The budget is rent-seekers central

Last week we got a reminder that, among its many functions, the federal budget is the repository of all the successful rent-seeking by the nation’s many business and other special interest groups. Unfortunately, it added to the evidence that the Albanese government knows what it should do to manage the economy better, but lacks the courage to do more than a little.

Rent-seeking involves industries and others lobbying the government for special treatment in the form of grants, tax breaks or regulatory arrangements that make it hard for new businesses to enter their market or protect them from competition in other ways.

Whenever that rent-seeking involves grants or tax concessions it weighs on the budget. Decades of continuous rent-seeking weigh hugely on every year’s budget, limiting the government’s ability to ensure every dollar of taxpayers’ money is spent to great effect in benefiting all Australians.

For example, a big lump of the feds’ spending on education is devoted to achieving the Howard government’s goal of enhancing parents’ choice of which school to send their kids to. When the callithumpians decide to build their own schools, so their children can be educated without contamination by people of other religions, the federal taxpayer coughs up.

That all this spending on choice leaves the great majority of kids attending public schools that aren’t adequately funded is just an unfortunate occurrence, which we may get around to fixing if we ever have any spare dollars looking for a home.

What you certainly couldn’t do is cut back the money you’re giving the callithumpians. They’d kick up the devil of a fuss and start telling their followers not to vote for you.

When rent-seeking leads governments to make grants to special interest groups, the details of this spending are there to be found in the bowels of the budget papers. Where it leads to some activities getting special tax breaks, Treasury attempts to keep track of these “tax expenditures” in an annual statement.

When it comes to extracting rents from governments, few industries or occupations are better at it than the medical specialists. (That’s not true of the GPs, however. Their Medicare rebates were frozen for years, as part of the former Coalition government’s pretence that it could cut taxes while in no way harming the provision of essential public services.)

Some years ago, a Labor government decided to cut back the Medicare rebate for cataract surgery because advances in technology now meant a surgeon could perform far more operations in a day.

The rest of the medical profession knew what a rort it had become but, under the ethical principle of dog doesn’t eat dog – or maybe, honour among thieves – they stood silent while their eye-surgeon brethren fought dirty to protect their swollen incomes.

They pretended the sky was falling, telling their elderly patients the wicked government had left them no alternative to charging them thousands more in out-of-pocket payments. If their elderly patient didn’t think this was fair, perhaps they might like to have a word with their local federal member, saying how terrible it was to have their lovely doctor treated so badly.

Predictably, the government backed off and the rorting continued.

Last week it was the turn of the chemists. Few industries are so heavily regulated by state and federal governments, all with a view to protecting pharmacists’ incomes. There are limits on how many chemists may set up within an area and, in particular, prohibitions on supermarkets having pharmaceutical sections.

Anthony Albanese and his government have made much of the way their introduction of 60-day medicine prescriptions – as recommended by an expert committee – has saved patients money and helped ease the cost-of-living crisis.

But hang on. Surely, that means chemists receiving fewer dispensing fees from the government? This evil must be opposed. Enter a union more powerful than any workers’ union, the Pharmacy Guild. This iniquity will see shortages of medicine and hundreds of chemists closing down across the land, it assured us.

The government fought back, refuting the talk of shortages and revealing figures showing a surge in applications for new pharmacies in the months following the announcement of the prescription change.

It had already promised to plough back into pharmacies the $1.2 billion it expected to save on dispensing fees. But the guild claimed pharmacies’ losses would be $4.5 billion, and last week the guild negotiated a new deal, which would see the government pouring a further $3 billion into pharmacies over five years.

Also last week, we saw the government releasing the report of the aged care taskforce, chaired by Aged Care Minister Anika Wells, calling for the well-off elderly to contribute more to the cost of their own care.

What was the problem? Wells spelled it out in a speech last June: “We must act now. The Baby Boomers are coming … We are going to need a fair and equitable system to meet the needs of Baby Boomers who, with their numbers and determination to solve problems, have shaken every single system they’ve come across.”

The report argued for the present mechanism used to get more from the better-off, the refundable accommodation deposit, to be replaced by a rental-only system.

But it called for the deposit system to be phased out over five years, and postponed the proposed start of the phase-out to 2030. With all its talk of “grandfathering” – applying the changes only to new entrants to the system – it remains to be seen how keen Albo & co are to take on the entitled Baby Boomers.

Finally last week, the Commonwealth Grants Commission’s carve-up of the proceeds from the goods and services tax for the next financial year was announced, bringing a bad shock for NSW and Queensland, and good news for Victoria and the other states and territories.

It was an unwelcome reminder of the separate, but related, special deal then-treasurer Scott Morrison awarded the West Australians in 2018. So great was the uproar from the other states that they were promised more money to ensure the sandgropers’ special deal left the others “no worse off”.

Meaning? That the West Australians’ successful rent-seeking is costing federal taxpayers from other states a bundle in forgone federal spending.

As the independent economist (and proud Tasmanian) Saul Eslake never tires of demonstrating, the Westies had less than zero grounds for arguing that they were getting a bad deal from the carve-up formula.

The grants commission was set up in the 1930s in response to their congenital paranoia that the rest of Australia was having a lend of them. For as long as they were classed as a “mendicant” state cross-subsidised by Victoria and NSW, they were happy.

But from the moment the growth of their mining industry was so great that they were required to join Victoria and NSW in helping maintain the quality of government services in the other states, it suddenly became yet another plot by those “over east” to do them down.

So, here’s the moral of the story for our weak-kneed federal politicians on both sides. Once you give in to rent-seekers, you’re gone. They won’t give up their ill-gotten gains without a massive, vote-losing fight.

Meanwhile, everyone else wonders why, despite the huge sums you’re raising in taxes, the quantity and quality of the services you’re providing is so poor.

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ABBA was right: Rockonomics shows the winner takes it all

Why do we live in the era of superstars – whether people or businesses? Why is there such a thing as winner-take-all markets? Why do the top 1 per cent of households get an ever-bigger slice of the pie?

Short answer: because the digital revolution is disrupting far more of the economy than we realise.

It’s explained in the new book, Rockonomics: What the music industry can teach us about economics and life, by Alan Krueger, and summarised in his article in the New York Times, from which I’ll quote. Krueger, an economics professor at Princeton University, died in March at the age of 58.

Krueger says the first economist to explain the growing income gap between superstar businessmen and everyone else was the great English economist Alfred Marshall, in the late 1800s.

Marshall argued that a remarkable development in communications technology, the undersea telegraph, allowed top entrepreneurs “to apply their constructive or speculative genius to undertakings vaster, and extending over a wider area, than ever before”.

Ironically, Marshall used the music profession as his counterexample. Because the number of people who could be reached by a human voice was so limited, it was unlikely that any singer could better the £10,000 that the great soprano Elizabeth Billington was said to have earnt in a season.

What the superstar businessmen had, but Billington and her rivals lacked, was the ability to scale up at no prohibitive cost. Of course, Krueger notes, the other thing you need to become a superstar is what economists call “imperfect substitutes”. In English, you must have your own unique style and skills.

Today, of course, music is a most extreme and obvious example of superstars and winner-take-all markets. Why? Because technological advance has provided the economies of scale lacking in Marshall’s day.

Start with amplification of the human voice and then musical instruments. Then, the advent of enhanced recording technology. Finally, the internet and digital streaming of individual tracks anywhere in the world.

“Scale magnifies the effect of small, often imperceptible differences in talent. With the ability of scale, the rewards at the top can be much greater for someone who is slightly more talented than his or her next-best competitor, because the most talented person’s genius can reach a much greater audience or market, in turn generating much greater revenue and profit,” Krueger says.

Album sales and digital streaming clearly reflect the superstar phenomenon, he says. In 2017, the top 0.1 per cent of artists accounted for more than half of all album sales. Song streams and downloads are similarly lopsided.

But a strange thing has happened. Because digital recording has made it so easy to copy and share recordings, the revenue earned by artists and record labels has collapsed. These days, musicians make most of their income from live performances – from nobodies playing in pubs to superstars touring the world’s major venues.

Krueger says that, in 2017, the top 1 per cent of artists increased their proportion of total concert revenue to 60 per cent, compared with 26 per cent in 1982.

Another funny thing: it's now so cheap and easy to record your performance and get it onto the internet, where it’s available to the whole world, that anyone can do it. But does that make you famous? No way. The amount of music available on the net is so vast that the chances of your genius being discovered are tiny.

If you’re already famous, it’s easy to become more so. We hear of some unknown’s YouTube video getting a million clicks, but these are the exceptions. And if that happens it does so because something about the video is exceptional, and because a cascading network of people hear about it and recommend it to their friends. Do you make any money out of it? Probably not.

What happens is not a normal, “bell-shaped” distribution of listens – or dollars – but a “power-law” distribution in which a small number of people get huge scores, which quickly fall off until you get to everyone else getting next to nothing.

In 2016, Krueger says, the most popular artist, Drake, was streamed 6.1 billion times, followed by Rihanna (3.3 billion streams), Twenty One Pilots (2.7 billion) and The Weeknd (2.6 billion). Move down just 100 places and you get to Los Tigres del Norte (0.5 billion).

See how quickly it falls away? That’s a power-law distribution. So is the “80/20 rule”.

Krueger says that the whole United States economy has moved in the direction of a superstar, winner-take-all market. Since 1980, more than 100 per cent of the total growth in income has gone to the top 10 per cent of households, with two-thirds of that going to the top 1 per cent, while the share of the remaining 90 per cent has shrunk.

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Who’s doing best in the rent-seeking business

Economists joke that, whereas they are taught that any barriers to new firms entering a market are bad, allowing profits to be too high, MBA students are taught that "barriers to entry" are good, and shown ways to raise them.

Economists have no quarrel with businesses making profits. The shareholder-owners who provide the financial capital needed to sustain those firms are entitled to a return on their investment, one that reflects not only the (opportunity) cost of their capital, but also the riskiness of the particular business they're in.

Economists call such a return on equity "normal profit". But sometimes the various barriers to new firms entering a market limit competition, allowing the incumbents to make profits in excess of those needed to induce them to stay in the industry.

These are called "super-normal" profits (super as in "above"). Now get this: the other name for super-normal profits is "rents" – economic rents, to be precise.

We're used to thinking of rent-seekers as businesses or industries that ask governments for special treatment. But it's common for rents to be sought in situations that have nothing to do with government favours.

One of the most informative pieces of economic research undertaken last year was conducted by Jim Minifie, of the Grattan Institute, who made detailed estimates of the economic rents being earned in particular industries – something no government agency would be game to do.

He focused on the two-thirds of the economy made up by the "non-tradable private sector", excluding export and import-competing industries and the public sector.

He found that the annual return on equity in the most competitive part of this sector averaged 10 per cent. That compares with returns exceeding 30 per cent in internet publishing, which includes online classified advertising of homes, jobs and cars.

Then came internet service providers on 25 per cent and wired telecom on a fraction less. Supermarkets were on about 23 per cent, sports betting on 22 per cent, liquor retailing on 19 per cent, and wireless telecom and (get this) private health insurance on about 18 per cent.

Delivery services and fuel retailing are on 15 per cent, with banking not far behind on 14 per cent, level pegging with electricity distribution and airport operations.

But the rate of an industry's super-normal profit or economic rent isn't the same as its absolute amount. Most industries with very high rates of profit are quite small.

Measured in dollar terms, the most rents are in banking, followed by supermarkets, electricity distribution (just the local poles and wires), wired and wireless telecom.

Minifie estimates that rents account for 20 per cent of the non-tradable private sector's total annual after-tax profits of $200 billion. This is equivalent to more than 2 per cent of gross domestic product.

Another way to judge the significance of super-normal profits is to express them as "mark-ups" – as proportions of total sales.

The average mark-up across the whole non-traded private sector is 2 per cent. So, if rents were eliminated, but costs didn't change, average prices would fall by 2 per cent.

Within that average, however, the mark-up in internet publishing is 26 per cent. Then come airport operations on 20 per cent, wired telecom on 19 per cent and electricity distribution on 12 per cent.

Further down the league table, electricity transmission – the high-voltage power lines, not the local poles and wires – has an estimated mark-up of 7 per cent.

But get this: the banks' mark-up is just 4 per cent and the supermarkets' is a bit over 3 per cent.

How come, when super-profits account for more than half the supermarkets' total profit? Because supermarkets are a high-volume, low-margin business (as are banks).

Minifie notes that Coles and Woolworths are so big they achieve huge economies of scale. And, as dairy farmers well know, they achieve further cost savings by using their market power to force down the prices they pay their suppliers.

Trick is, they pass much of these cost savings on to their customers, but keep enough of them to remain highly profitable.

Coles and Woolies have substantially higher profit margins than their smaller rival IGA, even though their average prices are lower than IGA's prices. So the big two's costs must be a lot lower than IGA's.

The list of industries with the highest super-profits reminds us how badly governments have stuffed-up the national electricity market, how much better they could be doing in controlling the prices of monopoly businesses such as Telstra, airports and port terminals, and in charging for liquor and gambling licences, not forgetting the indulgent treatment of private health funds.

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Radical policy change may be needed to fix wages

It's too early to be sure, but not too early to suspect that, if we and the other developed economies keep travelling the way we are, conventional wisdom about what constitutes good economic policy may soon need to be turned on its head.

We're living through very strange times. Each developed economy has its own story, but there are strong similarities. One is exceptionally low inflation, which doesn't seem temporary.

Another is surprisingly weak rates of measured productivity improvement, although our rate of improvement in the productivity of labour isn't too bad.

My guess is a fair bit of this is mis-measurement arising from our quite radical shift to a digital economy.

But the other explanation may be a decline in price competition in many industries, thanks to several decades of both natural and government-facilitated rent-seeking by big businesses, in ever-more concentrated industries.

Next, wages. It's too soon to conclude that wage growth – which in Oz has been slowing since mid-2012 and been pathetically weak for three years – is down for the count.

We don't yet know how much of the weakness is merely cyclical and how much is due to deeper, longer-lasting, structural causes.

Even so, it's hard not to suspect that a fair bit of the wage weakness is structural. My guess is that while we've been busy decentralising wage-fixing and removing all provisions thought to favour unions, globalisation and technological change have conspired to rob the nation's employees of any collective bargaining power.

This may sound like a dream come true for business and its high-paid executives but, if it's true, it's deeply destabilising overkill.

Wages are a key variable in the economy. Allow them to be either too high or too low and the economy gets out of kilter.

Allow the profits share of national income to keep continually expanding at the expense of the wages share and expect to pay a price economically, socially and politically.

And that's before you remember that wages are the chief source of governments' tax revenue. Not only personal income tax, but all the indirect taxes – notably, the goods and services tax – that households pay when they spend their labour incomes.

Low nominal wage growth isn't necessarily a worry if, at the same time, the rise in consumer prices is low.

What matters to working households and the rest of the economy (but not governments) is what's happening to real wages.

In a healthily functioning economy, real wages should rise pretty much in line with the improvement in the productivity of labour.

That way, both labour and capital get their fair share of the fruits of economic progress.

Trouble is, in the US this relationship broke down maybe 30 years ago, explaining why the top few per cent of households have captured most of the growth in the nation's real income over that time.

This doesn't just widen the gap between rich and poor. By directing so much income growth away from the high spenders at the bottom and middle to the high savers at the top, it slows growth in consumption and thus production.

It also adds to the disillusionment of ordinary voters, making them more likely to lash out and vote for the cunning wacko celebrity-de-jour candidate, such as Clive Palmer, Pauline Hanson or Donald somebody​.

Get this: there are tentative signs the relationship between real wage growth and labour productivity may be breaking down in Oz.

The relevant indicator, the index of real labour costs per unit, should hover around 100. It fell by 3.3 per cent during 2016, reaching 98.1, equal lowest since the series began in 1985.

If this weakness persists, it will raise the question of whether the formerly healthy relationship was a product of market forces, or the industrial relations system's achievement of a fine balance between employer and union bargaining power.

If it does persist, how could we return to a healthy relationship? By reversing the dominant wisdom of many decades, that governments must never do anything that adds to the regulatory burden on employers. By acting (very carefully) to strengthen the hand of union collective bargainers.

Final point: governments of all colours secretly rely on bracket creep to help tax collections keep up with the inexorable growth in government spending.

But bracket creep depends on both reasonable inflation and real wage growth to work its barely noticed fiscal magic.

What happens if inflation stays low and real wages stop growing? You have to junk your rhetoric about smaller government and keep doing what Malcolm Turnbull did in this budget: justify explicit tax increases.

Either that, or get wages growing properly.

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Mining boom our gift to rich foreigners

The mining tax - whose last-minute reprieve may well prove temporary - is the greatest weakness in the argument that we gained a lot from the resources boom. The blame for this failure should be spread widely, with economists taking a fair share.

Late last week a majority of senators passed the bill repealing the minerals resource rent tax, but not before knocking out its provisions cancelling various programs the tax was supposed to be paying for.

The government is refusing to accept the amended version of the bill, arguing that "by voting to keep many of the associated spending measures [naughty - most are actually tax expenditures], senators have effectively voted to keep the mining tax".

We'll see how long that lasts. But if you're thinking the tax raises so little it hardly matters whether it stays or goes, you're forgetting something. When Labor allowed BHP Billiton's Marius Kloppers and his mates from Rio Tinto and Xstrata (now Glencore) to redesign the tax, they predictably opted to take their depreciation deductions upfront. Once they're used up, however, receipts from the tax will be a lot healthier - provided it survives that long.

You can blame Kevin Rudd, Wayne Swan and Julia Gillard for their hopeless handling of the tax. But don't forget to copy in Tony Abbott who, faced with a choice between the interests of Australian taxpayers and the interests of three foreign mining giants, sided with the latter in the hope they'd fund his 2010 election campaign.

You can also blame Treasury for originally proposing an incomprehensible, textbook-pure version of the tax which couldn't survive, and so getting us lumbered with a fourth-best version. It also did a bad job of quietly test-marketing the tax with its banking contacts and of estimating the likely receipts.

But where were all the economists - including academics - explaining to the public why the tax wouldn't discourage mining activity or otherwise damage the economy, as it suited the big miners to claim?

Where were the economists explaining the special need for a resources rent tax in the case of the exploitation of mineral deposits, particularly when the miners were so largely foreign-owned?

As usual, they were keeping their mouths shut. Contribute their expertise to the public debate? Why? Better just to criticise from the sidelines.

Part of the problem is an ethic among economists that regards it as bad form to distinguish between local and foreign investors for fear of inciting "economic nationalism" - a form of xenophobia. If an investment generates jobs and income, why does it matter whether the firms involved are local or foreign?

It's no doubt thanks to this ethic that we do such a bad job of measuring foreign ownership (and so deny ourselves the ability to use hard facts to fight xenophobic impressions that foreigners now own everything). But the best guess is that mining is about 80 per cent foreign-owned.

Trouble is, mining is an obvious exception to this generally sensible aversion to economic nationalism, for two reasons: because our abundant natural endowment makes minerals and energy such a huge source of economic rent and because mining is so extraordinarily capital-intensive.

Added to that, as Dr Stephen Grenville (a former senior econocrat who does make a useful contribution to the public debate, via the Lowy Institute) has written, "mining royalties, a state government domain, fall victim to special relationships and inter-state competition to attract projects".

Put all that together and you see why having an effective resource rent tax is so essential to ensuring Australians get a fair reward for the exploitation of their birthright. High economic rents, few jobs created and the lion's share of profits going to foreigners mean unless especially high rates of profitability are adequately taxed we don't have a lot to show for the resources boom.

Saying that isn't anti-foreigner, it's simple self-interest, the driving force of market economies. Foreigners are welcome, provided we get a fair share of the benefits. Foreign investment isn't meant to be a form of aid to rich foreigners.

It's true our rate of national saving increased during the boom. But a lot of this was foreign-owned mining firms reinvesting their profits in local expansion rather than repatriating them, thereby increasing their share of our productive assets.

Now the construction phase is ending, more of the (undertaxed) profits will be sent back home. And the capital-intensive production and export phase will mean each $1 billion of growth in GDP now creates fewer jobs than it used to. Thank you Labor, thank you Coalition, thank you economists.

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Ending the mining tax will hurt jobs

Don't be misled by last week's better-than-expected figures for employment in February. If you peer through the statistical haze you see the problem is the reverse: employment is weaker than you'd expect. Follow that through and it takes you to - of all things - the mining tax.


The job figures were better than expected for two quite silly reasons. First, because economists are hopeless at predicting month-to-month changes in employment and unemployment. Their guesses are wrong most months.

Second, because it suits the vested interests of the financial markets and the media to ignore the Bureau of Statistics' advice and focus on the volatile seasonally adjusted estimates rather than the more reliable trend estimates.The markets like volatility because it makes for better betting; the media like it because it makes for sexier stories.

If we put understanding ahead of thrills and spills and use the trend estimates, they show total employment grew by a paltry 58,000 over the year to February, an increase of just 0.5 per cent. Worse, within that, full-time employment actually fell by 24,000.

This doesn't fit with the news we got the previous week that real gross domestic product grew by a not-so-bad 2.8 per cent over the year to December. (Comparing employment to February with economic growth to December isn't a problem because employment responds with a lag.)

Economic growth of 2.8 per cent is only a bit shy of our medium-term trend growth rate of 3 per cent, which Treasury estimates is consistent with annual employment growth of 1.5 per cent, or 170,000 extra jobs.
So the real question we should be asking is why employment has been weaker than you'd expect.

The answer isn't hard to find: it's because "net exports" (exports minus imports) account for 2.4 percentage points of the overall growth of 2.8 per cent. And most of that is explained by the resources boom's shift from its investment phase to its production and export phase.

On one hand, construction workers are losing jobs as the building of new mines and natural gas facilities winds up while, on the other, few extra jobs are required to permit a huge increase in mining production. All this is fine for growth in production (real GDP), but bad for growth in employment.

Fact is, mining's so hugely capital-intensive that though it now accounts for an amazing 10 per cent of GDP, it still accounts for a mere 2.4 per cent of total employment.

Now, I've never had any sympathy for those who argue an expansion in mining isn't worth having because it generates so few extra jobs. This reveals a fundamental misunderstanding of how economies work (via the "circular flow of income").

The size of an industry's economic contribution is determined not by the number of jobs it creates directly, but by the amount of income it generates. And even with falling coal and iron ore prices, our miners are still highly profitable because their efficiency, plus the quality and accessibility of our mineral deposits, mean their marginal cost of production is far lower than that faced by miners in most other countries.

In other words, our miners earn huge economic rents.

What the mining bashers miss is that when all the income generated by an industry is spent, it generates jobs throughout the economy. This includes the income the industry pays in tax, which generates jobs when it's spent by governments.

In the case of mining, however, there's a weakness in this argument. For the income earned by an industry to generate jobs in Australia, it has to be spent in Australia. And our mining industry is about 80 per cent foreign-owned.

Got the message yet? For our economy and our workers to benefit adequately from the exploitation of our natural endowment by mainly foreign companies, our government has to ensure it gets a fair whack of the economic rents those foreigners generate.

This, of course, is the justification for the minerals resource rent tax. And the fact that, so far, the tax has raised tiny amounts of revenue doesn't mean mining is no longer highly profitable, nor that the tax isn't worth bothering with.

Because Labor so foolishly allowed the big three foreign miners to redesign the tax, they chose to get all their deductions up-front. Once those deductions are used up, the tax will become a big earner. Long before then, however, Tony Abbott will have rewarded the Liberal Party's foreign donors by abolishing the tax.

This will be an act of major fiscal vandalism, of little or no benefit to the economy and at great cost to job creation.

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