NEW ISSUES IN MACRO MANAGEMENT: public debt, MMT and QE

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As you well know, thanks to a long period of weak economic growth, we hadn’t made any progress in reducing the federal government’s debt arising from the global financial crisis of 2008-09 before the arrival of the huge budget deficits associated with our response to the pandemic. This has left us – and all the other advanced economies – with levels of public debt higher than anything we’ve known since the period after World War II.

Right now, the economy has yet to recover from the protracted lockdowns employed to deal with the Delta variant of the coronavirus, but the econocrats and most other economists are confident the economy will bounce back almost as strongly and quickly as it did following the end of the initial lockdowns last year. It’s important to remember that the strength of these bounce backs owes much to the huge government spending on the JobKeeper wage subsidy scheme, the temporary Job Seeker supplement and various other assistance programs designed to hold the economy together during the government-imposed lockdowns. The huge loss of household income occurring in a normal recession was thus avoided, leaving people well able to resume spending as soon as restrictions were eased. So there’s no reason to regret the huge increase in public debt. It’s important also to make sure your students understand that the government’s explicit spending decisions explain only part of the huge budget deficits incurred. Much of it is explained by the collapse in tax collections and increased number of people on unemployment benefits – that is, by the automatic operation of the budget’s “automatic stabilisers”. That, too, should be seen as a good thing.

In passing, be clear that, contrary to the “policy mix” of the past 30 years, where monetary policy was the primary instrument used for short-term management of demand, with fiscal policy playing a subsidiary role, fiscal policy has now returned to primacy. To quote this year’s budget papers: “with further support from monetary policy limited, fiscal policy will need to continue to play an active role in driving the unemployment rate lower”.

It’s obvious that budget deficits lead to increased government debt, and only a return to budget surpluses will produce a fall in the absolute level of debt. The underlying cash deficit for last financial year, 2020-21, was $134 billion, or 6.5 pc of GDP, well down on what was expected at the time of the budget in May. This left us with a net debt of $590 billion, or 28.6 pc of GDP. We’ll see the latest estimates of this and future years’ deficits and debt in the mid-year budget update in mid-December. But, though all the pandemic-related assistance measures were temporary, meaning the deficit should fall pretty sharply, all the projections we’ve seen to date show no likelihood of the budget returning to surplus in coming years, “on unchanged policies”.

So, how concerned should we be about our post-post-war record level of debt, and what can or should we be doing to reduce it? And what about the argument of the proponents of “modern monetary theory” who say we should be covering the budget deficit not by borrowing from the public but simply by printing money. And finally, what does the RBA’s resort to “quantitative easing” involve, and how does it relate to the MMT debate?

The changed attitude to public debt

 After the big increase in the federal government’s net debt following the Rudd government’s use of considerable fiscal stimulus to stop the global financial crisis of 2008 causing a severe recession, the government’s view was that, in accordance with the “medium-term fiscal strategy” instituted by the Howard government in 1996, the budget should be returned to surplus as soon as reasonably possible after the economy had recovered. The strategy was to “maintain a budget balance on average over the economic cycle”. That is, the budget would be in deficit during the weak years of the cycle, but this would be offset by surpluses during the strong years, leaving a balanced budget on average, and leaving no net addition to the public debt.

The Abbott government promised to quickly eliminate the debt but, instead, the net debt doubled in nominal terms in the period up to the arrival of the pandemic in early 2020. By then, weak economic growth meant it had taken the Coalition six years just to get the budget back to balance.

The (delayed) budget of October 2020 announced a radical change in the government’s medium-term fiscal strategy. It became to “focus on growing the economy in order to stabilise and then reduce gross and net debt as a share of GDP”. That is, there was no goal to get the budget back to surplus – and, hence, no goal to reduce the public debt in nominal (dollar) terms. Rather, the goal was simply to reduce the size of the debt relative to the size of the economy (nominal GDP). In the government’s oft-repeated slogan: “repair the budget by repairing the economy”.

One of the reasons the advanced economies’ recovery from the Great Recession was so weak was that many of them panicked when they saw how much debt they’d run up and, before their recoveries had properly taken hold, they began cutting government spending and increasing taxes in an effort to get their budgets back to balance. This policy of “austerity”, as its critics called it, proved counterproductive. It weakened their economies’ growth and thus limited their success in reducing budget deficits. This is why Treasurer Frydenberg has repeatedly sworn not to “pivot to austerity policies”.

In switching from using budget surpluses to reduce debt in absolute terms to using stronger economic growth to reduce debt in relative terms, the government is adopting a change in concern about public debt that has occurred among leading American academic economists, influenced by the advanced economies’ pre-pandemic experience of “secular stagnation” or being caught in a “low-growth trap”. Weak growth makes “fiscal consolidation” (spending cuts and tax increases) harder and unwise at a time when governments should probably be investing more to offset the weakness in business investment. At the same time, the low-growth trap has produced exceptionally low interest rates, meaning the cost of “servicing” (paying the interest on) the public debt is lower than ever.

The government (and Treasury Secretary Dr Steven Kennedy) have taken up the American academics’ simple formulation that, whatever its absolute size, a stable amount of public debt will fall as a proportion of GDP so long as nominal GDP is growing at an annual rate exceeding the average rate of interest on the debt. The interest rates on Australian government debt have been between 1 and 3 pc, whereas our nominal GDP should be growing on average by 4 to 5 pc [inflation of 2.5pc plus real growth of 2.5pc]. The wider the gap between GDP growth and interest rates, the greater the scope for modest continuing budget deficits while the debt still falls as a proportion of GDP.

Several points can be made to reinforce this argument for being less anxious about the size of our public debt. First, as I’m sure you understand (but need to explain to every year’s bunch of students), the financial constraints that make it reckless for an individual household to have ever-growing debt don’t apply to governments, particularly national governments. In practice, governments mainly roll-over their debts rather than repaying them.

Second, measured relative to GDP, Australia’s public debt remains about half the size of most other advanced economies’ debt. Third, according to calculations by Saul Eslake, our projected interest payments on the federal public debt will be about 1 pc of GDP over the medium term to 2032, much lower than we’ve been used to. In the late 1980s it was above 2.5 pc. That is, there was never a time when we needed to be less anxious about the interest burden.

Even so, some respected economists – such as Productivity Commission chair Michael Brennan and former Treasury secretary Dr Ken Henry – have expressed concern that this more relaxed attitude to debt is too risky. Henry worries that, without efforts to get the budget back to balance and surplus, we will have limited scope to make an adequate response to the next fiscal crisis. Brennan worries people will conclude that debt and deficit no long matter, that “we can afford the next and the next ‘one-off’ rise in debt”.

But the new, more relaxed attitude to debt and deficit has also been attacked from the other direction – that this attitude remains more worried about debt than it needs to be – by proponents of “modern monetary theory”.

Modern monetary theory

MMT is a school of economic thought that’s been around for some decades. Its great proponent in Australia has been Professor Bill Mitchell, of my alma mater, Newcastle University. But it’s had a great push from the best-selling book, The Deficit Myth, by American Professor Stephanie Kelton.

There is nothing new about MMT. As the syllabus says, national governments face a choice of whether the finance their deficits via borrowing from the public or via borrowing from the central bank – that is, covering the deficit with newly created money. As recently as the mid-1980s, early in the term of the Hawke-Keating government, Australia followed other advanced economies in introducing the rule that deficits must be fully funded by borrowing from the public. This was at a time when the advanced economies were still struggling to get inflation under control. And, since the decision about how budget deficits should be funded is one to be made by governments, central bankers argue that MMT is about fiscal policy, not monetary policy.

Even so, there is much truth to the contentions of MMT. Like everyone else, we have a fiat currency, issued by the government and not backed by a quantity of some valuable commodity such as gold. So, in principle, governments are free to decide how many dollars to create. The MMTers remind us that it’s strange for us to have an arrangement where the private banking system (the banks in total, not an individual bank) able to create money, but the government prohibiting itself from doing so.

MMT is also right in rejecting the monetarist notion that printing money is always inflationary – “too much money chasing too few goods”. As economists have long understood. It’s not how much money has been created that matters, it’s the command over “real resources” – land, labour and physical capital – that money buys. Inflation occurs only when the demand for real resources exceeds the supply of real resources. To demonstrate the point, since the GFC the central banks of America, Britain, Europe and Japan have created massive amounts of money, yet inflation rates have stayed low or fallen (until the recent disruptions to supply caused by the pandemic). Inflation has stayed low because the demand for real resources has remained low relative to the supply of real resources.

Inflation is a consequence of demand being stronger than supply. At least since the GFC, the developed world’s problem has been the weakness of demand relative to supply. This does much to explain the new-found attention to MMT. What can be done to strengthen demand? Why shouldn’t the government add to demand by spending on lots of worthy projects and just create the money to cover it? This is the great theoretical truth highlighted by MMT: for as long as demand is running behind supply, anything the government spends can add to demand without causing inflation.

So in theory, MMT is correct. The econocrats’ objection to it is practical rather than theoretical. If you tell our fallible politicians they can spend as much as they like without bothering to borrow until we reach the point where the “output gap” has been eliminated and aggregate demand is running in line with “potential” – that is, the economy has reached full employment of all real resources – how will you get them to resume covering their spending by borrowing once that point has been reached? Even before you reach that point, how will you get fallible politicians to worry about stopping government spending that wastes real resources when government spending seems like a free lunch? This is what explains RBA governor Dr Philip Lowe’s vehement rejection of MMT. He sees himself responsible for achieving non-inflationary growth. He doesn’t want a new system in which the politicians tell him how much money they want him to create.

Quantitative easing

Short-term interest rates in the US and the other major advanced economies had got to very low levels before the global financial crisis of 2008 precipitated the Great Recession of 2008-09. The US Federal Reserve needed to cut its policy interest rate (the Fed funds rate) a long way to apply sufficient monetary policy stimulus, but was already close to the “zero lower bound”. So it resorted to “unconventional measures”. It intervened directly into particular financial markets that had frozen to get them trading again, and extended its conventional measures, of only influencing short-term interest rates, to lowering longer-term interest rates further out along the maturity “yield curve”. This is “quantitative easing”. Similar to conventional monetary policy, you buy longer-dated second-hand bonds, which forces up their price and so reduces their “yield” (interest rate). Since government bonds set the “risk-free” base on which private sector lending rates are set, this lowers the rates paid by people borrowing for longer fixed-rate periods. The central bank pays for the bonds it buys simply by crediting the accounts of the banks it buys from. That is, it creates the money out of thin air. Once the Fed adopted QE it was soon joined by the Europeans, Brits and Japanese.

It’s not clear that QE does much to encourage borrowing for consumption of goods and services or for business investment, rather than borrowing to buy assets such as houses and shares. But it is clear that the extra outflow of created dollars lowers the country’s exchange rate relative to the currencies of other countries. This lower exchange rate does stimulate the economy of the country engaging in QE by improving the international price competitiveness of its export and import-competing industries. This, however, adds to the reasons the other big advanced economies lost little time in also resorting to QE: so that their exchange rates wouldn’t appreciate against the US dollar.

In principle, once their economies had recovered from the Great Recession the Fed and other big central banks should have stopped buying second-hand bonds and started selling the bonds they’d bought back into the market, thus pushing rates back up to where they had been. It didn’t really happen. Rather, interest rates were still exceptionally low when the pandemic arrived. The Fed and the others leapt into another round of QE.

In Australia, the success of our efforts to avoid being sucked into the Great Recession, and our policy interest rate being a fair bit higher than those of the major advanced economies, meant we didn’t engage in QE at that time. It seems clear that Lowe had his doubts about the effectiveness of QE. But once the severity of the pandemic became clear in late March last year, the RBA cut the cash rate to 0.25 pc (and, in November, to 0.10 pc) and engaged in QE. It guaranteed that it would buy as many bonds as needed to keep the yield on three-year government bonds at the same rate as the cash rate. This was design to assure the financial markets that the cash rate wouldn’t be increased for at least the next three years. This was intended to encourage people to take advantage of the low, emergency-level interest rates. It also had the effect of encouraging the banks to offer very low fixed-rate home loans.

From November 2020, the RBA also announced it would buy $100 billion worth of second-hand federal and state government bonds with maturities of five to 10 years, at the rate of $5 billion a week. This was intended to lower interest rates further out along the yield curve. When the $100 billion had been spent in February this year, the RBA announced it would spend a further $100 billion, although it later decided to cut the rate at which it was buying bonds to $4 billion a week. Early this November, the RBA decided to discontinue limiting to 0.1 pc the yield on the Australian government bond maturing in April 3024. This made it possible for the RBA to decide to increase the cash rate in 2023, even though its forecast still suggested no increase would be needed before 2024.

Purchases of $200 billion worth of second-hand bonds represent about 20 pc of the total stock of federal public debt, meaning the RBA’s purchases of second-hand bonds would be about as much as the government’s issue of new bonds to cover the huge budget deficits it’s been running since the arrival of the pandemic. As part of QE, the cost of the RBA’s bond purchases has been covered merely by creating money, of course. So, despite Lowe’s vehement rejection of the MMT argument that the government fund its deficits by creating money rather than borrowing from the public, his QE has achieved essentially the same effect. The government will have to pay the RBA interest on the bonds the central bank has bought – and in due course, redeem the bonds when their term expires – but, since the government owns its central bank, this will just be a book entry inside the federal public sector. But though you and I can say MMT and QE amount to the same thing, Lowe would insist they are very different. How? MMT means the decisions about how much money to create are made by the fallible politicians, QE leaves the decisions about money creation in the hands of the independent central bankers. So the MMT advocates have had a qualified win.

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Interest rates definitely to rise - sometime, maybe

The geniuses in the financial markets – and they must be geniuses because they’re paid far more than we are – think next year will be an absolute ripper. Workers will be getting their first decent pay rise in six years or more. Say, 3 to 4 per cent. Whoopee. Gee, thanks guys.

Find that hard to believe? So do I. It’s the logical implication of the bets they’re making that the Reserve Bank will begin lifting its official interest rate – which has been at almost zero for a year – by the middle of next year and be up to 1 or 1.25 per cent by the end of next year.

For that to happen, the underlying or core rate of inflation, which has been below the bottom of the Reserve’s 2 to 3 per cent target for years and only just a few weeks ago lifted its head to 2.1 per cent, would need to have shot up close to 3 per cent.

And, because the inflation rate doesn’t rise sustainably unless it’s being driven up by rising wages, an inflation rate approaching 3 per cent couldn’t happen without annual pay rises averaging 3 to 4 per cent.

Reserve Bank governor Dr Philip Lowe has spelt out this relationship between inflation, wages and interest rates almost every time he’s opened his mouth since even before the arrival of the pandemic. He did so again twice last Tuesday and once on Friday.

So pay rises of unheard-of size are the logical implication of the money market’s bets that the Reserve is about to become so desperately worried about soaring wages that it will have raised the official interest rate four or five times in the next 12 months.

Trouble is, I doubt the financial market players are thinking logically. I doubt they’ve thought it through to the extent I just described. The economists who work in the financial markets are well-educated, but this episode makes me wonder whether the guys laying bets in the dealing room even have wages in their mental model of what drives inflation and interest rates.

By the way, I’m not just being disparaging in describing the financial markets as a casino. As Professor John Kay explained in his book Other People’s Money, the buying and selling of currencies, bonds and other real and derivative securities each day in the world’s financial market dwarfs the number of transactions needed by real businesses to conduct their ordinary affairs.

Indeed, Kay told me those genuinely necessary transactions could be put through in about a quarter of an hour a week. So, what are all the remaining transactions? They’re dealers using their bank’s money to trade with dealers from other banks in the hope of making a quick million or two and a fat bonus at the end of the year.

I’m sure these professional gamblers are better at playing poker than you or I would be, but they aren’t trained economists, and they don’t think like economists. Certainly, not like central bank governors.

Because Wall Street has the greatest single influence over what happens in the global financial markets, these guys know more about what’s happening – and likely to happen – in the American economy than their own.

They also have a huge superficial knowledge of what’s been happening in lots of economies in the past few weeks. They know inflation has shot up in the US, Britain and a few other countries, wages have increased somewhat in the US and a few other places, and some minor central banks have started raising their official interest rates.

I think these guys’ mental model of what’s driving interest rates is no more profound than this: prices and wages are rising in the US and other places, rates are already rising around the world, so pretty soon rates will be rising here.

Lowe, the man with his hand on the lever, says he still doesn’t think a rate rise will be needed until 2024, but last week he admitted things could turn out stronger than he expects and make a rise necessary in 2023.

There you are. He’s as good as admitted he’ll have no choice but to start raising rates in a few months’ time. Anyway, that’s what we’re betting on. If we turn out to be wrong, it wouldn’t be the first time, and we won’t lose our jobs. We’ll just lay new bets and keep doing it until we’re right.

Which they will be – one day. Since rates can’t go lower it’s a cert that the next move will be up. Right now, when they’ll be going up is known only to God. In the absence of inside intel, I’d rather put my money on Lowe than on those geniuses.

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Masterpiece: the spin is Morrison's plan to reach net zero is dizzying

The more our politicians are full of bulldust – known euphemistically as “spin” – the more they rely on our short attention span. They make a grand announcement that doesn’t bear close scrutiny, but the media caravan moves on before it’s had time for a closer look. Well, not this time.

I’ve been looking more closely at the Plan to achieve net zero emissions of greenhouse gases by 2050 that Scott Morrison unveiled last week, shortly before jetting off to Glasgow.

It’s full of . . . hyperbole. A masterpiece of the spin doctor’s art. A document carefully crafted to mislead.

For someone claiming to have a Plan to achieve a difficult objective over the next 29 years, it was surprising to see Morrison claiming the Plan contained no new policy measures. By implication, no additional cost to taxpayers.

That’s true – and untrue. We know, for instance, that Morrison had to promise to spend a lot of money just to get the National Party’s permission to commit to achieving net zero by 2050.

So, what policy promises did Morrison make, and how much will they cost? We weren’t told. They weren’t mentioned in the 130-page plan. We’re told we’ll be told sometime before the election.

The Plan says Morrison’s “technology investment roadmap” will “guide” more than $20 billion of government investment in low emissions technology to 2030. So, further spending of $20 billion?

If that’s what you thought, the spin merchants would be pleased. They love giving the impression we can have our cake and eat it. But no, this is not new policy. All the $20 billion has already been announced.

And much of it has already been spent. Much of it by the previous Labor government. A bit over half of it is spending by the Australian Renewable Energy Agency and the Clean Energy Finance Corporation.

These were set up by the evil Julia Gillard in 2011, in association with her job-destroying and cost-of-living killing carbon tax. Tony Abbott tried to abolish them along with the tax, but failed.

Now they’re produced as evidence of how much the Morrison government’s doing to promote new emissions-reducing technology.

The Plan claims the government’s $20 billion will “leverage” more than $80 billion from government and the private sector by 2030. (What it doesn’t mention is that Australia’s total spending on research and development has plummeted since the Coalition returned to power in 2013.)

As to whether the Plan commits the government to spending a lot more, note that the modelling showing we can get to net zero by 2050 rests on various assumptions about the success of future new technology in producing clean products at specified low costs.

For instance, clean hydrogen will be produced for under $2 a kilogram. Carbon emissions from fossil fuels will be captured and stored at a cost of less than $20 a tonne.

But these happy assumptions come with an asterisk. The asterisk leads to very fine print saying “subject to offtake agreements”.

Oh yes, what are they? The Plan doesn’t say. But they’re the government agreeing to buy loads of the clean product at a price that allows the real customers to pay a very low price. That is, it’s a massive subsidy.

How much will the government buy? At what price? Morrison couldn’t tell us if he wanted to because these deals are way off in the future – if they ever happen. They’re not a new policy to spend taxpayers’ money, they’re just an assumption the modellers needed to make - that the necessary money would be spent - to achieve their prediction that we’d get to net zero by 2050.

You’ve noticed that the Coalition which, ever since Abbott rolled Malcolm Turnbull as Liberal opposition leader in 2009, has been vigorously opposed to doing anything much to reduce emissions, has now embraced the net zero target.

But have you noticed that now he’s big on reducing emissions, Morrison is quietly rewriting history to remove any trace of that former opposition? Worse, have you noticed Morrison is now taking credit for any progress we’ve made to date?

Any progress made by the policies of his evil Labor opponents and – as with the pandemic – any progress owed to the policies of those appalling premiers?

This is why politicians have spin doctors. “Our Plan will continue the policies and initiatives that we have already put in place and that have proven to be successful, reducing emissions and energy costs,” some spinner wrote.

Next, Morrison’s claim that Australia’s on track to reduce emissions by “up to” 35 per cent by 2030, well above the government’s target of 26 to 28 per cent. Independent analysis commissioned by the Australian Conservation Foundation confirms this is quite believable.

But, apparently, it’s all the Morrison government’s doing. He speaks of “our record of reducing emissions and achieving our targets” and “our strong track record, with emissions already more than 20 per cent lower”. “We have already achieved 20 per cent,” his energy minister says.

But Bill Hare, of Climate Analytics, says the feds are doing little, but claiming credit from the hard work of the states and territories.

It was the NSW and Queensland governments that saved most of the 20 per cent by restricting land clearing. It’s the states that encouraged the record rollout of rooftop solar and large-scale renewables.

NSW, Victoria, the ACT and South Australia have strong electric vehicle policies. Meanwhile, Morrison & Co have been encouraging gas production with new subsidies – which, of course, won’t be paid for by increasing your taxes.

Spin is claiming credit for any good thing, but blaming others for anything bad. You’ve heard that the Plan “will not cost jobs, not in farming, mining or gas”.

But the actual promise says that “not one job will be lost as a result of the government’s actions or policies under the Plan”.

Get it? Jobs will be lost, but we’ve set it up so no one will be able to blame us.

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Net zero can't be reached by magic, but we can ease the pain

Scott Morrison’s long-term plan for net zero emissions by 2050 won’t impress anyone who’s been following Australia’s long and tortuous battle over climate change. But then, it’s not intended to.

His “learning” after miraculously wining the unwinnable election in 2019 is that whatever half-truths he tells voters will be believed by enough of them. Particularly since God is on his side, not the side of those other, untruthful and ungodly people.

No, his Plan – which is not a plan to achieve net zero, just an optimistic forecast that it will be achieved – is largely a political document, intended to be sufficient to convince those voters who aren’t paying attention that he’s “doing more” to cope with climate change.

His goal is not so much to fix the climate as to neutralise it as an issue at next year’s election. Climate change is an issue that naturally favours Labor. He wants all the focus to be on two issues that naturally favour the Coalition: the economy and national security.

He was walking a tightrope last week. He had to discourage voters in Liberal heartland seats who were worried about global warming from trying to send their party a message by voting for liberal independents – as they’ve done in Tony Abbott’s former seat and, briefly, Malcolm Turnbull’s – by convincing them he was serious about reducing emissions.

At the same time, however, he needed to reassure voters in the National Party’s various Queensland coal-mining seats that he wasn’t serious.

His solution was to produce a document that says: the boffins I hired assure me we’re on track to eliminate net emissions by 2050 but, don’t worry, this will be achieved by the miracle of new technology, without anyone feeling a thing.

There’ll be no new taxes, no new regulations forcing people to do things and no new costs on households, businesses or regions. We won’t shut down coal and gas production, and no jobs will be lost.

Does it sound a bit too good to be true? Voters in the Liberal heartland tend to be well educated and well informed. I doubt it will do the trick.

As we’ve seen with the pandemic, when our federal leaders fail to lead, others feel a need to fill the vacuum. The premiers, of course, but also many people from business and the community.

The latest report from Tony Wood and colleagues at the Grattan Institute, Towards net zero: a practical plan, offers a more realistic assessment of the challenge we face, says why we must get more achieved by 2030 and proposes ways this can be done without too much pain.

Perhaps because he’s not standing for office, Wood is frank about the difficulty in getting to net zero. The scale and pace of change involved in a net-zero target are “daunting, but they are outweighed by the consequences of the alternative.

“Factors outside Australia’s control will shape the flow of capital and the demand for our exports, while climate change itself will increasingly threaten Australians’ lives and livelihoods.”

Just so. Only a fool would believe we can avoid pain by doing nothing. We can seek to delay the pain, but that would relinquish our ability to influence our future, as well as making the pain greater.

The longer we leave it to make big progress towards net zero, the more pain we ultimately suffer. But also, our failure to throw our support behind the global push for earlier progress – which is what we’re failing to do in Glasgow this week – increases the risk that the goal of limiting warming to 1.5 degrees will be exceeded by the end of this decade, making it less likely we ever get back below it.

But while it’s foolish to think we can avoid pain, we shouldn’t imagine the pain will be intolerable. And here’s the trick: provided it’s done sensibly, paying a bit more tax and putting up with a bit more regulation is actually intended to reduce the amount of pain, and share it more fairly.

Wood accepts Morrison’s figuring showing that we’re likely to exceed the 26 to 28 per cent reduction in emissions by 2030 we promised to make in 2015. But we’ll still fall short of the 45 to 50 per cent reduction we’re being asked to make and other rich countries are agreeing to.

Wood’s plan for getting up to the higher target is neither heroic nor frightening. While we wait for the technological breakthroughs Morrison’s modelling assumes will come, we should get on with applying the technology we already have.

Generate electricity almost completely from renewables, and step up the move to electric cars and vans by tightening emission standards for petrol-driven cars, giving EVs tax breaks and supporting the spread of charging stations.

This is the first step towards the new green manufacturing industries that will provide the regional jobs for miners and gas workers to move to as other countries stop buying our coal and gas.

It won’t be easy or painless, but it’s not beyond the wit of decent governments.

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Beware of pedlars of supply-side solutions to home affordability

One thing you can be sure of is that if house prices are soaring, governments will be holding inquiries into it. Unfortunately, the other thing you can be sure of is that nothing will come of those inquiries.

Why? Because their purpose is to express the government’s deep concern about the worsening affordability of homeownership – its heart-felt sympathy for young people struggling to buy their first home – not to tackle the problem.

Why? Because policy decisions made by governments – federal and state – over many years have rigged the housing market in favour of people who already own their homes and against those who’d like to own.

Why? Because the number of voting homeowners far exceeds the number of voting would-be homeowners. The established homeowners – and the industries that benefit from the rigged market, such as property developers and real estate agents – get shirty if they think their privileges are threatened.

Labor summoned its courage and promised to act against negative gearing and the deep discount of capital gains tax in the 2016 and 2019 federal elections but, since its shock defeat in 2019, its courage has deserted it.

Speaking of housing inquiries, as we speak Treasurer Josh Frydenberg has a parliamentary committee inquiring into “housing affordability and supply”. As its terms of reference make clear, it’s not actually about housing affordability, but really about blaming rocketing house prices on inadequate supply rather than excessive demand.

Why? Because, with a federal election fast approaching, its real motivation is to shift the blame for increasingly unaffordable house prices away from the feds and on to the states. Whereas most of the policies promoting demand for homeownership are under the influence of the federal government, most of the policies affecting the adequacy of the supply of homes are influenced by the state governments and their creature, local government.

When I wrote about the causes of rocketing house prices last week, I knew I was leaving myself open to attack because I focused solely on factors adding to demand and didn’t get to supply factors before I ran out of space.

True, no analysis of change in any market price is adequate if it doesn’t examine both sides of the market. So let me make amends.

In simple economic theory, if the price of some item rises, the reason should be that demand has outstripped supply. Let supply catch up and the price should return to where it was. If the demand for homes rises by 100, build 100 more homes and the price should be unchanged.

But such thinking is grossly oversimplified – especially when applied to something as complex as the housing market. For a start, the simple model is designed to analyse markets for “commodities” – simple consumer goods or services you buy and soon eat or use up.

Homes, however, are assets that last for decades and have a resale value. Most of that value resides in the land on which the home is built, and the land goes on forever.

This means a home is both a consumption good – it provides its owner or tenant with somewhere to live – and an investment good, which should at least hold its value over time and probably increase in value.

As the Reserve Bank’s submission to the latest inquiry has pointed out, the growth in the number of homes has pretty much kept up with population growth in recent decades, meaning a shortage of places to live can’t explain rising house prices.

In any case, the price of buying a home is an unreliable guide to the price of finding somewhere to live since there are two reasons for buying a home: as a place to live and as an investment (a good place to park your wealth).

The better guide to the cost of finding somewhere to live comes not from the price of houses and units but from the price of renting. And the figures show that (with the possible exception of Sydney), the cost of renting in capital cities has risen only a little faster than other consumer prices.

This fits with our earlier finding that the number of homes has kept pace with population growth. And it leaves little support for the widely aired claims of people from conservative think tanks that house prices have risen because state and local government planning and zoning regulations are limiting the release of land for housing development or the growth of medium and high-density housing.

This argument has been debunked by Dr Cameron Murray of the University of Sydney. Being based on mere modelling, it fails to take account of the empirical fact that zoning regulations have been eased in recent years, specifically to ensure that home building keeps up with population growth.

This has happened over many people’s objections to the growth in high-density housing. But, unless we want our capital cities to keep sprawling outward forever, more high-rise housing is an inevitable consequence of business’s demand for – and almost every economist’s support for – rapid population growth.

All this suggests it’s the strong demand for home ownership, not any inadequacy in the supply of homes that’s driving prices up so rapidly. But what, and why? I think house prices are rising strongly because federal government decisions have made housing more attractive as an investment.

They’ve made home ownership more favourably taxed than other forms of investment, such as shares, art and antiques, or fixed-interest investments. This has always been true, but it’s become more so, first, with the Hawke government’s introduction of a capital gains tax in 1985, while exempting the family home.

But the biggest change came with the Howard government’s move in 1999 from taxing only real capital gains to taxing the full nominal gain but at only half your marginal tax rate. The popularity of negatively geared property investment took off from that time.

Ask yourself this: if the number of homes is pretty much keeping up with growth in the number of households, what happens when some homeowners decide they’d like to own more than one home, maybe many more? They use their superior borrowing-power to outbid the other home owners, existing and would-be.

The supply of land for housing is limited, but not fixed. That’s because cities can sprawl, or you can pack more households onto to the same bit of land by building up. But both solutions add to costs.

The simple demand-versus-supply model assumes the “commodity” in question is “homogeneous” – all the same. But with houses and units, it would be closer to the truth to say every home is different. Even two houses of the same design are different if they’re in different suburbs.

And some homes are in prime positions – on the harbour, near the beach, closer to town. The cheaper it becomes to borrow, the more people will bid prices higher to get the fabulous place they want.

The more governments use high immigration to increase the size of cities, the more competition there is to buy a detached house, and the more people will pay to get a place that’s close to the CBD.

Ever-rising house prices is a demand story more than a supply story.

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Praying for costless climate change: Lord, send down a miracle

Picture Scott Morrison kneeling by his bed, hands together, eyes closed, asking God to send him another miracle. Or maybe just giving Santa a list of all the things he’d like for Christmas.

Five things, actually. First, technology not taxes. That is, a sudden, unforced flowering of new technology that allows us to go on selling our fossil fuel to the world while – at negligible cost – the technology eliminates all our net emissions of carbon dioxide and other greenhouse gases.

Second, we reach net zero emissions by 2050 with “expanded choices, not mandates”. That is, no one should be forced to do anything. They’ll just choose to implement the new technology because it’s so wonderful.

Third, somebody somehow will “drive down the cost of a range of new energy technologies”. That is, reduce the cost of doing things without emissions so that it’s lower than the cost of doing things by, say, burning coking coal or burping methane. This, however, won’t destroy any jobs.

Fourth, we keep energy prices down with affordable and reliable power. That is, the solar and wind energy that we disparaged for many years is now cheaper than the coal-and-gas-fired power that we’re still trying to prop up, so you can thank us when electricity prices fall.

Fifth, we are accountable for progress. That is, just because we won’t show you our modelling, or tell you how much the deal with the Nationals will cost or what it’s going on, doesn’t mean we won’t tell you after the media’s lost interest.

We’re assured that Australia’s Long-term Emissions Reduction Plan will “achieve net zero emissions by 2050 in a practical, responsible way that will take advantage of new economic opportunities while continuing to serve our traditional export markets.

“This plan does not rely on taxes and it will not put industries, regions or jobs at risk. No Australian jobs will be lost as a result of the Commonwealth Government’s actions or policies under the Plan.”

As Energy Minister Angus Taylor summarised it, the plan “won’t impose new costs on households, businesses or regions.” Morrison says it will not “shut down coal and gas production”.

Other countries are pondering long and hard about how on earth they’re going to get to net zero. Until this week we had no idea either. Now, however, we have a plan that tells us how it can and will be done – at no perceptible cost to anyone or anything.

And if that isn’t hard enough to swallow, try this: the plan doesn’t involve announcing any new policy. So what’s changed since Monday? What’s different? What’s new is that Morrison now has modelling that says we’ll get to net zero with a bit to spare – without the need for any more changes.

The boffins added up the numbers and – surprise, surprise – we’re already on track to net zero. Is ScoMo lucky or what? The Americans, the Europeans, the Chinese, they’re all still struggling with it, but we’ve got it figured.

Funny thing is, it has the feel of Amateur Hour. Who wrote the report? The experts in the Energy Department? No, it was written by management consultants – McKinsey, and has all the colourful diagrams and big type and blank pages you expect from management consultants.

I hadn’t heard that McKinsey was expert on energy or climate science or technological innovation, but maybe I’m wrong.

So who did the modelling? Well, not Treasury – what would they know about modelling? We’ve been given the impression the modelling was done by McKinsey, but my guess is they contracted it out to some outfit that actually knows about modelling.

But management consultants and modellers do share a common temptation: to find out what bottom line the client’s after, and work back from that – a thought that came to me when I saw all the nice round figures in McKinsey’s lovely chart showing how net emissions in 2005 will be reduced to zero by 2050.

Reductions to date – 20 per cent (mainly from once-off land clearing restrictions in Queensland and NSW, which occurred before the 2005 starting point and the 2030 target were chosen). Next, reductions projected to arise from the government’s technology investment road map - say, 40 per cent.

Then reductions from “global technology trends” - say, 15 per cent. Reductions from “international and domestic offsets” – 10 to 20 per cent, but make it 10 per cent. Next, reductions from “further technology breakthroughs” - say, another 15 per cent.

Okay, you can stop there. We’ve made it to a neat 100 per cent. (I think I’m starting to see why Morrison isn’t keen to let the experts see the modelling.)

In a new paper from the Australia Institute, Bending the Curve, Dr Richard Denniss and colleagues assess the plausibility of the Morrison government’s belief that the course of our economy can be significantly altered without changes in policy, without the introduction of taxes and without new regulation or even legislated targets.

The authors say the plan “is based on the assumption that it is not just possible to forecast which technologies will be developed in the decades ahead, and the cost of deploying those technologies, but that such development is inevitable.

“In reality, as those who have pursued ‘carbon capture and storage’ in Australia for the last 30 years have clearly shown, it is not just possible that new technologies might be more expensive than expected, it is possible that they will fail completely to eventuate.”

The plan is just the latest iteration of “techno optimism,” albeit at the more optimistic end of the spectrum, they say.

“White it is inevitable that the cost of some existing technologies will fall rapidly, and that some new technologies will be developed, there is nothing inevitable about the timing of such improvements,” they conclude.

Morrison says his plan involves delivering net zero “the Australian way”. That bit I believe. This is the “no worries – she’ll be right, mate” way of doing it.

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Dearer houses: another problem we’re ‘learning to live with’

The poor relation in all our worries – about the pandemic, the economy, climate change – has been housing affordability. While everything else in the economy has been weak, house prices have been rocketing.

I can tell you why they have, and I can say with confidence that house prices can’t keep rising at double-digit rates forever. But I can’t assure you we’ll ever get house prices to rise no faster than we find easy to afford, nor that we’ll ever manage to reverse the steady decline in the proportion of households owning their home.

When I started in this business in 1974, it was at a record 70 per cent. Today it’s down to 65.5 per cent – it’s lowest since 1954 – and almost certain to keep going lower without radical change.

It’s always possible that it’s all a great bubble that one day bursts, bringing house prices crashing down. That, amid all the pain and destruction – all the families being evicted from homes the mortgage payments on which they could no longer afford – the consolation for others would be much more affordable prices.

For the housing market to one day go from boom to bust is almost certain. It’s happened plenty of times before. It’s a myth that house prices always go up and never down.

But in my experience, they’ve never fallen far, nor for very long. They take a breather for a couple of years before resuming their upward march at a more sedate pace. Until the next boom.

Why am I so confident that, over any period longer than a decade, house prices will be higher? I could say it’s because Australians are obsessed by the desire to own their home, and then gradually turn it into their mansion. But Aussies aren’t different to people in other rich countries.

So I’ll just say housing – along with education, healthcare and other things – is a “superior good”. As our incomes rise over time, we spend an increasing proportion of them on our housing.

This is mainly why house prices keep rising. One consequence of the rise of the two-income family was that a higher proportion of their joint income went on housing. What we hope we’d achieve by this was a better house – bigger, better located or better appointed.

It’s true that newly built houses are bigger and better than they used to be, and established houses are always being remodelled and extended. But when lots of people are trying to get a better place at the same time, a lot of the extra borrowing and spending just bids up the price.

It’s much the same story with the fall in interest rates. From their peak of 17.5 per cent in 1989, mortgage rates are now down to about 3 per cent.

Why? Primarily because the inflation rate’s fallen from 9 per cent to less than 2 per cent, but also because the advanced countries have never got their economies working properly since the global financial crisis, and have been using ever-lower interest rates to get things moving.

(Note that, unlike normal people, economists use the word “inflation” to refer only to the prices of ordinary goods and services, never to the prices of assets such as houses.)

The point is, every time interest rates have fallen a bit over the past 30 years people have used the opportunity to borrow more in an effort to buy a first home or move to a better one. Again, when too many people do this at the same time, house prices are bid even higher.

The main reason house prices have soared during the pandemic is that the Reserve Bank has acted to protect the economy by cutting its official interest rate virtually to zero, and we’ve responded the way we always do to lower rates.

So, much of the seeming benefit of lower interest rates ends up as higher house prices – to the benefit of existing home owners and the expense of young aspiring first-home buyers.

The good news for first-home buyers is that, with rates having hit the bottom, this is the last time house prices will soar simply because rates have been cut. So double-digit rises in house prices can’t last.

The bad news for would-be and recent actual first-home buyers – which won’t come for a couple of years yet – is that the next move in rates can only be up.

The rules of the home-ownership game are rigged in favour of existing home owners. That’s because they far outnumber aspiring home owners. And they’re not willing to give up their tax and other privileges to help the younger generation.

Except, of course, their own kids. The Bank of Mum and Dad has played a big part in making seemingly unaffordable house prices able to be afforded – by some.

The ever-rising proportion of Australians who’ll never own their homes are mainly those who failed to pick the right parents. Want proof of the widening gap between the rich and the rest? Look no further than home ownership.

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Morrison's deal: Nationals rewarded for agreeing to harm the regions

Let me be sure I’ve got this right. Scott Morrison is ending his Coalition’s deep divisions over climate change by agreeing to pay billions in regional boondoggles in return for the Nationals refusing to lift their veto of any increase in Australia’s commitment to reduce emissions by 2030.

The usual way blackmail works is that the blackmailer returns to you something you really value in return for you paying the blackmailer an arm and a leg.

But the way Morrison’s deal with Barnaby Joyce and the Nationals will work is that Morrison – or rather, the taxpayer – spends billions on projects of doubtful value in return for the Nats’ agreeing to nothing more than symbolism: to reduce carbon emissions to net zero by 2050, which will be after all the signatories are dead and gone.

The first point is that agreeing to net zero emissions in 29 years’ time is a decoy and a fig leaf if that’s all you do. To make it real you have to make a commitment you can be held to: a much bigger progress payment in the next nine years to 2030.

That, of course, is what the Glasgow conference is about. The major countries agreed on net zero months ago (as have all our premiers and many of our business and industry groups). That’s just the price of admission to the room.

What you do in the room is proudly announce the big increase in your commitment over what you promised at the Paris meeting in 2016. Those few leaders unwilling to commit to a significant increase will be pilloried as “free-riders” (aka bludgers) on the other countries – and rightly so. You’re a brave man, Scott.

But the second point is more important: all of us will be worse off if Australia’s selfish delinquency damages the global effort to limit the extent of global warming, but the biggest losers will be the small businesses and voters the Nats’ claim to represent – the regions.

The regions will be the biggest losers because, of all the industries, agriculture will be the hardest hit by continuing global warming. Farmers’ loss of freedom to keep clearing land will the least of their worries.

But the regions lose also because we don’t get on with expanding our renewable energy industries – most of which happens in the regions – and lose any “first-mover advantage” in establishing the new generation of manufacturing industries processing hydrogen, clean steel, clean aluminium, and even clean cement using all-renewable electricity. This, too, will happen in the regions.

That is, we don’t get on with generating the new, well-paid and skilled jobs for mine and gas workers to move on to as the rest of the world stops buying our coal and gas.

The amazingly perverse nature of Morrison’s deal with the Nationals – we pay them for refusing to allow us to get on with protecting ourselves against the world’s turn away from fossil fuels – has been brought to our attention in a study by Matt Saunders and Dr Richard Denniss, of the Australia Institute, All Pain No Gain, released today.

They argue that whatever the final cost of the deal turns out to be – no doubt a lot more than its announced cost – it will be far exceeded by the cost to the economy of us not acting earlier to reduce emissions.

To put it the other way, modelling commissioned from Deloitte Access Economics by the Business Council of Australia finds there would be significant benefits to the economy if we lifted our target to reducing our emissions by 46 per cent by 2030.

Comparing this with other modelling by Deloitte, the authors calculate that the additional benefits over the next 50 years would have a “net present value” (the value in today’s dollars of all the incomings and outgoings over the next 50 years) of more than $210 billion.

Now, I never take modelling results too literally, but the Business Council’s argument does make sense. The higher target leads to increased investment in renewables, which increases growth and jobs, as well as greatly reducing the cost of electricity (because, once you’ve built the plant, the cost of extra solar and wind energy is negligible).

Morrison’s excuse for not increasing the 2030 target is that, without the coming new technology, this would force choices and cost jobs. But he’s got that the wrong way round.

As the Business Council (and the Grattan Institute before it) have explained, forcing the pace in industries where the technology is already well-developed – electricity and electric vehicles – leaves more time for the technology to be developed in other industries.

With friends like the chancers of the National Party, the regions need Morrison to see more sense.

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Morrison's budget report card: could do a hell of a lot better

When it comes to the relative strengths and weaknesses of the two main parties, polling shows voters’ views are highly stereotyped. For instance, the Liberals, being the party of business, are always better than Labor at handling money, including the budget. But this hardly seems to fit the performance of Scott Morrison and his Treasurer, Josh Frydenberg.

Dr Mike Keating, former top econocrat and a former secretary of the Department of Finance, has delivered a two-part report card in John Menadue’s online public policy journal.

His overall assessment is that the Morrison government is guilty of underfunding essential government services on the one hand, and, on the other, wasting billions on politically high-profile projects.

Keating traces these failures to two sources. First, the government’s undying commitment to Smaller Government, but unwillingness to bring this about by making big cuts in major spending programs, such as defence, age pensions or Medicare.

This is a tacit admission that Smaller Government is an impossible dream. Why? Because it’s simply not acceptable to voters. But this hasn’t stopped Morrison and Frydenberg persisting with the other side of the Smaller Government equation: lower taxes.

The consequence is that they underfund major spending programs, while engaging in penny-pinching where they think they can get away with it. Too often, this ends up as false economy, costing more than it saves.

For instance, Keating says, the Coalition has reimposed staff ceilings. By 2018, this had cut the number of permanent public servants by more the 17,000. But departments now make extensive use of contract labour hire and consultants to get around their staff ceilings, even though it costs more.

Second, Morrison’s determination to win elections exceeds his commitment to businesslike management of taxpayers’ money. He’s secretive, reluctant to be held accountable and unwilling to let public servants insist that legislated procedures be followed.

Apparently, being elected to office means you can ignore unelected officials saying “it’s contrary to the Act, minister”.

Let’s start with Keating’s list of underfunded spending programs. The government has increased aged care funding following the embarrassment of the aged care royal commission, but spent significantly less that all the experts insist is needed to fix the problems.

On childcare, this year’s budget increased funding by $1.7 billion over three years, but this is insufficient to ensure that all those parents – mainly mothers – who’d like to work more have the incentive to do so. This is despite the greater boost to gross domestic product it would cause.

The National Disability Insurance Scheme is clearly underfunded – which is why we have a royal commission that’s likely to recommend additional funds. (I’d add, however, that it’s perfectly possible for underfunding to exist beside wasteful spending on private service-providers costing far more than the state public servants they’ve replaced.)

On universities, the government has recognised the need to provide more student places, but failed to provide sufficient funding. On vocational education and training, the extra funds in this year’s budget were too little, too late. They won’t make up for the 75,000 fall in annual completions of government-funded apprenticeships and traineeships over the four years to 2019.

While housing affordability has worsened dramatically, the government’s done nothing to help. Its modest new assistance to first-home buyers will actually add upward pressure to house prices. What it should be doing is increasing the supply of social housing.

Turning to wasteful highly political, high-profile spending, Keating’s list is headed by the JobKeeper wage subsidy scheme. He acknowledges, as he should, that the scheme was hugely successful in maintaining the link between businesses and their workers, so that the fall in unemployment after last year’s lockdowns ended was truly amazing.

Keating also acknowledges that the scheme was, unavoidably, put together in a hurry. At the start of recessions there’s always a trade-off between getting the money out and spent quickly and making sure it’s well-spent. The longer you spend perfecting the scheme, the less effective your spending is in stopping the economy unravelling. The stitch that wasn’t in time.

Remember, too, that since the objective is to get the money spent and protecting employment, it doesn’t matter much if some people get more than their strict entitlement. In these emergency exercises, it’s too easy to be wise after the event. And the more successful the scheme is in averting disaster, the more smarties there’ll be taking this to mean there was never a problem in the first place, so the money was a complete waste.

But it’s now clear many businesses – small as well as big – ended up getting more assistance than the blow to their profits justified, and many haven’t voluntarily refunded it. Keating criticises the failure to include a clawback mechanism in the scheme and rejects Frydenberg’s claim that including one would have inhibited employers from applying for assistance.

Next, he cites the contract with the French to build 12 conventional submarines. The process that led to the selection of the French sub was “completely flawed”. There was no proper tender, with the contract awarded on the basis only of a concept, not a full design.

Five years later we still didn’t have a full design, but the cost had almost doubled. The government was right to cancel the contract, but the cost to taxpayers will be between $2.5 billion and $4 billion.

Finally, spending on road and rail infrastructure projects, which was booming long before the pandemic. Keating quotes Grattan Institute research as finding that overall investment has been “poorly directed”.

More than half of federal spending has gone on projects with no published evaluation by Infrastructure Australia, suggesting many are unlikely to be economically justified.

“In short,” Keating concludes, “there is an enormous management problem with the government’s infrastructure program. The projects are much bigger, but often poorly chosen, and poorly planned with massive cost overruns.

“The key reason is that the government announces projects chosen for political reasons.”

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Problems abound, but we could yet emerge as winners

As we begin to lift our heads and look beyond the lockdown, it’s easy to see the many other problems we face. It’s possible to view those problems with fear and disheartenment – and it suits the interests of many groups to play on our fears.

But it’s almost as easy to see Australia as still a lucky country, with a populace that’s confident, resourceful, committed to the “fair go” and capable of co-operating to convert our problems into opportunities to flourish.

The keys to making life in Australia better rather than worse are to face up to all the change being forced upon us, and to unite in finding solutions that share both the costs and the benefits as fairly as possible.

Ideally, we’d have a political leader who offered us a more united, optimistic and confident vision of the path to a better world, but the sad truth is the two main parties are locked in a race to the bottom that we can’t even be sure they’d like to escape.

In reviewing our problems, let’s start with the pandemic. There’s a risk that we’ve opened up too soon, that our hospitals are overwhelmed and death rates rise unacceptably, forcing the premiers to backtrack.

But it’s only a risk and, assuming it doesn’t happen, I think we can be confident the economy will bounce back strongly and quickly, as it did last year. It won’t be quite as strong as last year because the feds haven’t splashed around nearly as much money as last time.

Even so, most households have saved a lot of their incomes and, as we saw last year, will spend much of the increase over coming months.

At a global level, the risk is that the pandemic continues for years more, as long delays in vaccinating everyone in the poor countries allow new variants to emerge. That the rich countries, having hogged all the vaccines, then lose interest in the topic.

Our first post-pandemic problem is that the economy will rebound only to the plodding rate of growth we were achieving before the plague arrived. Like the other rich countries, our rate of improvement in productivity – production per worker – is anaemic.

Our business people are going through a phase where the only way they can think of to increase profits is to use every tactic to keep wage rises as low as possible. The penny is yet to drop that, since wages are their customers’ chief source of income, this is not a winning formula.

Other problems abound: ever-rising house prices that can’t keep rising forever; adjusting to the ageing of the population and the growing demand for aged care; continuing digital disruption, with all its benefits to users but upheaval in affected industries; handling the growing assertiveness of China, while still taking advantage of being part of the global economy’s fastest-growing region; and the less tangible but no less worrying problem of the breakdown of trust in Australian and global institutions and relationships.

All that’s before we get to our biggest problem – responding to climate change – which, with the Glasgow conference starting in less than two weeks, is also our most pressing challenge.

No issue better illustrates the lesson that, if we want to be on top of our problems rather than crushed by them, we must face up to inevitable changes being forced on us by forces we don’t control.

We must stand up to powerful interests – our coal, oil and gas industries, in this case – hoping to stave off the evil hour as long as possible. They’ll protect their own interests at our expense for as long as we let them. We must be suspicious of political parties accepting donations from these urgers.

We must resist the blandishments of populist politicians – yes you, Tony Abbott – promising to save us from sky-high power costs (we got them anyway) because we can just let the whole thing slide.

Now we have the farmers-turned-miners National Party holding themselves out as champions of the put-upon regions and using their veto over adoption of the net zero emissions target to extort money from the Liberals.

People in the regions, we’re told, bitterly resent Liberal city slickers sitting pretty while imposing all the costs of adjustment on the bush.

This conveniently ignores two points. First, farmers are the biggest losers from climate change and the biggest winners from successful global action to limit further global warming.

Second, as Scott Morrison rightly says, coal mining jobs in NSW and Queensland will decline as other countries reduce their own emissions by ceasing to buy our coal and gas. But acting to get on with making Australia a renewable energy superpower – including by exporting hydrogen, clean steel and clean aluminium – will create many new skilled manufacturing jobs – all of them in the regions.

But only if we stop thinking and acting like losers, and do what it takes to be winners in the new, decarbonised world.

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Nobel winners make economics more useful, not a parlour game

It turns out that, in economics, maths – like technology and much else – can be used for good or ill. The three academic economists (and one ghost) who won this year’s Nobel Prize in “economic science” used mathematics to make economics more realistic and thus more useful to society.

The reason economics has become dominant among the social sciences – has had so much influence over the thinking and actions of governments - is the belief that understanding how and why people behave the way they do in the economic dimension of their lives – their producing and consuming – will help our leaders solve problems with the economy and make us happier and more prosperous.

But sometimes I suspect that the bulk of academic economists – whose beaverings won’t go anywhere near winning any prize – have lost sight of the goal of improving economists’ understanding of how the economy works and being more useful to the community and its leaders in improving our lives.

I worry that academic economists have become more inward-looking and more concerned with impressing each other than in serving the mugs who ultimately pay their wages. (I make the same criticism of journalists, by the way.)

In the years since World War II, the greatest project in academic economics has been to make it more scientifically “rigorous” by making it more mathematical. To express economic reasoning not in words or diagrams, but in equations.

These days, you shouldn’t do economics at university if you’re no good at maths (which may help explain why student numbers are down). No one gets to be an academic economist unless they’re good at maths. No one gets to be an economics professor unless they’re really good at maths.

Impressing the other academics with your great maths is the way you get on in academic economics. Maths is just so logical, so beautiful, so “elegant”. But sometimes I think these people love maths for its own sake and are turning economics into a branch of applied mathematics.

In an infamous study economists prefer to forget, economists attending the American Economics Association’s annual meeting were asked to answer a question about opportunity cost. Eighty per cent of them got it wrong. Opp cost is the foundation on which most economics rests. Makes you think all these PhDs know more maths than basic economics.

It’s true that expressing an argument in mathematical equations exposes any flaws in your logic – given the assumptions the argument is built on. That’s why the results of modelling – including the epidemiological variety – should be viewed with caution until you know and accept as plausible the key assumptions on which the modelling’s based.

The other day I wrote that economics’ greatest weakness is its primitive model of human behaviour, based on the mere assumption that people always behave “rationally” – which I defined as acting with carefully considered self-interest.

A couple of economics professors took me to task on Twitter. Oh no, not that old canard. “Rational” is just one of the many words in economics that are used to mean something other than their meaning in common speech.

No, what we mean by “rational” is not that people always think logically, but that we look at people’s “revealed preference” – what they actually do, not just what they say. This, I was assured, had long been part of mainstream economics.

Sorry, not convinced. It’s a circular definition: what people actually do (as measured by the statistical data available) is rational behaviour. Why? Because people are always rational. It’s getting around an implausible assumption by making it even more implausible. By defining non-rational behaviour out of existence.

Why would you do that? To make the assumptions of the neo-classical model mathematically “tractable”. That contrived meaning of “rational” may be longstanding mainstream econometrics, but it ain’t mainstream economics. That’s unconsciously assuming economics is now just maths.

When people were going crazy buying toilet paper last year, Australia’s brightest young economist export, Professor Justin Wolfers, argued it was “rational fear” to join the queue because, if you didn’t, toilet paper might all be gone when yours ran out. That was using “rational” to mean what everyone thinks it means.

You can say the same about former Federal Reserve chairman Alan Greenspan’s famous admission in 2008, after the global financial crisis, that he was mistaken to assume the banks’ “self-interest” would protect them from doing risky things that ended up damaging their shareholders.

The commentator Ian McAuley has observed that both engineers and economists use equations and mathematical models, but engineers check their maths against reality and modify their equations accordingly. Economists? Not so much.

To be fair, predicting the behaviour of bridges and suchlike is a lot easier than predicting the behaviour of human beans. This has led many academic economists not to worry about the plausibility of the assumptions on which their model rest.

Just make whatever nips and tucks are need to mathematise the mainstream model and think of all the fun games you’ll be able to play running different “data sets” through it. Other academic economists will be impressed.

Fortunately, not all academic economists are content with their work having such a tenuous link to real-world problems. Nor are the people who decide who gets the Nobel Prize in economics. The various founders of behavioural economics – which my critics contend isn’t real economics - have received awards, including a psychologist.

And the three academic economists sharing last week’s awards were about trying to make economics more realistic and therefore useful to economic policymakers.

Professor David Card, of the University of California, Berkeley, sought to test the straight-from-theory belief - then almost universally accepted by mainstream economists – that raising the minimum wage would increase unemployment, by searching for empirical evidence to support or refute neo-classical theory.

Until relatively recently, economists believed there was no way they could use experiments to test their theories. But a previous Nobel laureate showed some laboratory experiments were possible. And Card showed how theory could be tested by finding a “natural experiment” – a circumstance where the real world had created a test group and a control group, such as two nearby cities in different states, where one state had raised the minimum wage and one hadn’t.

Professors Joshua Angrist and Guido Imbens have done natural experiments too, and have also developed statistical methodologies for going beyond finding correlations between two variables to being able to demonstrate which caused which – showing other social scientists how it could be done.

The point is that the three honoured economists (plus the ghost of Professor Alan Krueger, who was a co-author with two of the three, but died in 2019) did reams of maths – or, more specifically, statistics – but put it to much more productive purposes. There’s hope for economics yet.

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The 'net' in net zero emissions offers a huge temptation to cheat

Perhaps the hardest part of reaching net zero emissions by 2050 is the “net”. We won’t get to zero emissions without it, but it’s tricky and presents us with a great temptation to turn the whole exercise into a rort.

The goal is “net zero” because it’s neither possible nor sensible for us to eliminate every last emission of carbon dioxide and other greenhouse gases. But that won’t be a problem provided we can offset what few emissions remain by finding ways to remove from the atmosphere an equivalent amount of carbon dioxide that’s already there.

How could we do that? By taking advantage of “carbon sinks”. Before we began burning fossil fuels – coal, oil and gas - for energy at the start of the Industrial Revolution, the amount of carbon dioxide in the atmosphere was fairly steady and so had little effect on the world’s average temperature.

There were natural emissions of carbon dioxide, but these were matched by natural processes – carbon sinks - that removed carbon dioxide from the atmosphere.

As the Grattan Institute explains in its latest report, trees, vegetation, soils and oceans absorb carbon dioxide as part of their lifecycle, and hold it for a period before releasing it again.

“Sometimes this cycle is short (for example, a plant that grows and dies within a year) and sometimes the cycle is long (for example, a tree that lives for hundreds of years and takes hundreds more to decay).

“Natural cycles tend to balance out: the carbon that is absorbed by a plant will be released when the plant dies, but will be reabsorbed by the new plant that grows in its place,” the report says.

But all our burning of fossil fuels has destroyed this natural balance. The past 250 years have seen a huge build-up of carbon dioxide in the atmosphere, which has trapped heat from the sun and caused a rise in global average temperatures, in the same way a greenhouse allows you to grow tropical plants in Europe.

We’ve reached the point where further addition to greenhouse gases in the atmosphere will cause average temperatures to become even more uncomfortable and damaging, as well as causing more extreme weather events.

The obvious solution is to move away from burning fossil fuel and get our energy from renewable sources – sun and wind – that don’t affect temperatures and weather patterns. We don’t have to stop producing and using fossil fuels immediately, but we shouldn’t get in any deeper by building new fossil-fuel power stations, coal mines and oil and gas wells.

But not all emissions come from burning fossil fuels for energy. Some come from, for instance, the coking coal used to make steel, from making cement and from burping and defecating cattle and sheep.

So, some emissions may never be eliminated and others would cost far more to eliminate than to offset by other means.

The obvious way to offset is to remove carbon dioxide from the atmosphere by beefing up our natural sinks – many of which have been diminished by economic development.

The Grattan report says we can avoid further land clearing, manage our forests better and restore forest to land that’s been cleared. We can manage fires better by doing planned burning earlier in the season.

We can store more carbon in soil by changing management practices – no-till agriculture, crop rotation, stubble retention on cropping land and sowing more productive grass varieties on grazing land. We can store more carbon – “blue carbon” – by encouraging more mangroves, sea grasses and tidal marshes.

But the report warns “there is still considerable uncertainty about the costs, permanence and measurement of many offsetting activities”. For this reason, offsetting should be used as a supplement to, not a substitute for, reducing emissions.

When governments encourage carbon removal by paying farmers and others who do it – or permit a market in which businesses required to reduce their emissions buy carbon credit certificates from others who’ve removed carbon from the atmosphere – they must ensure these transactions have “integrity”. That they’re ridgy-didge.

Grattan lists six requirements for certification: establishing a credible baseline for measuring progress; assessing how long the carbon will stay locked up; assessing whether, without payment, the activity would have happened anyway; ensuring no double-counting by people on both sides of the transaction; ensuring no adverse environmental side-effects; and requiring adequate monitoring, reporting, record-keeping and verification.

Many people fear carbon credits will be used to avoid reductions in the production of fossil fuels. And when you hear Energy Minister Angus Taylor assuring people in the coal, oil and gas industries that they “have a great future”, it makes you think such fears are warranted.

The Australia Institute recently ran a TV ad saying net zero is a fraud if the fossil fuel industries continue expanding. True.

And the sad truth is that Scott Morrison doesn’t have clean hands when it comes to using carbon credits to mislead us. He’s claimed repeatedly that our emissions are falling and we’re on track to “meet and beat” our target of a 26 per cent reduction by 2030.

In truth, emissions from the non-land sectors are continuing to grow. He’s able to say total emissions are down only because of a huge once-only reduction in emissions from land clearing that occurred before the 26 per cent reduction was promised in 2015.

Research by the Australia Institute and the Australian Conservation Foundation has found there was a massive surge in applications to clear native forest before the NSW government imposed limits on land clearing.

Since little of this approved clearing has actually happened, the administrators of the federal Emissions Reduction Fund have counted the difference as “avoided deforestation”, even though it’s quite implausible that anything like that much land could have been cleared in the time available.

Encouraging farmers to remove carbon from the atmosphere is a good idea. But there’s great scope for the unscrupulous to turn it into a fraud and another National Party rort.

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