Greed is the market's forgotten vice

Where do Easter and business intersect? Well, what about at greed.

According to Dr Brian Rosner, principal of Ridley Melbourne, an Anglican theological college, greed has been glamorised by the market economy and is a forgotten sin.

Maybe it's this that allows those Christians who are business people, economists and politicians to share their colleagues' commitment to unending economic growth and an ever-rising material standard of living.

In his book, Beyond Greed, Rosner defines greed as ''wanting more money and possessions'', a refusal to share your possessions and ''the opposite of contentment''.

Greed has always been with us, and insatiability isn't unique to modern Western civilisation, but we're certainly giving it a workout. To us, money is the simplest measure of whether you're winning at the game of life.

But what is unique to our age, according to another author, is the cultural acceptance, even encouragement of insatiability. A survey of regular churchgoers in America found that whereas almost 90 per cent said greed was a sin, fewer than 20 per cent said they were ever taught that wanting a lot of money was wrong, and 80 per cent said they wished they had more money than they did.

It seems that, by comparison with the past, greed is regarded as a trivial sin. A retired priest has recounted that, in his long years of service, all kinds of sins and concerns were confessed to him in the confessional, but never once the sin of greed.

But Rosner's having none of that. He says greed is at the heart of three major threats to our existence as individuals and societies: pollution, terrorism and crime.

Pollution is caused by human unwillingness to pay the price for the cleaner alternative (ain't that the truth, Tony). ''On any reckoning, climatic change due to the effects of pollution could cause major 'natural' disasters in the days to come,'' he says.

In most cases of terrorism, each side accuses the other of some form of greed, whether involving people, land or property. ''Greed also fits both sides of the equation in many cases of crime,'' he says. ''Thieves steal because they want more, and often because they perceive the victims as having more than their fair share.''

The greedy are those who love money inordinately, trust money excessively, serve money slavishly and are never satisfied with their possessions.

Rosner says greed is a form of religion, the religion of Mammon. Literally, mammon means wealth or possessions, but it could just as easily be taken as the biblical word for the economy. And if greed is a religion, that makes it a form of the greatest of all sins: idolatry. (First Commandment: you shall have no other gods before me.)

In Western society, the economy has achieved what can only be described as a status equal to that of the sacred.

''Like God, the economy, it is thought, is capable of supplying people's needs without limit. Also, like God, the economy is mysterious, unknowable and intransigent,'' he says. ''It has both great power and, despite the best managerial efforts of its associated clergy, great danger. It is an inexhaustible well of good(s) and is credited with prolonging life, giving health and enriching our lives.

''Money, in which we put our faith, and advertising, which we adore, are among its rituals. The economy also has its sacred symbols, which evoke undying loyalty, including company logos, product names and credit cards.''

Rosner says we have to distinguish between the legitimate enjoyment of material things, which the Bible takes for granted, and an illegitimate and unhealthy attachment to wealth as an end in itself.
But if we don't want to be greedy, what should we be? Contented.

''To be content is to be satisfied, to enjoy a balance between one's desires and their fulfilment. To be content is in effect to experience freedom from want,'' he says. But note, it's being content with your own lot, not those of others less fortunate than you.

And the other side of the contentment coin is giving. Rosner says that if Charles Dickens' Scrooge epitomises greed, giving is epitomised by Victorian jam maker Sir William Hartley. Hartley regularly and voluntarily increased wages, practised profit-sharing and supplied low-cost, high-quality housing to some of his employees and free medical attention to all of them.

He was also concerned for his suppliers, and would amend contracts in their favour if a change in the price of fruit and economic circumstances conspired against their making a decent living.

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Badly taught economics has high opportunity cost

Is it possible the discipline of economics is becoming so mathematical it's in the process of disappearing up its own fundament?

While you're thinking about that, let me take the opportunity to ask you a quiz question (it's a holiday weekend, after all).

You've won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost $40. On any given day, you'd be willing to pay up to $50 to see Dylan. Assume there are no other costs of seeing either performer.

So what is the ''opportunity cost'' of seeing Clapton? Is it $0, $10, $40 or $50? Take your time (especially if you fancy yourself as an economist).

The opportunity cost of a decision is the value (benefit) of the next-best alternative. So the right answer is $10. When you go to the Clapton concert you forgo the $50 of benefit you would have received from going to the Dylan concert. But that's the gross benefit. You also forgo the $40 of cost, so the net benefit you forgo is $10.

If you didn't get the right answer, don't feel too bad. When two economists at Georgia State University, Paul Ferraro and Laura Taylor, asked that question of almost 200 economists attending a professional conference, almost 80 per cent got the wrong answer.

The answers they gave were spread across the four possible answers, with more than a quarter saying $50, apparently believing it was only the ''willingness to pay'' of $50 that was relevant.
The next most popular answer was $40, apparently because people thought the cost of a Dylan ticket must also have been the opportunity cost. Those who answered $0 must have concluded there could be no opportunity cost if the Clapton concert was free.

This left fewer than 22 per cent of respondents getting the right answer. And if that (along with your own failure to get it right) doesn't shock you, it should.

Opportunity cost is probably the most fundamental concept in economics. One introductory textbook lists it along with ''marginalism'' and ''efficient markets'' as three of economics' most fundamental concepts. Opp cost seems a pathetically simple concept, but non-economists keep forgetting to consider it - meaning they don't always make the best decisions about how to spend the limited time and money available to them.

And it seems the concept isn't as simple as we assume. If about 80 per cent of non-economists got the question wrong, that would be a pity, but not too surprising. But the respondents to the survey were, in the authors' words, ''among the most well-trained economists on the planet''. Two-thirds of the respondents had PhDs, with the remainder studying for their PhD.

What's more, more than 60 per cent of them had actually taught introductory economics courses. Those who'd taught the course were no more likely to get the right answer than those who hadn't, nor were those who'd attended one of America's top-30 graduate schools, nor those who'd graduated before 1996 rather than after it.

The only significant differences were in the economists' field of specialisation. Only the tiny number specialising in micro-economic theory got a halfway respectable score, followed well back by those doing applied micro. Worst were those doing macro or international economics.

The first reason for concern is what these results say about the quality of the teaching of economics at postgraduate level. After surveying students in seven top-ranking US graduate programs in 1987, David Colander, a leading researcher of the economics profession, concluded the programs emphasised mathematics to the detriment of empirical content and economic reasoning.

A commission on graduate education in economics in 1991 found that it generated ''too many idiot savants, skilled in technique but innocent of real economic issues''. This survey suggests little improvement since then.

Does it matter for economic research if economists can't identify opportunity cost? ''Obviously,'' the authors say, ''it matters for PhD economists who take jobs in the private or government sectors, in which opportunity costs are the fodder of daily decisions …

''Theoretical research rarely requires that an individual calculate an opportunity cost in the form of a word problem. Empirical research tends to focus more on appropriate techniques to make inferences about parameter values in models.

''But can economists be relevant in the world of ideas and policy if we cannot answer simple … opportunity cost questions?''

But whatever the failings of post-graduate teaching, there's also failure at the undergraduate level. The authors say the concept of opportunity cost is usually covered in the first week of introductory undergraduate classes and often deemed so straightforward as to not require further teaching time.

A Nobel laureate complained that ''the watered-down encyclopaedia which constitutes the present course in beginning college economics does not teach the student how to think on economic questions. The brief exposure to each of a vast array of techniques and problems leaves the student with no basic economic logic with which to analyse the economic questions he will face as a citizen.'' That was George Stigler, writing as long ago as 1963.

The authors say that ''if we are not able to instil in our students a deep and intuitive understanding of one of the most fundamental ideas that the discipline has to offer (and the idea whose frequent application could do most good in peoples' private and public lives) then we wonder what we can claim as our value-added to the college curriculum''.

It makes me wonder whether, in its preoccupation with using maths to make itself more ''rigorous'' and thus academically respectable, economics has lost its way.

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Why manufacturing in Australia has a future

Few things about the economy are worrying people - particularly older people and those from Victoria and South Australia - more than the decline in manufacturing. But many of our worries are misplaced, or based on out-of-date information.

For instance, many worry that, at the rate it's declining, we'll pretty soon end up with no manufacturing at all. And everyone knows that, unlike other states, Victoria's economy is particularly dependent on manufacturing.

But Professor Jeff Borland, a labour economist at the University of Melbourne, has written a little paper that sheds much light on these concerns.

It's true that manufacturing's share of total employment in Australia is declining. But this is hardly a new phenomenon, which suggests the end may not be nigh. Half a century ago, manufacturing accounted for a quarter of all employment. Today it's 8 per cent.

And almost none of that dramatic decline is explained by a fall in our production of manufactured goods. The great majority of the fall in manufacturing's share is explained simply by the faster growth of other parts of the economy, particularly the service industries.

It's true, however, there's been a (much less dramatic) decline in employment in the industry over the years. Employment in manufacturing reached a peak of 1.35 million in the early 1970s. Today, it's about 950,000. Of the overall loss of 400,000 jobs, about 200,000 occurred during the '70s, about 100,000 in the recession of the early '90s and the rest since the global financial crisis in 2008.

Many people would explain this decline in terms of the removal of protection against imports in the '80s and the very high dollar since the start of the resources boom in 2003. But, in fact, the great majority of it is explained by nothing more than automation.

How do I know? Because if you look at the quantity (or real value) of manufactured goods we produce, it reached a peak as recently as 2008, and has since fallen just 6 per cent. Nowhere have the machines of the computer age replaced more men (and I do mean mainly men) than in manufacturing. Is this a bad thing? It would be a brave Luddite who said so.

The consequence is a change in the mix of occupations within manufacturing, the proportion of machine operators, drivers and labourers falling by 10 percentage points since 1984, with the proportion of managerial and professional workers increasing by about the same extent. The proportion of technicians and tradespeople is little changed.

But there's also been a change in the types of things we manufacture, with the share of total manufacturing employment accounted for by textiles, clothing and footwear falling from 11 per cent to 4 per cent since 1984, while the share accounted for by food products has risen from less than 15 per cent to more than 20 per cent.

The share of transport equipment (cars and car parts) is down, but the share of other machinery and equipment is up by much the same extent.

The next thing that's changed a lot since 1984 is the location of manufacturing in Australia. Then, almost 70 per cent of manufacturing employment was located in NSW and Victoria; today it's down to 58 per cent. Then, NSW had more manufacturing workers than Victoria; today they have 29 per cent each. (Bet you didn't know that.)

But if the big two states now have smaller shares, which states' shares have grown? The two we these days think of as "the mining states". Western Australia's share has risen to 10 per cent, while Queensland's share has almost doubled to 21 per cent. (Bet you didn't know that.)

So far, South Australia's share of national manufacturing employment has fallen only a little to 8 per cent.

This tendency for manufacturing's distribution between the states to become more even over time, plus the much faster growth of other industries, has made all states less dependent on manufacturing for employment, as well as narrowing the gap between the most dependent (SA on 10 per cent of its total employment) and the least (WA on 7 per cent).

Whereas in 1984 Victoria depended on manufacturing for 21 per cent of its jobs, today it's 9 per cent. (See what I mean about out-of-date information?) Victoria's more dependent on the health industry (12 per cent) and retailing (11 per cent), with almost as many jobs in professional services as in manufacturing.

The wider conclusion is that, though the faster growth of other industries has made all states less dependent on manufacturing for jobs, this doesn't mean manufacturing's dying. Its actual output hasn't fallen much, though it's using fewer workers to produce that output.

The unwritten story is there've been big changes in what Australia's manufacturers produce: less stuff that relies on protection against imports and more stuff that fits with Australia's comparative advantage. You see that with food products - including things such as wine-making - now being the biggest category within manufacturing, employing 20 per cent of all manufacturing workers.

You see it also in the growth of manufacturing employment in the mining states - a spillover from the resources boom.

Manufacturing is undoubtedly suffering from the high dollar. But, apart from that, it's in good shape. It has shed some fat and is fitter and wirier than it has ever been, better able to survive in a harsh world.

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Our econocrats' vision is too narrow

Part of my job is making sure readers are kept fully informed about the messages our top econocrats are trying to get across to the public. They're usually much franker and clearer than the spin we get from our political leaders.

But just because I report their views faithfully doesn't mean I always agree with them.

As it related to the outlook for the economy, the message in the speech Treasury secretary Dr Martin Parkinson delivered last week fitted well with the messages we've been getting from Glenn Stevens and Dr Philip Lowe, of the Reserve Bank.

It's a warning that, between the slowdown in our rate of productivity improvement, the expected continuing fallback in mineral export prices and the reversal of the "demographic dividend" delivered by the baby boomers, "we face a significant challenge in maintaining the rate of growth in living standards that Australians have come to expect".

Specifically, Parkinson projected that, even if we assume labour productivity grows at its long-term average, the other two factors would cause real income per person to grow by just 0.7 per cent a year over the decade to 2023-24, rather than the 2.3 per cent "to which Australians have become accustomed".

So over 10 years our present annual real income of $63,600 per person would grow only to $69,000, rather than $82,000, leaving us only $5400 a year better off, rather than the $18,400 a year to which we've become accustomed.

To keep average incomes growing as fast as we've come to expect will require us to double our present rate of productivity improvement to 3 per cent a year.

Sorry, but I very much doubt we'll be willing to make the many controversial reforms needed to achieve such a transformation. More to the point, I'm not convinced we should.

The admonitions we get from our econocrats are far too relentlessly materialist and, hence, mono-dimensional. Whatever their professed "wellbeing framework", when the chips are down their advice is to make maintaining the rate at which our material standard of living is rising our highest priority, if not our only priority.

We're always being reminded of the pecuniary price to be paid for worrying about foreign ownership, or saving family farming or preserving the weekend. But the warnings never run the other way: the greater personal stress or relational problems or loss of leisure or greater social disharmony that could accompany going all out to maximise economic growth.

No one knows better than I do that you can't say everything you want to say in the time allotted for a speech or the space allotted for a column. But, even so, some obvious caveats and qualifications almost never rate a mention.

The most obvious is the environment. What reason is there to believe acting to maintain our rate of growth won't do significant further damage, even unacceptable damage to the ecosystem? How do we know continuing climate change - a problem about which we've decided not to make a genuine contribution to international efforts to combat - won't negate our productivity-raising efforts?

How can we talk about capturing a big share of the growth in Asia's demand for Western foodstuffs without mentioning climate change?

To be fair, their present political masters are so down on the environment that our econocrats aren't free to speak on the subject. Parkinson is facing the sack for having been chief designer of the emissions trading scheme (including the Howard government's version) and his successor - an outstanding Treasury officer - has already had the chop. It's a wonder Professor Ross Garnaut isn't behind bars - or at least had his office raided by ASIO.

Another obvious but never-mentioned caveat is the distribution of all this increased income. It's all very well to talk about increasing the average income, implicitly assuming the extra income will be shared in line with the existing distribution. Our experience of income growth over the past 30 years is that a disproportionate share ends up in the hands of the people at the top.

Why no mention of this when ordinary workers are being asked to support reforms that could cost them their jobs?

More basically, how do the econocrats know we'd find a slower rate of growth in our affluence bitterly disappointing? They don't. Their confident claims that we would are based on their faith in materialism, not evidence.

Most of us are condemned to spend 40 years of our lives working 40 hours a week. Why do econocrats never wonder whether making that work more satisfying would do more for our "wellbeing" than making extracting more productivity from our labour the only priority?

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Treasury's opportunities and threats facing our economy

It shouldn't surprise you that when the secretary to the Treasury, Dr Martin Parkinson, devoted half his major speech this week to "fiscal sustainability" - the tax increases and spending cuts needed to get the budget back on track - the media virtually ignored the other half.

But the budget isn't the economy. And in that other half Parkinson offered a revealing SWOT analysis of the economy, outlining its Strengths and Weaknesses, Opportunities and Threats. So let me tell you what he said (and leave my critique for later).

For people worried about what we do for an encore after the resources boom - about where the jobs will come from - Parko points to three big "waves of opportunity".

The first wave is the mining investment boom, which is ending but not leaving us high and dry. "With the capital stock in the mining and energy sectors now triple what it was a decade ago, additional productive capacity will drive strong growth in resources exports for several years to come," he says, although this will involve employing fewer workers than in the investment phase.

The second opportunity wave flowing from the vast economic shifts in Asia is rising global demand for agricultural produce. The Australian Bureau of Agricultural and Resource Economics and Sciences estimates that China's imports of fruit will treble by 2050. Imports of beef will grow by a factor of 10 while imports of sheep and goat meat increase by a factor of 19. Dairy will increase by a mere 165 per cent.

Asia already takes more than 40 per cent of our food exports. Parko warns, however, that our ability to gain a slice of its rising demand rests on continued productivity gains in our rural sector, supported by the right policy settings.

"Our handling of the concerns raised by foreign ownership of Australian agricultural land (and food manufacturing) in some parts of our community is one dimension of the agricultural policy challenge, along with our approach to trade policy, stimulating investment in on- and off-farm infrastructure and supporting research and development."

The third wave is the opportunities in the services and high-value manufacturing sectors brought about by the steadily increasing growth of the Asian middle class. It's estimated that, by 2030, just under two-thirds of spending by the world's middle class will come from the Asia Pacific region, compared with about a quarter today.

"To capture the benefits of the third wave, we will need to compete on the global stage for Asian demand for services and high-end manufactures on the basis of both cost and quality," he says. "We will also need to compete for foreign direct investment to help put the right export-related infrastructure in the right places."

But get this declaration from the economic rationalist-in-chief: "Contrary to how it is sometimes portrayed in the media, competing on the global stage does not mean driving down wages or trading off our standard of living. Far from it."

Parko says improving Australia's competitiveness in global markets means investing in the skills of our workforce so Australians have the opportunity to move into sustainably higher paid jobs, and investing in infrastructure that has a high economic return.

It means ensuring firms and their employees are freed from unnecessary regulatory burdens, and establishing the right incentives to encourage innovation and competition. "In other words, it means raising Australia's productivity performance," he says.

Which brings us to Parkinson's three big threats to our further economic success. The first is productivity improvement. He says that, even after you allow for temporary factors, there's been a slowdown in "multi-factor" productivity improvement that's broad-based across industries, suggesting that deeper, economy-wide factors are at play.

The second threat arises because, until mid-2011, the effect of this productivity slowdown on the rise in our living standards was masked by the rise in the prices we were receiving for mineral exports. But now the likelihood that these prices will continue falling means a "significant drag on Australia's national income growth" over the rest of this decade.

The third threat to continued strong economic growth comes from the turnaround in the "demographic dividend" delivered by the baby boomers. For about 40 years until 2010, the proportion of the population of working age (here defined as 15 to 64) grew a lot faster than the overall population because of the postwar baby boom, followed by a dramatic fall in the birth rate in the 1960s and '70s. This boosted economic growth.

"Over the next few years, this demographic dividend, which has been fading for some time, will actually reverse. The proportion of the population aged 65 and over is expected to increase to nearly 20 per cent in 2030, from 13.5 per cent in 2010."

As the population ages, the total participation rate - the proportion of people 15 and over participating in the labour market - will fall, despite the increase in the participation rate among older Australians. "This expected decline has already begun and will become more pronounced by the end of the decade," he says.

Productivity is the key long-run driver of income growth, but declining export prices and labour-force participation are expected to subtract from national income growth in future.

If we assume the productivity of labour grows at its long-term average, then income per person would grow over the coming decade by about 0.7 per cent a year, about a third of the rate to which we've become accustomed, he says. To avoid that, we'd need to sustain labour productivity growth of about 3 per cent a year, about double the rate we've achieved so far this century.

If we fail to make the reforms needed to achieve that rate of productivity improvement, by 2024 our income per person will have risen only to $69,000 a year, not $82,000. We'll each be $13,000 a year less affluent than we could have been.

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Bracket creep has become highly regressive

If you think you're having trouble coping with the rising cost of living now, just wait until you see what the politicians have in store for you over the next three years. In all likelihood, you'll be losing a significantly higher proportion of your pay in income tax, though people on low incomes will be hit a lot harder than those on high incomes.

This will happen because an increase in the overall tax we pay is inevitable, but it suits both sides of politics to avoid the obvious, up-front increase that would come from raising the rate of the goods and services tax (or from extending the tax to spending on fresh food, education and healthcare) and rely on what Malcolm Fraser called "the hidden tax of inflation" - otherwise known as bracket creep.

The pollies know voters much prefer any increase in taxation to be hidden from their view. Trouble is, the increase in "marginal" tax rates (the tax on the last part of your income, such as on a pay rise or some overtime) many workers face will be so big, you'd have to be pretty thick not to notice.

Treasurer Joe Hockey has been softening us up for the tough budget he's preparing for next month. Fine by me. But he's studiously avoiding admitting there's no way his spending cuts will get the budget back into lasting balance. He's pretending all the problem is on the spending side (and all caused by Labor), when he knows the problem on the budget's revenue side is just as big, if not worse.

Consider the facts. Collections from company tax - which account for about a fifth of total tax collections - aren't likely to grow any faster than the economy (gross domestic product). And collections from indirect taxes - which include the goods and services tax and excises on alcohol, tobacco and petrol - are likely to grow a lot more slowly than GDP.

Collections from excises are declining relative to the rest of the economy, partly because John Howard abolished the indexation of the petrol excise, but also because consumers' spending on alcohol and tobacco accounts for an ever-declining share of their total spending.

Collections from the GST are also in relative decline, because consumer spending has stopped growing faster than the overall economy (as it did when households were borrowing heavily) and because consumers' spending on items subject to the GST is growing more slowly than overall consumer spending. Putting it another way, private spending on untaxed education and healthcare is growing faster than our spending on taxed items.

That leaves collections from income tax, which account for about half the federal government's total collections. Assuming regular tax cuts, income tax collections will grow in line with GDP. Only if further tax cuts are avoided will continuous bracket creep mean income tax collections grow strongly enough to make up for the revenue-raising deficiencies of the GST and other indirect taxes.

Guess what? All the budget projections Hockey is using to justify big cuts in government spending assume no further income tax cuts. Without that assumption the underlying weakness on the tax side would be apparent.

His first reason for ignoring the budget's revenue-raising weakness is his need not to expose as wishful thinking the line Tony Abbott ran from the moment he became Liberal leader, that the Libs stood for low taxation, opposed all "great big new taxes on everything" (except the GST, of course) and should be voted for by anyone who didn't like the sound of the carbon tax or the mining tax.

Hockey's second reason is that any hint of increasing the GST (or any other tax) would allow Labor to do to Abbott what Abbott did to Labor. The party of higher government spending opposes the other side's new taxes for reasons of blatant political advantage.

But Labor also professes to oppose the GST because it's "regressive" - taking a higher percentage of low incomes than of high incomes. It must face the unpalatable truth that the past eight tax cuts have left us with a rate-scale that now makes bracket creep highly regressive.

Consider this. The average full-time wage next financial year, 2014-15, will be about $76,000. On the basis of reasonable assumptions about the growth in wages over the three years to 2017-18, you can calculate that someone on half the average wage would see the proportion of their wage that they lose in tax increase by 3.5 cents in the dollar.

For someone on the average wage the increase would be 2 cents in the dollar. On twice the average wage it's 1.1 cents. And on six times the average wage it's 0.8 cents.

Now that's regressive. Does Labor really think a rise in the GST would be much worse?

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We need less fancy financial footwork, not more

Attention conspiracy theorists: see if you can detect a pattern in this. Tony Abbott wants to review the renewable energy target, so he appoints self-professed climate change "sceptic" Dick Warburton, who feels qualified to explain to the scientists where they're going wrong.

Abbott wants to review the financial system, so he appoints a former boss of a big four bank, David Murray, who feels qualified to explain to economists where they're going wrong.

So, which industry sector stands the better chance of getting what it wants from its review?

Can you imagine how many proposals Murray's committee will receive aimed at making the financial system bigger and better - and all in return for just a little more help from taxpayers?

I read that the Australian Bankers Association's submission proposes abolition of interest withholding tax, so as to support offshore fund-raising by local banks and to encourage overseas banks to lend more in Australia. It also calls for the removal of "tax disincentives" on bank deposits. All to increase this financial sector's contribution to economic growth and jobs, naturally.

The government's terms of reference say "the inquiry is charged with examining how the financial system could be positioned to best meet Australia's evolving needs and support Australia's economic growth".

Fine. But if it's to be more than just an industry sales pitch, the inquiry needs rigorously to examine the industry's convenient assumption that the bigger it gets the more it benefits the rest of us.

In a brief submission that deserves more attention than it's likely to get, Professor Ron Bird and Dr Jack Gray, of the Paul Woolley centre at the University of Technology, Sydney, summarise the growing evidence that the developed economies' much expanded financial systems have been a bad investment from the perspective of the wider economy. (Both are former fund managers.)

The growth in America's financial sector has been amazing, with its share of gross domestic product rising from less than 3 per cent in 1950 to about 5 per cent in 1980 and more than 8 per cent in 2006. Its share of total corporate profits grew from 14 per cent in 1980 to almost 40 per cent by 2003.

Salaries in US financial services were similar to other industries until 1980, but are now on average 70 per cent higher than those elsewhere. This remarkable growth is referred to as the "financialisation" of the economy. One test of the inquiry's thoroughness will be whether it works out comparable figures for Oz.

The first warning that this growth might be making economies more risky came from Professor Raghuram Rajan, of the University of Chicago, at a central bankers' conference in 2005. They told him not to worry. He has since argued that the financial system's big rewards for risk-taking (with other people's money) result in the economy proceeding from bubble to bubble.

Since the mid-2000s, an increasing amount of analysis has questioned whether the growth of the financial system has worked to the betterment of anybody other than those working in the industry, Bird and Gray say.

One study for the Bank for International Settlements concludes that "big and fast-growing financial sectors can be very costly for the rest of the economy ... drawing essential resources in a way that is detrimental to growth at the aggregate level". A British minister has said: "We need more real engineers and fewer financial engineers."

Other research has found that real (physical) investment is being crowded out by the increasing size and profitability of financial investment. Even our Reserve Bank governor, Glenn Stevens, has questioned "whether all this growth [in finance] was actually a good idea; maybe finance had become too big (and too risky)".

The huge advances in information technology could have been expected to result in lower costs for financial services, but unit costs have actually increased over the past 30 years.

All the trading on financial markets is supposed to lead to better "price discovery" and thus improved efficiency in the allocation of resources, but a study found no evidence of financial market prices becoming more "informationally efficient".

Adair Turner, former chairman of Britain's Financial Services Authority, sees "no clear evidence that the growth in the scale and complexity of the financial system in the rich developed world over the last 20 or 30 years has driven increased growth or stability".

Bird and Grey conclude that the starting point of the Murray inquiry's analysis should be to assess the financial system's effectiveness and highlight where it is falling short and why.

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Your guide to business entitlement

With the Abbott government's close relations with big business, we're still to see whether its reign will be one of greater or less rent-seeking by particular industries. So far we have evidence going both ways.

We've seen knockbacks for the car makers, fruit canners and Qantas, but wins for farmers opposing the foreign takeover of GrainCorp and seeking more drought assistance, as well as a stay on the big banks' attempt to water down consumer protection on financial advice.

The next test will be the budget. Will the end of the Age of Entitlement apply just to welfare recipients (especially the politically weak, e.g. the unemployed and sole parents, rather than politically powerful age pensioners) or will it extend to "business welfare"?

With Joe Hockey searching for all the budget savings he can find, there's a lot of business welfare or, euphemistically, "industry assistance" to look at. The Productivity Commission measures it every year in its Trade and Assistance Review.

Government assistance to industry is provided in four main ways: through tariffs (restrictions on imports), government spending, tax concessions and regulatory restrictions on competition. Although much rent-seeking takes the form of persuading governments to regulate markets in ways that advantage your industry, the benefit you gain is hard to measure, so it's not included in the commission's figuring.

Assistance through tariffs is far less than in the bad old days before micro-economic reform, but there's still some left. However, its cost is borne directly by consumers in the form of higher prices. So it's not relevant to Hockey's search for budget savings. Even so, I'll give you a quick tour.

The commission estimates that, in 2011-12, tariffs allowed manufacturing industries (plus the odd rural industry) to sell their goods for $7.9 billion a year more than they otherwise would have.

In the process, however, this forced up the cost of goods used by manufacturers and other industries as inputs to their production of goods and services by $6.8 billion a year. About 30 per cent of this cost to inputs was borne by the manufacturers themselves, leaving about 70 per cent borne by other industries, largely the service industries.

(This, by the way, shows why import protection doesn't help employment as non-economists imagine it does. It may prop up manufacturing jobs, but it's at the expense of jobs everywhere else in the economy.)

So now we get to budgetary assistance to industry. On the spending side of the budget it can take the form of direct subsidies, grants, bounties, loans at concessional interest rates, loan guarantees, insurance arrangements or even equity (capital) injections.

On the revenue side of the budget it can take the form of concessional tax deductions, rebates or exemptions, preferential tax rates or the deferral of taxation. In 2011-12, the total value of budgetary assistance was $9.4 billion, with just over half that coming from spending and the rest from tax concessions.

Often people will virtuously assure you their outfit doesn't receive a cent of subsidy from the government, but omit to mention the special tax breaks they're entitled to. Think-tanks that rail against government intervention and the Nanny State, hate admitting they're sucking at the teat because the donations they receive are tax deductible (causing them to be higher than otherwise, but at a cost to other taxpayers).

This is why economists call tax concessions "tax expenditures" - to recognise that, from the perspective of the budget balance and of other taxpayers, it doesn't matter much whether the assistance comes via a cheque from the government or via the right to pay less tax than you otherwise would.

Of the total budgetary assistance in 2011-12 of $9.4 billion, 15 per cent went to agriculture, 7 per cent to mining, 19 per cent to manufacturing and 45 per cent to the services sector (leaving 14 per cent that can't be allocated to particular industries).

To put that in context, remember that agriculture's share of gross domestic product (value-added) is about 3 per cent, mining's is 10 per cent and manufacturing's is 8 per cent, leaving services contributing about 79 per cent.

Within manufacturing, the recipients of the most business welfare are motor vehicles and parts, $620 million, metal and metal fabrication, $270 million, petroleum and chemicals, $220 million, and food and beverage processors, $110 million.

Within services, the big ones are finance and insurance, $910 million, property and professional services, $610 million, and arts and recreation, $350 million.

But if you combine tariff and budgetary assistance, then compare it with the industry's value-added (share of GDP), you get a different perspective on which industries' snouts are deepest in the trough. The "effective rate of combined assistance" is 9.4 per cent for motor vehicles and parts, 7.3 per cent for textiles, clothing and footwear, and 4.7 per cent for metal and metal fabrication.

Get this: outside manufacturing, the most heavily assisted goods industry relative to the size of its contribution to the economy is forestry and logging on 7.2 per cent. We pay a huge price to destroy our native forests.

Within services, the most heavily assisted industry is the one where incomes are so much higher than anywhere else: financial services. Virtually all the assistance picked up in the commission's calculations comes via special tax breaks, such as the tax concession for offshore banking units and the reduced withholding tax on foreigners receiving distributions from managed investment trusts.

But that ain't the half of it. These calculations don't pick up two big free kicks: the benefit to the industry because the government forces almost all workers to hand over 9.25 per cent of their pay to be "managed" by it, and the benefit it gains from having one of its main products, superannuation, so heavily subsidised by other taxpayers.

Cut these fat cats? Naah, screwing people on the dole would be much easier.

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How we can do better on Aboriginal imprisonment

You don't need me to tell you that in a country such as America, with all its history of racial conflict, the rate of imprisonment for African-Americans is far higher than the rate for whites. Twelve times higher, in fact. But you may need me to tell you we make the Yanks look good. Our rate of indigenous imprisonment is 18 times that for the rest of us.

Aborigines make up 2.5 per cent of the Australian adult population, but account for 26 per cent of all adult Australian prisoners.

If you want me to give you some economic reasons we should care about this, it's not hard. On average it costs $275 a day to keep an adult in jail. So it's costing taxpayers about $800 million a year just to keep that many Aborigines in prison. And this takes no account of the cost of juvenile detention centres, police costs in responding to offending, the cost of investigating and prosecuting suspected offenders and the health costs in responding to and treating victims.

Obviously, for every Aborigine who was in a job and paying tax rather than in jail and costing money, there'd be a double benefit to taxpayers, as well as a gain to the economy.

But the far more important reason for caring about the high rate of indigenous imprisonment is moral. As the criminologist Dr Don Weatherburn argues in his new book Arresting Incarceration, the consequences of European settlement have been truly calamitous for Aboriginal Australians.

"The harm might not have always been deliberate and it may not have been inflicted by anyone alive today, but it is no less real for that," Weatherburn says. "An apology for past wrongs would be meaningless without a determined attempt to remedy the damage done."

The trouble is, particularly in the case of Aboriginal imprisonment, we've been making such an attempt, but getting nowhere. If not before, the problem was brought to our attention by the 1991 findings of the Royal Commission on Aboriginal Deaths in Custody.

The commission found that Aborigines were no more likely to die in jail than other prisoners. The reason so many died was that they constituted such a high proportion of the prison population.

The Keating government accepted all but one of the commission's recommendations and allocated the present-day equivalent of almost $700 million to put them into effect. State and territory governments committed themselves to a comprehensive reform program.

But get this: rather than declining since then, the rate of Aboriginal imprisonment has got worse.
"It is hard to imagine a more spectacular policy failure," Weatherburn says.

It would be easy to blame the problem on racism in the justice system but, though there may be some truth in this, it's not the real reason. Similarly, Weatherburn argues it's not good enough to blame it on "indigenous disadvantage".

If that were the case, virtually all Aborigines would be actively involved in crime and they aren't. Most are never arrested or imprisoned.

The plain fact is that more Aborigines are in jail because more Aborigines commit crimes, particularly violent crimes. In NSW, for example, the indigenous rate of arrest for assault is 12 times higher than the non-indigenous rate. The rate of indigenous arrest for break and enter is 17 times higher.

Measures taken after the royal commission failed to reduce crime because they assumed this would be achieved if indigenous Australians were "empowered". Much of the money and effort was devoted to legal aid and land acquisition.

Weatherburn argues that if you want to understand indigenous offending, you need to look at the factors likely to get anyone involved in crime, regardless of race.

"The four most important of these are poor parenting (particularly child neglect and abuse), poor school performance, unemployment and substance abuse," he says. "Indigenous Australians experience far higher rates of drug and alcohol abuse, child neglect and abuse, poor school performance and unemployment than their non-indigenous counterparts."

The first and most important thing we need to do, he says, is reduce the level of Aboriginal drug and alcohol abuse. This is key, not just because drug and alcohol abuse have direct effects on violence and crime, but also because they have such a corrosive effect on the quality of parenting children receive, which greatly increases the children's risk of involvement in crime.

Weatherburn's second priority is putting more resources into improving indigenous education and training. As the mining boom in the Pilbara has shown, it's much easier to find jobs for Aborigines when they have the degree of education and skill employers are looking for.

His third priority is investing in better offender rehabilitation programs. Efforts to divert serious and repeat offenders from prison have been a dismal failure. But small changes in the rate of indigenous return to jail have the potential to produce large and rapid effects on the rate of Aboriginal imprisonment.

Much existing spending on Aboriginal affairs is ineffective. Were it not for Tony Abbott's special affinity with Aborigines in the Top End, we could expect the coming federal budget to really put the knife through it.
But this would save money without reducing the problem.

It will be a great day when the advocates of smaller government abandon the false economy of not wasting money on the routine, rigorous and independent evaluation of the effectiveness of government spending programs. Then we might make some progress.

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Abbott's red tape play-acting hides rent-seeking

The world of politicians gets deeper and deeper into spin, and so far no production of the Abbott government rates higher on the spin cycle than last week's Repeal Day.

Hands up if you believe in red tape? No, I thought not. So how about we package up a huge pile of window dressing with some worthwhile but minor measures, slip in a few favours for our big business supporters and generous donors, and call it the most vigorous attack on red tape ever? This will give a veneer of credibility to our claim it will do wonders for the economy.

In the process, of course, we'll have changed the meaning of "red tape". It's meant to mean bureaucratic requirements that waste people's time without delivering any public benefit. In the hands of the spin doctors, however, it's being used to encompass everything from removing dead statutes to the supposed deregulation of industries.

Repealing redundant laws and regulations dating back as far as 1900 is mere window dressing. By definition they don't waste anyone's time - if they did they'd have been repealed long ago. Their primary purpose is to allow Tony Abbott to quote huge numbers: today I announce the abolition of more than 1000 acts of Parliament and the repeal of more than 9500 regulations. A trick you can pull only once.

Somewhere in there is some genuine, time-wasting red tape we're better off without, but it doesn't add up to much - hence the need for so much padding. Governments of both colours are always promising to roll back red tape, mainly because it gives people such an emotional charge.

But while it's true there are examples of mindless, unreasonable bureaucratic rules and requirements that could be eliminated or greatly simplified at no loss to anyone, much alleged red tape is in the mind of the beholder: it's red tape if you don't like it and good governance if you do.

There are plenty of small business people who'd try telling you supplying information to the Bureau of Statistics was "pointless red tape", maybe even filling out tax returns. In an era when big business is going overboard on "metrics", it's whingeing about the "reporting burden" the government imposes so it - and the rest of us - can know what's going on in the economy.

When business isn't complaining about "compliance costs" it's demanding greater transparency and accountability from governments. Guess what? They're opposite sides of the same coin. The world is and always will be full of compliance costs. The sensible questions are whether they're higher than they need to be and whether the benefits of compliance outweigh the costs.

The notion that all so-called red tape comes from power-crazed bureaucrats is a delusion. Most excessive regulation comes from politicians. Sometimes they act at the behest of lobbyists for particular industries, sometimes they're merely trying to create the appearance of action (an old favourite is laws to make illegal something that's already against the law) and sometimes they pass an act to impress the punters while carefully leaving loopholes and escape hatches for the industry pros.

But the most objectionable feature of the whole red tape Repeal Day charade is the way it has been used as cover for rent-seeking by the Coalition's industry backers. It's an open secret the protections for investors provided by the Future of Financial Advice legislation are being watered down at the behest of the big banks, which want to be freer to incentivise unqualified sales people to sell inappropriate investment products to mug punters.

Then there's the strange case of the Charity Commission,which was set up only recently to reduce inefficient regulation and red tape. It's to be abolished despite the objections of most charities, presumably because the Catholic Church doesn't like it.

It's being claimed all these dubious doings will "drive productivity, innovation and employment opportunities", not to mention "creating the right environment for businesses of all sizes to thrive and prosper and to drive investment and jobs growth".

Yeah sure. The claimed savings of $700 million a year (don't ask how that figure was arrived at) are equivalent to 0.04 per cent of GDP, and yet they'll work wonders. Must be an incredible multiplier effect.

We're told we'll be getting at least two Repeal Days a year, with the goal of achieving savings worth $1 billion a year. Really, a minimum of six Repeal Days in Abbott's first term? What's the bet that promise will be quietly buried?

But for as long as this pseudo reform lasts it seems it's intended as a substitute for genuine deregulation.

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We own as much of their farm as they own of ours

Did you know that, at the end of last year, the value of Australians' equity investments abroad exceeded the value of foreigners' equity investments in Australia by more than $23 billion?

It's the first time we've owned more of their businesses, shares and real estate ($891 billion worth) than they've owned of ours ($868 billion).

These days in economics there's an easy way to an exclusive: write about something no one else thinks is worth mentioning, the balance of payments. We'll start at the beginning and get to equity investment at the end.

Before our economists decided the current account deficit, the foreign debt and our overall foreign liability weren't worth worrying about, we established that, when measured as a percentage of national income (gross domestic product), the current account deficit moved through a cycle with a peak of about 6 per cent, a trough of about 3 per cent and a long-term average of about 4.5 per cent.

Those dimensions were a lot higher in the global era of floating exchange rates than they'd been in the era of fixed exchange rates (which ended by the early '80s). This worried a lot of people, until eventually economists decided the new currency regime meant there was less reason to worry.

This explains why economists haven't bothered to note that for four of the past five financial years, the figure for the current account deficit as a percentage of GDP has started with a 3. And, as we learnt earlier this month, the figure for the year to December was 2.9 per cent.

So it seems clear that recent years have seen a significant change in Australia's financial dealings with the rest of the world. And the consequence has been to lower the average level of the current account deficit.

The conventional way to account for this shift is to look for changes in exports, imports and the "net income deficit" - the amount by which our payments of interest and dividends to foreigners exceed their payments of interest and dividends to us.

The first part of the explanation is obvious: over the past decade, the world's been paying much higher prices for our exports of minerals and energy. This remains true even though those prices reached a peak in 2011 and have fallen since then.

On the other hand, the prices we've been paying for our imports have changed little over the period. So, taken in isolation, this improvement in our "terms of trade" is working to lower our trade deficit and, hence, the deficit on the current account.

Next, however, come changes in the quantity (volume) of our exports and imports. Here, over the full decade, the volume of imports has grown roughly twice as fast as growth in the volume of exports. Until the global financial crisis, we were living it up and buying lots of imported stuff. And maybe as much as half of all the money spent on expanding our mines and gas facilities went on imported equipment.

The more recent development, however, is that the completion of mines and gas facilities means enormous growth in the volume of our mineral exports - with a lot more to come. At the same time, as projects reach completion there's a big fall in imports of mining equipment. That's a double benefit to the trade balance and the current account deficit.

Turning to the net income deficit, it's been increased by the huge rise in mining companies' after-tax profits, about 80 per cent of which are owned by foreigners. Going the other way, world interest rates are now very low and likely to stay low.

Put all that together and it's not hard to see why current account deficits have been lower in the years since the financial crisis, nor hard to see they're likely to stay low and maybe go lower in the years ahead.

The current account deficit has to be funded either by net borrowing from foreigners or by net foreign "equity" investment in Australian businesses, shares or real estate. This means the current account deficit is the main contributor to growth in the levels of the national economy's net foreign debt, net foreign equity investment and their sum, our net foreign liabilities.

Historically, our high annual current account deficits worried people because they were leading to rapid growth in the levels of our net foreign debt and net total liabilities.

But looking back over the past decade, and measuring these two levels relative to the growing size of our economy (nominal GDP), there's no longer a clear upward trajectory. Indeed, it's possible to say our net foreign debt seems to have stabilised at about 50 per cent of GDP, with net total liabilities stabilising a little higher.

Over the decades, the level of net foreign equity investment in Australia has tended to fall as big Aussie firms become multinational by buying businesses abroad and Aussie super funds buy shares in foreign companies, thus helping to offset two centuries of mainly British, American, Japanese and now Chinese investment in Aussie businesses.

But the net total of such equity investment is surprisingly volatile from one quarter to the next, being affected not just by new equity investments in each direction, but also by "valuation effects" - the ups and downs of various sharemarkets around the world as well as the ups and downs in the Aussie dollar.

Between the end of September and the end of December, net foreign equity investment swung from a net liability of $27 billion to a net asset of $23 billion. This was mainly because of valuation effects rather than transactions, so I wouldn't get too excited.

What it proves is that, these days, the value our equity investments in the rest of the world isn't very different from the value of their equity investments in Oz.

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More to infrastructure problem than spending money

We get bombarded with economic and political news. Some of it is worth knowing, some isn't. Some gets much attention, some gets little. Sometimes we give too much attention to things that aren't worth knowing and too little attention to things that are. The Productivity Commission's draft report on public infrastructure is one of the latter.

Ostensibly, it's a report advising Tony Abbott on how to achieve his dream of becoming the "infrastructure prime minister". In fact, it's an urgent warning to Australia's voters and taxpayers: we've wasted a lot of money on infrastructure and, if we're not careful, we could waste a lot more.

The point is not that all infrastructure is a waste of money, but that we tend to get too emotional about the topic and not sufficiently hard-headed. We need to think a lot more carefully, demand that our politicians - on both sides - lift their games, and insist on a lot more information being made public.

Almost all of us believe the country is suffering a serious infrastructure deficit, that there's a huge backlog of essential public infrastructure waiting to be built and our top priority must be to get on with clearing it as soon as possible.

I believe there's some truth to this perception. There most certainly are categories where we have an infrastructure problem. Big-city traffic congestion is a glaring example.

But to say we have an infrastructure problem is not to say we have an infrastructure deficit. To say we have a backlog is to presuppose the answer to the problem: just get out there and build a lot more ASAP.

It never occurs to us that, when we jump to that conclusion, we are, first, rewarding the lobbying efforts of the infrastructure industry and, second, making life too easy for our political leaders. We're doing just what the radio shock-jocks make their not-inconsiderable living encouraging us to do: use our hearts not our heads, react emotionally rather than intelligently.

Remember, we live in the age of rent-seeking - of big business interests using public opinion to extract favours from governments. Favours that, one way or another, you and I end up paying for.

It has suited the pockets of the infrastructure lobby - big developers, engineering construction companies and associations of engineers - to give us the impression we have an infrastructure crisis that's getting bigger by the minute and needs fixing by yesterday.

Much less effort has gone into checking out the existence of this backlog and its precise whereabouts than into spending like fury. Although these figures probably understate the full extent of spending on public infrastructure, it's true that, measured as a proportion of national income, spending on engineering construction work for the public sector fell to a low of just more than 1 per cent in 2003.

By 2012, however, it had doubled to more than 2 per cent. In present-day dollars, that's more than $30 billion a year being spent on new infrastructure.

Ever seen a headline screaming we've more than doubled our infrastructure spending in a decade? No, didn't think so. It suits too many people to have us go on thinking the backlog's getting bigger by the day.

One problem with the not-spending-enough approach to the infrastructure question is that it rewards politicians - particularly state politicians - merely for spending more of our money which, as we've seen, they've been doing like crazy for up to a decade.

Another problem is we have too little assurance the money is being well spent. In our concern about the backlog, we seem to have forgotten how prone politicians are to pork-barrelling - spending money disproportionately in marginal or National Party electorates - and how tempting it is to spend on those projects that happen to be the forte of generous corporate donors to party funds.

And not just that. Politicians of all stripes are terribly prone to favouring big-ticket, showy, popular projects over smaller, technical, hidden, boring projects that would actually do more good. They almost invariably favour projects where there's a ribbon they can cut.

They tend to underspend on boring repairs and maintenance then, when the infrastructure has gone to wrack and ruin, make heroes of themselves by building a brand new replacement.

For reasons I don't understand, the present crop of Coalition governments - federal and state - seem biased against public transport as the answer to traffic congestion and have reverted to the 1960s notion that more tollways will fix everything.

As the Productivity Commission has outlined, the answer to this is much more rigorous evaluation of the costs and benefits of projects - taking account of social factors, not just financial ones - by genuinely independent infrastructure authorities, with all their findings made public and no exceptions for bright ideas such as the national broadband network.

As well, the commission makes the obvious but easily forgotten point that we should make sure existing infrastructure is being used efficiently before we rush off and build more. Often this will involve smarter charging for infrastructure. This failing explains much of the rise in electricity prices being blamed on the carbon tax.

In infrastructure, as in everything, there's no free lunch. One way or another you and I end up paying for it. That's an argument for thinking it through.

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Ending the mining tax will hurt jobs

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


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

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

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

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

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

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

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

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

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

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

In other words, our miners earn huge economic rents.

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

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

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

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

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

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

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Many economists don't get the labour market

The world is full of economists who, though they know little of the specifics of labour economics, confidently propose policies for managing the labour market based on their general knowledge of the neo-classical model. All markets are much the same, aren't they?

I fear this is the best we'll get from the Productivity Commission's inquiry into regulation of the labour market. So a test of the commission's report will be whether it displays knowledge of advanced thinking on how labour markets actually work or is just another neo-liberal rant about free markets.

In their efforts to bone up on the topic, the commissioners could do worse than start with a quick read of Nobel laureate Robert Solow's 90-page classic, The Labor Market as a Social Institution.

Since the book was published in 1990, it should be old hat to economists, but I doubt it is. If so, it shows how little effort most economists - even academic economists - have put into studying the labour market.

Solow starts by reminding economists of a glaring problem they prefer not to think about: if the market for labour is just a market like any other market, and so is capable of being adequately analysed by the economists' standard tool kit of demand and supply - prices adjust until demand and supply are equal and the market "clears" - how come the labour market never clears?

How come we always have high unemployment, which shoots up during downturns and stays very high for years before falling only slowly?

To put the puzzle another way, if the labour market works like any other market, making wages just a price like any other price, why don't wages fall and keep falling as long as the supply of labour exceeds the demand for it?

Why do nominal wages almost never fall? Why is it the closest we ever get is nominal wages not rising as fast as ordinary prices, so wages fall a bit in "real terms"?

In a country with Australia's history of many minimum wages, carefully specified in awards and agreements, it's easy for economists to claim wages can't fall because they're being held up by legal minimums. But this doesn't wash. In reality, many if not most wages are well above the legal minimum, meaning the minimum isn't "binding" and so isn't stopping actual nominal wages from falling back to the minimum. But they don't - and nor do they in the US, where the minimum wage is kept so low it's almost never binding.

Overseas, some extreme neo-classical economists have tried to escape this problem by arguing most unemployment is voluntary rather than involuntary. It just so happens that, when economies turn down, a lot of people decide now's the time to take unpaid holidays and stay on them for many months. Yeah, right.

Solow says a more credible line of explanation is to admit the obvious: there must be something about labour markets that makes them different from other markets (such as the market for cars, or the market for bank loans) and so renders economists' usual analytical tools inadequate.

And it's not hard to think of what that something could be. Other markets are for the purchase and sale of inanimate objects, whereas every unit of labour bought or sold comes with a real live human attached. Every human is different - some are smart, some aren't; some work hard, some don't; some are co-operative, some aren't - and bosses turn out to be humans, too.

The thing about humans is they have egos and feelings and moods. One apple doesn't care about the other apples in the barrel, but a human cares about how they're being treated by their human boss, as well about how they're being treated relative to all the other humans working for the boss.

Hence the title of Solow's book. Unlike other markets, the labour market is also a social institution. Only an economist could imagine you could analyse the labour market successfully without taking account of the human factor.

So maybe it's the social dimension of labour that explains why wages are inflexible and the labour market doesn't clear. Solow uses the work of some woman whose name seems vaguely familiar, a Janet Yellen, and her Noble-prize-winning husband, George Akerlof to outline one possible explanation of the conundrum, "the fair-wage-effort hypothesis".

The "efficiency-wage theory" says that in the modern economy workers often have some control over their own productivity. They produce more when they are strongly motivated to do so. "One way for an employer to provide more motivation is by paying more than other employers do; another is to threaten to fire the excessively unproductive if and when they are detected," Solow says.

If that sounds obvious, note the radical implication: a firm's physical productivity depends not just on how much labour (and capital) it uses, but also on how well the labour is paid. If so, wages won't fall just because unemployment rises.

Yellen and Akerlof's version of efficient-wage theory says workers who believe they're being paid "a fair day's wage" feel a social obligation to deliver "a fair day's work" in return.

A different approach is "insider-outsider theory". This says the people already working for a firm (the insiders) are likely to be more productive than those who aren't (the outsiders) because they understand how the firm works. If so, the insiders are helping to generate "economic rent" for the firm and thus are able to share this rent by negotiating higher wages.

An outsider may be prepared to work for the firm for a smaller wage, but the boss won't want to risk reducing his productivity by switching from insiders to outsiders.

Whichever of those theories you find more persuasive, the point is the workings of real-world labour markets are far more complicated than most economists realise. Let's hope the Productivity Commission does.

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A REVIEW OF CURRENT AUSTRALIAN ECONOMIC POLICY

The main reason for reviewing the present state of economic policy is, of course, the election of the Abbott government in September 2013. Often a new government will introduce a new approach to economic policy, with the rationale for the changes spelt out in the first set of budget papers following the election. But the explanatory material in this year’s budget papers was little different from previous years. From this I deduce that, at the level of macroeconomic policy, the differences between the old and new governments are more rhetorical than actual.

If this judgement surprises you, it’s probably because you’re thinking not about macro policy as such but about the nature of the measures announced in the 2014 budget and who they would affect. The Year 11 course tells us all budgets affect the economy in three different ways: first, the effect on demand (ie macro management), second, the effect on the allocation of resources (ie microeconomic policy) and, third, the effect on the distribution of income (ie fairness or equity). This year’s budget was the classic example of a budget that needed to be analysed by dividing issues into that three-part framework to make sure people’s reactions to the budget didn’t get muddled up. Teaching your students to discipline their thinking about the budget in this way is good training in how to analyse issues logically.

Looking beyond straight macro management, the Abbott Coalition government’s policy preferences are obviously quite different from the Labor government’s in various respects, and those differences are now far clearer than they were before the election. They’re the preferences you’d expect of a Coalition government, though the measures proposed in the budget were harder-line than anything from the Howard government. Some may be tempted to regard this as an ‘ideological’ government, but all politicians (and all economists) have ideology in their kitbag and it’s not a label I’d apply.

If this was a highly ideological government there would be far more written expositions of that ideology than there have been. I certainly wouldn’t accuse the government of being dominated by the doctrines of economic rationalism. Some of its proposals may seem to fit that label but, as we will see, many don’t. No, I think this is a prime minister and government more of strong likes and dislikes, friends and foes. So many of its actions depart from the principles of economic rationalism to benefit particular big businesses - the miners, the banks, the coal-fired power generators. And the government is not above a little agrarian socialism at the behest of its National Party colleagues.

MACROECONOMIC POLICY

Monetary policy

The Abbott government has affirmed its commitment to the existing ‘framework’ for monetary policy. Monetary policy - the manipulation of interest rates to influence the strength of demand - is conducted by the RBA independent of the elected government. It has been assigned the objective of achieving internal balance. The 2012 budget papers said monetary policy plays ‘the primary role in managing demand to keep the economy growing at close to capacity, consistent with achieving the medium-term inflation target’. Monetary policy is conducted in accordance with the inflation target: to hold the inflation rate between 2 and 3 pc, on average, over the cycle. The primary instrument of monetary policy is the overnight cash rate, which the RBA controls via market operations.

Fiscal policy

Similarly, the 2014 budget papers give no reason to believe there has been any change to the framework in which fiscal policy operates. Fiscal policy - the manipulation of government spending and taxation in the budget - is conducted according to an unchanged medium-term fiscal strategy: ‘to achieve budget surpluses, on average, over the medium term’. The 2012 budget papers nominated a new and different role for fiscal policy: ‘the primary objective of fiscal policy is to maintain the budget in a sustainable position from a medium-term perspective’. That is, the primary objective of fiscal policy is now maintaining ‘fiscal sustainability’.

However, it has also been made clear the budget retains an important role in assisting monetary policy achieve internal balance. How? By allowing the budget’s automatic stabilisers to be unimpeded in doing their job of helping to stabilise demand as the economy moves through the business cycle. The stabilisers bolster aggregate demand when private demand is weak and restrain aggregate demand when private demand is strong. The latter process is known as ‘fiscal drag’ - which is, of course, a helpful thing when you’re trying to keep the growth rate stable. You would never hear Mr Hockey using those Keynesian terms, but it’s still how fiscal policy is expected to work under this government. And the 2014 budget is clearly consistent with it.

This year’s budget papers do set out a Budget repair strategy, which is designed to deliver budget surpluses building to at least 1 per cent of GDP by 2023-24, consistent with the medium-term fiscal strategy.

The repair strategy sets out that:

• new spending measures will be more than offset by reductions in spending elsewhere within the budget;

• the overall impact of shifts in receipts and payments due to changes in the economy will be banked as an improvement to the budget bottom line, if this impact is positive; and

• a clear path back to surplus is underpinned by decisions that build over time.

The Budget repair strategy will stay in place until a strong surplus is achieved and so long as economic growth prospects are sound and unemployment remains low.

The 2014 budget

 Mr Hockey’s first budget was quite remarkable and absolutely fascinating for a connoisseur of budgets like me. So I’m going to describe it as it was delivered and intended to be enacted, even though we know that various of its more controversial measures have been abandoned or modified in their passage through the Senate, while some - the $7 GP co-payment, the changes to university fees - remain in limbo.

The most notable feature of the budget as planned was that it was our first ‘decadal’ budget. The government continued Labor’s recent practice of publishing not just the figures for the budget year and the forward estimates for the following three years, but also projections of the budget balance out 10 years on the assumption of unchanged policies. The projection to 2024-25 showed that the measures announced in the budget could be expected to return the budget to balance in 2018-19 and to an ever-growing surplus of more than 2.5 pc of GDP by 2024-25. However, this assumed 10 years of unrelieved bracket creep. If instead the growth in tax collections was capped at 23.9 pc of GDP from 2019-20 by means of tax cuts, the surplus would still reach a healthy 1.4 pc in 2024-25.

So, the budget announced measures which, though many didn’t take effect until the 2017 budget following the next election, and others would take years before their effect on the budget became significant (eg the restoration of indexation of fuel excise), would get the budget firmly back on track over the coming decade and do it in just one go. Our first ever ‘decadal’ budget. It was the budget of an incoming government, confident of its ability to stay in office for ages. A budget with high political costs up front, but a big payoff way into the future.

How was this remarkable feat to be achieved? Mainly through fiddling with indexation arrangements, adjusting them in any way that favoured the budget. Few people noticed how obsessed this budget was with indexation. It proposed to change the indexation of pensions from average weekly earnings to the CPI, it reduced the indexation of grants to the states for public schools and public hospitals, it paused the indexation of certain family benefits, it changed the indexation of overseas aid from gross domestic income to the CPI, it changed the indexation of HECS debt from the CPI to the long-term bond rate and it restored the indexation of fuel exercise.

As well as all these indexation adjustments the budget proposed to increase the user charges for pharmaceuticals and university students, plus the new $7 co-payment for GP visits and tests. So the budget isn’t about cost cutting so much as cost-shifting: to people on pensions, to the young jobless, to university students, to the sick and, to the tune of $80 billion, to the states. Some opponents of the GP co-payment are referring to it as the ‘GP tax’. This is simply wrong, but it gives you the opportunity to make sure your students understand the difference between a tax and a user charge.

Budget’s effect on demand

From a macro management perspective, the budget had three key features:

1) A slow pace of fiscal consolidation. The new measures and revisions to forecasts were expected to improve the budget balance by just $4 billion in the budget year and by $7 billion in each of the following two years, but by $26 billion in 2017-18. This slow start was intended to avoid the budget having a dampening effect on growth while the economy was expected to be growing at a below-trend rate.

2) A switch in the composition of government spending. While spending on transfer payments leading to consumption was reduced, spending on infrastructure investment was increased by $12 bil. Half of this was spent on an ‘asset recycling initiative’ intended to encourage the states to increase their own infrastructure spending. The goal was to help fill the vacuum left by the fall in mining investment.

3) Headroom for tax cuts. The government’s 10-year budget projections assume that tax revenue is capped at 23.9 pc of GDP (the average level between 2000 and 2008) after 2019-20, with spending cut so hard that budget surpluses are still projected to reach 1.5 pc of GDP in 2024-25. The cap is intended to make room for tax cuts to counter the effect of bracket creep.

So, clearly, this was not a highly contractionary budget. Indeed, in terms of the first two or three years it wasn’t contractionary to any significant degree. The contraction was designed to come only after the economy was expected to have returned to above-trend growth. Thus no matter how much people may object to some of its measures, it’s quite wrong - quite ignorant - to describe the budget as pursuing a policy of ‘austerity’. Austerity doesn’t mean acting to improve the budget balance (the term for which is ‘fiscal consolidation’), it means doing so while private demand is still very weak and thus running a high risk that efforts to reduce the deficit backfire and actually make it worse. This is just what Mr Hockey tried not to do.

When the mid-year review is published in December, we will see the effect on the projected budget balance of those budget measures the government has been obliged by Senate opposition to modify or abandon (although those it has yet to put up to the Senate may remain in the forward estimates). We also know that greater-than-expected falls in export commodity prices and low wage growth will necessitate a continuation of the downward revisions to budget revenue estimates than became so frequent under the previous government. We also know that, consistent with his rejection of austerity policy, Mr Hockey will not announce further budget savings intended to offset the effect of the downward revisions to revenue. So the budget’s return to surplus will now be even later than projected at budget-time.

It’s clear that, despite all the Coalition’s criticism of Labor while in opposition, and its various promises to get the budget back to surplus much earlier than Labor could, it’s not having much success, and this does not seem to worry it greatly. The measures it proposes may be very different to those Labor would propose, but its approach to fiscal policy turns out to be remarkably similar to Labor’s.

Budget’s effect on allocation

Viewed as an instrument for raising allocative efficiency - as a vehicle for microeconomic reform - the budget was not an impressive document. Its proposed measures did a lot to shift costs from the federal budget onto state budgets and household budgets, but little to raise the efficiency of government spending. Far from increasing spending on preventive health programs (with beneficial effects on employment, wellbeing and the budget) it cut such spending.

The budget could have done a lot to reduce distorting subsidies to business (‘business welfare’) but, apart from eliminating subsidies for the production of ethanol, it didn’t. Its real cuts to public school funding and eventual discontinuation of spending on the Gonski equity program may well have the effect of reducing the employability, skills and productivity of disadvantaged young people. While many economic rationalists believe imposing a $7 user charge on previously ‘free’ (bulk-billed) doctor visits and tests would reduce their unnecessary use, empirical studies suggests it would do more to discourage poor people from seeing a doctor when they needed to than to discourage frivolous visits.

Many economic rationalists believe that deregulating university fees would eventually do a lot to force greater efficiency on universities. But this is debatable because the market in which the universities would operate is far from perfect. They would remain government-owned and regulated and they enjoy a degree of monopoly in granting access to the best jobs in the labour market.

Budget’s effect on distribution

The budget was widely judged by the public to be unfair, even by people who themselves weren’t greatly affected by it. It was seen that poor people would be hit a lot harder than the better-off. This was, in fact, an almost inevitable consequence of the government’s unusual decision to return the budget to surplus largely by cuts in spending rather than increases in taxes. This is because our system of tightly means-tested transfer payments comes on the spending side, whereas various questionable ‘tax expenditures’ - such as the superannuation tax concessions, negative gearing, family trusts and the 50 pc discount on capital gains - heavily favour high income-earners.

The plan to withhold access to the dole to people under 30 for six months would clearly have hit low income-earners. The $7 co-payment would be regressive. Because we measure relative poverty, the plan to index age, invalid and sole-parent pensions to the CPI rather than average earnings, would cause the rate of pension payment to fall over time below the poverty line.

Even without any increase in the level of university fees, the proposal to index HECS debt to the government bond rate rather than the CPI - that is, to impose a real interest rate on the debt - would leave people who didn’t complete their degrees and those with breaks in their full-time employment (particularly married women) with significant levels of debt and interest charges. The HECS scheme was designed to allow students to be required to pay a proportion of the cost of their tuition in an equitable way, but this would rob the scheme of much of its fairness.

By contrast, I believe the proposal to deregulate uni fees, which would no doubt permit significant increases in those fees over the years, while being highly unpopular, would be a progressive rather than regressive measure. Why? Because the great majority of uni students come from well-paid homes and go on to themselves have well-paid jobs. Those who attended the higher-status sandstone universities would be obliged to pay a lot more for that status.

It’s important to note that, though the government’s rhetoric focused on getting savings from the spending side, in truth a high proportion of the projected improvement in the budget balance would come from the revenue side. That’s not just because of the temporary ‘deficit levy’ imposed on high earners nor the restoration of fuel excise indexation, but because the budget projections imply six years without another income-tax cut and thus six years of bracket creep. And it’s worth remembering that the particular shape of our tax scale at present means bracket creep is regressive, hitting low income-earners proportionately harder than high earners.

Over the years I’ve seen incoming Coalition governments bring down some pretty unfair initial budgets without drawing much public outcry over that unfairness. Why was the reception to this budget so different? Partly because the treatment of the young unemployed was so obviously excessive. But also because I never expected to see a government of any colour getting so tough with age pensioners. When a Coalition government gets tough with the aged it’s getting tough with its own heartland. The same goes for its plan to permit big increases in university fees and debts. Remarkable politics.

MICROECONOMIC POLICY

One of the ways the Coalition kept itself a ‘small target’ in the 2013 election campaign was to avoid promising controversial reforms in key economic policy areas by promising to establish inquiries and take any reform proposals arising from those inquiries to the next election. There is a belief among politicians that it’s easier to bring about reforms from government than from opposition. As yet, few of those inquiries have delivered their final reports and had the government announce which of their recommendations it was accepting. So it is too soon to have a clear picture of how reformist the Abbott government has proved to be, how rationalist it is and how brave it is. Although the initial signs haven’t been encouraging, it’s not yet clear whether it is pro-market or just pro the interests of influential industries.

Even so, while it waits for the many inquiry reports the government has been getting on with keeping its election promises. It has succeeded in abolishing the minerals resource rent tax and the carbon tax/emissions trading scheme. It has claimed that this will lead to faster economic growth, but it’s hard to take such claims seriously. It has sought considerable publicity for its red-tape-cutting ‘repeal days’, but though some of these measures are genuine, much is window-dressing.

Throughout its term the Labor government had been negotiating free-trade agreements with South Korea, Japan and China, without much sign of progress. The new trade minister was given the task of completing those agreements within his first year, and he completed it within about 14 months. The agreements with Korea and Japan will deliver modest gains in market access to certain categories of Australian agriculture, but the surprise agreement with China involves wide-ranging cuts in Chinese tariffs and other trade restrictions, making it a far more significant advance.

The interim report of the inquiry into competition reform, chaired by Professor Ian Harper, implied than various competition-promoting changes would be recommended, but we have yet to see his final report and the government’s response to it.

The interim report of the inquiry into financial regulation, chaired by David Murray, drew a favourable reaction from economists but, again, it’s too early to be confident of what will finally emerge from it. In the meantime, the government has sought to water down the consumer protections in the Labor government’s Future of Financial Advice legislation in response to pressure from the big banks and insurance companies, but the Senate has reversed its initial support for the government’s changes.

The Coalition has yet to initiate its promised inquiry by the Productivity Commission into industrial relations. The delay reinforces suspicions Mr Abbott has little enthusiasm for radical reform, particularly anything his opponents could portray as an attempt to restore Work Choices. And, assuming he will take proposals for controversial reform in some policy area into the 2016 election, by this stage he may be keen to ensure he isn’t fighting on too many fronts.

Mr Abbott is also yet to initiate the promised inquiries into tax reform and federalism, which he has linked. In a recent speech on federalism he raised the possibility of tax reforms, ‘including changes to the indirect tax base’, calling for ‘mature debate’ and ‘rational discussion about who does what’. He wants to reverse the creeping centralisation, reaching a rational division of roles that would make each level of government ‘sovereign in its own sphere’. I find it hard to believe the federal government could ever reach an agreement with the premiers on a more rational division of responsibilities.

And though Mr Abbott’s remarks imply that, as part of a wider tax reform package, he’d support a joint plan to increase collections from the (withering) GST and give all the proceeds to the states, such joint agreement - virtually all premiers supporting a more onerous GST - is hard to imagine. Apart from that, the arithmetic isn’t adding up. Mr Abbott has stressed that any reform package including a higher GST would not involve any increase in the tax burden overall. Mr Hockey says in the context of reform that the government ‘wants taxes that are lower, simpler and fairer’. In which case, it’s hard to see how raising GST collections could solve the budget-balancing problems of both the federal and state governments. And that’s before you remember that the Business Council and other vocal business advocates of tax reform have been hoping the proceeds from a higher GST would be used to cover cuts in the rate of company tax and/or the top personal tax rate. The path to a tax reform package that even the government and influential lobby groups could agree on, to then put before voters, at an election is long and rocky.

We will have a clearer idea this time next year, but it won’t surprise me if, in practice, the Abbott government proves to be much less radical than its rhetoric to date has led many to expect.

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