of a network of drovers, camel drivers, Aborigines, dingo trappers and friendly telegraph operators, who provided information about the movement of competing herds being driven to various markets, allowed him to direct his cattle to the city market where prices were likely to be highest.

Kidman’s modern relevance is not just in overcoming a harsh and unpredictable climate, but in coping with unexpected changes – in his case, rabbit infestation, erosion, the rapid spread of cattle ticks in northern Australia and the results of overstocking by earlier pastoralists.

Kidman’s “real options” were innovative ways of coping with, reducing and even profiting from uncertainty – which Dobes concludes is the hallmark of climate change. Australia’s farmers and others can adapt to climate change by finding their own real options.

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Back to the future: Keynes can lift us out of stagnation

Every so often the economies of the developed world malfunction, behaving in ways the economists’ theory says they shouldn’t. Economists fall to arguing among themselves about the causes of the breakdown and what should be done. We’re in such a period now.

It’s called “secular stagnation” and it’s characterised by weak growth – in the economy, in consumer spending, in business investment and in productivity improvement. This is accompanied by low price inflation and wage growth, and low real interest rates.

Let me warn you: the last time the advanced economies went haywire, it took the world’s economists about a decade to decide why their policies of managing the macro economy were no longer working and to reach consensus around a new policy approach.

That was in the mid-1970s, when the first OPEC oil-price shock brought to a head the problem of “stagflation” – high unemployment combined with high inflation – a problem the prevailing Keynesian orthodoxy said you couldn’t have.

The Keynesians’ “Phillips curve” said unemployment and inflation were logical opposites. If you had a lot of one, you wouldn’t have much of the other.

The developed world’s econocrats lost faith in Keynesianism and flirted with Milton Friedman’s “monetarism” – which was just a tarted-up version of the “neo-classical” orthodoxy that had prevailed until the Great Depression of the 1930s.

That was the previous time the economics profession fell to arguing among itself. Why? Because neo-classical economics said the Depression couldn’t happen, and had no solution to the slump bar the (counter-productive) notion that governments should balance their budgets.

It was John Maynard Keynes who, in his book The General Theory, published in 1936, explained what was wrong with neo-classical macro-economics, explained how the Depression had happened and advocated a solution: if the private sector wasn’t generating sufficient demand, the government should take its place by borrowing and spending.

In the period after World War II, almost all economists – and econocrats – became Keynesians. Until the advent of stagflation.

Notice a pattern? We start out with neo-classical thinking, then dump it for Keynesianism when it can’t explain the Depression. Then, when Keynesianism can’t explain stagflation, we dump it and revert to neo-classicism.

Enter Dr Mike Keating, a former top econocrat, who thinks the present crisis of stagnation means it’s time to dump neo-classicism and revert to Keynesianism.

Why do economists have rival theories and keep flipping between them? Because neither theory can explain every development in the economy, but both contain large elements of truth.

So it’s not so much a question of which theory is right, more a question of which is best at explaining and solving our present problem, as opposed to our last big problem.

I think there’s much to be said for this more eclectic, horses-for-courses approach. There’s no one right model. Rather, economists have a host of different models in their toolbox, and should pull out of the box the model that best fits the particular problem they’re dealing with.

And much is to be said for Keating’s argument that we need a different economic strategy to help us into the 21st century. Got a problem with stagnation? The tradesman you need to call is Keynes.

Although the rich economies are in a lot better shape than they were during the Depression – mainly because, in the global financial crisis of 2008, governments knew to apply Keynesian stimulus - Keating sees similarities between the two periods of economic and economists’ dysfunction.

In this context, the key difference between the rival theories is their differing approaches to supply and demand.

Neo-classical economics assumes the action is always on the supply side. Something called Say’s Law tells us supply creates its own demand, so get supply right and demand will look after itself.

The modern incarnation of this is “the three Ps”. In the end, economic growth is determined by the economy’s potential capacity to produce goods and services, and our “potential” growth rate is determined by the growth in population, participation and productivity improvement (with the last being the most important).

By contrast, Keynesianism is about fixing the problem Say’s Law says we can never have: deficient demand. Insufficient demand was what kept us trapped in the Depression. Keating argues the fundamental cause of our present stagnation is deficient demand, and the solution is to get demand moving again.

Back in the stagflation of the 1970s, however, the problem wasn’t deficient demand. It was the supply side of the economy’s inability to produce all the goods and services people were demanding, thus generating much inflation pressure.

After realising that Friedman’s targeting of the money supply didn’t work, the rich world’s eventual solution to the problem was what we in Australia called “micro-economic reform” – reduced protection and government regulation of industries, so as to increase competition within industries and spur greater productive efficiency and productivity improvement, thus increasing our rate of “potential” growth.

Keating – who, with another bloke of the same name, played a big part in making those early reforms – insists they worked well and left us with a more flexible, less inflation-prone economy. True.

By now, however, assuming you can fix a problem of deficient demand by chasing greater competition and improved productivity just shows you haven’t understood the deeper causes of the problem.

But when Keating advocates a new economic strategy of demand management, he doesn’t just mean governments borrowing and spending a lot of money now to give demand a short-term boost.

He mainly means a new kind of micro reform that, by increasing the income going to those likely to spend a higher proportion of it, and by lifting our education and training performance to help workers cope with new technology, ensures demand strengthens and stays strong in the years to come.

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Compared to you and me, the feudal serfs had it easy

Back at work yet, or still enjoying your summer break? Either way, you probably wish you had more annual leave. I could tell you to count your blessings, that today’s full-time workers get much longer holidays than workers have ever had.

But maybe that isn't true. It’s certainly true that we get longer holidays and work fewer hours than workers did in the 19th century but, according to the sociologist Juliet Schor, the 19th century – not long after the end of the Industrial Revolution – was an aberration in the history of human labour.

Indeed, if we’re to believe Dr Lynn Parramore, senior research analyst at the Institute for New Economic Thinking, we’re working a lot harder than medieval peasants did. “Ploughing and harvesting were backbreaking toil,” she says, “but the peasant enjoyed anywhere from eight weeks to half the year off.”

The church, mindful of how to keep a population from rebelling, enforced frequent holy-days. Weddings, wakes and births might mean a week off, quaffing ale to celebrate, and when wandering jugglers or sporting events came to town, the peasant expected time off for entertainment, she says.

There was no work on Sundays, and when ploughing and harvesting seasons were over, peasants got time to rest, too. In fact, according to Schor, during periods of particularly high wages, such as 14th century England, peasants might put in no more than 150 days a year.

I’m not sure every scholar would agree with this assessment, and the 14th century was the tail end of England’s feudal system, which began after the French Norman Conquest of England in 1066.

So if you’re not sure you’d have been happier as a serf – good thinking.

Feudalism was the system of political and economic organisation that preceded England’s Agricultural Revolution and Industrial Revolution, before we got to a capitalist or market economy approximating what we have today.

According to the father of modern economics, Adam Smith, feudalism was a social and economic system defined by inherited social ranks, each of which possessed social and economic privileges and obligations. Wealth derived from agriculture, which was arranged not according to market forces but on the basis of customary labour service owed by serfs to landowning nobles.

The king owned all the country’s land, but leased much of it to nobles, often called barons. The barons ran the decentralised, feudal system. These “lords of the manor” were in complete control of their manor, meting out justice, minting their own money and setting their own taxes.

The barons divided some of their land between their knights. The knights, in turn, distributed some of their land to the serfs, also known as villeins or peasants.

That covers people’s privileges, now their obligations. In return for their land, the barons paid rent to the king and provided him with knights to fight his battles when required. In return for their land, the knights provided their baron with personal protection and military service to the king.

In return for their land, the serfs paid their master with maybe a third of the food they grew, as well as being compelled to work on his own land. They couldn’t leave the manor and needed their lord’s permission to marry. They were often charged a fee for use of any of the improvements on the manor – roads, bridges, mills and bakehouses. And sometimes they had to fight in the baron’s battles.

Serfs lived with their animals in one-room homes they built themselves with wattle-and-daub (woven twigs daubed with mud). Their clothes were self-made, mainly of wool and very scratchy. They grew rye, wheat and other grains, grazed sheep on the common, had a kitchen garden and a few apple and pear trees.

Most of what they ate they grew themselves: little meat, but lots of rye bread and a stew of peas, beans and onions, called pottage. Berries, nuts and honey were gathered from the woods.

The feudal system fell into decline for many reasons. One was that the military became full-time professionals. Another was the Black Death (bubonic plague) of 1348, which killed many of the serfs. Landowners desperate for workers to harvest their crops had to do the unthinkable: pay actual wages to anyone who’d work their land – and the wages were high. Thus did the lords lose their hold over the serfs.

But Professor Richard Grabowski, of Southern Illinois University, has advanced a more economic theory. Manorial agriculture wasn’t very efficient, even though productivity could have been improved by such measures as removing stones from fields, adding mineral fertilisers and making greater use of fodder crops.

But the system of forced labour precluded use of these techniques because they required more care and skill than the serfs had any incentive to apply when working in the lord’s fields rather than their own.

Creating this incentive would have required shifting to paid labour, but this would cost the lord the ability to order his serfs to help fight a rival lord trying to grab his land. The first lord to free his serfs would lose his land to the others.

So the lack of national enforcement of property rights was another barrier to greater productivity. As the feudal system gradually broke down, the basis for power shifted from how many serfs you controlled to how good you were at using your land to generate more income.

England’s long Agricultural Revolution involved moving to market relationships between land owners and labourers, and almost all rural production being sold in markets, as well as huge improvements in agricultural productivity, making the nation much more prosperous.

People may have worked more hours on more days in the year, but they were much better paid to do it.

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How we killed off Australia's inflation problem

Before we let 2018 go, do you realise it’s the 25th anniversary of the introduction of the Reserve Bank’s target to achieve an inflation rate of between 2 and 3 per cent? It’s a milestone worth celebrating.

Why? Because it’s worked so well. For the past quarter century, we’ve had inflation that has fallen within the target range “on average, over time” and hence been low and stable.

This week the Reserve Bank issued a volume of papers from its conference to discuss inflation targeting, and whether it needed to change. (Conclusion: it didn’t.)

In that 25 years we haven’t had a serious worry about inflation – which certainly can’t be said of the 20 years before the target was unveiled in 1993.

In those earlier years we were continually worried about high inflation. It reached a peak of 17 per cent in the mid-1970s, averaged about 10 per cent for that decade and 8 per cent during the 1980s.

All the other advanced economies had high inflation rates at the time, but ours was higher and took longer to fix.

Our problem was usually linked with excessive growth in wages, and the “wage explosions” of the mid-1970s and early 1980s prompted the authorities to jam on the brakes, leading inevitably to severe recessions.

Even though inflation remained high, a third and more severe recession in the early 1990s was more the consequence of the authorities’ overdone attempt to end a boom in commercial property prices.

It’s not by chance that this year we reached 27 years of continuous growth since that recession. Before it, we had recessions about every seven years, all of them caused by the authorities jamming on the brakes – and then, when we crashed into recession, stepping on the accelerator, a “stop/go policy”.

The first reason we haven’t needed to worry much about inflation since then is that, as part of the adoption of the inflation target, responsibility for setting interest rates was moved from the politicians to the econocrats running an independent central bank.

They’ve been a much steadier hand on the interest-rate lever, moving rates up or down according to the needs of the business cycle, not the political cycle.

Another reason we’ve stopped worrying about inflation is that this year is also the 35th anniversary of the floating of our dollar in 1983. A floating exchange rate – which, remarkably, has almost always floated in the direction needed to keep the economy on an even keel – has made it a lot easier for the Reserve to keep inflation low and stable.

A third reason is the extensive program of “micro-economic reform” begun by the Hawke-Keating government in the 1980s – including the deregulation of many industries and the decentralisation of wage-fixing – which has made our economy much less inflation-prone than it used to be.

Yet another factor was the realisation at the time the inflation target was adopted – informally by the Reserve in 1993, and then formally by the incoming Howard government in 1996 – that the key to lower inflation was to get “inflation expectations” down to a reasonable level.

Why? Because there’s a strong tendency for the expected inflation rate in the minds of shopkeepers and union officials to become a self-fulfilling prophecy. If they expect prices to keep rising rapidly, they get in first with their own big price or wage rises.

We’ve spent the past 25 years demonstrating that if you can get everybody expecting inflation to stay low, you have a lot less trouble ensuring it actually does.

The hard part was how to get from the high expectations of the late-1980s to the low expectations we’ve had for most of the past 25 years.

Bernie Fraser, Treasury secretary turned Reserve Bank governor, the man who introduced the target, knew what to do: define what was an acceptably low inflation rate – between 2 and 3 per cent, on average - and keep the economy comatose until you actually achieved the target, then keep it low until everyone had been convinced that “about 2.5 per cent” was what today we’d call “the new normal”.

How did Fraser achieve this? He did the opposite of what his predecessors did whenever they realised they’d hit the economy harder than they’d intended to. Despite knowing we were in for a bad recession, he let the interest-rate brakes off only slowly, and didn’t hit the accelerator.

In other words, he made the recession of the early ‘90s longer and harder than it could have been. I think he decided that, since we were in for a terrible belting anyway, he’d make sure we at least emerged from the carnage with something of value: a cure for our inflation problem that wasn’t just temporary, but lasting.

And that’s what he delivered. With low inflation expectations embedded, he was able to stimulate the economy to grow faster and get unemployment down. It went from 11 per cent after the recession to 5 per cent today.

At the time the inflation target was adopted, some people worried it meant the Reserve didn’t care about unemployment. As events have demonstrated, that was wrong. To Fraser, low inflation was just a means to the ultimate end of low unemployment.

I rate him the best top econocrat we’ve had in 50 years. He was wise and caring, with the best feel for how the economy worked. Peter Costello gets the credit for formally adopting Fraser’s inflation target, pursued by an independent Reserve Bank.

But another person also deserves credit – Dr John Hewson. It was Hewson who, as Coalition shadow treasurer, made the most noise about the need for an independent central bank with an inflation target.

Fraser decided he’d better get on with specifying his own target before “some dickhead minister” tried to impose a crazy one on him.

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Things I've learnt in 40 years as an economics editor

Fortunately, I made the greatest misjudgment of my working life while I was still at university in Newcastle. I concluded that economics was hopelessly unrealistic and boring, whereas accounting was practical and fascinating.

The most disillusioning moment of my working life came soon after I heard that I’d passed the last exam to become a chartered accountant. For years I’d told myself that, once I was qualified, I’d be confident, capable and contented as an auditor.

Nothing changed. I had to admit to myself I neither enjoyed being an accountant nor was much good at it. A year or so later I washed up at The Sydney Morning Herald to offer my services as an over-aged graduate cadet, at a much lower wage.

The news editor who hired me said he didn’t imagine I’d last, but it was worth a try. It was only at the man’s wake a year or two ago that his widow explained what he meant. Knowing I was an accountant, he’d tried to persuade Fairfax to pay me more than a cadet’s wage, but failed.

The editor soon suggested I try my hand at economic journalism. “Accountant, economist – pretty much the same thing, surely?” I bit my tongue and took his advice. Smartest move in my working life.

This month is the 40th anniversary of my appointment as the Herald’s economics editor – surely some kind of record. I’ve been writing for The Age for much of that time.

My survival is owed to a great extent to the trouble I had recovering all the economics I was supposed to have learnt at uni – and to the many hours people who ultimately became professors, Treasury secretaries and Reserve Bank governors spent on the phone with me, explaining the facts of economic life.

Whatever I learnt I immediately explained to the readers. For all those years I’ve seen my role as explaining how the economy works, why economists take the attitudes they do and what the government is seeking to achieve with its policies.

Four decades as an opinion writer leave you with a lot of strongly held opinions. In the early years I preached the prevailing gospel of economic reform; lately I’ve been more like a theatre critic, helping readers decide whether they agree with particular policies.

And, like many old journos, these days I don’t have much faith in either side of politics.

Economic life – and that’s what economics is, the study of “the ordinary business of life” – has changed hugely while I’ve been in this job. All the deregulation and privatisation of the Hawke-Keating years have greatly increased the degree of competitive pressure facing our businesses – from imports and other businesses – much of which they have passed through to their employees.

It’s a long time since anyone thought of Australia as The Land of the Long Weekend.

The world changes more frequently than it used to. The value of our dollar now changes by the minute; the Reserve Bank reviews the level of interest rates once a month. Jobs – even full-time, permanent jobs – have become less permanent.

Much of this change stems not from governments but from the rapid pace of technological change and globalisation (itself to a large extent the product of advances in telecommunications and information processing).

Our standard of living has risen greatly over the years, and we’re surrounded by gadgets that do amazing tricks, though it’s no longer certain that children will end up richer than their parents. Youngsters stay much longer in education, but will have to work until they’re 70.

Home loans have become much easier to get, but infinitely harder to afford.

Pay rises have to be bargained for – often less via unions than directly with the boss - and, over the past four years, have become tiny to non-existent. Rises used to be doled out several times a year by a bench of judges in Melbourne.

My enthusiasm for my topic – for my 43rd federal budget, for instance – is undiminished. Why? Because I keep learning more economics and because the economy, and economic fashions, keep changing.

One “learning” I've acquired is that, while economics - the business of producing and consuming, earning and spending – is and always will be vitally important, it needs to be kept in its place. An economics-obsessed nation isn’t likely to be a happy, fulfilled nation.

Malcolm Turnbull now portrays himself as the great champion of “aspiration”. He’s right. All of us should aspire to something better. But there are plenty of goals more worthy and likely to be more satisfying than gaining a higher income.

What would be wrong with aspiring to make life better for others rather than ourselves?

It’s the same with that great god, economic growth. It’s a good thing to grow. But why must the economy grow bigger rather than better?

I aspire to an economy where bosses are less obsessed with earning more and less convinced that being tough on their employees and customers is the way to get there. Why are they so sure making more money under those conditions will make them happy?

I aspire to an economy where bosses (and politicians) calm down and realise that working with an engaged and satisfied staff to give customers value for money is a more genuinely rewarding way to work and live. I can’t believe such an economy would do badly.

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How Keynesianism came to Australia

Whenever you meet someone who uses the words Keynes or Keynesian as a swear word – or as synonyms for socialist – know that their adherence to neoliberal dogma far exceeds their understanding of mainstream economics.

Though John Maynard Keynes' (rhymes with gains) magnum opus, The General Theory of Employment, Interest and Money, was published in 1936, and he died 10 years later at 62, most economists – including many who wouldn't want to be called Keynesians – acknowledge him as the greatest economist of the 20th century.

It's true that the "monetarist" counter-attack on Keynesian orthodoxy led by Milton Friedman in the 1970s and early 1980s led to lasting changes in prevailing views about how the macro economy should be managed – mainly, that the primary instrument used to stabilise demand should be monetary policy (interest rates) rather than fiscal policy (the budget).

But the monetarists' advocacy of using control of the money supply to limit inflation was soon abandoned as unworkable, and these days few economists would want to be called monetarist.

What remains is a host of fundamentally Keynesian ideas. First is the distinction between micro-economics (study of particular markets) and macro-economics, study of the economy as a whole.

Then there's the idea that governments should seek to stabilise the fluctuations in aggregate (total) demand as the economy moves through the business cycle, a notion rejected by some "new classical" academic economists, but daily practised by the world's central banks and treasuries.

Macro-economists' obsession with fluctuations in gross domestic product is a product of Keynesian thinking, made possible by the development of "national income accounting" by Keynes' followers.

The General Theory was Keynes' attempt to explain how the Great Depression of the 1930s occurred – when the prevailing "neo-classical" orthodoxy said it couldn't occur – and how the world could return to healthy economic growth.

Eventually, it led to a revolution in the way economists thought about the macro economy. Neo-classical theory was out, Keynesian theory was in. Usually, radically different ideas can take years to be accepted – but this time, not so much in Australia.

In his book published earlier this year, A History of Australasian Economic Thought, Alex Millmow, an associate professor at Federation University in Ballarat, explains how Keynesianism​ came to Oz.

Although The General Theory laid out Keynes' new approach in all its exciting but confusing glory, the thinking of Keynes and his associates at Cambridge University in England had been developing since the start of the Depression in late 1929, and expressed in several of his earlier books and papers.

Australian academic economists had also been puzzling over the causes and cure of the international slump. They'd been closely involved in our initial policy response, to devalue the Australian pound, cut wages by 10 per cent and try to balance the budget.

Only slowly did the evolving thinking of Keynes and his circle in Cambridge cause them to doubt the wisdom of this deflationary approach, which made things worse, and shift to the opposite tack of using government spending on capital works to stimulate economic activity and create jobs at a time of mass unemployment.

Cambridge was then the Mecca of economics – especially for Australians – meaning our academics had plenty of contact. Our leading economist of the era was Lyndhurst Falkiner Giblin, a Tasmanian based at the University of Melbourne.

Anther leader was Douglas Copland, a Kiwi also at Melbourne Uni. They were early and influential, if cautious and qualified, supporters of the Keynesian approach.

Among the Australians who studied at Cambridge and brought back Keynesian thinking was E. Ronald Walker (later Sir Edward Walker; several of these people ended up as knights), based at the University of Sydney.

Over the years, Walker did most to inculcate Keynesian macro-economics among Australian academics and students. Another Aussie who returned from Cambridge as a convert was Syd Butlin, also at Sydney, who became our greatest economic historian.

Keynes was interested in how Australia had been hit by the Depression. Among his colleagues and students who made extended visits to Australia in the 1930s was Colin Clark, who stayed on after accepting an invitation to become a top bureaucrat in the Queensland government.

Clark was a brilliant economic statistician, who played a leading part in the development of what these days are known in every country as the national accounts.

When a Labor federal treasurer, Edward "Red Ted" Theodore, proposed a program of reflation in 1931, to counter the effects of the earlier deflationary measures, he quoted Keynes in his support. His plan was blocked by the Senate.

All this explains why Keynesian ideas were widely accepted by Australian economists even before the publication of The General Theory in 1936.

Publication came just as our first royal commission into "the monetary and banking systems" was getting under way. Many economists gave evidence, making a more influential contribution than the bankers, who defended the status quo.

The leading member of the commission, who wrote most of its report, was Richard Mills, an economics professor from Sydney University. Its other member of note was Ben Chifley, future Labor treasurer and prime minister, whose part in the commission caused his biographer to call him "a Keynesian of the first hour".

It's key finding was that "the Commonwealth Bank [then Australia's central bank, as well as a government-owned trading bank] should make its chief consideration the reduction of fluctuations in general economic activity in Australia".

The commission's recommendations shaped the regulation of Australian banking – including establishment of the Reserve Bank of Australia in 1959 – until the advent of financial deregulation in the mid-1980s.

As Millmow has observed elsewhere, the latest banking royal commission is unlikely to be nearly as influential as the first.

The federal government's national mobilisation following the outbreak of war in 1939, then the preparations for "postwar reconstruction and development", saw the full acceptance of Keynesian economics.

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