Our ever-rarer elixir: restraint

There's a paradox at the heart of modern capitalist economies: if they really worked the way economists think they work, they wouldn't work for long, they'd seize up. And as the Yanks have been busy demonstrating, it's a similar story for modern democracies.

Economists believe the motivating force driving market economies is self-interest: businesses and consumers do what they do purely for their own benefit. But the "invisible hand" of market forces transforms all this selfishness into a system by which everyone benefits.

Although most economists prefer the euphemism "self-interest", Professor Paul Frijters, of Queensland University, prefers to call it "greed" in his path-breaking book written with Dr Gigi Foster, of the University of NSW, An Economic Theory of Greed, Love, Groups and Networks.

Frijters argues that a variety of "institutions" is required to ensure individuals' greed doesn't prevent the operation of free markets. If people will do anything to increase their material wealth, as implied by the Homo Economicus view of humanity, why would they simply pay the prices traders wanted to charge? Frijters asks.

"Why would they not, for example, steal products or production technology, kill competitors, or in some other way seek a market advantage through dishonest or immoral behaviour?" he asks.

Because of the existence of formal and informal institutions. Formal institutions include parliaments that pass laws prohibiting certain behaviour and police and courts that enforce those laws.

But ask yourself this: is your knowledge that it's illegal and that you risk being punished the only reason you don't steal from shops, your employer or your neighbours? Do you adhere to contracts only to avoid having to defend your behaviour in a court case with the other side?

Of course not. Even where we're confident of not getting caught, almost all of us refrain from doing those things because we don't believe they're the right thing to do. And there is any number of perfectly legal things we could do, but choose not to. So our behaviour in the marketplace - or in politics - is also constrained by a host of informal institutions, such as notions of fairness, conventions, customs, rules we've internalised and other norms of socially acceptable behaviour.

"Formal and informal institutions in combination are important in the running of societies, as together they form the rules of the game to which people adhere. They constrain the possibilities for opportunistic behaviour in human interactions," Frijters says.

This isn't the first time the US Congress has refused to pass the budget and thus shut down the US government, but it's rare. The Financial Times' Martin Wolf, doyen of the world's economics editors, observes that if President Obama's political opponents are prepared to inflict such damage on their own country, "the restraint that makes democracy work has gone".

Dr Chris Caton, of BT Financial Group adds: "Thank god that couldn't ever happen in Australia!" Not half.

Just as we need social norms to restrain our instinctive selfishness and so keep the economy functioning smoothly, we need restraint among the players in the political game to ensure we don't descend into impasse and policy impotence. But as the Americans' appalling predicament reminds us, restraint isn't a given, and can't be taken for granted. Our selfishness does propel the economy onward and upward, but when voluntary restraint breaks down - almost always egged on by competition - we can end up with greedy bankers causing the devastation of the global financial crisis.

Similarly, we need our adversarial two-party system of democracy to keep a check on the corruption and incompetence of governments, but when personal ambition and party rivalry become unrestrained, government suffers.

The sweeping economic reforms of the Hawke-Keating era were made possible by John Howard's principled restraint in providing bipartisan support. But bipartisanship in the interests of good government ended with Labor's opportunistic scare campaign against Howard's GST.

Tony Abbott returned the favour with his ruthlessly dishonest scare campaigns against the carbon tax and the mining tax. Now how do you think Labor will react should Abbott propose a controversial reform in this term or the next?

The self-seeking, short-sighted, rivalry-fanned lapse in restraint by both sides makes further major economic reform highly unlikely until, by some hard to imagine means, the former norms of acceptable political behaviour are restored.

But don't blame it all on the politicians. That's too easy. As Professor Ross Garnaut observed in May, the past dozen years have seen "interest groups" - I'd say industry lobby groups - become less inhibited in pursuing private interests at the expense of the wider public interest, ferociously resistant to reform proposals involving private costs to them, and willing to pursue their private interests by costly ad campaigns and party donations.

Less restraint, less reform.

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Economist proposes a socio-economic model

What can economists tell us about love and power, why people are loyal, how groups form and how they get their members to abide by the group's norms of acceptable behaviour? Not much.
Everyone knows conventional economics is built on a stick-figure conception of humans and the way they work.
 
Until now. An economics professor at the University of Queensland, Paul Frijters, has attempted the remarkably ambitious project of developing a unified theory of human behaviour, turning the mainstream model of the economic system into a model of the socio-economic system.

With help from Dr Gigi Foster, of the University of NSW, he's set it all out in the book An Economic Theory of Greed, Love, Groups and Networks. We'll find out soon enough what the rest of the economics profession makes of it.

He starts with the principles of mainstream economics, then adds and integrates selected ideas his research has determined have considerable power in explaining human behaviour.

The bit he starts with, which comes straight from the mainstream, is the assumption that humans are carefully calculating maximisers of their personal benefit. Or, as Frijters prefers to put it, ''humans are mainly motivated by greed''.

This conception of ''homo economicus'' - economic man - emerged in the Enlightenment period. In the early Middle Ages, by contrast, materialism was seen in society as strongly immoral, Frijters explains.
Even so, it's a quite one-dimensional conception of human behaviour. We're a lot more complicated than that. This assumption accounts for much of the criticism of conventional economics (including from yours truly).

So the ''core concepts'' Frijters adds to the conventional assumption of ''greed'' aim to broaden the model's explanation of human motivations and behaviour.

The first concept he adds is ''love'', by which he means love for other humans, but also love for one's beliefs. ''Love is defined as a form of unconditional loyalty, and will be said to be present whenever a person would be willing to help advance the interests of the object of his love, even if the object of his love would not notice the help and even if the loving person would receive no observable reward,'' Frijters says. So love includes the ideas of altruism and loyalty.

''Selfish materialism is extremely powerful in explaining many of our laws, our customs, our politics, and our choices as consumers. Yet selfish materialism alone cannot lead to the kind of human organisations we see in reality.

''I expect to see love as a major player involved in almost every facet of an individual's decision making ? Love within companies should be an integral part of how teams of people actually get things done within organisations.''

Another major criticism of the simple model of conventional economics is its assumption that each of us acts only as an individual, unaffected by the behaviour of those around us. This means no ''economic actor'' has more power than another.

In truth, humans are a group animal whose self-image is inextricably linked to the groups of which they are part. And the reality is that the dominant power relations in modern societies aren't between one individual and another, but rather between individuals and groups.

So the second feature Frijters adds to the mainstream view is groups and the power they generate. Each of us is a member of any number of groups, affecting our family life, social life and working life. Beyond that, our religion, ethnicity and nationality make us members of more, often powerful, groups.

It's because groups generate and exercise power that they need to be added to the model. Power is the ability to influence the behaviour of others. Part of this power comes from the development of norms of acceptable behaviour within the group. Many of us feel considerable loyalty to the groups we're in, which partly explains why we confirm to group norms.

Frijters argues there are five basic types of social groups: small hierarchies, with a clear leader, a few of high rank and a group of underlings totalling no more than a few dozen individuals in all; small circles of reciprocity, with people who are equals and share a common goal; large hierarchies, where members don't know each other; large circles of reciprocity; and networks.

Networks are his third addition to the mainstream view. They are facilitators of exchange - of goods and services, or just information. They exists because of the need to overcome ''frictions'' in markets arising from the information and transactions costs the simple mainstream model assumes away.
Individuals search for goods, buyers and suppliers within networks of small size or large anonymous networks such as the internet.

So how does Frijters' model improve on the answers to questions from the mainstream model? What questions does it answer that the mainstream can't?

On the common questions of whether international trade should be encouraged or protected against, what governments should do about monopolies and how to discourage firms from polluting, his model doesn't much change the conventional answers.

But it can answer some questions the conventional approach can't. With its assumption of calculating, self-interested behaviour, the old approach can't explain why people go to the bother of voting when the chance one vote will change the outcome is minuscule.

Frijter's model says people vote because they're idealistic and identify with the group that is Australian voters.

Nor can the old approach explain why people don't avoid or evade paying tax a lot more than they do. Rates of ''voluntary compliance'' are, in fact, surprisingly high (though not as high as in the old days).
Frijter's model says people feel loyalty to the group of fellow Australians and conform to the social norm that paying taxes is a form of reciprocity that's reasonable to expect of members of the group.

And this is no idle question. He says getting people to pay taxes is probably the single most important ingredient supporting our system of governance.

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THE POLITICAL ECONOMY OUTLOOK FOR REFORM

Australian National Conference on Resources and Energy, Talk to conference dinner, Canberra, Wednesday, October 3, 2013

I suppose I should start by warning you I’m an adherent to the Paddy McGuinness school of public speaking, which holds that there’s no point in speaking to an audience unless you say something that makes them sit up, challenges their comfortable assumptions and gives them something uncomfortable to think about. This has become, I admit, a terribly unfashionable way to engage an audience. The fragmentation of the media that’s occurring in the digital age is increasingly allowing consumers of the media to customise their news and opinion, selecting those items they’ll find congenial and reinforcing, and selecting out anything that jars with their long-held view of the world. And it’s certainly the case that the main organs of business news have switched to a strategy of only ever telling the captains of industry what they want to hear, of echoing their own opinions back to them.

Sorry, but I’m too close to retirement and too comfortably off to be bothered abasing myself in such a way. In Paddy McGuinness’s heyday the business bible saw its role as being devil’s advocate to business and that’s a role I’m much more comfortable with. And since I didn’t ask to be paid to talk to you tonight, I’m going to do it my way. So I imagine many of you won’t enjoy what I’ve got to say and may even heartily disagree with some of it. Feel free to think of some disparaging label to attach to me and use as an excuse to close your mind to the challenging things I say. I’ll still bother saying them in the hope at least some of you are bosses who don’t want to be surrounded by yes-men and do want to be challenged to rethink some of your more comforting beliefs.

Perhaps among all the labels you could use to dismiss my views the least abusive is that I’m ‘anti-mining’. I assure you I’m not. I’ve spent the past decade singing the praises of the resources boom to my readers, arguing staunchly that this reinforcement of Australia’s comparative advantage in the provision of minerals and energy to the rest of the world is a blessing, and that the rest of our economy has to cop the painful structural adjustment this new stroke of good fortune makes necessary.

What I’m not, however, is pro-mining. I’d like to think I’m not pro any particular sector of industry. When I got into the economic commentary business 40 years ago it was the farmers and the manufacturers who were always trying to tell us they were special, that the rest of the economy rode on their back and that this entitled them to special consideration. It was self-serving self-delusion then, and it still is. What’s changed is that, these days, we also have the miners trying to tell us they’re special, that the rest of the economy rides on their back and that they’re entitled to special consideration. Sorry, not buying that one, either.

With the change of government I’m sure you’re a lot happier about the prospects for the economy and its management, and a lot more confident of a sympathetic hearing from the new government. I wouldn’t be so sure. I suspect the mining industry’s lobbying success is reaching its zenith as we speak. It won’t surprise me if, looking back on the life of the Abbott government, you come to realise the big gains the industry made actually occurred under the Labor government. They occurred no thanks to Labor, and all thanks to the Coalition, but they occurred in reaction to the policies of Labor as part of Tony Abbott’s successful four-year campaign to fight his way back into office. Why did Abbott immediately oppose the mining tax and promise to repeal it? Because he genuinely believed it would wreck the mining industry and do great damage to the wider economy? I doubt it. He did it primarily because he saw opposing the tax as a popular cause and was hoping for a lot of monetary support from the big miners in the 2010 election campaign. Why did he set his face against the carbon pricing scheme? Because it was the price of getting the backing within the party that allowed him to wrest the Liberal leadership from Malcolm Turnbull and because he could see what a popular cause it would be to oppose this ‘great big new tax on everything’.

Now, I have no doubt that keeping his promises to get rid of the mining tax and the carbon tax - delivering on the commitments he made as a result of policies pursued in Labor’s term - will be among his highest priorities. But my point is this: Having delivered so handsomely for the mining industry, I doubt if he’ll feel in any way indebted to the miners. Indeed, he may well feel he’s the one that’s owed. Certainly, he’ll feel the miners have had enough favours to be going on with. And it won’t surprise me if that’s the attitude other industries take: that the miners have had their turn and it’s time to give other industries a go. I suspect the mining industry’s lobbying power has just reached its zenith.

Does this analysis shock you? Does it seem extraordinary cynical? Sorry, it’s just being brutally realistic. We all pursue our self-interest, but we all cloak our self-interest in arguments about how this would be in the best interest of the economy. All I’m doing is stripping away the bulldust.

Most people in business are hoping that with a more enlightened government in power with a big majority in the lower house and a reasonably workable Senate after July, we’ll now see some major economic reform - if not in Abbott’s first term then certainly in his second. I think this is an idle hope.

In a prophetic speech he delivered in May - and which he’s in the process of expanding into a short book - Professor Ross Garnaut argued that our political culture has changed since the reform era of 1983 to 2000, in ways that make it much more difficult to pursue policy reform in the broad public interest. ‘If we are to succeed, the political culture has to change again,’ he said. Policy change in the public interest seems to have become more difficult over time as interest groups have become increasingly active and sophisticated in bringing financial weight to account in influencing policy decisions, Garnaut said. ‘Interest groups have come to feel less inhibition about investment in politics in pursuit of private interests. ‘For a long time, these past dozen years, it has been rare for private interests of any kind to be asked to accept private losses in the interests of improved national economic performance. When asked, the response has been ferocious partisan reaction rather than contributions to reasoned discussion of the public interest in change and in the status quo,’ he said.

I would remind you that, though John Howard’s introduction of the GST is a notable exception, the many reforms of the Hawke-Keating era were achieved with bipartisan support - something that’s unthinkable today. Much of that reform, particularly in the area of taxation, involved packages of measures in which particular interest groups suffered some losses, offset by other gains. As Garnaut argues - and I’m about to demonstrate - this kind of co-operative give-and-take between interest groups willing to accept reforms in the wider public good simply isn’t conceivable today.

My way of making Garnaut’s point is that since the reform era of the 1980s and 90s we’ve regressed to a culture of rent-seeking. You can see this at the level of the political parties and at the level of the industry lobbies. When Howard had the courage to propose introducing a GST, Labor saw its chance to regain office by running a populist scare campaign against it, and came within a whisker of winning the 1998 election. At the time it professed to be righteously opposed to such a regressive tax, but when it finally regained power seven years later, the idea of doing something about that supposedly abhorrent regressivity never crossed its mind. When, in turn, the Rudd government - in its own quite ham-fisted way - attempted the risky reforms of installing the ‘economic instrument’ most economists recommend for responding to the challenge of climate change, and rebalancing the tax system by reforming the taxation of mineral deposits and using the proceeds to reduce taxes elsewhere, Abbott lost little time in deciding to take advantage of Labor’s vulnerability.

Do you really think the events of the past three years will have no bearing on the Labor opposition’s attitude to any controversial reforms Abbott might propose in the next six years, or that Abbott’s foreknowledge of this attitude will have no bearing on his willingness to propose such reforms? The truth is the nation has fought itself to an impasse on controversial reform - of the labour market as well as taxation - and, among the industry lobbies, the miners have played a more destructive role than the rest.

Now, you can respond that the miners did no more than what you’d expect them to do: oppose two new taxes they perceived to be contrary to their industry’s interests. But this is making my point: the reason the outlook for major economic reform is now so bleak isn’t solely because the two sides of politics have regressed to short-sighted, self-interested advantage seeking, it’s also because the industry lobby groups have done the same thing. There’s nothing new about industry lobbying but, as Garnaut says, in the past dozen years it’s become far more blatantly self-interested and far more willing to devote large sums to advertising campaigns to oppose whatever government reforms an industry sees as contrary to its interests.

What hasn’t yet occurred to many business people - but you can be sure is well understood by the politicians and their advisers - is that when industries lobby governments for favours or in opposition to new imposts, the various industries are in competition. It’s easy to imagine the government’s coffers are a bottomless pit but, in fact, there’s only so much rent to go around. As an economist would say, all concessions have an opportunity cost. It’s easy to believe all industries could pay less tax if the pollies would only make households pay more tax, but I wouldn’t hold my breath waiting for it to happen. I doubt either side of politics would see that as consistent with their own self-interest. The truth is, when one industry gets in for a big cut, there’s less left in the pot for the others.

That industries don’t understand this simple point about opportunity cost - don’t realise they’re in competition with each other - is easily demonstrated by the demise of Labor’s mining tax package. Think about the original package: the big three miners were going to pay a lot more tax on their resource rents, but pretty much the whole of the proceeds was going to be distributed to other industries. In particular, all companies (including miners, big and small) were getting their company tax rate cut by 2 percentage points, small miners were getting a resource exploration rebate, small business was getting instant write-off of most assets, the banks were getting more concessional taxation of their depositors’ interest income and the financial services industry was getting its great dream of having compulsory super contributions jacked up from 9 per cent to 12, a one-third increase in contributions. So three big miners had a lot to lose, but the rest of industry had a lot to gain. So what was the rest of industry’s attitude to the resource super profits tax? Didn’t like the sound of it. And what did they do when the miners sought to scuttle the new tax? Precisely nothing. What happened then? The exploration rebate was to first thing to disappear and, in several stages under Labor, the cut in the company tax rate got whipped off the table. Now, with Abbott’s plan to abolish the cut-down mining tax, the small business concessions are being withdrawn and the phase-up of compulsory super contributions has been deferred for two years. With all the pressure on the Abbott’s budget, and the super industry extracting a promise from Abbott not to make any further savings on the concessional taxation of super, I’m prepared to bet the two-year deferment will become permanent.

Thus did the rest of business allow the miners to screw them over. And thus did the miners destroy faith in one of the techniques tax reformers believed made major tax reform possible: put together a large package with a mixture of wins and losses and the various industry lobbies keep each other on board in the wider interest.

But it doesn’t stop there. When the miners and the rest of business dream of further tax reform under the Abbott government - perhaps after yet another root-and-branch tax review - what do they have in mind? Mainly, a big cut in the company tax rate. Do you really see the Abbott government daring to fund such a cut by increasing the GST? Had the minerals resource rent tax survived and got past its accelerated depreciation phase, the fact that the most highly profitable part of the corporate sector (along with the banks) was paying a lot more tax on its profits, would have greatly strengthened the argument for a general cut in the company tax rate (this is particularly so because mining is so heavily foreign-owned). So the absence of the resource rent tax makes a cut in the company tax rate a lot less likely. One way a cut in the rate could still be afforded is if was covered by a broadening of the base by the removal of sectional concessions. But the bitter experience of the demise of the mining tax package makes it less likely any government would risk proposing such a compromise.

We can continue going down the road of ever-more blatantly short-sighted and narrowly self-interested behaviour by political parties on the one hand and industry lobby groups on the other, but while we do so it’s idle to dream of major, controversial reform. What we can do - as the miners have shown - is veto any reform we don’t fancy.

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Abbott should repeal great big 'Australia tax'

When government changes hands, it s possible for important issues to fall between the cracks and useful work to be lost. In late July, a Labor-constituted parliamentary committee issued a report about the Australia tax . It drew a fair bit of media attention at the time but, coming so close to the election campaign, was soon forgotten.

But the report made some important recommendations recommendations the Coalition members of the committee were happy to support on measures the government could take to reduce the Australia tax and it s important the new government takes up those recommendations.

The report was an inquiry into the prices of information technology hardware and software sold in Australia, conducted by the House of Representatives standing committee on infrastructure and communications. It found, unsurprisingly, that Australian consumers and businesses must often pay much more for their IT products than their counterparts in comparable economies. Hence the term Australia tax .

Evidence presented to this inquiry left little doubt about the extent and depth of concern about IT pricing in Australia. Consumers are clearly perplexed, frustrated and angered by the experience of paying higher prices for IT products, the report says.

Submissions to the inquiry compared the prices of more than 150 professional software products and found an average price difference usually between Australian and US prices of 50 per cent. The median price difference was 46 per cent for Autodesk products, 49 per cent for Adobe products and 67 per cent for Microsoft products. Submissions compared the prices of more than 50 IT hardware products and found a median price difference of 26 per cent. Comparisons of 70 music products found a median price difference of 67 per cent. For 70 games products it was 61 per cent and for 120 e-books it was 13 per cent.

How can such differences be justified? A lot of possibilities spring to mind. Taxes might be higher in Australia. For physical products, freight and handling costs would be higher. Australian companies may face higher rent and wage costs. And our much higher dollar has greatly improved the comparison between the prices of imports and local prices.

Obviously, the inquiry needed a lot of help from the representatives of the global IT companies to explain these puzzles and possibilities. It didn t get it. The big companies repeatedly declined to appear before the committee, sometimes saying they d be represented by their industry body while the body said it couldn t represent the views of individual members.

So in February the committee took the unusual step of summonsing Apple, Adobe and Microsoft. The evidence they gave was incomplete, conflicting and unconvincing.

It s hard to see how claims of higher costs in Australia can account for the price differences, particularly in the case of content that s delivered digitally. And when the same overseas site puts up its prices for such content as soon as it discovers you re from Australia, it s hard to avoid the conclusion there s something funny going on.

The inquiry concluded that many IT products are more expensive in Australia because of regional pricing strategies implemented by major vendors and copyright holders .

Just so. To anyone with any training in economics it s obvious what s going on: global IT companies are engaging in price discrimination by charging different prices for the same product in different parts of the market. They maximise their profits by charging what the market will bear in each market segment, taking advantage of differences in customers willingness to pay .

Economists have long studied this phenomenon and regard it as perfectly normal profit-maximising behaviour. Global companies charge higher prices in Australia than in the US because they know Australians have a higher willingness to pay than Americans have. Why? For no reason other than that we re used to paying higher prices than the Yanks are used to.

As the inquiry s report acknowledges, there s nothing new about international price discrimination. It s been going on for decades. What s new is the digital revolution. The internet has made it much easier for us to see what s going on and get around it.

Economists know that for price discrimination to succeed, you have to be able to keep the two markets separate. Otherwise people will switch to buying in cheaper markets or some middleman will make a quid by doing it for them.

To keep national markets separate in the old, physical world, many governments used legislative bans on parallel importing , where companies buy in the cheaper market and sell at a discount in the local market.

To keep national markets separate in the digital world, big companies use various forms of geoblocking the use of internet addresses, credit card numbers or other means of electronic identification to block internet sales and downloads of electronic products ... based on the geographic location of the consumer .

There are ways around geoblocking ask any teenager to show you but it s not certain all the ways around are strictly legal.

So the committee recommends the government remove the few remaining parallel importation restrictions in the Copyright Act and also secure consumers rights to circumvent measures supposedly intended to protect copyright, which are being used to impose higher prices on honest customers.

And it should amend the Competition and Consumer Act to render void consumer contracts that seek to enforce geoblocking.

Let s hope Tony Abbott is still listening.

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Hockey can turn budget problem into big reform

Perhaps the biggest question the Abbott government needs to ask itself is whether it aspires to be a highly regarded government or merely one that's "better than the last lot". Paradoxically, to end up highly regarded you have to be bold, run risks, even do the opposite of what was expected.

Consider the case of the budget. On the face of it, Treasurer Joe Hockey's problem is that the closer he got to inheriting the budget and its deficit, the more he realised that - contrary to everything he and his boss had been saying for three years - returning it to surplus would be no easier for the Coalition than it had been for Labor.

That's why, in the campaign proper, he took care to make no meaningful promise about when he would get back to surplus - even leaving open the possibility it wouldn't be within the government's first term - and why, as soon as the election was won, all talk of a "budget emergency" instantly self-destructed.

Had a Labor government changed its tune so abruptly we would never hear the end of it. But Hockey is right in confidently assuming a Liberal treasurer can get away with things no Labor treasurer could. Tony Abbott keeps saying the Libs have good economic management in their DNA and, as decades of polling make crystal clear, most punters know in their heart it's true.

In other words, Hockey's budgetary performance need be no better than Labor's for his government to be judged "better than the last lot".

But the challenge he faces isn't quite that simple. As we were reminded last week by two economics professors from Melbourne University, John Freebairn and Max Corden, some time over the next year or two investment spending by the mining industry is expected to drop from 8per cent of gross domestic product to 2per cent.

That's a massive fall in economic activity. And it's not at all certain the most expansionary stance of monetary policy (low interest rates) will be sufficient to ensure consumption and investment spending in the rest of the economy are strong enough to offset that massive fall.

Saul Eslake, of Bank of America Merrill Lynch, says there's a 25 per cent chance the economy could contract in 2015. The econocrats think that sounds pretty right.

Even if the economy didn't actually go backwards, it could easily slow to a point where unemployment started climbing rapidly. With monetary policy already fully extended, what should a responsible treasurer do? Stick with all the anti-Keynesian rhetoric about unnecessary, even wasteful fiscal stimulus the Liberals subjected Labor to, and do precisely nothing?

The treasurer - Liberal or Labor - who could resist the temptation to use the budget to apply stimulus at a time when the economy was slumping has yet to be born (the ill-fated John Kerin excepted). Hockey would be no exception.

As the two professors have argued, the obvious answer to the rapid retreat of mining investment spending is to fill the vacuum by ramping up federal infrastructure spending. They propose being ready to roll out a "capital investment stabilisation fund".

This would limit the rise in unemployment, invest at a time when construction prices were low and, if the projects were well chosen, help raise the productivity of the wider economy.

Even so, it would involve consciously adding to the budget deficit at a time when all your debt-and-deficit-anxious supporters were expecting you to do the reverse. This could present credibility problems even for the most arrogant treasurer.

What to do? Follow the example of the state governments and redefine the deficit to include recurrent spending but exclude capital spending. This would bury the Libs' hypocrisy under genuine fiscal reform.

The one glaring conceptual weakness in the bipartisan medium-term fiscal strategy to "maintain budget balance, on average, over the course of the economic cycle" is its failure to distinguish between recurrent and capital spending.

Shifting the focus to the budget's "operating" balance (as opposed to its overall borrowing requirement) would retain the discipline of public opinion over recurrent spending, though it would risk taking the discipline off capital works spending, which is undoubtedly susceptible to political temptation.

This why the reform should be completed by taking up the professors' proposal that all capital projects be rigorously evaluated by a body with independence, similar to the Productivity Commission's, which would publish benefit-cost assessments for all major projects.

If Abbott and Hockey could summon the courage to make such a reform, they would immediately put themselves up with Bob Hawke and Paul Keating, John Howard and Peter Costello.

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Why borrowing for investment isn't a problem

It doesn't seem to have occurred to anyone - perhaps not even the man himself - to wonder how Tony Abbott can establish himself as an ''infrastructure prime minister'' and also get the budget back to surplus ASAP.

It doesn't seem to have occurred to anyone - perhaps not even the man himself - to wonder how Tony Abbott can establish himself as an ''infrastructure prime minister'' and also get the budget back to surplus ASAP.

He's certainly right to imply we need to be renewing and expanding a lot of our infrastructure and that this can't be left solely to the state governments.

But as everyone knows, building new infrastructure can be very expensive. In principle, it can be paid for by increasing taxes, by cutting spending elsewhere or just by allowing the budget deficit to get bigger and borrowing to cover it.

Trouble is, from where Abbott sits, none of those possibilities looks attractive. He's spent four years railing against higher taxes, and though he's also promised to cut government spending by eliminating Labor's waste, in practice it's hard to get much agreement on what's wasteful and what's not. It's highly unlikely Abbott could identify sufficient waste to pay for much infrastructure as well as getting the deficit down.

But simply allowing the deficit to get bigger by borrowing to finance infrastructure spending is surely unthinkable. Leaving aside all Abbott and Joe Hockey have said about the Labor government's debt and deficit, wouldn't it involve living beyond our means and leaving our debts to be inherited by our children and grandchildren?

(There is a fourth possible solution, to use ''public-private partnership'' arrangements to get the private sector to pay for and build the infrastructure and then, in effect, rent it back to us. But even if you think the private sector is better at building and managing infrastructure than the government, this solution is still a way of hiding the debt by shifting it off the government's books onto those of the private sector. It involves creative accounting.)

So what about this notion of living beyond our means and burdening future generations? I'm sure this is a big part of the reason so many people agreed with the Liberals' attack on debt and deficit.

This is an issue to which economists have given much thought over many years (more thought, dare I say, that many of the people who readily accepted Abbott's argument).

For a start, economists and accountants have long drawn a distinction between day-to-day spending to maintain the operations of a household (or a business or a government) and spending of a capital nature, where you're building or buying some kind of asset that will last for many years, that will contribute to meeting your day-to-day needs for many years, and usually can be sold to someone else if circumstances change.

An accountant will tell you you're only living beyond your means if you're borrowing to cover day-to-day needs (''recurrent spending''), not if you're borrowing to buy an asset that will retain its value for many years. After all, do you regard a family that borrows to buy a home, thereby acquiring a mortgage usually many times greater than its annual income, as living beyond its means? Of course not.

But the analogy between households and governments shouldn't be pushed too far. A family and a government have very different sizes, obligations and powers. Governments, for instance, have the right to levy taxes, which is one reason their borrowings are regarded as low-risk.

And when it comes to borrowing by governments to finance infrastructure, economists have given the matter much thought. Two professors at the University of Melbourne, John Freebairn and Max Corden, argue in a paper this week that by focusing on the debt being left for the next generation we're seeing only half the story.

Their first point is that spending on needed infrastructure and other things of a capital nature benefits the economy we all live in. By increasing the economy's productivity, it leads to economic activity far greater than just that which is involved in building the infrastructure. This leaves the community better off, as well as generating increased tax revenue for state and, particularly, federal governments.

So were we to decide to build no more infrastructure than we could afford to pay for without borrowing, we'd also be deciding to keep the economy less productive than it could be and thus to leave for the next generation a less-productive economy than it could have.

That's the ''economic efficiency'' case for borrowing to fund infrastructure (and also such things as education and training, which add to the economy's stock of ''human'' capital). But next the profs outline the equity case, involving ''inter-generational equity'' - fairness between the generations.

Many people have become conscious that government debt may remain unrepaid and so become a cost imposed on our children. True. But in the case of spending on infrastructure and other forms of capital, which will deliver benefits to the community over periods of 30, 40 years or more, it's equally true that our children will enjoy the benefits.

As the profs put it, ''these same future generations reap most of the investment benefits of a more productive economy and higher income levels''. Sound unfair to you?

But, being economists, the profs are very much aware that some government infrastructure spending can be undertaken for short-term political gain, not long-term economic benefit. To guard against this, they outline two questions to be asked of every infrastructure proposal.

First, are there good reasons for government investment rather than leaving the decisions to the private sector and competitive market forces?

Second, have the chosen investment projects passed explicit, transparent and robust benefit-cost assessments? And then, if funds are limited (as they always are), have the higher yielding projects been selected?

They say a body with independence similar to the Productivity Commission's should be set up to evaluate projects and publish rigorous benefit-cost studies. Governments would be free to reject the body's advice, but would have to justify this to a better-informed public.

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Is reversing Labor all we need for our future?

I'm starting to think we didn't get much of a deal when we decided to change the federal government. We got rid of a bunch racked by infighting and bad at executing policy, but substituted a bunch with a very limited idea of what needed to be changed to get us back on the right path.

What a to-do list: sack econocrats guilty of having worked with the enemy, pass an edict against climate change and discourage all discussion of it, stop publicising boat arrivals, build more motorways, move to a cut-price national broadband network and take science for granted.

It's early days, of course, and there's more, but not a whole lot more: abolishing the onerous tax on our impoverished global mining companies, getting rid of red and green tape (translation: making it easier for big business to get its way without delay) and beating up the Tax Office for being too diligent in making small business pay its tax.

It's as if Tony Abbott believes returning the Liberals to power will, of itself, solve most of our problems. Everything was fine when we last had a Liberal government, so restore the Libs and everything will be fine again.

It smacks of complacency, of a belief that nothing much has changed or could change. But that's not how Ian McAuley, an economist at the University of Canberra, sees it in his chapter of a new book from the Centre for Policy Development, Pushing Our Luck: Ideas for Australian Progress.

McAuley argues that, after another round of good luck with the resources boom, we need to secure our long-term prosperity by building a more resilient economy. (He harbours the eccentric notion that there's more to economy policy than balancing the budget, but even Abbott has abandoned that goal.)

"The legacy of our economic history conditions how we think," McAuley says. "After Federation we diversified our economy by building up a strong manufacturing base behind tariff walls. That started out as a smart policy, but it has left us with an undue concern for 'making things' rather than creating value.

"Our success in commodities, which allows for little product differentiation, has contributed to a 'price taker' mentality in business and therefore an obsession with production costs. We think about productivity in terms of mere cost reduction, particularly when labour costs are involved ...

"And our strong growth in the 20th century has created unrealistic expectations about profitability; we find it hard to imagine that the days of easy investment returns may be behind us."

We need to break free of the notion that our economic fortune must inevitably be driven by the fluctuating demand for minerals and energy, McAuley argues. And our dependence on coal exports makes us particularly vulnerable.

"As more countries place a price on carbon, or switch to other energy sources for local environmental or health reasons, there is a chance that we could find ourselves left with some large holes in the ground and idle ports and railways."

The experience of many countries shows that an abundance of natural resources can become a curse because it leads them to keep all their eggs in one basket.

"The consensus among economists is that countries can avoid the resource curse only by treating natural resources as an opportunity to invest through a sovereign wealth fund or domestically in education and infrastructure.

"We should see carbon pricing as an opportunity for industry modernisation, to prepare for an era in which many countries are cleaning up their energy sectors and limiting their carbon emissions."

McAuley says the old manufacturing model was one in which physical capital was expensive and labour was comparatively cheap. Our thinking, still focused on physical capital, distracts us from a new realisation of the meaning and role of capital.

"Capital in the form of a row of machines or a fleet of trucks is less important than the capital in the form of ideas, skills and education, capacities to communicate and to work with others - human capital, in other words. It is the knowledge worker who is emerging as the capitalist of our day, but we are a long way from recognising this."

Rather than thinking about manufacturing and its products, we should think about activities people undertake in adding customer value. Some activities involve transformations to physical products, but there are many other ways to apply skills to add value.

"Policies directed at developing manufacturing for its own sake are bound to fail. Those that enable businesses to adapt to big changes and to develop strong positions in global value chains are more likely to be effective for all businesses, regardless of their sector."

In summary, McAuley says we need to understand the risks of being too dependent on natural resources, break from our old obsession with producing physical products, focus on increasing customer value and not just reducing costs, get rid of the class struggle model of economic activity, stop thinking the only goal is job creation and develop realistic ideas about the rate of profitability.

"We pay far too little attention to our human capital. We still see education expenditure as an expense, or even as a welfare entitlement. And we pay even less attention to our environmental, social and institutional capital," he concludes.

It's hard to imagine Abbott has any of these things in his field of vision.

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No need to exaggerate Labor's failings

They say history is written by the victors, and already the Rudd-Gillard-Rudd government's many critics are busy reshaping our memory of the recent past. But, though Labor's performance was poor in many respects, they shouldn't lay it on too thick.

Those who claim Labor Party governance led to "chaos" should look up the meaning of the word, while those who repeat Tony Abbott's claim that this was "the worst government ever" are too young to remember the Whitlam era.

What is true is that Labor's latest incarnation was far inferior to the 13-year Hawke-Keating government. In just the term of the Howard government, Labor seemed to lose its race memory of how to govern.

Rather than blame all its troubles on the three years of Rudd-Gillard infighting, or keep telling itself its policies were good, Labor needs to reflect deeply on why its execution of policy fell so far short of the Hawke-Keating example.

A fair bit of the reason is its failure to unceasingly explain and justify its policies and instead rely on wet-behind-the-ears spin doctors and dodgy taxpayer-funded ad campaigns.

Rather than explain and justify, ministers preferred to criticise their opponents, forgetting the punters are never edified or impressed by arguing pollies and inadvertently giving the opposition greater credibility. Labor forfeited most of the advantages of incumbency.

One big difference was the way Bob Hawke and Paul Keating maintained the confidence of business. Part of the explanation was that when you reveal yourself to be a soft touch for rent seekers - as Rudd did almost from the start - you incite envy and disaffection, not respect.

Another part of it was Gillard's resorting to the rhetoric of class conflict, which did much more to disenchant business than to energise complacent workers. Hawke and Keating did a lot to redistribute income, but didn't make speeches about it.

The more Abbott and Joe Hockey are forced by economic reality to back-pedal on their promises to "end the waste" and "repay the debt", the more they'll cover their retreat by exaggerating Labor's budgetary failings.

So let's set the record straight from the start. It's unimpressive enough without any need for hyperbole.

The standard critique of Labor governments is that they're "big-spending, big-taxing". This time the latter accusation is false, but the former is all too true.

If you measure the burden of federal taxes as a percentage of gross domestic product - as you should - it reached an all-time high of 24.2 per cent in the mid-noughties and was 23.7 per cent in Howard's last year.

Under Labor, and with much help from the recession we supposedly didn't have, it fell to 20 per cent in 2010-11 and is expected to have recovered only to 22.2 per cent in Labor's last year.

How could this be when Labor introduced two "big new taxes" on carbon and mining? The trick was that most of the expected revenue from these taxes was returned to taxpayers on the form of income tax cuts, business tax breaks and other "tax expenditures". This is why Abbott's unwinding of both tax packages will do so little to cut taxes overall.

Turn to the spending side, however, and you find spending was 23.1 per cent of GDP in Howard's last year and is expected to reach 25.3 per cent in Labor's last year. That represents average real growth of 3.9 per cent a year.

Both those calculations effectively abstract from Labor's clearly labelled fiscal stimulus spending after the global financial crisis, because it really was temporary.

And that average real growth rate of 3.9 per cent occurred even though, in the last four of its six budgets, Labor professed to be more than achieving its goal of limiting real spending growth to 2 per cent on average over the forward estimates.

How was this trick done? All the restraint was in the "out years", never the present. To be fair, real annual spending growth averaged 3.7 per cent in the 10 Howard years before the financial crisis.

The big areas of growth under Labor were public housing, education and health, not counting the biggest, interest on the public debt.

Treasury projected in its pre-election economic and fiscal outlook that, left to its own devices, spending will grow at the real rate of 3.5 per cent a year in the coming decade, spurred by health, the national disability scheme and the Gonski education reforms.

Labor's problem was that its appetite for increased spending on worthy causes knew no bounds but it lacked the courage to ask the electorate to pay more to cover this expansion.

We'll see how much more courageous Abbott and Hockey prove to be.

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What's driving our dollar

The clouds over our economy got a bit darker this week with the news that the US Federal Reserve was in no hurry to begin "tapering" its quantitative easing.

This underlined the reality now dawning on the new Abbott government that the outlook for the economy is quite uncertain and, unless we're lucky, quite weak. It's certainly not a time when you should shift to a contractionary stance of fiscal policy because of some misguided desire to force the pace in getting the budget back to surplus.

But let's start with the Americans and their quantitative easing. "QE" is a form of economic stimulus - the sort you resort to when you can't stimulate the economy the conventional way by cutting the official interest rate because it's already close to zero.

It involves the central bank buying government bonds or other securities in the marketplace and paying for them by just crediting money to the sellers' bank accounts (a trick only central banks, the creators of money, can do).

The intention is that increasing the money in circulation encourages demand (spending) at a time when aggregate (economy-wide) supply exceeds aggregate demand, with workers lying idle and firms operating well below full capacity.

Some people, remembering stuff their heard in the 1970s and '80s, worry that "printing money" causes inflation. It does if it causes demand to exceed supply - as would have been the case back then - but it doesn't when demand is a lot weaker than supply, as has been the case in the North Atlantic economies since the global financial crisis.

Even so, the Fed has been warning it will start cutting back (tapering) the amount of its continuing monthly purchases of bonds as it sees the economy strengthening, just to be on the safe side.

What happened this week was the Fed's decision that the economy wasn't yet strong enough to start the tapering. It was worried that recent figures for employment weren't as strong as expected.

It was also aware that the congressional deadlock over the budget was bringing about cuts in government spending and increases in taxes that exerted significant contractionary pressure on the economy. And another confidence-sapping battle between the President and Congress was brewing.

So how do our interests fit into this? Well, this is where it gets tricky. It's not bad news that, in the face of a weaker-than-expected economy, the Fed decided not to start withdrawing monetary stimulus. It's in our interests for the US economy to be as strong as possible.

What is bad news is that the US economy isn't strong enough for the tapering to begin. That's because one of the ways quantitative easing stimulates demand is by putting downward pressure on the country's exchange rate.

And anything that puts downward pressure on an important currency like the US dollar puts upward pressure on our dollar. What's stimulatory for them is thus contractionary for us.

As we've been reminded only too well in recent years, a high dollar reduces the international price competitiveness of our export and import-competing industries, causing us to produce less than we otherwise would.

From our perspective, our dollar has been high because of the resources boom: the high prices we were getting for our exports of mineral and energy and because of the foreign capital flowing in to finance all the investment in new mines and natural gas facilities.

With export prices having fallen a fair bit over the past two years, we expected to see our dollar come down and stimulate production in manufacturing and tourism.

For a long time nothing happened. It started falling in mid-April, but still hasn't fallen as far as it probably should given the size of the fall in export prices.

It took us too long to realise what the problem was: quantitative easing in other countries, particularly the US. Our dollar couldn't come down because it was being held up by the weak greenback.

This is a reminder that the exchange rate is a relative price: the value of our currency relative to the value of some other country's currency. So it's affected both by developments in our economy and developments in theirs.

It was when the Fed started making noises about tapering its quantitative easing that the currency market began anticipating this occurrence, pushing the greenback up and allowing our dollar to fall. Between mid-April and the end of July the Aussie had fallen about 14 per cent.

But this week's surprise announcement from the Fed saw the greenback drop against most currencies, including ours. Last time I checked, the fall since mid-April had narrowed to 10 per cent.

It's always dangerous to assume some change of direction that's just happened in financial markets will continue or even just not be reversed. But this week's events do suggest that the further fall in the Aussie dollar we've been hoping for is now less likely because the phasing out of America's quantitative easing is now further away.

Our present problem is familiar to you: with the resources boom's net contribution to growth now turning negative, we need the rest of the economy - particularly investment in new housing, and non-mining business investment - to take up the running. A decent fall in the dollar would do a lot to help stimulate the non-mining economy.

The other hope is for a turnaround in business and consumer confidence following the change of government.

The main indicators of confidence have improved since the election, with the Westpac-Melbourne Institute index of consumer sentiment jumping 4.7 per cent this month as Coalition voters' confidence leapt 19 per cent and Labor voters' fell 10 per cent.

But it's far too soon to say whether this improvement in the indicators of business and consumer confidence will translate into a significant improvement in actual economic activity and employment.

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The transformation of Tony: can you believe it?

On Classic FM last month they used to play an ad with just a second or two of arguing politicians before the kicker: "Election? What election?" Then on with the soothing music. It was a bit naughty for the ABC, but it was just what many people were thinking.

According to group discussions conducted in the last week of August by the Ipsos research firm for its Mind and Mood report, the consensus from participants' lounge rooms around the country was loud and clear: "We are sick of this election campaign and we just want it over with."

When the groups were invited to discuss what mattered most in people's lives, politics was barely mentioned. When the researchers did raise the election, participants often rolled their eyes or groaned.

Many thought this was "one of the worst elections we've ever had".

But I remember people complained a lot about the 2010 campaign. What doesn't seem to have occurred to people is that it's hard to get excited about a contest when you know who's going to win it. And with the media's incessant quoting of opinion polls, no one could have been in any doubt. If the media want their election coverage to excite interest, they're fouling their nest.

But "one of the main reasons participants felt disconnected from politics and the election was their dissatisfaction with both of the major parties' leaders," the report says. "Regardless of whether their values were more closely aligned with Liberal or Labor (or the Greens) few people had positive things to say about either Kevin Rudd or Tony Abbott."

There was also disappointment with how the campaign had been run and, in particular, the lack of debate about policy, we're told. Many complained the Liberal and Labor campaigns focused on "slagging off" their competition instead of explaining policies.

Participants were tired of the mud-slinging and personal attacks launched directly by the major parties' leaders and felt that both lacked the charisma and vision required to inspire and help them connect with politics.

To this end, many hoped the election would bring an end to minority government, the constant bickering and lack of stability that has characterised the last few years of Australian politics, the report says.

But I say all the bickering and seeming lack of stability arose not from minority government as such, but from Abbott's reaction to it, which was to assume government could fall into his hands at any moment and maintain a stance of total opposition to everything.

The past three years have left a nasty taste partly because of Julia Gillard's unpopularity and Labor's constant feuding, but mainly because Abbott ran a three-year election campaign of politicians eternally at each other's throats.

But did you notice the way he transformed himself for the campaign proper? The man who'd run the highly effective but dishonest scare about the terrible effects of the carbon tax and - as we only now discover - a quite insincere scare about debt and deficit, became the man professing to be "embarrassed" by Rudd's scare campaigns on the Coalition's supposed plans to raise the GST and to "cut, cut, cut" government spending.

And by the campaign proper the man who wrote the book on negativity was accusing Rudd of being "so negative".

In government, the Transformation of Tony has continued. The bruiser and attack dog of opposition now promises a "stable and sensible" government that brings "stability and predictability" and is "methodical, measured, calm" in discharging its duties.

Huh? At one level he's a man who knows he has to mend his ways; that successful prime ministers don't act the way he did as opposition leader. He understands people's longing for greater stability and certainty than they experienced over the past three years.

At another level it's what every incoming Liberal PM says. Malcolm Fraser wanted to "get politics off the front page". John Howard wanted to make us "comfortable and relaxed". They dream of returning us to a Menzian torpor.

Historically, it's what the Liberals stand for. Labor is the eternally dissatisfied party of "reform" while the Libs are the conservatives, satisfied with the world as is and trying to stave off disruptive change as long as possible.

A truth our politicians too often forget is that most of us hate change. I confess Abbott's vision appeals to me enormously. Should the 24-hour media cycle slow down and politics become less thrill-a-minute I'm sure I could still find plenty to write about.

But can Abbott attain this degree of stability and tortoise-like approach to progress? He's always struck me as a man who makes plenty of new year resolutions but never keeps 'em for long.

The sad truth is steadiness is contrary to the spirit of our age. Things have sped up as technology and globalisation have opened us up to changing pressures originating anywhere in the world.

And the non-Labor side of politics has changed from conservative to radical. It's as much addicted to "reform" as Labor. Whereas once it resisted changes proposed by those lower on the ladder, today it wants to reclaim lost ground.

Abbott's promise of "no surprises, no excuses" will be the first he has no choice but to break. As Harold Macmillan apparently didn't say, "Events, dear boy, events".

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