ENVIRONMENTAL ECONOMICS

July 24, 2007

The environment and economic activity

Mankind's economic activity - the production and consumption of goods and services - adversely affects the natural environment in many ways. It causes pollution, the using up of natural resources and the endangering of species. Linked with mankind's economic activity as a cause of environmental damage is the growth in the human population. More people mean more disturbance to the natural environment.

Economic activity will have a damaging effect on the environment no matter what system is used to organise that economic activity, whether it be a market system, command system or traditional system. However, since our economy is organised using the market system, we will focus on the way a market system affects the environment.

Economic arguments for preservation of the environment

There are four main economic arguments in favour of the preservation of the natural environment:
1) environmental assets. Environmental assets (such as clean air, clean water, attractive views, native species and fish in the sea) are just as much economic resources as the resources on which economics traditionally focuses: land, labour, capital and enterprise. Environmental assets are used in the process of production and consumption and are scarce (in limited supply). They are not 'free goods' because they can be used up. (Note: air can't be used up, but clean air can be.) If environmental resources can be used up, they should not be used wastefully, but used with economy ie allocated to their most efficient use. The main difference between traditional economic resources and environmental assets is that traditional economic resources have clearly defined private property rights, whereas environmental assets are common property. The price mechanism (and economic analysis) has difficulty coping with resources that are common property (ie market failure), but this isn't a reason to ignore environmental assets.

2) satisfaction of wants. The goal of economics is to maximise the satisfaction of the community's wants. It's clear that, as well as its material wants (more goods and services), the community has environmental wants (eg clean air and water, attractive views and the preservation of species). If economics ignores environmental wants because the market mechanism finds it hard to cope with them, it will not help maximise the community's satisfaction. It seems that, as the community's material standard of living rises, the value it places on environmental wants ('quality of life') increases.

3) environmental feedback. Much economic activity depends on the preservation of the environment eg effect of environmental damage on tourism; effect of land degradation on farming; effect of water quality on commercial fishing; over-harvesting of fish. As well, some environmental damage generates private costs eg double-glazing of windows to reduce noise pollution.

4) inter-generational equity. Much environmental damage is irreversible (eg clearing of land, building dams, destruction of native forests and extinction of species) and some resources are non-renewable. Current economic activity has implications for the environmental inheritance of future generations.

Economic arguments against preservation of the environment

There are three main economic arguments against preservation of the environment:
1) opportunity cost. Just as some material wants may only be satisfied at the expense of others, so some environmental wants may only be satisfied at the expense of some material wants. This is the correct way to express alleged economic arguments against environmental protection eg banning the logging of native forests will 'destroy jobs'; banning mining in national parks will 'harm the balance of payments'. A higher 'quality of life' may well involve a lower material standard of living. This is not a problem as long as the community understands the consequences of the choices it makes.

2) distributional implications. The costs and benefits of environmental protection may not be shared equally across the community. eg the people who gain most satisfaction from protecting native forests may not be the same people who lose their jobs.

3) the value of labour. Economists seek to make the most economical use of all resources, including man-made capital and labour. But environmentalists are concerned to make the most economical use (or even minimum use) of only natural resources, including energy. Implicitly, they attach little value to capital and labour. Because of the high cost of capital and labour, the market (and market-based intervention) will not produce as much recycling and avoidance of waste of raw materials as environmentalists desire.

Conflict between economic growth and environmental protection

The mainstream economists' view is that there is a conflict between man's desire to increase his material standard of living (ie produce more goods and services) and his desire to preserve the environment. The conflict arises because resources are scarce but wants are infinite. The opportunity cost of faster economic growth is more damage to the environment; the opportunity cost of less damage to the environment is slower economic growth.

There is, however, an exception to this general proposition: instances of government failure. Underpricing of publicly owned resources (eg forests, minerals) and underpricing of publicly provided services (eg electricity and water) can cause misallocation of resources and faster depletion of natural resources or unwarranted environmental damage (eg land degradation through irrigation; need to build more dams).

This is not to say that we face a mutually exclusive choice between either economic growth or environmental protection. It means the community must decide what trade-off it wants to make, what balance it wishes to strike, between these two valid, but conflicting, objectives. Economists are very familiar with trade-offs between conflicting objectives - which is why they developed the concept of opportunity cost.

Normally, the community determines the trade-off it desires between conflicting objectives in the market place via the price mechanism. It votes with its dollars. However, in the case of the conflict between economic growth and environmental protection, the market mechanism is not very effective in providing the community with the trade-off it desires. This is because environmental assets are common property rather than private property. Economic activity generates environmental externalities for third parties which those third parties lack the property rights to do anything about. This market failure means governments have to intervene in the market to ensure that the community's desired trade-off between economic growth and environmental protection is achieved. However, the political process by which governments seek to implement the community's preferences is an imperfect one where the true opportunity costs of choices may not be understood by the community.

Government policies to preserve the environment

Government policies to preserve the environment can be divided into two broad classes: command and control measures and economic instruments.

Command and control. In practice, most environmental intervention takes the form of legislation to prohibit or limit undesirable emissions and other activities. Local government zoning regulations limit polluting activities to certain areas, generally away from residential areas. State environment protection agencies set emission standards and rules for the disposal of waste and prosecute firms which fail to comply.

To the public, politicians and many environmentalists, regulation is the obvious way to respond to environmental problems. Regulation deals with the problem directly.
However, while economists accept that regulation and prohibition may be the only practical responses in some circumstances, they believe that, generally, regulation will not produce the best trade-off between SoL and environmental protection. This is because regulations impose costs without always creating incentives to find cheaper ways of reducing environmental damage.

Economic instruments. In our efforts to preserve the environment, economists favour the use of instruments which harness market forces to the service of the environment, believing that this will achieve the government's environmental objectives with minimum loss of economic growth. Economic instruments aim to 'internalise' externalities and, in the process, create incentives to meet environmental standards in ways that allocate resources efficiently.

Tradable permits. Governments may set an environmental standard which determines an acceptable level of emission, then award (or auction) permits to emit pollution up to the standard. Producers with low costs of controlling pollution have an incentive to do so, so they can sell part of their pollution rights to producers who face high costs of controlling pollution. The effect is to reduce the industry's overall cost of compliance with the standard. Tradable permits have an advantage over pollution taxes because the rate of emission is certain and the price of the permits uncertain, whereas with pollution taxes the rate of tax is certain and its effect on the level of emission is uncertain. Tradable permits can be used for other environmental protection, such as minimising the economic costs of limits on irrigation or fishing catches.

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TALK TO HOPE STREET BUSINESS LUNCHEON

Sydney, Friday, May 26, 2007

Brendan has asked me to say a few words sharing my background and experiences and what I’m really passionate about these days, and I’m happy to do so.

To understand me you have to know that I come from an extended family of Salvationists and that both my father and my mother were Salvation Army officers - ministers - making me a member of a strange group known to the Sallies as OKs - officers’ kids. My father was the minister of a long succession of very small congregations in NSW and Queensland. The Army moved him every two years - sometimes after only one year - and when he moved, we did too. In consequence, I went to five primary schools and three high schools around NSW and one in Brisbane. These days I’m what the Sallies call a ‘backslider’, but I think you can see pretty clear evidence of my upbringing in the things I write and the attitudes I take in my columns.

Both my parents came from big families in Queensland and I’m the only one in the family who’s not a Queenslander. Since I was born in Newcastle and ended my education in Newcastle I’m happy to tell people I’m from Newcastle and proud to say I was educated at the now-defunct Newcastle Boys High. Only when I’m trying to impress people do I say I went to Fort Street - and omit to mention it was only for a year. I did a commerce degree at Newcastle University, majoring in accounting but also doing a lot of economics - which I couldn’t see the point of and struggled to pass. In 1969 I left Newcastle, got a job working for the national auditing firm of Touche Ross (now merged with KPMG) and eventually qualified as a chartered accountant.

Not long after I qualified I took a year off to go back to uni and ended up stumbling into journalism. In 1974 I started at the bottom as a cadet journalist, at what was then considered to be the very mature age of 26. The editor who hired me said he couldn’t believe a qualified accountant would take to being a cadet reporter, but it was worth a try. A Kiwi mate was amazed and appalled that I’d consider giving up the status of being a chartered accountant to become a lowly reporter.

That was 33 years ago and I’ve been at the Herald ever since. I did a bit of reporting from the press galleries in Macquarie Street and Canberra, and wrote a fair few of those unsigned editorials on the same page as the readers’ letters. But I’ve been the Herald’s Economics Editor for 29 years, I’ve been a Herald columnist for 30 years and I’ve been doing exactly the same job I’m doing now for 24 years. I know I should have left the Herald and gone to another paper years ago, but my problem is that my ambition was to become the Herald’s Economics Editor, I achieved that ambition at the age of just 30, and in all the time since then I haven’t been able to think of a job I’d more like to do or a paper I’d more like to work for. I have the best job in the world: I’m paid a fat salary to sit in an armchair and pontificate three times a week. Bernard Levin, when a columnist on The Times, said he could never understand why they paid him for the privilege of publishing his opinions rather than making him pay them - and that’s how I feel (but don’t tell David Kirk I said so).

You should know that a great part of my success in journalism - certainly, my rapid rise to prominence - comes from being in the right place at the right time. The year I joined the Herald, 1974, has since been identified by economists as the great turning-point in the post-war economic history of Australia and the developed world. It was the year we felt the destabilisation of the first OPEC oil shock, the year the post-war Golden Age ended with the advent of stagflation, the year our economy entered a period of high inflation, high unemployment and general economic dysfunction that we didn’t start to emerge from until the mid-1990s, the year the Whitlam Government didn’t have any idea what had hit it, and the year it first dawned on the editors of Australian newspapers that the dominant, unending political story of their times was actually the economy. In such an environment there was a sudden, strong demand for the services of journalists who were capable of writing about the mysteries of economics. There weren’t many takers, so someone with my background was quickly pressed into service and promoted up the line. But I confess I’ve had to learn or relearn most of my economics on the job.

People often refer to me as an economist, but I’m not, and no true economist thinks I’m one. I used to say I was an accountant pretending to be an economist, but I can’t say that any more because, these days, I’d only be pretending to be an accountant as well. So now what I prefer to say is that I’m a journalist who writes about economics. This fits well with my changing views about my role. I’ve always been on about explaining economics and for a long time I saw my role as convincing my readers of the truth of economics. I was an early salesman for economic rationalism. But experience and wider reading has helped me see the limitations of conventional economics, so now I see myself as someone paid to provide my readers with a critique of economics, just as a theatre critic provides his readers with a critique of the latest plays. Economics has strengths and weaknesses and it’s my job to point them out.

As for something I’m feeling passionate about, I been thinking a lot lately that there’s a contradiction at the heart of the capitalist system. The system includes many people who make their living by tempting you to buy things and do things which are fine if you do them only in moderation, but which can bring you down if you do too much of them. So the key to being a winner - a master - in the capitalist system is to possess the self-control to resist the temptations it continually throws at you. If you oblige the capitalists and always buy what they’re pushing, you’ll help to make them rich but, paradoxically, you’ll become a loser - a victim - of the system.

What are these temptations? They’re manifold. The one we’re most conscious of these days is the temptation to eat too much. But there are many more: to get too little exercise, to smoke, to drink too much, to watch too much television, to gamble too much, to shop too much, to save too little and put too much on your credit card, to work too much at the expense of your family and other relationships.

All of those things are being pushed on us by the system. They’re what the capitalists are trying to sell us. A lot of highly paid advertising people, marketers and merchandisers make their living finding ever-more effective ways to persuade us to indulge. In the case of exercise, no one’s selling the lack of exercise, but lots of people are selling ways to avoid exercise - whether it’s going everywhere by car, using the remote or watching sport on telly rather than playing it. Admittedly, people are also selling ways to get fit - from exercise bikes to gym subscriptions and all the right gear to wear - but then you’ve got to make sure you don’t get hooked on being underweight or using steroids to bulk up.

OK, so we need to demonstrate a bit of self-control in our lives. What’s so new and surprising about that? Two things.

First, research by psychologists, neuroscientists and behavioural economists has shown that humans have a great problem exercising self-control. We think it’s up to us to decide how much to eat or how much TV to watch but, in fact, many of us find it very hard to restrain ourselves in the way we know we should. This is because our brain is a complex mechanism, which evolved over millions of years. The older, more primitive part of our brain tends to make instant decisions on an instinctive, emotional basis. The newer, more rational part of our brain tends to make more reasoned judgements, but to be a lot slower off the mark. Experiments with people who’ve had the two sides of their brains severed in some accident show that the reasoning part of our brain often doesn’t know why the faster, more instinctive part of our brain decided to do what it did, but is adept at thinking of plausible explanations for its behaviour. Psychologists call this process ‘confabulation’ - others call it ex-post rationalisation.

It’s as though we have two selves, an unconscious self that’s emotional and short-sighted and a conscious self that’s reasoning and far sighted. We have trouble controlling ourselves in circumstances where the benefits are immediate and certain, whereas the costs are longer-term and uncertain. When you come home tired from work, for instance, the benefits of slumping in front of the telly are immediate, whereas the costs - feeling tired the next day; looking back on your life and realising you could have done a lot better if you’d got off your backside and played a bit of sport, sought a further qualification at tech, studied harder for exams, spent more time talking to your kids etc. Similarly, the reward from eating food is instant, whereas the costs of overeating are uncertain and far off in the future - being regarded as physically unattractive, becoming obese, becoming a diabetic, dying younger etc. As everyone knows who’s tried to diet, give up smoking, control their drinking, save or get on top of their credit card debt, it’s very hard achieve the self-control our conscious, future selves want us to achieve. Many of us may have no trouble controlling ourselves in most of the behaviours I’ve listed, but I doubt there’s anyone much who can claim to have themselves perfectly under control in every area.

The second reason for getting so excited about the problem of self control is the likelihood that the very success of the capitalist system in making us more affluent is serving to heighten our self-control problem. Our brains work the way they do as a result of our evolution. We are what we are because it contributed to our reproductive fitness. We evolved the way we did to protect us from the risk of death, for instance, and to cope with the problem of scarcity. As it happens, economics is all about coping with the problem of scarcity. But human ingenuity - including the development of the capitalist system - has increasingly overcome scarcity. These days, most of us in the developed economies have a greater problem coping with abundance than scarcity. For instance, we’ve evolved to eat everything that comes our way, because nutrition was scarce on the African savanna, but now food is abundant and, hence, cheap. So we’ve lost the natural control that, until relatively recently, stopped our instinct to overeat from making us overweight. Similarly, the huge growth in our real incomes over the past century has made it easier for us to afford to overindulge in many of the other vices I listed. Credit is another thing that’s become readily available and relatively cheap.

So I’m beginning to think that overindulgence and difficulties in self control are the big problem of our age. Even the worries we have about our despoiling of the environment and our excess emissions of greenhouse gases can be seen as problems of abundance. Too much unguided economic activity - which has also led to too much population growth - is upsetting the earth’s natural balance.

There are solutions to the problem of self control - at the government policy level and at the level of individuals controlling their own behaviour (the latter involving subtle ways of tricking our unconscious selves) - which I suspect will become an increasing focus as the 21st century progresses.

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WELLBEING, MONEY, PSYCHOLOGY AND ECONOMICS

Conference on Quality of Life, Deakin University
November 30, 2006

I want to talk to you about the increased interaction between the disciplines of psychology and economics, and focus particularly on the relationship been income and subjective wellbeing, as befits a conference on quality of life. But first I need to explain that I’m not an economist myself. Rather, I’m a journalist who writes about economics.

Psychology and economics

You won’t be surprised to know that the academic discipline of economics is pretty inward-looking and hidebound. It’s still dominated by the neoclassical model of markets developed first by economists such as Adam Smith in the 18th century and Alfred Marshall in the 19th. It’s evolved a bit since then, but not as much as you might expect and not as much as I suspect psychology has. The conventional neoclassical model is built on many debatable assumptions, but most of the academic effort has gone not on trying to improve those assumptions but on mathematising the model, which permits many rigorously logical conclusions to be drawn - given the assumptions. All this maths allows the economists - like psychologists - to believe their discipline is more rigorously scientific than the other social sciences.

There have been various new developments in economics over the years - most of which have come to dead ends - but the relatively recent developments I find most interesting and most promising are based on borrowings from the work of psychologists. It may surprise you to know that the Nobel Prize in economics has twice been won by psychologists. Herb Simon of Carnegie-Mellon won it in 1978 for his ‘pioneering research into the decision-making process within economic organisations’. Conventional economics assumes economic man - homo economicus - to be a lightning-quick calculator of costs and benefits. Simon argued that people often use rules of thumb that economise on the cost of collecting information and on the cost of thinking. Their rationality was thus ‘bounded’ and rather than maximising their utility they ‘satisfice’ - they do as well as they think possible.

The second Nobel to a psychologist went to Daniel Kahneman of Princeton in 2002. He took Simon’s work a lot further, winning the prize ‘for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty’. It’s not directly relevant to quality of life, but I’ll say a little about it because it is interesting and it does, at present anyway, represent psychology’s most successful incursion into the thinking of economists. With the help of some economists, Kahneman founded a new school of thought within economics, known as behavioural economics, which has attracted a big following among younger academics.

Decision-making

As we’ve seen, behavioural economics challenges one of the central elements of conventional microeconomic theory: the assumption of Homo economicus. Economic man is assumed to be rational and self-interested. She always carefully evaluates all the options before making any decision, and always with the object of maximising her personal ‘utility’ or satisfaction. But cognitive psychologists have demonstrated that humans simply lack the neural processing power to make the carefully calculated decisions economists assume. People aren’t rational, they are intuitive. And altruism is often an important consideration in their decision-making. People can’t chose correctly between three options where the best option is not immediately apparent. Rather than carefully thinking through the pros and cons of every decision, people tend to rely on mental shortcuts (‘heuristics’) which often serve them well enough, but also lead them into systematic biases. People are often slow to learn from their mistakes. They are frequently capable of reacting differently to choices that are essentially the same, just because the choices have been ‘framed’ differently. This means that, rather than being coldly rational, people’s decisions are often influenced by emotional considerations.

All this means that Homo sapiens differs from Homo economicus in many important respects. He doesn’t conform to economists’ assumption of fungibility (one dollar is indistinguishable from another), he is often not bothered by opportunity cost and thus has a strong bias in favour of the status quo. He doesn’t ignore ‘sunk costs’ as he is supposed to and often cannot order his preferences consistently. He is not averse to risks so much as averse to losses and he focuses more on changes in his wealth than on its absolute level.

Unlike Homo economicus, Homo sapiens cares deeply about fairness. Experiments show people will walk away from deals they consider treat them unfairly, even though those deals would leave them better off. People are prepared to pay a price to punish others they consider to have been behaving badly towards the group. Often people are concerned about ‘procedural fairness’ – how things are done, not just how they end up.

Wellbeing and utility

That’s enough about psychology’s first challenge to economic orthodoxy. After Kahneman had made his mark on the theory of decision-making he moved on to join many other psychologists - and a few pioneering economists - in studying subjective wellbeing, quality of life, life satisfaction, happiness, call it what you will. This study ought to be of intense interest to economists because it’s hard to see much difference between psychologists’ subjective wellbeing and economists’ utility or satisfaction. In original intention, neoclassical economics is about studying the way individuals maximise their utility. As you know, conventional economics was heavily influenced by Bentham’s utilitarianism. So if economics has a goal, it’s to help the community maximise its utility.

The problem is that economics has rather lost its way on the question of utility. Sometime in the 1930s it was decided that the trouble with utility is that it’s unobservable - you can’t measure it. You can’t know how much utility A derives from the consumption of a glass of beer relative to B. The most we can hope to know is how they order or rank their choices. A prefers beer to wine, but wine to lemonade. But no mater. Since A and B are rational, and are always seeking to maximise their utility, it’s clear their preferences will be revealed simply by looking at what they choose to buy with their income. Their ‘revealed preference’ will tell us all we need to know about their utility.

Note how this seemingly neat shortcut relies heavily on the assumption of rational choice, that people always know and do exactly what’s best for them. They never do anything they subsequently regret and if occasionally they make a mistake, they quickly realise their error and never repeat it. Note, too, how circular the logic has become. How do we know what people want? From what they do. How do we know they do what they want? Because they do it. And here we see an old prejudice among economists that affect their attitudes towards psychology and its experiments, as well as surveys of wellbeing: ignore what people say they want, just focus on what they do. The other short-circuitry at work is that, though in theory economics is about maximising utility, in practice it ends up being about maximising consumption. Which particular forms of consumption? Doesn’t matter - just consumption. Which consumption is the private business of each consumer and not a fit subject for economists or governments to meddle with. How do you maximise consumption? By maximising the income from which people finance their consumption. How do you do that? By getting the economy to grow as fast as you reasonably can.

Now perhaps you see why the psychologists’ huge body of work on wellbeing is highly relevant to the work of economists - and highly challenging to their conventional views. And the particular pressure-point is obvious: the relationship between income and wellbeing. That’s what the economists who study wellbeing are most interested in. So what have we discovered about income’s role in wellbeing? We’ll get to that in a moment, but first I want to say something about terminology.

Speaking the same language

I think there’s much to be gained from an inter-disciplinary approach to many issues, but I’m constantly disappointed by the lack of contact between academics of different disciplines. They often criticise each other from afar - from the comfort of their own camps - but rarely get together to argue through issues of common interest. As a result, they’re often quite ignorant of the others’ way of looking at things, thus allowing much misunderstanding and incomprehension.

Joan Robinson, perhaps the most famous female economist and a contemporary of Keynes at Cambridge, once said that the purpose of studying economics is to learn how to avoid being deceived by economists. My take on the subject isn’t so defamatory: I think we study economics to learn when to use the many synonyms for the word ‘money’. Money is a vague term, can’t you be more specific? I’ve noticed that many social scientists use the words ‘income’ and ‘wealth’ interchangeably, whereas to economists they have quite specific, and different, meanings. Economists, like a lot of academics, are quite arrogant. So when you use those two words interchangeably, they’re either confused or they conclude you’re ignorant and not worth taking seriously.

Income is what you earn during a period from wages, business profits or investments, plus cash benefits received from governments. Most income is spent on living expenses - consumption - while some is saved. Wealth, on the other hand, is the value of the assets you own, less any money you owe. You add to it by saving some of your income, by gifts and bequests from others and by capital gain. Income is measured over a period of time - a week or a year - whereas wealth is measured at a point in time, such as the first day or the last day of a week or a year. So income is a flow of value over time, whereas wealth is a stock of value at a point in time. Consumer spending is primarily done from income, but the two aren’t the same thing because people spend less than their income when they save, or more than their income when they borrow to finance additional consumption.

It’s clear that what we’re talking about in the wellbeing context is almost always income, not wealth or consumption. Another thing psychologists seem weak on is the distinction between absolute levels of income and relative income. Relative income is how much I earn during a period relative to what other people are earning. A person or household’s absolute level of income is viewed in isolation from other people’s, though it can be compared over time - with how much I earned a year ago or how much I expect to earn in a year’s time. This distinction may seem pedantic but, as we shall see, it’s pivotal to the interpretation of the effect of income on wellbeing.

Income and wellbeing

Let me summarise the research results as I understand them. The first point to make is that, contrary to popular wisdom, money does make us happy - up to a point. Studies of developing countries show that the higher the average level of income per person in a country, the happier the people in that country say they are. So, up to a certain point, rising GDP per person does make people happier. That point, however, is about $US10, 000 or $US15,000 a year per person - a point that Australia and all the other developed countries passed a very long time ago. Studies show that even though the people in rich countries' income per person has doubled or trebled in real terms since the 1950s, average levels self-reported happiness haven't changed - they haven't fallen, but nor have they risen. In other words, and to use an economists' term, when it comes to happiness, money is subject to significant DMU - diminishing marginal utility. An increase in our income adds little if anything to our utility.

Why do increases in absolute income do little to make us happier? Because of a pervasive human trait psychologists call adaptation. It doesn't take long before we get used to our newly improved circumstances and come to take them for granted. They get absorbed into the status quo and we go back to being about as happy as we always were. To put the point another way, soon after we achieve a higher level of material success, our aspirations move up another notch and we go back to being dissatisfied with our achievements.

The second point to make is that if, instead of comparing different countries over time, we look at particular countries at a point in time, we do find that people with higher incomes are happier than people with lower incomes. Particularly in the case of Australia, however, the difference is surprisingly small - that is, on average, rich people are only a bit happier than poorer people. How are these two seemingly contradictory findings reconciled? It's simple: people seem to be a lot more concerned about the level of their income relative to others than about what's happened to the level of their income over time. When all of us enjoy rising incomes at pretty much the same rate - which is what's been happening over the decades - none of us feels any better off. What little satisfaction we get from high incomes comes from having an income that's higher than other people's. We use our income as an indicator of success in life and of our social status. And some research suggests that it's really social status that affects our happiness much more than income as such.

Now, here’s where I beg to differ with my mate Bob Cummins (professor of psychology at Deakin University, Melbourne). When Bob looks at the results from the Australian Unity Wellbeing Index, and in his article in the Journal of Happiness Studies in 2000, he concludes that income has a significant effect on wellbeing. On average, people in the top income bracket report greater subjective wellbeing than those in the middle bracket and those in the middle report greater wellbeing than those in the bottom bracket. Well, I could quibble about whether those differences are big enough to be judged significant - to me they seem quite small. Very large increases in income are needed to produce quite modest increases in wellbeing - my point about income being subject to greatly diminishing marginal utility as income rises beyond the poor-country threshold.

Bob uses this evidence of greater levels of wellbeing for higher income-earners to argue that it supports the homeostatic theory of wellbeing - the theory that subjective wellbeing is held within a narrow range determined by personality. Bob argues that people with higher incomes enjoy higher wellbeing because they suffer less from homeostatic defeat. This is because they can buy the resources necessary to optimise the operation of their homeostatic system. Now, I want to make it clear that I’m not attacking the homeostatic theory as such. Indeed, I think we can drop the homeostatic bit out of the argument completely and we’re left with the standard materialist argument in favour of being rich: the rich are happier because they can afford to buy more than other people - more comfort, more assistance, more everything.

My point is that Bob hasn’t demonstrated, as he claims, that income has a significant effect on wellbeing. Rather he’s demonstrated a much smaller claim, that relative income has an effect on wellbeing. The point is that, if more income makes us happier because we can afford to buy more stuff (or, in Bob’s terms, because we can buy resources to overcome homeostatic failure) then, as everyone’s income rises over time in line with economic growth, all of us can afford to buy more stuff so our reported wellbeing should rise over time. But we know from many studies that though the real incomes of people in the developed economies have risen by a factor of three or four since World War II, their reported wellbeing hasn’t budged. So we’re left with the much more qualified statement that higher relative income increases the wellbeing of those towards the top. And we’re left with the likelihood that the reason a high-income earner feels a little happier has to do not with her ability to buy more stuff but with her knowledge that’s she’s been more socially successful than many others.

Why am I labouring this distinction between increasing absolute income over time and possessing a higher relative income at a point in time? Because it has profound implications for the goals of economic management. From the point of view of economists and politicians, this finding is bad news. Why? Because though the pursuit of economic growth can raise everyone's income in absolute terms, there's nothing it can do to raise everyone's relative income. Obviously, there'll always be some people who come towards the top of the class and some people who come towards the bottom. We might change the order around, but that will produce as many losers as winners, leaving the population no better off overall.

To repeat, this is a devastating conclusion for economists – and particularly economic rationalists – whose whole practical motivation has been based on the assumption that helping the community raise its productivity and increase its production and consumption of goods and services will leave it unequivocally better off. There is no doubt that, materially, we are better off than we were even 10 years ago: our homes are bigger and better, our cars are better, our food and clothing are fancier and we have any number of wonderful new gadgets to save us labour or entertain us. But though we are better off, we don’t feel better off.

Implications for economic policy

This brings us to the implications of wellbeing research for economic policy should economists and politicians someday incorporate them into their thinking. Richard Layard, a leading British economist who has embraced the psychological push says that, beside adequate income, the research shows six main factors affect happiness: mental health, satisfying and secure work, a secure and loving private life, a secure community, freedom, and moral values.

So my first policy implication is that reducing unemployment should be given a much higher priority by the economic policy-makers. Research shows that being unemployed makes people particularly unhappy, a lot more unhappy than can be explained by the loss of income they suffer by not having a job. What people miss is the sense of identity and self-worth that comes from a job, and also, no doubt, the social contact. Economists may protest that they are already giving high priority to reducing unemployment but, in truth, their pursuit of this goal is conditional. Their concern with the efficient allocation of resources means they frown on any solutions (job sharing, job-creation schemes, public sector employment, for instance) that involve modest inefficiencies. The truth is that the overwhelming goal of economists is to hasten the growth in the economy’s production of goods and services, and the jobs generated in this process are just a fortunate by-product.

My second policy implication is that governments and employers could do a lot to raise subjective well-being if they put more emphasis on the enrichment of jobs – increasing job satisfaction by giving workers more personal control, opportunity to use their skills, variety in tasks, respect and status, and contact with others. Taken literally, the economists’ model assumes that all work is unpleasant – a disutility – and is undertaken purely to gain the money to buy the things that bring utility. Like the rest of us, economists know that, in reality, work carries much intrinsic satisfaction. But they don’t follow this realisation through to their policy prescriptions. They are perpetually advocating labour market reform aimed at ensuring labour is used more efficiently, treating labour as though it were just another inanimate economic resource, and ignoring the feelings of the human beings attached to the labour. Various of the ways labour can be used more efficiently make life unpleasant and even unhealthy for the workers involved: ever-changing casual hours, rolling shift work, split shifts and firms continually moving their staff to different cities. When we pursue efficiency at the expense of people, economists have got things round the wrong way, trashing ends so as to advance means.

A third implication is that economic policy-makers should recognise the benefit of stability. People like stability – it makes them feel secure and happy. What’s more, it breeds a highly valuable commodity: trust. People don’t like continuous change. Macroeconomic management is aimed a stabilising the rate of growth in demand, and that’s good. But microeconomists perpetually advocate change (‘reform’) aimed at increasing efficiency, raising productivity and quickening the production of goods and services – the very objective we now know doesn’t make people any happier. Often, micro reform involves ‘displacing’ workers from the reformed industries where their labour wasn’t being used efficiently. This is a process that causes no heart searching among economists because their model: first, assumes alternative employment will be readily forthcoming; second, ignores the intrinsic satisfaction from work and, third, assumes unemployed workers will have a whale of a time enjoying all their new-found leisure.

A fourth policy implication is that the thing economists celebrate as ‘competition’ and are always trying to encourage because it acts as a spur to efficiency and growth, is actually ‘rivalry’ that creates losers as well as winners and thus generates roughly as much unhappiness as happiness. Rivalry is hardwired into our brains, but a case can be made that social comparison is not something we should be encouraging. Seen in this light, we should think twice about the unceasing calls for us to do this or do that to preserve or improve the economy’s international competitiveness. But why? It is just rivalry on a global scale. It is saying, we must make sure foreigners do not get richer at a faster rate than we are, or even, God forbid, overtake us on the league table.

Fifth, instead of merely unquestioningly promoting consumption, economists should be doing something they rarely do: studying it. They need to see whether there are some forms of consumption that that yield more satisfaction than others. It may be that, in our striving for social status, we are devoting too much of our time and income to the purchase of ‘positional goods’ - conspicuous consumption – and too little to activities empirical research now tells us would yield greater satisfaction. Robert Frank of Cornell says the ‘gains that endure’ are more likely to include social life, time with our children, less travel time to work, more job security and better health care. Layard says we should be spending a lot more on fighting glaring evils – and sources of profound unhappiness - such as depression.

Sixth, the evidence that income is subject to diminishing marginal utility strengthens the case for redistributing income from rich to poor, since such transfers should increase total happiness. As yet, however, there is mixed evidence on the question of whether people who live in countries with a narrower gap between rich and poor are happier. Alesina et al. (2001) find that income inequality has a large negative effect on happiness in Europe, but not in the United States.

Finally, we should look sceptically at the incessant calls for lower tax rates to encourage people to work harder. By its very nature, the economists’ model assumes away all non-monetary motives for work. We do it only for the money. But the reminder of the intrinsic satisfaction we derive from work also reminds that higher income-earners in particular have powerful non-monetary motives for working long and hard: job satisfaction and the pursuit of power and status. Reducing tax rates would merely allow us to run faster on the hedonic treadmill, whereas I think we should slowdown. The drive for reduced government spending and lower taxes would leave people with more disposable income they could use to purchase education and health care privately, in the hope that these positional goods would enhance their social standing. Layard warns we should worry lest leisure, public goods and inconspicuous consumption (consumption that is not compared with the consumption of others) are under-produced because people focus so much on conspicuous consumption.

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THERE’S NO BUDGETARY ISSUE BIGGER THAN HEALTH CARE

Talk to Federal Health Department’s Biennial Health Conference
Sydney, Tuesday, November 14, 2006

So far we’ve heard from speakers giving expert and finely tuned comments on technical aspects of acute care funding, but I think the most useful contribution I can make given my own expertise is to help you see acute care funding in a broader budgetary and political context. I’ll also range wider than just hospital funding, partly because outsiders (including politicians) tend to see hospitals as part of the total health care package, but also because it can be a mistake to focus on particular elements of health care spending in isolation. The various elements are interrelated and these linkages can be overlooked if we’re not careful - particularly when different levels of government are responsible for different elements.

Consider the case of hospitals on the one hand and the pharmaceutical benefits scheme on the other. One of the trends of advance in medical technology is for the use of better medicines to keep people out of hospital. The result is we spend more on pharmaceuticals but make savings on the number and length of hospital stays - which, as we all know, are very expensive. When you divide health care funding into silos, however, it’s too tempting for the feds to get overexcited about the rapid growth in the cost of the PBS, and wonder what draconian measures could be taken to slow the growth, while ignoring the savings being generated elsewhere in the system.

I’m sure you’re aware of the many reports econocrats have produced in recent years examining the budgetary pressures likely to arise over the next 40 years as the baby boomers retire and the population ages. Federal Treasury began the fashion in 2002 with its Intergenerational Report, which it will update in next year’s budget. Then the Productivity Commission had a go - trying to add the implications for state as well as federal budgets - and most state treasuries have now completely similar exercises, culminating in the NSW Treasury’s report on long-term fiscal pressures, issued with this year’s state budget.

Although there’s been some attempt to obfuscate matters, all these studies come to the same, surprising conclusion: though population ageing will generate considerable budgetary pressures in most developed countries, the likely pressures in Australia are modest and manageable. This is mainly because our age pension is flat-rate and heavily means-tested. The budgetary cost of ageing will show up more in health care spending than in pensions, but won’t be great. Even so, all the reports have projected considerable upward pressure on government budgets over the coming 40 years. Most of that pressure will be coming in one spending category: health care. The studies show that, whether you look at federal or state, health accounts for about three-quarters of the projected growth in total government spending. At present in the NSW budget, health (mainly hospitals) is the second biggest spending category after education, accounting for 26 per cent of total expenses. In 40 years time it’s projected to be the biggest category, accounting for 37 per cent.

As we’ve seen, this growth will be partly due to the higher proportion of older people in the population. For the most part, however, it will be due to a combination of supply and demand factors unrelated to demography. On the supply side, continuing advances in medical technology will add to costs for various reasons: because improved procedures tend to be more expensive than those they replace, because more conditions become treatable and because safer, less intrusive treatments can be prescribed for a wider range of patients. On the demand side, the public will continue to press for the fullest and earliest possible access to medical advances.

The first point to make is: don’t let anyone tell you this inexorable pressure for increased spending on health care is a bad thing. It’s a good thing. The projections assume real income per person will double over the coming 40 years. And health care is what economists call a ‘superior’ (or merit) good. Superior goods are things to which we devote an increasing share of our income as it rises over time. In the case of health care, that’s eminently sensible and hardly surprising: as we get richer why wouldn’t we spend more on staving off death and disability? What more pressing priority could we have?

If health care was sold in the marketplace like most goods and services, the news that we were likely to significantly increase our spending on it over coming years would attract not the slightest controversy. The contention arises because health care is delivered primarily by the public sector, with its cost funded mainly by general taxation. So the first problem is: will the public be prepared to pay the higher taxation needed to cover the cost of the greater care it will be demanding? Short answer: it will almost certainly be reluctant to but, since the politicians’ desire to please voters will ensure health care spending continues growing strongly, the pollies will have no choice but to keep raising taxes.

It’s not that simple, however. The fact that so much health care is delivered by - or, at least, funded by - the public sector rather than the private marketplace does mean there’s less discipline on spending and greater scope for over-servicing and other forms of waste and inefficiency. Even so, health care is funded primarily by general taxation for good reason: because we’re not prepared to let people who can’t afford health care they need go without. Health care is judged too important to be left to the market. And even though we can expect to see economic rationalists in the bureaucracy and elsewhere urging governments to shift more of the cost of health care off the budget and into private hands, I wouldn’t expect to see that process go very far.

Put all these factors together - inexorable pressure for greater spending, reluctance to pay the higher taxes needed to fund this spending, and well-founded suspicion that our delivery and funding arrangements aren’t as cost-efficient as they could be - and they add up to continuing and increasing pressure on the health system to do more with less.

In other words, I foresee health as the greatest public sector battle ground in coming years. There’ll be unrelenting pressure for improvement - or at least change - in funding arrangements. The likely growth in health care spending makes this inevitable. It’s possible a future federal Labor government could simply replace the now ailing Medicare with a completely new funding system that was just as radical as Medicare - or really, Medibank - was in its day. There’s nothing sacrosanct about Medicare. As Dick Scotton, one of its original designers has remarked, it was state of the health economists’ art when first conceived in the late 1960s, but there’d be something wrong if the health economists couldn’t come up with a vastly improved model 40 years later. There’s nothing sacrosanct about Medicare - save for one not-negotiable design feature: universality; the guarantee that all are covered and no one misses out. Preserve that and all the details are up for grabs. It’s universality that gives national health insurance its fairness or equity. What you’d be hoping for in replacing Medicare is greater efficiency in the allocation of health resources without much loss of fairness - or, in the parlance of economists, a better trade-off between the equally desirable but conflicting objectives of equity and efficiency.

I have to say, however, that if Labor has such a big bang replacement for Medicare up its sleeve, I’ve see no sign of it. The more likely prospect is for governments of either colour to be engaged in a process of continuous tinkering in response to the budgetary pressures I’ve described. We’ve heard from other speakers indications of the directions that reform could take. I’d just make two points. I believe the essential first step on the road to reform is to resolve the division of responsibility for health between levels of government, and the obvious answer is for the feds to take over public hospitals. That wouldn’t solve all problems, but it would make progress in solving them very much easier to achieve. Second, I don’t have much doubt that any progress we do achieve will involve moving the system in the direction of managed care. That’s the only way to achieve the unmentionable objective in every health bureaucrat’s mind: ensuring that too much of the increased spending on health care doesn’t end up lining the pockets of medical specialists.

Finally, it’s worth remembering that, though much of the talk about the need to increase efficiency and eliminate waste will be couched in terms of saving money and reducing spending on health, the reality is that, no matter how successful the economies are, there’ll be no reduction in health care spending nor even much slowing in the rate at which spending grows. Why not? Because of those inexorable pressures I’ve described. Rather, any success in raising efficiency will simply mean better value for the taxpayers’ ever-growing dollars.

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AN OUTSIDER’S CRITIQUE OF THE PERFORMANCE OF TREASURIES

Talk to Australasian Treasury Officers’ Conference, Hobart
November 3, 2006

I’m pleased to be here to talk to you and offer an outsider’s view of the performance of Treasuries - when I say Treasury, please take that to include finance departments where they’re separate from treasury and to refer to the ‘purse-string departments’ at both federal and state level. It’s not my practice in speaking to any group to tell them how wonderful I think that are, so my critique will be fairly critical. Of course, as an outsider it’s quite possible I’m misinformed - but, if so, I’m sure you’ll set me straight. Before I launch into any criticism, however, I should make it clear that I have a great deal of sympathy for treasuries and the vital role they perform in controlling public spending. It’s not a popular job, but someone has to do it and it may be that my original training as a chartered accountant gives me sympathy with those whose lot in life is to be that someone. Any fool can make themselves popular by spending money; it takes character to be the one who often says no. Or it may be my knowledge of economics gives me an acceptance that, despite the unwillingness of so many to accept it, there is a budget constraint, which will make its presence felt one way or another, and it’s much smarter to learn to live within it.

My basic claim, however, is that treasuries could be doing that job a lot better than they are. That, too often, they’re going through the motions using old fashioned budget restrictions to limit the growth in spending, using instruments that either aren’t very effective or that do a lot of collateral damage, whereas they need to be using newer techniques that are a lot more effective, imaginative or, as I like to say, scientific. And in that respect I think we need more than just the latest accounting fad.

But before we get on to all that, first we need to be clear about why we want to control spending and about the challenge that lies ahead. I’m not a believer that everything private is good and everything public is bad, so government needs to be kept as small as possible. Rather, government needs to be efficient and effective whatever its size. Why? Because of nothing more profound than opportunity cost. Because money doesn’t grow on trees and there’s a limit to how much tax people are prepared to pay. And because, to make the high levels of tax we must pay more politically palatable, we need to do more to counter the widespread perception that a much government spending is wasteful.

I don’t think we’ll ever reach a time when most voters have a realistic acceptance that, at least in the long run, budgets must balance, thus producing a clear link between how much governments spend and how much they raise in taxation. Most people remain hopeful that governments will increase their spending - because there are so many worthwhile things the government could be doing - without that requiring them to pay higher taxes.

You’ve probably been labouring under that tension for as long as you’ve been in treasury, but I think it’s clear that tension is likely to intensify rather than abate. We’ve now been through a large number of exercises examining future fiscal pressures, starting with federal Treasury’s Intergenerational Report in 2002, then the Productivity Commission’s report and then studies by most if not all state treasuries, including the NZ dept of finance.

All those studies tell us much the same thing: if you look out over the next 40 years or so, yes, you do see considerable pressure for increased government spending. But only some of this pressure will be coming from the ageing of the population. If it were just population-related it would be quite manageable. According to all the studies, most of the pressure will be coming from spending on health - from the ever-more-expensive advances in medical technology and the public’s demand that it be given access to the benefits of that advance as fully and quickly as possible. It’s paying for health that will present the greatest single challenge to the treasury officers of the next 40 years.

Now, before I go on, I want to make it clear that I do see a bit of treasury propagandising at work here. When before have we had this amazing rash of studies of future fiscal pressures in every jurisdiction? I don’t think it’s been purely because of concerns about ageing. I think it’s also because of treasury concerns about living in an age of strongly growing revenue, budget surpluses and a record length expansion phase in the economy (with resources boom). With spending demands so easily accommodated, with no deficit problem to hold over politicians, where does the discipline come from? It doesn’t. So you have to manufacture it, fashion yourself a stick to wave around people’s heads. I suppose that’s fair enough.

In the process, however, we’ve managed to highlight an important point: many if not most forms of government spending are what I call ‘superior goods’, otherwise known as merit goods and bearing similar characteristics to luxury goods. That is, as our income increases, our spending on them increases at an ever faster rate. The classic example of a superior good is health care spending - and that makes all the sense in the world. As we get richer, why wouldn’t we want to devote a significant proportion of the increase to staving off death and staying hale and hearty for as long as possible? So be clear that the unrelenting pressure for increased health spending is fundamentally a good thing, not a bad thing. It’s a trend to be accommodated, not resisted. And, since we choose for good reasons (mainly to do with equity) to deliver health care mainly through the public sector, there’s no reason we should be unduly concerned about the likely increase in taxation needed to accommodate the community’s desire to live longer.

The wider point, however, is that health care is just one of the superior goods delivered by governments. Education is another obvious example - which is why it will be difficult to realise in practice the savings theoretically made possible by the lower birth rate. Take health and education and you’ve covered at least half of a state government’s recurrent spending. But the superior goods don’t stop there. Think about it and you realise that even something as mundane as law and order is a superior good: the richer I get, the more susceptible I become to worries about my personal safety and to fears that my wealth will be stolen from me.

The point is that, if so much of what governments do is deliver superior goods, then as incomes rise the pressure for increased government spending will be irresistible, and so will be the pressure for higher taxation. All governments have been reluctant to admit the obvious: that the primary solution to the future fiscal pressures their studies have identified will be higher taxation. (Treasuries haven’t wanted to admit it either because it counteracts their use of these studies as a weapon for enforcing discipline on the spending side.) It’s clear, however, that as our real incomes rise over the coming decades and our desire for spending on publicly-provided superior goods grows accordingly, the result will be a steady increase in the share of our incomes devoted to tax.

In principle, there’s no reason for that to be regarded as a bad thing. You’re the people who’ll be responsible for helping the politicians bring about that rise in taxation - or, perhaps, for persuading them that, since they’ve happily acceded to electoral pressure to bring the higher spending about, they must raise taxes to finance it responsibly.

I must concede, however, that while an increase in spending on superior goods is inevitable as incomes rise over time, there are extra risks of inefficient and wasteful spending where those superior goods are delivered through the public sector. Sometimes superior goods are delivered through the public sector because of their public-goods characteristics, but mainly I suspect it’s because of equity considerations. So a major responsibility for treasury officers over the next 40 years will be not simply trying to keep the lid on government spending, but continually searching for better trade-offs between equity and efficiency. If you try simply to impose increased efficiency at the expense of equity you’ll have limited success in getting your proposals adopted and persisted with (because equity considerations are so powerful politically). So, much better to be working on the much more intellectually demanding task of finding a better trade-off between the two.

Before I leave that outline of the likely outlook for both sides of the budget in coming decades, let me make one further point. I think it vitally important for treasury people to become more conscious of Fred Hirsch’s concept of ‘positional goods’. Positional goods or services are those which, along with doing whatever it is they’re supposed to do, are purchased also with the hope that they’ll demonstrate to the world our superior position in the social pecking order. In other words, it’s about conspicuous consumption and keeping up with the Jones. When you think about it you realise that, the more our incomes rise and the cost of necessities accounts for an ever-declining proportion of that income, the higher the proportion we’re likely to devote to the pursuit of social status via the purchase of positional goods - remembering that, when you choose to buy a BMW over a Toyota, the price of the Toyota is the cost of the transport vehicle you bought and the extra you shelled out to get the BMW is the cost of the positional good. Our private spending abounds in the payment of premiums intended to demonstrate our status. You can see it in the clothes we buy for ourselves and our children, the cars we buy, the homes and suburbs we choose to live in, the private schools we send our kids to, the private hospitals we insure for, the restaurants we eat at, the holidays we take and much, much more.

Why am I telling you this? Partly because I believe much of the pressure on governments to keep taxes down comes from the public’s desire to be left with as much disposable income as possible, to be spent on the pursuit of social status. But the pursuit of status, like an arms race, is a zero sum game. I can advance my place in the pecking order only at the expense of those I pass. So I wouldn’t have thought it an important public policy objective to leave people with as much positional spending money as possible. And yet, if you examine the descent into middle-class welfare by the Howard Government, for instance, I believe you can find examples of Howard providing public subsidies for positional goods: the 30 pc private health insurance rebate is one example, the increased grants to undeserving private schools is another.

To me, this is all the wrong way round. If you’ve got a situation where people are dead keen to spend money on private health and private schools - on things that are superior goods and publicly provided - you shouldn’t be subsidising them you should be exploiting them. In other words, the more we can make people pay privately for their pursuit of status-linked superior goods, the better off we are. Treasury officers forever searching for relatively politically painless ways of increasing taxation should never forget the device I call the ‘voluntary tax’. Private health insurance was a voluntary tax (you didn’t have to take it but, if you did, your public subsidy diminished), sending kids to private schools was a voluntary tax, gambling taxes are voluntary in a sense (though with risks of social costs if their pursuit is overdone) and tobacco tax is, too, in a sense. You should be looking for ways to increase voluntary taxation - which includes ‘taxing’ people pursuing social status - and perhaps it would help if this way of looking at things were explained to politicians tempted to go the other way.

OK, now let’s turn to my critique on the spending side. The conventional means used to try to limit spending - by imposing cuts or caps on agencies - has various disadvantages. It tends to favour existing programs over new programs, even though some older programs could be abandoned or turned over to private provision. It tends to favour cures over prevention - fixing problems after they’ve happened rather than stopping them happening. It often fails to motivate agencies to co-operate in identifying the fat and making sure it gets chopped rather than the bone. Indeed, it can leave governments vulnerable to passive resistance, where cuts are directed to those areas the government is likely to find most politically embarrassing, in the hope of forcing it to relent. I guess many of the new accounting approaches are aimed at overcoming these limitations, but I think we can do better.

One of the great temptations facing treasuries is to get so locked into the annual budget round that they end up focusing on cost containment in the short term rather than cost effectiveness in the longer term. When treasuries’ behaviour becomes too hand-to-mouth - too focused on getting this year’s budget balance looking OK - they can resist spending on the evaluation of programs that could be most informative in subsequent budget rounds, they can resist spending on health prevention and promotion simply because the costs are up front and the savings down the track. In other words, there’s a great temptation to be a short-term maximiser, with the result that you commit the greatest treasury sin: false economy. Public servants tell me of the crazy things agencies do in the name of efficiency - so much so that, to them, efficiency is synonymous with inefficiency. If something done in the name of efficiency is counterproductive or short-sighted, it’s not efficient by definition. I think the public sector abounds with false economy. Sometimes this won’t be the direct result of treasury decisions, it will be a damaging response by the agency to perverse incentives created by treasury.

When we lift our sights beyond this year’s magic budget-balance figure, we’re able to pay greater attention to the quality of government spending. Quality goes to the effectiveness of spending programs, but also to the thing the top-flight treasury officer should be perpetually in search of: the program which, though it’s classed as an expense, is actually an investment - an investment in future cost containment.

It’s important to remember that the spending agencies often have very little vested interest in measures that offer high value for taxpayers’ money. What departments are genuinely keen to have their programs rigorously evaluated? How many doctors would support spending on health promotion and prevention when that money could be spent on their own curative specialty? How many agencies want to do rigorous cost-benefit analysis of their capital works projects? In other words, if treasury isn’t pushing for these improvements, who will be? Now, you may say that if treasury were mad enough, it could support the spending of millions on dubious health promotion advertising campaigns. True - but all the more reason treasury should be pressing for - and paying for - rigorous assessment of what prevention programs work and what don’t.

I don’t know a lot about all the various accounting reforms - I won’t call them fads - I think the latest is performance budgeting. They may carry the answer to some of my criticisms. I have a feeling, however, that what we need is not so much better accounting as more economics. When I say we need a more scientific approach to spending control, the examples I have in mind come from economists, not accountants.

I’m thinking of such innovations as case-mix funding of hospitals. This is where, rather than giving a hospital funding based on an adjustment to what it got last year, it gets a flexible amount based on the known cost of efficiently dealing with particular types of cases, multiplied by the particular mix of cases the hospital encounters. Health economists put an enormous amount of research into developing the cost data needed for such a funding system. I’m not sure how much of the encouragement and funding of this research came from treasuries.

Another example is the advent of income-contingent loans. Australia has been a world leader in this area, with Professor Bruce Chapman’s application of the concept to university fees being the finest example of applied economic rationalism. As is easily seen in the case of HECS, the beauty of income-contingent loans is the superior trade-off they offer between equity and efficiency. You can require students to make a higher contribution towards the private benefits they receive from a university education, without fear of making uni education too expensive for kids from poor families. If Treasury and Finance had been doing their job, the idea would have been developed by them. Now Professor Chapman and his colleagues are elaborating on the many other ways - such as drought assistance - in which savings could be made by replacing grants with income-contingent loans. But it’s not clear the purse-string departments are pursuing this opportunity with any enthusiasm.

To me, however, the cost-effectiveness potential of these ideas is dwarfed by the scope for long-term savings arising from the neuroscientists’ discovery of the crucial importance of an infant’s early years in determining both its IQ and its EQ - its intellectual ability and its emotional ability to fit in socially, apply itself to work or study and generally lead a successful life. I suspect that many of our politicians are better versed on this remarkable research than the econocrats are. But there’s no excuse for the purse-string controllers: the whole thing’s been checked out by the Nobel-winning economist James Heckman, who’s given it a rave review.

Heckman’s studies demonstrate that spending programs aimed at early childhood development (that is, long before school-age) have far higher cost-benefit scores than remediation programs for students, prisoners or the unemployed in later life. If you leave it that late, you’ll be lucky if the benefits exceed the costs. Heckman makes a killer point for economists: spending on early childhood development involves no conflict between equity and efficiency. That is, the things you might do to promote equality of opportunity are just as effective in promoting productivity and human capital formation, and vice versa. In other words, improving on early childhood development is as close as we come to a free lunch.

The implication of this body of research for spending on social programs is profound. It says that, in neglecting babies and spending money trying to help or punish young people and adults once their educational or behavioural problems come to the attention of the authorities, we’re getting it exactly the wrong way round. Whether you care about economic efficiency or about fairness, we ought to be massively re-orienting our social spending in favour of the very young. In fact, the only remaining justification for trying to help non-infants is simply the ethical point of not abandoning people who are victims of our earlier neurological ignorance.

At an intellectual level, many of our political leaders know this. The trouble with modern politicians, however, is that they’re more interested in being seen to be responding to problems than in actually solving them. So they spread their spending too widely and thinly. Explain to them about how babies’ brains develop and they ‘respond’ by initiating a few new early childhood programs, but they never spend anything like enough. Why not? Because they have other interest groups to keep happy and so they’re not prepared to divert funds from social programs where, though we now know the money is largely wasted, the profile is higher and the political pressure greater.

The people who should be throwing their weight behind the neuroscientists, social workers and early childhood educators in helping persuade the pollies to reform their spending priorities are the purse-string controllers. But are they? I doubt it. Why not? Because they’re not applying their brains and they’re not trying hard enough.

I want to finish by adding something different: I believe every up-and-coming treasury officer needs to be familiar with the relatively new school of economic thought known as behavioural economics. BE draws heavily on the findings of psychologists - including the psychologist Daniel Kahneman who won the Nobel Prize in economics in 2002 for founding the school - to study the way people actually make economic decisions in contrast to the conventional assumption of rational self-interest. It finds that most people don’t act on opportunity cost, don’t ignore sunk costs, dislike losses more than they like gains of equivalent size, are more loss averse than risk averse, practice mental accounting which breaks the assumption of fungibility, have big self-control problems and much more.

Why do ambitious treasury officers need to be familiar with this stuff? Various reasons. Because it helps them understand why the conventional model often mispredicts. Because it teaches them to respect and accommodate the electorate’s inescapable concerns about fairness, particularly procedural fairness - economists can abstract from fairness considerations, but the people to whom politicians answer never can. But also because the two professions with an instinctive understanding of BE are the marketers and the politicians. BE helps economists convince themselves of the truth and relevance of propositions politicians simply know to be true. So BE is a counter to the old treasury line that there are always only two policy choices: good economics (ie conventional economics) and political expediency. It turns out the pollies often have good reason to reject advice based on conventional economic assumptions that are normative (how people should behave) but not positive (how they do behave). The point is that when econocrats’ understanding of BE allows them to break out of the good-v-expedient mindset, they’re better equipped to find a better trade-off between what would be ideal in an ideal world and what politicians are likely to accept as doable.

There is much scope to elaborate on this point - to draw out the practical lessons for policy advisers from BE - but let me highlight just one: when you understand BE you realise that hypothecation should be embraced rather than opposed. Treasuries traditionally oppose hypothecation because it’s either a con on the public (it doesn’t actually lead to increased spending in the area in question) or it distorts spending choices (it does oblige more spending in the area than would otherwise occur). The trouble with this logic is that it’s too rational by half. In an era when people’s demands for increased spending are insatiable but their willingness to pay higher tax is limited, hypothecation is a useful tool. At the moment when public demand for new spending is at its height, the politician steps in and says sure I’d like to spend the money but I’d need to cover it by introducing this small levy or surcharge. The public invariably agrees. Why? Because it wants to see what normally is concealed from it: the link between what you pay and what you get. The Howard Government has made extensive use of the hypothecated surcharge. Why? Because it’s unconscious understanding of BE gives it better policy judgement than many econocrats, who’ve been blinded by the unrealistic assumptions of conventional economics.

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FUNDING SCHOOL EDUCATION

Talk to Cornerstones Conference, Sydney
September 23, 2006

By rights, what I should be giving you now is a learned and crystal clear exposition of federal-state funding of school education, about how crazy, unfair and irrational the Howard Government’s formula for funding non-government schools is and about how, when you look at it properly, what Howard and his cronies claim to be economic rationalism is actually quite irrational, bad for the economy in the longer run and, certainly, bad for the people in the economy.

This is what my friend and adviser, Lyndsay Connors, hoped I’d do but, unfortunately, I didn’t leave myself enough time to get on top of all the technicalities, so what I’m actually going to do is much easier - and possibly more interesting: talk about the politics of school funding and then say something more personal about my love/hate relationship with teachers and the Teachers Federation.

It’s true that the formula the Howard Government has adopted for determining its grants to non-government schools - independent schools, and Catholic systemic schools, but I’ll call them private schools for short - is quite appalling. For one thing, it sweeps away need as the basic criterion for assistance, making large payments to quite prosperous schools and doing so in a quite eccentric way so that certain schools, not necessarily the most prosperous, get more than other elite schools because of an accident of postcodes. One particular private school, only an associated school not a GPS school, with not a fraction of the social status of Cranbrook or the opulence of Kings, won the jackpot, getting an extra $25 million: Trinity Grammar. More of Trinity anon. For another thing, the formula is corrupt in that it’s self-multiplying. The more students drift to private schools, the more the average cost-per-student rises in the public schools because of the loss of scale economies, and the more the public per-student cost increases the more the per-student grant to private schools increases because the latter is indexed to the former. For a third thing, the formula ignores the competitive disadvantage the public schools face in being left with the poorest and least-able students, having to take the kids with behaviour problems rejected by the privates and having to stay open without enough students to remain viable if they’re the only school left in a district. For a fourth thing, the Howard Government doesn’t bother enforcing the funding formula whenever it would result in a reduction in a private school’s grant.

So the formula is completely rigged in favour of independent schools. Now, people should be studying these defects and shouting them from the rooftops to bring them to the public’s attention. But do you think it makes much difference politically? Politically, it’s beside the point. Do you think the defects are there by accident? Do you think the Howard Government can’t know about them or it would have fixed them? No, the formula is blatantly biased towards private schools because the Howard Government is blatantly biased towards private schools.

So, politically, what are the Liberals on about? It might look like they’re on about economic rationalism, but they’re not. They’re on about traditional Liberal ideology. They believe in private schools and want to see them expand and prosper. They may believe this will attract them a few extra votes at the margin - if so, it would only be in the swinging ‘aspirational’ seats in the western suburbs - but for the most part this policy is for the party heartland; for the party faithful who already send their kids to private schools and would see a greater subsidy to their school as a boon. If the increased subsidy attracts more kids to the private system, fine, but Howard would do it anyway because he shares the Liberals’ traditional support for private health insurance and private schools. Was the funding formula deliberately selected because it was so biased in favour of independent schools? Sure. Will Howard ever reform it? Why?

A similar analysis applies to Howard’s line that it’s vitally important parents be able to choose between public and private. Now, it’s probably important that somebody somewhere subjects this choice argument to critical scrutiny. The first point is that there’s choice and there’s choice. What does being free to choose mean? If it means that, in a capitalist economy, where for almost everything else, the more money you have the more you can buy and the better quality you can buy - where one dollar equals one vote - you simply can’t sustain a situation where people who can afford to buy their way out of public provision are actually prohibited from doing so. You can’t stop rich people sending their kids to expensive schools or being treated in expensive private hospitals. In that sense, yes, there should be ‘choice’ and we’ve always had it. But that choice is just the standard choice that exists in all markets: you can buy what you consider to better than standard issue provided you can afford the full cost. That is, this argument contains no implication that the private receives any public subsidy, just as private health insurance carried no public subsidy in the original concept of Medicare.

But that’s not what Howard means when he says people should be free to choose. He means that the private - whether it’s private schools or private insurance - must be generously subsidised so people are free to choose. It’s the same when he talks about mothers of young children being free to choose whether to have a job or not. What gives them the freedom is the extra family benefit paid to stay-at-home mums. What these three examples - private schools, private hospital insurance and stay-at-home mums - have in common is that they’re all things the Liberal middle-income heartland is already doing or wishes it could afford to do. So we’re talking straight taxpayer subsidy to the middle. All the fancy talk of choice is just a cover for Howard’s addiction to middle-class welfare.

How does Labor fit into this story of political motivations? I think federal Labor does have a firmer commitment to egalitarianism and equality of opportunity, so it could be relied upon in government to change the funding formula to something far less generous and more needs based, and that’s true pretty much regardless of its specific promises before the election. It would probably do this in the traditional way - that is, a hastily contrived budget blowout crisis immediately after the election, which is used as a cover while policies that favour the Liberal heartland are cleaned out and replaced with policies that favour the Labor heartland.

But I must add two qualifications. Labor, being the party that really got into ‘state aid’ under Gough, will be ‘working both sides of the street’ - seeking the public-school vote but also the private-school vote. That’s particularly true, of course, with special deals for the Catholic systemic schools. The idea of attracting the Catholic vote, of being photographed beside a beaming archbishop, is so enticing to politicians of both sides at both federal and state level that it will be a permanent feature of school funding for the duration. This is one reason it isn’t possible to try to simplify the terrible matrix of both federal and state levels funding both public and private sectors by having the states simply leave private school funding to the feds and focus exclusively on the public system. No state pollie would ever walk away from such a chance to buy the Catholic vote.

The second qualification is that the greater the drift from public to private, the more Labor will focus on winning and retaining the private school vote. It’s a straight numbers game. The greater the drift, the greater the political momentum it develops, making it harder to reverse.

If you enjoy feeling persecuted - and I suspect some of you do - you’d do well to note the message coming out of all the budgetary future-gazing exercises we’re seeing. Peter Costello kicked it off with the Intergenerational Report of 2002 (a revised version of which will be published with next year’s federal budget), then the Productivity Commission had a go and pretty much all the state governments, with NSW Treasury’s report on Long-term Fiscal Pressures as part of this year’s state budget. All these exercises involve projecting government spending and revenue out for the next 40 years to get an idea of how they’re likely to be affected by the ageing of the population. They all come to the same conclusion: in this country, ageing’s effect on the budget won’t be too terrible. Even so, all these reports end up pointing to the likelihood of significant and increasing pressure on budgets in coming years. Why? Because of the inordinate pressure on governments - state and federal - to increase spending on health care. Advances in medical technology are always expensive, but the public wants access immediately.

Why do federal and state treasuries keep producing reports that say this? Because they want to use them as a stick to keep the spending ministers in line. But there doesn’t seem much doubt that health care spending will come to dominate government budgets as never before. In NSW, for instance, it’s expected to go from second biggest item to first, from 26 pc of total recurrent spending to 37 pc. Why am I telling you this? Because as health spending expands, the main thing that’s supposed to contract to accommodate it is spending on school education. Student numbers will decline which ‘presents some opportunities to redirect spending to more pressing needs’. That will happen only if declining enrolments lead to fewer classes and the closing of whole schools. But education’s share of total state recurrent spending is projected to decline from 28 pc to 20 pc. You have been warned.

But here’s where the persecution complex comes in. What better way to ensure that education spending’s share of total spending does decline than to allow the drift from public to private to roll on forever? Now, Lyndsay Connors’ Public Education Council has argued persuasively that the individual student moving from public to private saves the public system very little - because most school costs are fixed costs rather than variable costs or, if you like, because the loss of an individual involves diseconomies of scale. But significant savings do come when the number of individuals lost reaches the point where whole classes or schools are lost.

Diabolical, eh? Just continue on our present path and the problem of education funding drifts away. Let all those silly parents, desperate for the social status of having kids at independent schools, pay extra for their kids’ education. Privatise government spending. Of course, the extent to which the drift to private schooling saves you money is determined by the extent to which you’ve ramped the public subsidy to private schools. And I’m not at all sure the Howard Government will resist the temptation to keep raising the subsidy.

That’s enough politics. Now to something more personal: my love/hate relationship with teachers and the Teachers Federation. In a nutshell, I love teachers and hate the federation. I have to be careful what I say in public about teaching for a range of reasons. The first is that I come from the teaching class. My sister’s a teacher, most of my friends at uni became teachers and a lot of my friends at present are teachers. So, if I had known my place, I would have been a teacher myself. Actually, I’m a frustrated teacher. If you examine my columns you find they’re much more pedagogical than most journalists’ columns. Sometimes I think I’m the most overpaid teacher in the country. Another reason I have to be careful what I say about teachers is that economics teachers are the local organisers of my fan club - and I know many of them.

Lately, however, I’ve acquired a special reason for watching what I say about teachers: my son, Sandy, has just become one (and, of course, a member of the federation). He’s on his first year out as a maths teacher - with a full load - at a high school in Albury, which he’s loving. I want to tell you about my son, mainly because I’m so proud of him, but also because I think it’s instructive in this context. Where did he acquire his ambition to be a teacher? Well, that’s his guilty secret: he acquired it at the unspeakably evil Trinity Grammar. Why did I, the product of two selective schools (Fort Street and Newcastle Boys) out of three high schools and five primary schools in all, not a believer in private schools, send my son to Trinity? I’ll tell you.

Why do I have a love/hate relationship with the federation? Because it combines the best and worst of trade unionism. Its best is its unwavering commitment to liberal values: its preoccupation with equity concerns, equality of opportunity, its belief in co-operation and suspicion of competition. When Howard said people want to send their kids to private schools because they wanted them to be given ‘values’ he implied that public schools lack values. Nothing could be further from the truth, and I’m sure Howard knows it. His problem is that he so dislikes the federation’s values. In particular, he wants everything done to foster competition between students. Liberals, economists and business people are great believers in the virtue of competition in reducing inefficiency and getting everyone to do their best. They think the competitive spirit is a fragile flower, perpetually at risk of dying out unless constantly ‘incentivated’. I used to believe that but, since I’ve read more evolutionary psychology, I’ve come to the view that competitiveness is hard-wired in our brains, particularly in males, and that it needs to be controlled and civilised rather than ramped up. So I’ve come to sympathise with the federation’s view that children should be protected from full-on competition and rather have their natural curiosity and love of learning fostered.

John Howard is a life-long Liberal warrior against the class enemy, the unions. You can see that in his enmity towards industry super funds and in WorkChoices, his ultimate attempt to stamp out unions forever. He would look at the public school system, see it as amazingly union-dominated (as I do), and be repulsed (as I’m not). But that brings me to the worst of the federation. At its worst it’s too keen to protect failed teachers, who should be gently shown the door, too into levelling down, where the best are required to subsidise the worst, too into rewarding seniority rather than merit, too resistant to being publicly accountable (always wanting to suppress information on the spurious argument that the media and parents are too ignorant to interpret it correctly), and too reluctant to share power with parents at the local school level. The federation is a reflection of teachers’ remarkable persecution complex and inferiority complex. Talk about defensive.

The bias in the Howard Government’s funding of private schools, and the state governments’ neglect of public school infrastructure, have made capital works the main battleground of the competition between the public and private sectors for the hearts and minds of parents. The generous funding of independent schools has had zero impact on the rapacity with which they raise their fees. They’re charging what the market will bear, and the market will bear big fee increases because education is both a ‘merit good’ and a ‘positional good’. This means they have huge funds to pour into lavish campus improvements. Maybe even the Catholic systemics have more funds for maintenance and capital works.

I’m sure many of you - with your shitty toilet blocks and rundown buildings - feel the injustice of this keenly. You’re terribly conscious of the competitive disadvantage at which it places the public system. It’s all true. But I’m here to say: hey, let’s not be too materialistic about this. Anyone who believes the thing that makes a good school is the quality of its sporting facilities or its music and drama wing is a fool. Anyone with any sense - any parent with any sense - knows instinctively what the research tells us: that what makes or breaks a school is the quality of its teachers and its teaching, plus the leadership skills of its principals.

So while you’re feeling your keen sense of injustice at the way the game has been stacked against public schools, while you’re despairing for the future of egalitarianism and equality of opportunity (as I am), while you’re waiting eternally for the political pendulum to change direction, you need to be out there competing, doing all in your power to halt the drift to private by raising the quality of public schools. That’s about raising the quality of teachers and teaching, doing more to encourage and reward excellence and responsibility, about putting the needs of students ahead of the needs of teachers (as I know many, many teachers do) and being more co-operative with well-motivated principals.

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CHRISTIANS IN A CONSUMER CULTURE

Talk to Baptists Today conference at Collaroy
August 24, 2006

In his book In Praise of Slowness, the journalist Carl Honore says that all the world’s a store and all the men and women merely shoppers. Sometimes it feels like that. I think we all know what consumerism is, but let’s look at it anyway. Consumerism is the belief that personal happiness lies in the purchasing of material goods. Sometimes that idea motivates our behaviour without us consciously believing that consumption is the source of happiness. But I have to say that I regard ‘consumerism’ as merely a euphemism for ‘materialism’. Materialism means a devotion to material rather than social or spiritual considerations. I’ve done a lot of thinking about materialism in recent years, so please forgive me if I use that term more than consumerism.

The material is an important and, indeed, inescapable part of our lives. You can’t live a life of utter unconcern for the material aspects of life - unless you’ve got someone who worries about them for you. You can’t avoid spending a fair bit of your life buying things in shops unless you’re the Queen. And it would be foolish to spend all that time and money with complete disregard for the choices available, the prices being charged, the amount we have available to spend and the need to get value for money. So it’s really a question of how high a priority you attach the material business of life. A question of whether you view the material as a means to some more important end - to staying alive and healthy so you can be of service to others, for instance - or as an end in itself. A question of where your heart is. As Christians like to say, it’s not money that’s the root of all evil, it’s the love of money. Materialism and consumerism are about the love of money - for the things it will buy. Some people are open about their love of money and material possessions, but I think there’s a much larger group - perhaps including many of us - who, while never espousing materialism as the great guiding principle of our lives, nonetheless end up allowing material concerns to crowd out relational and religious obligations that, in principle, we’ve always held to be more important. The material is seductive. Why? Because it’s tangible - you can see it, it’s always there and its importance is readily apparent, whereas the relational and spiritual are intangible. You can’t see them and it’s easy to underestimate their importance. And, since they’re less likely to have deadlines attached, they can be pushed back in the queue for our time and attention.

All of us are materialist to a greater or lesser extent. And in seeming to preach a sermon against consumerism, I don’t mean to imply that I’m impervious to its temptations. I suspect that Christians are particularly susceptible to the temptations of consumerism. Why? Two reasons. First because, with so many of the pleasures of the flesh declared off-limits - smoking, drinking, gambling, illicit sex - there’s a tendency to break out in areas that, for reasons I don’t quite understand, our preachers seem reluctant to speak out against. But second because the Christian life of sobriety, honesty and diligence is conducive to material success. I suspect many of you would be in the position of saying, well, yes, I do have a comfortable income and our family does live well, but I don’t love money, I’m not a materialist. There’s a good test of this claim: how generous are you? If all your money isn’t important to you, how much of it do you give to people who need it more than you do? From my reading of the psychological literature I’ve discovered another test: how much do you throw away? Some research suggests that people with materialist values are reluctant to give up all the stuff they’ve acquired.

There’s nothing new about materialism or even its trendier brother consumerism. That’s why you can find a fair bit about it in the Bible if you’ve a mind to. But I think it can be demonstrated that we’re more materialist than we used to be and that at present we’re going through a period of what I call hyper-materialism. Sometime over the past 20 or 30 years we suddenly became a lot more preoccupied with money than we had been. Materialism is the dominant characteristic of our era. Our descendants will look back on the last part of the 20th century and the early part of the 21st as The Age of Materialism. That’s true not just for Australians, but for people throughout the developed world. Such claims about changes in people’s values are hard to prove, but a leading American social psychologist, David Myers, has produced impressive evidence for the United States.

In an American poll that regularly asked people what factor was most important in a job, ‘high income’ rose to second highest between the early 1970s and the early 1980s. Now consider the evidence from the American Council on Education’s annual survey of over 200,000 newly entering college students. Asked about their reasons for going to college, the proportion agreeing that an important one was ‘to make more money’ rose from half in 1971 to almost three-quarters by 1990. And the proportion believing it ‘very important or essential’ that they become ‘very well-off financially’ rose from 39 per cent in 1970 to 74 per cent in 1990. Over the same period, the proportion who began college hoping to ‘develop a meaningful philosophy of life’ slumped from 76 per cent to 43 per cent. This reversal stayed unchanged throughout the 1990s. Professor Myers calls this cultural shift ‘the greening of America’. And though our bank notes are multicoloured, I don’t doubt it’s true of us, too.

If we have become more materialist over the past 20 or 30 years, what has changed to bring this about? I don’t know. It’s tempting to blame it all on economists, especially that evangelistic brand of economist known as the economic rationalists. But I think it would be wrong to blame economists for starting the trend to hyper-materialism. The economic rationalists in the bureaucracy have been proposing the same policy prescriptions to their political masters for many decades. The question is, why was it that, from the early 1980s, the pollies began accepting the advice they’d ignored for so long? Perhaps because they sensed some change of attitude - some more materialist tendency - in the electorate. But even if it’s wrong to blame economists for starting the trend, there’s no denying that, by the policies they have persuaded the politicians to adopt, the economic rationalists have considerably heightened the trend. Take the rationalists out of the picture and we wouldn’t be as materialist as we are today.

Economic rationalism turns out to be the religion of materialism and rationalists the high priests in the temple of mammon. Economics is the study of how best to achieve humankind’s material objectives. It’s meant to be all about means, and say nothing about ends. But it’s about material ends, and the best way to maximise those ends. It’s on about efficiency in the use and allocation of physical resources so as to maximise consumption. Even an economist as sensible as Keynes, for instance, wrote that ‘consumption - to repeat the obvious - is the sole end and object of all economic activity’. This is why economists are obsessed with promoting economic growth - which means continuously increasing production and consumption of goods and services, and involves an ever-improving material standard of living.

Now, I think you have to agree that, given their objective, the economic rationalists’ advice on policy has been very successful. Over the past 15 years of economic expansion since the recession of the early 90s productivity has grown strongly, real incomes have grown strongly and consumer spending has grown strongly - all of them more strongly than during the 70s and 80s. So what’s the problem with economics? The problem is that it’s one-dimensional analysis. It focuses exclusively on our material objectives - on factors whose value can be expressed in dollars - while ignoring the non-material. In consequence, non-material ends - such as family life, relationships more broadly, and the spiritual - tend to be sacrificed to material ends. We should be optimising our material objectives, given the competing claims of our non-material objectives, but instead we maximise the material at the expense of the non-material because the non-material is excluded from our calculations. At one level the economists say, sorry, the material is all we’re professionally competent to advise on - which is true - but they’re always tempted to forget the limitations of their model - all the factors they have deliberately abstracted from - and lay down the law about what we must do to maximise efficiency as though consumption was our only goal.

If we had any sense as a community we’d take advice from economists about the material, but then weigh it against the advice of people who specialise in the social and spiritual. Why don’t politicians seek wider advice? Why do they allow people whose advice is so narrow so much influence? Because they’re responding to what they believe is the materialist preferences of the electorate. Why is almost every politician - Labor or Liberal - a vocal believer in rapid economic growth and rising material living standards? Because they’re convinced that’s what the punters want. Why do even Green politicians rarely express any doubt the supreme objective of maximising economic growth? Because they believe their opponents would wipe the floor with them if they did.

Conservative politicians are always lecturing us about the evils of envy. Say that a tax cut is unfair because high income earners got disproportionately more than middle and low income earners and you’ll be accused of indulging in ‘the politics of envy’. Trouble is, they never lecture against the opposite vice, greed - of which there’s a fair bit about. So their message on behalf of the well-off is, ‘it’s immoral for you to envy the fruits of my greed’.

The main device the economic rationalists have used to increase economic efficiency has been increased competition - competition from imports, or competition from other domestic players because of reduced government regulation of markets. But one of the consequences of the increased competitive pressure to which business people have been subjected has been to make them more aggressive in urging governments to change laws in ways that benefit producers. Businesses are in the business of satisfying our material needs. So the pressures on politicians from business are also pushing them in a materialist direction.

Many people imagine that capitalist economies must exist for the primary benefit of the capitalists. But, as hinted at in that quote from Keynes, one of the tenets of conventional economics is the doctrine of ‘consumer sovereignty’. This is the belief that the chief beneficiaries of the economy should be - and are - consumers. So production isn’t an end in itself, it’s a means to an end - consumption. And consumers are the king of the capitalist economy because the operation of markets means that producers maximise their profits only by giving their customers exactly what they demand.

If you find that hard to believe - so you should. It simply doesn’t fit with the pervasiveness in modern market economies of advertising and other marketing techniques. Advertising is an embarrassment to economists. They don’t like thinking about it and try to tell themselves it’s purely informational - that the purpose of advertising is merely to make sure consumers know what you’re selling, how much you’re charging and where your shop is. But we all know advertising is persuasive. The advertiser is seeking to persuade us to purchase his product and he does this not by intellectual argument but by appealing to our emotions. In the old slogan, advertisers sell the sizzle, not the steak. The ads for margarine, for instance, are trying to persuade us that buying a certain brand of marg - or sliced bread - is the way to have a happy, healthy family. Ads for menthol cigarettes used to associate themselves with good-looking women on pristine tropical beaches. At an intellectual level, these propositions are absurd. At an unconscious level, however, they work - which is why advertising persists. All of us are far more influenced by advertising than we realise.

And it’s not just the ads that promote consumerism. Most of the TV shows and films we see do it too. They do it by portraying a totally unreal world in which most people are very good looking, slim and fit. They live in beautiful, always-tidy homes, in leafy suburbs. Families always get on well together and no one’s ever boring or bad-tempered. All this exposure to the beautiful people leaves many of us perpetually dissatisfied with our own far-from-perfect lives and unconsciously trying to attain the beautiful life by buying things. The trouble with all this is that it turns consumer sovereignty on its head. This is not the producers as servants of the consumers, it’s producers seeking to con consumers into buying more stuff - stuff they didn’t know they wanted and that won’t satisfy the crazy aspirations the advertisers have excited.

Another device the modern economy uses to promote consumption is the greater availability of credit, particularly through personal loans and credit cards. In principle, credit should produce only an essentially once-only drawing forward of consumption, not a continuous increase. I suspect that those people who make heavy use of credit cards don’t consume all that much extra at the end of the day. Rather, their impatience to draw forward their consumption means they end up devoting a lot of their income to interest payments. It’s true that household debt has grown amazingly over the past decade, and that some people will get into difficulties. Even so, I think the extent of problem with household debt is easily exaggerated. The great majority of the growth in debt is due not to credit cards but to increased borrowing for housing - including for investment housing.

That raises another spectacular demonstration of rampant consumerism in recent years, the record housing boom with its doubling of house prices. House prices and mortgage debt doubled for various reasons, but by far the greatest reason was the halving of mortgage interest rates following our return to low inflation. The halving of rates roughly doubled the amount people on a given income were able to borrow. They didn’t have to respond by borrowing more to move to a bigger and better house, but many people did. Because they all did it at pretty much the same time, however, the main thing they achieved was to bid up the price of houses. It was, as I say, a spectacular display of rampant consumerism. Australians idolise their homes.

Another manifestation of the Age of Materialism is the longer hours some of us are working. Not every person with a full-time job is working long hours, but a significant minority are. It’s fashionable to see longer hours as something that’s been forced on us by grasping employers, but I believe most long hours are voluntary and are paid for by employers, directly or indirectly. People are doing it for the money, either because they want to buy more stuff or because they need to pay off the debts they’ve already incurred from buying more stuff.

People often ask what happened to all that extra leisure time the experts predicted back in the 70s would have come our way by now. The answer is that we’ve had plenty of productivity growth that would have permitted us to work fewer hours without loss of pay, but we’ve preferred to take those productivity gains in the form of higher pay rather than shorter hours. Another sign of our increased consumerism.

Perhaps this is the time to point out that all the increased consuming we’ve been doing has done nothing to make us any happier. Surveys of how satisfied people are feeling about their lives don’t go back far in Australia, but they do in most other developed countries and the conclusion from all of them is the same: the population’s average level of subjective wellbeing hasn’t budged in decades - it hasn’t fallen, but it hasn’t risen despite very much higher material living standards. Why not? Psychologists advance two reasons.

First, because of a pervasive human trait psychologists call adaptation. We do feel happier after we’ve had a pay rise, bought a new car or dress or house, but that feeling of pleasure doesn’t last long. It doesn’t take long before we get used to our newly improved circumstances and come to take them for granted. They get absorbed into the status quo and we go back to being about as happy as we always were. Studies show that even people who win the lottery return to their earlier level of happiness within a few months. To put this point another way, soon after we achieve a higher level of material success, our aspirations move up another notch and we go back to being dissatisfied with our achievements. Surveys show that a lot of people believe they’d be happier if only their incomes were ‘just a little bit higher’. Trouble is, they always believe that. Their income rises over time, but they’re still saying, I’d be happier if only I had just a little bit more. Talk about the donkey chasing a carrot. Actually, the psychologists call it the ‘the hedonic treadmill’ - you keep running and running to earn more and spend more, but you never get anywhere.

The second explanation psychologists propose for the inability of general increases in the standard of living to make us happier is our tendency to compare ourselves with those around us. When I get the same pay rise as everyone else, that doesn’t do a lot for me, but when I get a bigger pay rise than other people that does make me feel good. Trouble is, the people I’ve passed in the status race now feel worse. And when we all engage in an eternal struggle to get ahead of each other - a kind of arms race - no one feels better off for long.

Australia is a prosperous country. Most of us managed to satisfy our most basic needs for food, clothing and shelter a long time ago. So what have we done with all the extra income we’ve enjoyed since then? I believe most of it has gone on what economists call ‘positional goods’ - goods (or services) that, as well as doing whatever it is they’re designed to do, are also intended to demonstrate our superior position in the social pecking order. Why do we buy an expensive European car when an old Toyota would get us from A to B just as comfortably and reliably? Because we want to display our socio-economic status. Why do we send our kids to private schools, dress toddlers up to the nines, keep moving to bigger houses in better suburbs? Because we’re trying to impress people. The older term for it, of course, is ‘conspicuous consumption’. Why do we pressure governments to cut taxes? So we can devote more of our incomes to conspicuous consumption.

I said earlier that the modern emphasis on reforming the economy to make it more efficient and so raise living standards even higher gave priority to the material at the expense of social and spiritual objectives. The man who’s done most to make me conscious of the price we’re paying for our material success is Dr Michael Schluter of Britain’s Relationships Foundation and now our own Relationships Forum. Consider the way WorkChoices’ attack on penalty rates seeks to continue the abolition of the weekend - or the sanctity of Sunday, if you like - begun by the deregulation of weekend trading. There’s no doubt that the way to raise the productivity of capital is to keep factories working and shops open for as close as we can get to 24/7. But there’s equally no doubt that the more we move away from having common days when most members of a family aren’t working or at school, the more strain we put on families and other relationships. Similarly, there’s no doubt that economic efficiency and living standards are raised by having resources, including labour, as mobile as possible. But there’s equally no doubt that moving people around the country is deleterious to our relationships - relationships that psychological research joins the Bible in proclaiming to be of the highest importance to our lives.

But let’s say we were successful in persuading people to be less materialistic and consumerist. Or say we banned all advertising. Wouldn’t the economy collapse? You often hear people say that - and there are plenty of business people who’d be happy for you to believe it - but the answer is no, not really. They’re just displaying their ignorance of economics or lack of imagination. The first point is that the economy exists to serve us, not we it. It’s true that if everyone suddenly slashed their consumption, this would plunge the economy into recession and rising unemployment. But the economy would eventually adjust. In any case, it’s hardly likely that everyone would slash their consumer spending at once. It’s more likely to be a gentle slowdown in the rate of growth of consumption and hence in the economy’s rate of growth. And that wouldn’t be a bad thing if, in return, we got the benefit of more stable and satisfying relationships and more room for the spiritual. Assuming the same thing wasn’t happening in all the economies with which we trade, we could move to a position of lower consumption, but higher saving, increased exports and falling foreign debt. Does that sound bad? But let’s assume the worse and imagine a situation where the economy wasn’t growing fast enough to generate sufficient additional jobs for people joining the workforce. We could then engage in the job-sharing economists have frowned on as being not particularly efficient. But that’s the point: we’d give up some efficiency - some growth in income - in return for better relationships - with man, and God.

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