A FISCAL POLICY UPDATE

VCTA Student Revision Lectures
September 12, 2010

The economy has been on a roller-coaster ride from resource boom to global financial crisis to recovery from the mildest of recessions to the likelihood of an early return to the resources boom and an economy at near full employment. Monetary policy played its accustomed role in all this and Keynesian fiscal policy returned to the fore. But did we have a recession? And just what was the role played by fiscal/budgetary policy?

Yes, we did have a recession

The widespread belief - encouraged by the Rudd government - that Australia avoided recession is based solely on the notion that a ‘technical’ recession occurs when real GDP contracts for two quarters in succession. But though this rule is widely used by the media, it’s merely rule of thumb with no status among economists. It’s quite arbitrary, and doesn’t always give the right answer. A better definition of recession was given by Dr David Gruen of Treasury: ‘a sustained period of either weak growth or falling real GDP, accompanied by a significant rise in the unemployment rate’.

The evidence that we did have a (very mild) recession is clear: we saw the collapse of various local fringe financial institutions, a 0.7 per cent fall in real GDP in the December quarter of 2008 and weak growth in later quarters, a rise of 230,000 (1.8 percentage points) in unemployment and a bigger rise in under-employment, much tougher borrowing conditions for small business, and weakness in retail sales and home building as the effects of budgetary stimulus wore off.

The reasons why the recession was so mild and short-lived were many: our banks didn’t get into difficulties, the continued strength of our exports to China, the strong growth in the population, the reluctance of employers to retrench their skilled staff and the dramatic cuts the official interest rate. But much of the credit must go to the fiscal stimulus, which was particularly effective in turning around the collapse in business and consumer confidence following the US and European banking crisis.

Fiscal policy

Definition: the manipulation of government spending and taxation to influence the strength of demand.

Instruments: variation of the size and composition of government spending and taxation.

Objective: to serve as a backup to monetary policy in achieving internal balance - low inflation, low unemployment and a relatively stable rate of economic growth. It is conducted in accordance with the government’s ‘medium-term fiscal strategy’: to ‘achieve budget surpluses, on average over the medium term’.

This strategy, which the Rudd government essentially took over intact from the Howard government, was carefully worded so as to fully accommodate a Keynesian approach to fiscal policy. It implies that fiscal policy will support economic growth and jobs by allowing the budget to move into temporary deficit during an economic downturn. So it was deliberately framed in a way that permits the automatic stabilisers to respond to a downturn by turning the budget balance from surplus to deficit. But it also permits the Government to apply discretionary fiscal stimulus, provided the budget balance is brought back into surplus once the economy recovers. In this way, the deficits in the bad years will eventually be offset by surpluses in the good years, thus causing the budget to be balanced (or even in surplus) on average over the full cycle. In other words, the strategy is constructed to permit what I call ‘symmetrical Keynesianism’.

The fiscal stimulus

During the boom, fiscal policy was given a limited role to play in the policy mix, with the heavy lifting left to monetary policy. Once the economy turned down, however, fiscal policy came to fore. The Government announced its first fiscal stimulus package (worth $10 billion) in October 2008, then a second package (worth $42 billion) in February 2009. And it announced a $22 billion national infrastructure program in the 2009 budget.

The measures included in the various packages were intended to comply with three principles enunciated by Treasury and known as the ‘three Ts’: measures needed to be timely, targeted and temporary. Timely meant they should take effect as soon as possible; targeted meant the spending should go to those people or activities most likely to involve spending rather than saving; temporary meant they should involve only a one-off cost to the budget (eg cash bonuses, specific capital works) rather than a continuing cost (eg tax cuts, pension increases).

Some people have the impression that most of the stimulus spending went on cash bonuses. In fact, they cost about $22 billion, less than a third of the Government’s total stimulus spending of $74 billion over the four financial years to2011-12. The remaining two-thirds went on ‘shovel-ready’ minor capital works (road black spots, level crossings, public housing, roof insulation and primary schools) and major infrastructure projects (roads, rail, ports and broadband).

Whereas in May 2008 the government was projecting a long run of budget surpluses, it is now projecting large budget deficits, leading to an increase in the Australian Government’s net debt. It is important to understand, however, that most of this deterioration has been caused by the operation of the budget’s automatic stabilisers, rather than by the Government’s explicit spending decisions. Lower prospective tax collections required the Government to write down its projected revenue by $110 billion over the five years from 2008-09 to 2012-13. Higher prospective dole payments would also have contributed to the deterioration in the budget balance.

The latest estimates suggest the government is expecting the budget deficits over the four years to 2011-12 to total $135 billion. Thus discretionary fiscal stimulus accounts for only a bit over half of the accumulated deficits, with the automatic stabilisers accounting for the rest.

Stimulus spending by governments is intended to have ‘multiplier effects’. Empirical research shows, however, that, particularly because of leakages to saving and imports, the multiplier effects are much smaller in real life than in textbooks. In the Treasury’s calculations for the budget it used highly conservative (pessimistic) multipliers of 0.6 for the Government’s cash bonuses and 0.85 for capital works spending. It now seems clear that the fiscal stimulus has been far more successful than even its promoters expected. That is, the multipliers seem to have been greater than expected.

The changing policy mix

The Opposition’s calls for the stimulus spending to be curtailed now the economy has begun to recover fail to take account of the originally planned phase-down as the T-for-temporary spending programs expire. According to Treasury’s calculations, after the December quarter of 2009 the stimulus spending’s contribution to GDP growth swung from positive to negative. This occurred because, though more stimulus money was spent in the March quarter, it was less than the stimulus money spent in the December quarter. And this meant it subtracted from the rate of growth in GDP (even though it still added to the level of GDP). In other words, from the end of December the stance of fiscal policy switched from expansionary to (mildly) contractionary as the stimulus was withdrawn. To hasten this planned withdrawal would make fiscal policy more contractionary.

By contrast, the various increases in the cash rate we’ve seen, taking it to 4.5 per cent, merely represent moves to take the stance of monetary policy from stimulatory to neutral.

What we have to show for the fiscal stimulus

The Opposition runs hard with the line that, thanks to all the fiscal stimulus, we’re left with nothing to show but a lot of deficits and debt. This isn’t true. Clearly, we’ll be left with all the shovel-ready capital works - rail crossings, fixed black spots, social housing, school buildings and ceiling insulation - and major infrastructure.

But that’s not all - though you have to be an economist to see it. Even the money spent on the cash splashes and unneeded assembly halls has left us with something to show. All the spending - discretionary and automatic - reduces the time it will take for the level of real GDP to return to its previous peak. And that leaves us better off than we would have been in two respects. First, the smaller the rise in unemployment and thus the fewer people unemployed - and the shorter the time they spend unemployed - the less the atrophy (wasting away) of individuals’ skills. Reducing this problem, which economists call ‘hysteresis’, is a benefit not just to the individuals involved, but also to the community.

Second, the milder the recession, the fewer viable businesses go bust, thus avoiding the destruction of various forms of tangible and intangible capital. Some capital equipment - and some understandings, networks and arrangements the firms have made - that could have been used to produce goods and services in the upswing is destroyed. So the milder the recession, the less the loss of productive potential because of the destruction of human, physical and intangible capital.

The opposition opposed all but the first stimulus package and has been continually finding fault. At first it argued the measures - particularly the cash splash - wouldn’t work. But it’s clear from the economic indicators - for retail sales, home loan approvals, new home building approvals and business investment in equipment - that the measures were highly successful in leading to increased private spending. It’s true some of the cash was saved rather than spent, but the marked improvement in business and consumer confidence at the time suggests this saving made many people less anxious about their debts and so less keen to cut back their spending as a precautionary measure.

Later the opposition switched to claiming much of the stimulus - particularly the spending on ceiling insulation and school buildings - had been wasted. It’s true the insulation program should have been much more carefully administered and that there was a degree of waste in the school building program. However, an official inquiry received complaints from only 2.7 per cent of schools, suggesting the extent of waste had been greatly exaggerated by the opposition and sections of the media. Stimulus spending always involves a difficult trade-off between conflicting objectives: the macroeconomic objective (getting the money spent as soon as possible so as to limit downturn in activity) and the value-for-money objective (making sure we have something of lasting value to show for the spending). The way to avoid waste is to take as long as necessary to ensure the money is spent well. So when speed is a high priority, some degree of waste is inevitable. Note, too, that even when spending is wasted on classrooms no one wants, it still creates jobs.

The tax reform package

The main measure announced in this year’s budget was a tax reform package, in partial response to the report of the Henry review of the tax system. After its amendment by Julia Gillard, the package consisted of a minerals resource rent tax, expected to raise about $10 billion in its first two years, the proceeds from which would be used to cover the cost of reducing the company tax rate from 30 per cent to 29 per cent, plus tax concessions for small business, superannuation and individuals. Note that the new tax won’t take effect until July 2012, so the measures it pays for will be phased in from that date. Note, too, that the package is roughly revenue neutral, meaning it’s wrong to imagine the resource tax will play a significant part in returning the budget to surplus.

Mr Swan is now expecting a budget deficit for the old financial year (2009-10) of $57 billion (or 4.4 per cent of GDP), falling to a deficit in the present financial year of $40 billion (2.8 per cent). With the cessation of most stimulus spending programs, this means the stance of policy adopted in the budget is mildly contractionary.

The budget is projected to reach a small surplus in 2012-13 for three reasons: First, the effect on the budget’s automatic stabilisers of the economy’s expected return to strong growth; second, the always-planned completion of the government’s temporary stimulus measures; and third, the government’s adherence to its ‘deficit exit strategy’ of allowing the level of tax receipts to recover naturally as the economy improves (ie avoid further tax cuts) and holding the real growth in spending to 2 pc a year until a surplus of 1 pc of GDP has been achieved. The fact that the government now expects the return to surplus to occur three years’ earlier than it expected in last year’s budget is explained by the much milder recession than it expected and the much stronger forecasts for the next four years.

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Debt is good when it means investment

One of the most remarkable, but unremarked, features of the election campaign was the extraordinary fuss made about a net federal government debt expected to peak at a mere $90 billion, while not a word was said about Australia's net foreign debt of $670 billion - and rising.

Similarly, despite all the feigned concern about the size of federal budget deficit, nothing was said about the current account deficit, which is almost always much bigger.

This just proves politicians carry on about what it suits them to. It hasn't suited the opposition to bang on about the current account deficit because it was consistently high throughout the Howard government's 11 years - meaning the net foreign debt just kept getting bigger.

But the Liberals - and Labor, for that matter - aren't alone in not wanting to talk about the current account deficit (which is the amount by which our imports and income paid to foreigners exceed exports and income received from foreigners) and the resulting net foreign debt (which is the money Australians owe foreigners, less the money they owe us).

These days, the nation's "external accounts" hardly rate a mention in the media, either. So surprisingly little has been made of the news that, at $4.2 billion, the current account deficit for the June quarter was the lowest in almost a decade.

It turned out our export earnings were up 24 per cent on the previous quarter, whereas our imports were up 6 per cent, causing the trade balance to swing from a deficit of $2.8 billion to a surplus of $7.8 billion. Trade surpluses aren't all that common, and this one was our biggest since 1973.

For good measure, our net income payments to foreigners (covering interest payments on the foreign debt and dividend payments to foreign owners of Australian businesses) were down by a bit under $1 billion to about $12 billion, yielding the current account deficit of $4.2 billion. Wow. Why such an improvement? Because everything went right with our exports. For a start, there was a big increase in the prices we received for our exports of coal and iron ore. The volume of coal exports was up, as were exports of gold. Exports of oil were up as two new oil fields off the coast of Western Australia came on line.

But it's not such a bad thing the media didn't make a fuss about the improvement. Why? Because it can't last. It's the calm before the storm.

When our terms of trade improve - when export prices rise relative to import prices - as they have mightily this year, people always expect this to lead to an improvement in our trade balance and current account deficit, but it rarely does. They think this because they forget to ask one of the great economists' questions: but what happens then? You never get the right answer until you take account of what economists call "second-round effects".

What happens then is the rise in exports leads to a rise in imports. This happens several ways. First, the improved terms of trade represent an increase in the nation's real income. As this real income is spent, a fairly high proportion is spent on imports: imports of consumer goods, but also imports of components and capital equipment.

This process is accentuated because an improvement in our terms of trade usually leads to an appreciation in the exchange rate. The higher dollar makes imports cheaper, thus encouraging people to buy more of them relative to locally produced goods and services.

Second, a rise in world prices for minerals and energy encourages our mining industry to expand its production capacity, building new mines and natural gas facilities. A high proportion of the equipment needed for these expansions is imported. Take the coming Gorgon natural gas project on Barrow Island. It's expected to involve investment spending of about $50 billion over five years. Roughly half that money will go on imports.

The truth is the return of the resources boom is expected to involve a return to the big current account deficits (and thus faster-rising levels of foreign debt) we have seen since the start of the boom in the early noughties. So whereas the current account deficit got down to the equivalent of just 1.6 per cent of gross domestic product in the June quarter, the econocrats are expecting it to go back up to 5 or 6 per cent during the rest of the decade.

To see why this isn't as worrying as it sounds - and to debunk the Liberals' dishonest implication that anything labelled "deficit" or "debt" must always be bad - it's useful to pull another economists' trick and switch the discussion of our "external imbalance" from the language of exports and imports to the language of saving and investment.

Huh? Just as Australia almost always imports more than it exports, so the nation also spends more on investment (in new housing, business equipment and structures, and public infrastructure) than it saves (whether by households, companies or governments).

All physical investment spending has to be financed from savings, and when we don't save enough to finance all our investment we make up the difference by borrowing the savings of foreigners. This is why Australia runs a surplus on the (financial) "capital account" of our "balance of payments" to and from the rest of the world, which exactly matches and finances the deficit on the "current account" of the balance of payments.

The current account deficit is low at present because private sector investment spending fell somewhat in the economic downturn, while the mining companies are saving (as retained earnings) much of their extra income from higher world commodity prices.

Soon enough, however, national investment spending will boom as households build more houses, ordinary businesses invest in better equipment and, in particular, as the miners hugely increase their investment spending.

All this is likely to happen without much increase in the nation's rate of saving. If so, the capital account surplus is likely to be much bigger as we call more heavily on the savings of foreigners - and so is its mirror image, the current account deficit (as we import more capital equipment).

If the worsening in the current account comes from higher investment spending rather than lower national saving - as happened in the first part of the resources boom and is expected to happen now - we don't have a lot to worry about. Eventually, the investment will pay for itself.

5302.0

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Perhaps now politicians will stop trashing their reputations

Let's hope it's not back to politics as usual. And let's hope the fortnight or so since the voters' collective refusal to award the election to either of the major parties has allowed both sides time to reflect on something that hasn't troubled them to date: when will the political profession decide to call a halt to its trashing of its own reputation?

The process by which our politicians have slowly destroyed their credibility with the electorate has been running for so long it's easy for them - and us - to be unconscious of what is happening. But it reached a new low in this campaign, so it shouldn't have been such a surprise when the electorate couldn't decide who it distrusted less.

The disdain with which we've come to regard our politicians struck me when I considered the success of the mining industry's advertising campaign against the resource super profits tax. With world coal and iron ore prices at record highs, the largely foreign-owned mining companies are raking in unbelievable profits.

The Labor government said the new tax was needed to ensure the people who actually owned these resources - you and me - got a fairer price for them. The miners claimed the tax would cripple them, discourage further development and cause people to lose their jobs.

You might have expected the public to respond to these over-the-top claims with scepticism - they would say that, wouldn't they?; whoever likes paying more taxes? - but it seems many people believed them.

(Think about it: we were being asked to believe the Secretary to the Treasury, the high priest of economic rationalism, backed up by two highly regarded economists and the chief executive of a major business association, was proposing a tax that would lay waste to the mining industry and seriously damage the economy.)

So why was the word of fat-cat miners favoured over that of our own government? Because the credibility of our politicians is at rock bottom. Even big businesses on the make are judged more likely to be telling the truth.

Surveys of the reputation of various occupations show politicians well down the list (but above journalists, advertising people and car salesmen). The company pollies keep on the list makes it clear: the public has a low opinion of people they have come to believe seek to manipulate them and tell them things that aren't true.

The more politicians have relied on the techniques of market research - polling, focus groups, advertising and direct mail - the more they've sought to con us.

Top of the list of behaviour that has cost politicians our respect is broken promises. We have seen it so many times from both sides we have come to view all political promises with suspicion. Consider the possibility that Gillard's last-minute promise to build the on-again-off-again Parramatta to Epping rail link cost Labor as many votes as it gained.

It will always be that some promises aren't kept because they have been overtaken by events and it would be foolish, even impossible, to press on with them. But so many promises have been broken many voters believe they are often given without any intention to keep them.

My guess is the process is more cavalier. Pollies think: if I win that's when I'll worry about whether I can honour them all.

The answer is for pollies to be a lot more cautious in making promises. But why do they make so many? Because of the way, under the influence of marketing techniques, election campaigns have come to take the committed voters for granted and focus on winning the votes of swinging voters in marginal electorates. Swinging voters are judged to be people with little interest in politics, whose only thought is what's in it for them and their families. Hence the temptation to keep promising goodies.

Election campaigns have become increasingly unreal. The pollies create a fairytale world in which nothing bad ever happens. They'll spend more on this and that, but without increasing taxes and, of course, while also eliminating deficits and debt.

In this imaginary world, the law of opportunity cost doesn't operate. We can have everything we want, without price. The pollies encourage people to believe the government can - and should - solve all their problems. Is it any wonder disillusionment is rife?

Often - as with all the pseudo-sympathetic talk about the rising cost of living in this campaign - the pollies seek to appear empathetic while carefully avoiding promising to do anything. They think they're being clever, but when people gain the impression you're going to fix their problem and you don't, they feel just as cheated as if you really had promised it.

In Queensland, voters feel they were ambushed by Anna Bligh because she waited until after the election to announce unpopular tax changes and privatisations.

That's the "positive" way politicians have damaged their reputations. Of late they've resorted more to negative methods: trashing each other. This campaign boiled down to rival scare campaigns about Work Choices, the mining tax, the "Woollies and Coles tax", mountainous debt and boat people.

Politicians wouldn't resort to scare campaigns and negative advertising if they didn't work. They play on the gullibility of people who don't think much about politics. But what works in the short term comes at a long-term cost to the politicians' credibility. The same goes for oppositions automatically opposing everything governments do and the endemic abuse of statistics.

Many voters are naive and gullible. But when eventually they realise they've been conned, they switch not to reasoned scepticism but utter cynicism about the untrustworthiness of our political leaders.

Many politicians believe John Howard lost office because voters had simply "stopped listening" to him. Those who deposed Kevin Rudd concluded voters had "stopped listening". If this isn't ringing alarm bells in the political profession, it should be.

The hung parliament offers politicians the chance of a circuit breaker in this mutually destructive process.

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Our economic challenge will be feast not famine

Perhaps we're seeing the emergence of a new law of elections: the real issues facing the economy in the next term won't bear any resemblance to those discussed during the campaign.

In the 2007 campaign, the Liberal slogan was Go for Growth and Labor wanted the growth to involve more investment in training and infrastructure. In reality, the Reserve Bank was hauling on the interest-rate brakes because of rising inflation pressure, and we ended up spending most of the term fending off the worst global recession in 60 years.

In this campaign, the Libs defined our biggest economic problem as combating Labor's horrendous budget deficits and struggling to overcome Labor's mountainous public debt. They assumed their net cuts in spending (which Treasury and Finance later found to be largely illusory) were the only thing that could return the budget to surplus.

Lacking convictions and the courage of them, Labor - which had done a remarkably good job of shepherding the economy through the global financial crisis - fell in with this bookkeeper's vision of economic management.

But two weeks after the election, the June quarter national accounts have swept away all the nonsense of the campaign. The resources boom is back, the economy is roaring along, the government's filling coffers will soon get the budget back into surplus without the pollies doing any more than resolving not to spend all of it, and the economy's big problem will be growing at full employment without overheating.

Before we explore those challenges that await us, why is economic debate during election campaigns so off-beam?

It's partly because the modern practice of aiming election campaigns almost exclusively at swinging voters in marginal electorates - people known to be uninterested in politics, without ideology, economically illiterate and of a self-centred, what's-in-it-for-me? disposition - means nothing unpleasant or even faintly serious can be raised.

Consider the recent British elections. Anyone taking the slightest notice would have known that whichever side won the election would immediately plunge into sweeping spending cuts and tax increases to hack into a budget deficit that really was a worry. But all sides studiously avoided engaging with the issue.

The other reason election campaigns are so unreal is that even economists can be quite ill-informed about the state of the economy and direction in which it's headed.

Throughout this campaign most economists thought consumer spending and home-building were quite weak, with the worries about the US and European economies, and maybe even the disincentive effects of the new mining tax, putting a question mark over the medium-term prospects for our economy.

Most of those doubts and misconceptions have been swept away by last week's figures, including the survey of firms' capital expenditure plans, which exposed how much the mining companies were lying about the resource super profits tax's supposed threat to their future activities.

I've come to the view that few people - even economists - have a good feel for how the economy's travelling at any moment. It's never very clear what's happening until we see the national accounts. Then, of course, any fool can tell you what the score is.

I suppose it's possible a double dip in the US and lingering weakness in Europe could be sufficient to knock China, India and the rest of emerging Asia off its stroke and thus bring our resources boom to a sudden halt, but I doubt it's likely.

It is likely coal and iron ore prices are near their peak and will fall back as world supply catches up with world demand. But prices could fall a fair way and still settle well above their long-term level. Part of what we lose on price we'll make up on increased volume. And the miners and natural gas companies have maybe a decade's worth of construction projects in the pipeline.

We're back to growing at the trend rate and are already close to full employment. As in all Australian commodity price booms, our big problem will be how we manage the inflation pressure as the extra export income is spent.

Can we keep travelling at full-employment level without overdoing it and having to induce a recession? Rest assured, the Reserve Bank will raise interest rates to whatever level is needed to keep inflation in check, but can we do better than that?

Could we keep tightening budgetary policy to take some of the pressure off monetary policy and interest rates? The bookkeeper's approach to economic management doesn't augur well. The flipside of the nonsense we heard in the campaign is that once the budget's back in surplus, whoever's in government will imagine they're able to spend more freely (just as John Howard did during the first stage of the boom).

To help with the macro management part of the problem, but also to ensure we have something to show for the boom, we need to save a higher proportion of the extra national income. Perhaps we need a sovereign wealth fund to justify ever-higher budget surpluses.

The idea of increasing compulsory superannuation contributions to raise national saving is attractive, but a Coalition government wouldn't go ahead with it and Labor's present scheduled phase-up is too delayed to be of much use.

We need to revisit - more intelligently - the question of population growth, but ask whether meeting the mining industry's need for more labour actually requires open slather on skilled immigration (with all the increased spending on public infrastructure that would necessitate).

Now the election's (almost) out of the way, there's so much we need to debate about economic policy.

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Our resources boom comes bouncing back

This time three months ago it was clear the economy was being propped up by rapidly withdrawing budgetary stimulus, and it was not clear private spending would perk up in time to take over the running.

This time two weeks ago it seemed clear business investment spending was doing OK but households were dragging the chain, with retail sales and home building approvals surprisingly weak.

What a difference three months - or even two weeks - makes. This week's national accounts for the June quarter show the economy roaring along, with the private sector firing on (almost) all cylinders even as the budgetary stimulus continues to withdraw. The boom is coming back.

One lesson: don't get too carried away by talk of a two-speed economy.

The accounts issued by the Bureau of Statistics showed real gross domestic product growing by 1.2 per cent during the quarter and 3.3 per cent over the year to June. If we were quoting the figures the way the Americans do, we'd say the economy grew at an annualised (that is, made annual) rate of almost 5 per cent during the quarter (multiply 1.2 by 4 and add a bit for compound interest).

Now that's a boom. But since the quarterly rate of growth varies a lot, it probably exaggerates the pace of the upturn, so it's better to do it the Aussie way and focus on the actual annual growth of 3.3 per cent - right on our medium-term trend rate of growth.

Public sector spending accounted for just 0.3 percentage points of the 1.2 per cent growth for the quarter. Consumer spending grew by 1.6 per cent and (because it makes up well over half of GDP) accounted for most of the rest.

Home building activity grew by 5 per cent, showing households have really started pulling their weight.

How can consumer spending be so strong when retail sales have been quite weak? Because there's a lot more to consumer spending than retail sales.

We get figures for retail sales monthly while we wait for the quarterly national accounts, so we watch them closely, but they take no account of many of the services households buy, nor the cars they buy. In this quarter, spending on cars was up 11 per cent. How could home building be growing strongly when local government home building approvals have been weak for quite a few months?

Because of lags in the system. There's a delay between new homes getting the council go-ahead and actual building starting. The recent downturn in approvals says actual building activity isn't likely to keep growing strongly.

The accounts show a sharp fall in the level of business inventories subtracted 0.7 percentage points from GDP growth for the quarter. But the volume of exports grew by 5.6 per cent, whereas the volume of imports grew by only 3 per cent, meaning "net exports" (exports minus imports) contributed 0.4 percentage points to overall growth.

Actually, the fall in inventories and the jump in exports are related. Bad weather caused a lot of Queensland coal to be stockpiled rather than shipped overseas in the March quarter, but there was a catch-up in the June quarter.

So that's where the growth came from in the quarter: consumer spending, home building and exports, with just a little help from government spending.

Notice something missing? Business investment spending recorded negligible growth during the quarter. But not to worry. We know from the capital expenditure survey that, relative to this time last year, businesses are expecting to increase their investment spending by 24 per cent in the present financial year.

Within that, mining investment is expected to be up 48 per cent. Now, the actual increase isn't likely to be so huge. But it will be big - so there ain't much doubt: the resources boom is back.

And the other sign of the return of the resources boom is the marked improvement in our terms of trade - the prices we receive for our exports relative to the prices we pay for our imports. The ratio improved by 12.5 per cent during the quarter and by 24.5 per cent over the year.

An improvement in our terms of trade means the same quantity of exports now buys a greater quantity of imports.

Guess what? That's one definition of getting richer. Whereas real GDP grew by 1.2 per cent during the quarter, real gross domestic income grew by 4 per cent. And now you know why.

As the nation's higher income circulates around the economy a lot of it gets spent and, as it's spent, jobs are created. So where's the impetus for greater consumer spending coming from now that the budgetary stimulus has largely been withdrawn? That's where.

In nominal terms, households' earnings from wages grew by 2.9 per cent during the quarter, with average earnings rising by 2.5 per cent and the number of employees up by 0.4 per cent. So this is what allowed consumer spending to grow by 1.6 per cent, even though it involved the rate of household saving falling from 3.4 per cent to 1.5 per cent of net household disposable income. Talk of resources booms makes people think of two-speed economies. The quarterly national accounts don't divide GDP by state, but they do divide up a poor substitute for it, "domestic final demand" (which is GDP before you allow for changes in inventory levels and for exports and imports).

Consider this. Nationally, domestic final demand grew by 5.3 per cent over the year to June. Three states had growth fairly close to the national average: NSW on 5.7 per cent, South Australia on 5.9 per cent and Victoria on 6 per cent.

Way above the national average was Western Australia on 7.9 per cent. Dragging down the average were Tasmania on a weak 2.6 per cent and Queensland taking out the wooden spoon with a pathetic 1.6 per cent.

Huh? Queensland in the slow lane? Yep. Its consumer spending and business investment spending are particularly weak. It's suffering a hangover in the residential and commercial property markets after a boom preceding the financial crisis. And the resources-boom-caused high exchange rate has hit Queensland's tourism industry as Australians take advantage of cheaper overseas holidays.

The broader lesson is that, for all the talk of a two-speed economy, the six states form one, highly integrated national economy. Income that arises in one state easily flows across state borders as it's spent.

Economists call this "the circular flow of income", but you can say what goes around comes around.

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House, marriage and children - in their own sweet time

The media leap on any suggestion of social change. At present there's talk of younger people being happy to keep renting rather than buy their own homes. Before that there was talk of career women not wanting children. And before that, we kept hearing about young people not bothering to get married, even after the kids had started arriving.

I guess there's some truth in all these stories. Perhaps the truth is that, whereas in times past just about everybody conformed to expected behaviour, these days a minority rebels. Or perhaps it's just that these days more young adults are turning to the conventional response later, rather than not at all.

But whatever the explanation, don't let an excitable media convince you the world is changing beyond recognition. Human nature's a bit more resistant. Things change, but not dramatically.

According to a new report from social researchers Ipsos Mackay, almost everyone in their 20s to mid-30s who participated in their group discussions wanted the "trifecta" of marriage, house and children. What's changed is they're a lot more flexible about the order in which they come and how long they take.

Young adults still want to see the world before they settle down. Perhaps these days it's easier for more of them to do so and they're inclined to make several overseas visits rather than just one extended working holiday. (Sometimes I wonder whether declining oil supply and concerns about greenhouse gas emissions will one day cause us to look back with longing on a golden age of international travel.)

One change is that, when young adults start to settle down, buying a property is often the highest priority. They're "keen to get started for fear of missing out," according to the report. So much so that some of them, unable to afford their own home, nonetheless seek a foothold in the market by buying an apartment and renting it out.

The fear of missing out - of delaying until the point where prices become unaffordable - is the very mentality that keeps prices rising, of course. It's a self-fulfilling prophecy.

The surprising thing is many years of strongly rising house prices seem to have done so little to dull the home-owning ardour of the next generation. They repeat their parents' conviction that rent is "dead money" and mortgage payments are no higher than rent (not really true).

They see property as a good investment and - in what may be an advance on their parents - a means of forced saving. Just so. Until the advent of compulsory superannuation, it had long been the case the main way Australians saved was to borrow a huge sum on their mortgage and spend the next 25 years paying it back.

Even where people continue to live in that home in retirement rather than trading down to a smaller and cheaper one, owning your home makes it a lot easier to live on the age pension.

Why is the next generation so keen to own the roof over its head? Because it creates "a sense of security and pride in ownership".

Just so. We all have an urge to own. I have a holiday house I love, but only rent. It took my head years to convince my heart I was getting the best of all worlds since the place was almost always available when I wanted it and I had no responsibility for the upkeep of the place. If the grass needs cutting when I roll up for a break, I experience not the slightest twinge of conscience.

The report says young people "invariably" rely on support from family. That's something all parents need to understand. The rise in house prices represents a transfer of wealth from the younger generation to the older. At the level of the individual, that wealth needs to be recycled from old to young if the young aren't to be dispossessed.

At the collective level, should sufficient recycling fail to occur, house prices would slip (which might be no bad thing). In the end, this generation sells its homes to the next. If the next generation can't stump up the money, prices will fall until they can. The remarkable thing is, so great is our continuing desire to own our homes that young couples keep finding the money from somewhere. One way they do it is by allowing housing costs to take up a bigger share of their weekly budgets than in earlier times. Another way is for wives to keep working and delay the start of their families.

There's the rub. According to the report, most young people accept the impossibility of buying property on one income. In theory, having two incomes makes it possible for couples to enjoy a much higher standard of living. In practice, the presence of two incomes, with their greater purchasing power, has simply bid up the price of houses. What began as an advantage to those couples able to command two incomes has become a disadvantage to those unable or unwilling to have the wife go out to work.

It seems to remain the case that most young people marry - eventually. What's changed is the variability in when in the process of acquiring a house and children marriage occurs.

Big weddings are fashionable and seem to have become more expensive - with the average cost said to exceed $35,000 - but the couple is now likely to pick up more of the tab. With prices like that, it's not hard to see it postponed to a more financially convenient time.

So marriage is no longer a major point of transition for many young people. On the other hand, the young adults covered in the report found having kids radically transformed their lifestyle. Now who among us oldies would ever have imaged that?

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Why political rivalry reduces voters' options

Simple economic theory tells us competition leads to increased choice. But as the election campaign showed, competition between the two main parties seems to be reducing the choice we're offered.

Before the election, many people complained about how unengaging the campaign was. It didn't seem to be aimed at people with brains. It seemed dominated by trivia. The two sides were locked in furious argument, but the policy differences between them seemed minor.

We were offered no real choice on climate change, industrial relations, the harsh treatment of boat people, the war in Afghanistan or economic management (the choice between a budget surplus in 2012-13 of $3.5 billion or $6.2 billion).

The main issues of genuine choice were the mining tax and the national broadband network. And even these didn't get a lot of attention. I'd like to believe the electorate's failure to decide which of the parties it wanted and its tendency to turn to minor parties and independents was a reaction to the unattractive choices we faced. Let's hope the pollies learn never to stage such an empty campaign again.

I don't deny the media's part in the campaign's superficiality. Every available diversion from serious discussion of policy choices was seized on. There was more "race calling" - Who won the leaders' debate? Which side won the week's campaigning? Who do the polls say is winning? - as politics was turned into a spectator sport rather than an earnest evaluation of policies.

One lesson from behavioural economics is that when consumers face excessive, confusing choice they tend to avoid making a decision. In this case, however, it seems it was lack of choice that caused voters to be so indecisive.

Most economists believe choice is a virtue in itself (true) and the more choice the better (above a certain point, not true). They love competition because their simple neo-classical model of markets predicts competition leads to wider choice.

So how come competition between political parties seems to be reducing choice? The simple market model rests on the assumption of "atomistic" competition: a large number of small sellers, none big enough to be able to influence the price, with each needing to give customers exactly what they want or be forced out of business.

In the modern world, few, if any, markets work that way. Much of our increased prosperity is owed to firms' pursuit of economies of scale. But this has created a tendency for firms to get much bigger and for many markets to be dominated by a small number of large firms.

Hence the real-world prevalence of "oligopoly". Clearly, under oligopoly - and duopoly, a form of it particularly common in Australia - there's only a small number of sellers and thus less choice, although each firm is likely to offer a full product range.

Under oligopoly, firms compete for market share, with increased share of the market being the main way they seek to maximise profits. But because each firm has a fairly big share of the market, each has the ability to influence the market price and thus affect the fortunes of the others.

This means competition in oligopolised markets takes on a form unknown in the basic market model: rivalry. Firms focus on each other and never make a move without first considering how their rivals may react to that move.

Here we're getting closer to competition in the political "market". Most people imagine governments, holding the reins of power, concentrate on deciding what to do and whether the voting customers are likely to react well or badly.

It's always a surprise to people to realise how much the behaviour (or expected behaviour) of oppositions influences the behaviour of governments. You and I may regard oppositions as largely irrelevant until the next election, but governments never do. That's rivalry.

Hugh Mackay says the key to competition is to focus on the customers and their needs, not your competitors and what they're doing. I think he's right, but it's tough advice to follow in an oligopolistic market.

The same goes for politicians. In their case, I think rivalry - obsession with your competitors - and the fear of taking a misstep help explain why both sides converge on the centre and adopt similar policies.

The market analogy takes us only so far. In a duopoly the two rivals share the market and fight for greater market share only at the margin. Politics, by contrast, is a winner-takes-all market. Lose the election and you get a zero market share.

Perhaps this all-or-nothing feature of political competition tends to make the parties more risk averse. Maybe it's the case that, just as oligopolists prefer to avoid competing on price, so the major political parties prefer to avoid competing on policy. In this campaign, both sides wanted to battle over perceptions of competence rather than my policy versus yours.

But this doesn't explain why the aversion to policy choice is relatively recent, why we now live in post-ideological times. I suspect the reason is the advent of what I call "scientific" politics, the rise of backroom specialists who use polling, focus groups and other market research techniques to peer into the minds of voters, particularly those judged to be swinging voters in marginal seats.

Knowing so clearly the likes and dislikes of key voters - chosen explicitly for their lack of ideological commitment - probably drives the major parties towards common ground, encourages pragmatism over idealism and prompts them to offer bribes rather than reforms.

Let's hope the hung parliament causes them to reconsider this form of scientific "progress".

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Numbers say we're growing quite nicely

The mildness of last year's recession means the economy has now entered its 20th year of growth since the deep recession of the early 1990s. But how has this growth been distributed through the economy? That's a question Ric Battellino, the deputy governor of the Reserve Bank, set out to answer in a most informative speech last week.

It's a question you can answer in different ways. For a start, since June 1991, 3.5 million additional jobs have been created, representing an average increase of 2 per cent a year. Income per household has risen in total by 30 per cent in real terms.

But this means employment grew faster than the population. How was this possible? Because there was a rise in the proportion of the population choosing to participate in the workforce and also because of a fall in the rate of unemployment from 9 per cent to a little over 5 per cent.

When you divide the growth between the states, however, it was quite uneven. Over the 18 years to 2008-09, Queensland grew at an average rate of 4.8 per cent a year, followed by Western Australia on 4.5 per cent. Victoria came third on 3.7 per cent. At the rear came South Australia, Tasmania and NSW on about 2.9 per cent.

But much of this faster economic growth came because of faster population growth. Queensland's population grew at the rate of 2.2 per cent a year, followed by Western Australia on 1.8 per cent, Victoria (1.2 per cent), NSW (1 per cent), South Australia (0.6 per cent) and Tasmania (0.4 per cent).

So it turns out when you look at growth per person - that is, at the growth in material living standards - much of the disparity disappears. Western Australia's average growth in real income per person of 2.7 per cent was just a fraction faster than Queensland's (2.6 per cent) and Victoria and Tasmania's (both 2.5 per cent). Then came South Australia on 2.3 per cent and NSW on 1.8 per cent.

Thus a 2 percentage point disparity in income growth between the fastest and slowest states was reduced to less than a 1 percentage point disparity after allowing for population growth.

Similarly, the disparity in unemployment rates isn't all that great, with most states ending up on 5.6 per cent, but with Tasmania on 6.5 per cent and WA on 4.4 per cent.

Another question is how the increased income over the period was distributed between households of different income levels. If you imagine it's got a lot more unequal, then you've been reading too many newspapers.

"Income relativities across the bulk of the population did not change much over the period, though the relative position of households in the top 10 per cent of the income distribution improved somewhat, and that of households in the lowest 10 per cent deteriorated," Battellino said.

One area where there has been sizeable differences in growth performance is between industries.

Over the 17 years to June 2009, Australia's total output grew at an average rate of 3.6 per cent a year and each of the 14 industry categories recorded positive growth in their output. But some grew faster than the national average and some grew more slowly than it.

Those growing at rates well above the average included financial services, professional and technical services, and construction. Those growing at rates well below the average included agriculture and manufacturing.

Now we've covered the differing growth rates, we can look at how the structure of industry has changed - that is, at industries' changing shares of the economy.

The financial services sector's share of total output (gross domestic product) has grown by a remarkable 3.8 percentage points to 10.8 per cent, making it now our biggest industry.

The financial sector has long grown faster than the rest of the economy in all the developed countries because we've been borrowing and lending more, saving more for retirement through pension funds (in Australia, because 9 per cent of wages is going into super funds) and doing more to manage risks by use of derivatives.

Just how sensibly based all this financial activity has been we may now question, following the global financial crisis and its revelations. It might not be a bad thing for the financial sector to grow at a slower rate than the rest of the economy in coming years.

The mining sector's share of GDP has grown by 2.7 percentage points to 7.7 per cent, probably the biggest it's been since the gold rush and bigger than any other developed country can claim.

Even so, that's probably not as big as many people have imagined from all the fuss about the resources boom. But with the growth of mining has gone the rise in the construction sector's share of GDP, by 1.1 percentage points to 7.4 per cent.

You may imagine that, to the extent it comes from the building of new mines and natural gas facilities, this increase in construction will be temporary. Not that temporary. The miners have plans to keep constructing new facilities for the rest of the decade at least.

Leaving aside China's continuing demand for our resources, if India keeps growing at the rates it has been over the past decade it will need huge quantities of iron ore, and much of that will come from Australia.

The growth in mine building probably also does much to explain the rise in the share of the "professional, scientific and technical services" sector by 1.8 percentage points to 6.1 per cent.

But if some industries' shares of the economy are getting bigger, others' shares must be getting smaller. The two stand-out cases are agriculture (down 0.7 percentage points to a mere 2.6 per cent of GDP) and manufacturing (down 4.6 percentage points to 9.4 per cent). So the past 17 years have seen manufacturing decline from our largest industry to our fourth largest (after financial services, education and health, and retail and wholesale). Remember, both agriculture and manufacturing are producing a lot more than they did in the early '90s; it's just that other sectors have grown faster.

Many people lament manufacturing's declining importance in our economy (and every other developed economy) as economies become more services-intensive and less goods-intensive and as the global growth in manufacturing shifts to the developing world. But as Battellino observes, manufacturing's small share of our economy has been one reason we fared so well over the past couple of decades (not to mention in the global financial crisis).

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Revolution of thinking voter turns politics green

Sorry but I'm not convinced a hung parliament is a terrible thing. It may end up being a good thing. I see it as the revolt of thinking voters against an election campaign that was aimed almost exclusively at unthinking voters.

Labor's been given an almighty kick in the pants but there was no enthusiastic embrace of the Liberals, whose campaign was almost completely negative. The parties should take it as a warning that if they want to win sufficient votes to form government in their own right next time, they should offer more sensible policies and arguments.

The big winner is the emerging third party, the Greens. Labor's share of the primary vote fell by almost 5 percentage points but the Coalition's share rose by only about 1.4 percentage points, with the Greens' share up by 3.6 points.

Those figures make it seem as though all the Greens' additional votes came from Labor. In truth, they show only the Coalition's net gain in votes, concealing those votes it too lost to the Greens. Had the optional preferential voting system been available, I'm sure many of those who voted for the Greens wouldn't have allowed their preferences to flow back to either party.

The swing to the Greens was even greater in the Senate, where their primary vote of almost 13 per cent is expected to give them an extra senator in each state, with some of those positions taken from the Libs. This will lift the Greens' total senators to nine, giving them the balance of power in the Senate from July next year and probably for at least the next six years.

So unattractive was the choice the main parties offered that I'm sure people voted Greens for various reasons. But no doubt concern about lack of "real action" on climate change was the most prominent. Consider the way people concerned about global warming - still a majority of voters - were dudded by the two main parties. Both went to the last election promising to introduce (similar) emissions trading schemes; both went to this election promising not to introduce such schemes.

As Dr Richard Denniss of the Australia Institute observes in a paper to be released today, this election has shown just how much of a challenge new issues such as climate change are for old political structures. Despite much of the election allegedly being fought on economic management, neither Labor nor the Libs had to explain how they could claim to be "good economic managers" yet they were determined to ignore all economic evidence about the best way to tackle climate change.

The Libs describe their approach as "direct action" - which translates as support for the regulation and government intervention once primarily associated with Labor. Labor's major contribution to the climate change policy debate during the campaign was its proposal for a "citizens' assembly", which sounds reminiscent of the Greens' historical preference for "consensus-based" decision-making. "The Greens, on the other hand, have been pushing for the economic rationalist approach of relying on a carbon tax and price signals," Denniss says.

Despite the Liberals' pious condemnation of waste in the campaign, most of their direct action policies would be riddled with waste, with the likely cost per tonne of emissions reduced by their subsidy schemes far exceeding any price per tonne contemplated under emissions trading or a carbon tax. The same is true of Labor's proposed cash-for-clunkers scheme.

The parties' failure to gain a majority in their own right means neither can claim a Mandate for the policies they took to the election. The side that finally reaches a deal with the independents will probably have had to change its policies to achieve that deal.

But this sudden need for policy flexibility in response to unexpected circumstances could be good news for those silly sausages who worry about saving the planet. By my reckoning, three of the four members expected to hold the balance of power in the lower house - the three country independents and the Greens MP for Melbourne - accept the need for a price on carbon. And then, of course, there's the Greens' balance of power in the Senate.

There's no substitute for a government with a logically consistent set of policies (and no reason only one major party should have a monopoly on the desire to save the economy from the ravages of climate change). But for the benefit of those independents - or anyone else - seeking a coherent approach to the problem, the Australia Institute's paper, Once More With Feeling, sets out six principles for good policy design.

First, remove subsidies that encourage the use of greenhouse gas-emitting fuels. These include the concessional taxation of company cars and (controversially for the country independents) the fuel tax credit scheme.

Second, introduce a price on greenhouse gas emissions. Given the rejection and abandonment of Labor's carbon pollution reduction scheme, a simple carbon tax - as already proposed by the Greens - may be the best starting place.

Third, remove existing subsidies to renewable energy that don't deliver low cost of abatement or help develop a domestic industry. For instance, the present subsidy for photovoltaic solar panels on rooftops has been found to cost $447 per tonne of emissions avoided. As for developing a local industry, the panels are imported.

Fourth, invest in public transport and other infrastructure to ensure consumers can more easily respond to the higher price of fossil fuels.

Fifth, regulate to enhance energy efficiency where existing market failures reduce the ability of higher energy prices to achieve reduced energy consumption.

And finally, provide business investors with certainty about the direction, if not the destination, of legislative change.

Two-party government has reached a sad state when neither side is offering such a sensible - dare I say, rational - approach to our greatest and most pressing economic threat.

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Voters censure Labor's lack of principles

The one thing we can be sure of is Labor has suffered a huge reverse. While we wait to learn which party will form government, it's instructive to ponder what it did wrong.

By all the rules of federal politics, Labor should have romped home. The rules say first-term governments get an extension to finish proving their worth. They say governments get tossed out after they've allowed the economy to bomb, not after they've seemingly avoided a recession. They also say voters distinguish between federal and state. But one rule has stood up: oppositions don't win elections, governments lose them. This disaster for Labor is its own fault.

Labor has been a remarkably timid government. Saturday's failure could make it even more so, but that would be fatal. Similarly, the conclusion Labor's reversal was caused just by a bad election campaign would be delusional.

No, if Labor wants to learn from its drubbing it needs to draw the obvious lesson: voters punished it for its lack of principles. Those who still voted for it did so with no enthusiasm and many registered their protest by turning to the Greens.

The great paradox of politics is that though voters hate change and hip-pocket pain, they want to be led by people with convictions and the courage of them. First Kevin Rudd and then Julia Gillard were too conscious of the former and oblivious to the latter.

Every politician wants to be re-elected, but good politicians don't want just to preside over the economy and keep it on track, they also want to reform it. They understand the hard part of politics is getting re-elected and making reforms. When the going got tough, Rudd threw overboard the economic reform that, along with rolling back the Work Choices false reform, had been at the centre of his case for election: introduction of an emissions trading scheme.

The end of Rudd's remarkably long honeymoon with the electorate can be dated to his decision to give up on climate change rather than fight for its approval by a joint sitting following a double dissolution.

Even those relieved to be free of a "great, big, new tax" were shocked by such a cowardly repudiation of one of Labor's core values. Sensing this, the Liberals immediately switch from criticising the scheme to criticising Labor's abandonment of its "greatest moral challenge". With this act Labor sent the electorate a signal: we're not moral.

When Gillard deposed Rudd and set about getting the government back on track she had an opportunity to redeem the position to some extent, but again Labor's lack of conviction let it down. She toyed with taking tentative steps towards a carbon price, but in the end decided on a gimmick the public instantly saw through: the 150-person citizens assembly. The end of Gillard's own brief honeymoon can be dated to that gutless decision.

Voters work on instincts and impressions, not rational analysis. They can smell a politician who puts self-preservation ahead of the national interest. They can smell it even when they're not sure they fancy the measures need to advance the national interest. And they're never impressed. But Labor's loss of principles extends beyond its loss of core belief in the need for reform. It also involves standards of acceptable behaviour in public life. It's now clear many voters were repelled by Labor's ruthless treatment of Rudd, and by Gillard's part in it despite all her protestations of loyalty.

No policy reform principles and no personal principles turned out to be a deadly combination. Gillard stands revealed as little more than a careerist. Such people never endear themselves to the electorate.

Labor should dispense with the unprincipled Sussex Street thugs who were behind-the-scenes urgers on every major false step it made in its first term. It was they who (acting behind Gillard and Wayne Swan) persuaded Rudd to abandon his climate-change commitment, they who staged his beheading in a way that offended so many Labor supporters and they who advised Gillard to rush to an election while her honeymoon lasted, when she should have allowed more dust to settle and given voters more time to get to know her.

These are the same geniuses who've brought us the debacle of the Carr-Iemma-Rees-Keneally government (which itself contributed to Gillard's drubbing). They're uncomprehending bunglers of the first order. They're so ruthless and cynical they've lost consciousness of the electorate's basic decency.

They're all expediency and no values, all tactics and no strategy. But with all their pragmatism and tricky tactics, they can't deliver the goods.

Labor must abandon its obsession with controlling the 24-hour news cycle. The spin doctors kept Rudd in control of the news for the best part of three years, but where did that get Labor in the end? This preoccupation with control and an unending stream of trivial "announceables" distracts ministers and their departments from real work. The excessive control antagonises the press gallery, which waits its chance to strike back when you're vulnerable (as Rudd discovered as soon as his ratings slipped).

Apparatchik Labor's lack of convictions saps it of the will to fight for needed but controversial reforms; the 24-hour spin doctors' dark arts sap it of the ability to fight. It's a snare and a delusion. Senior ministers get so used to relying on media stunts and emotional button-pushing their ability to explain and defend complicated policies atrophies.

That Labor ended up on the defensive over its enviable economic performance shows how badly it was served by its media minders. Their stock in trade is always to change the subject, never to stand and fight; to bamboozle, never to educate.

Labor's Hollow Men period has brought it disaster. Time to recover some values.

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The deficit we really should worry about

The biggest and most worrying deficit in this election campaign has been the policy deficit: the reluctance of both sides to debate any aspect of economic management bar the budget.

What has passed for economic debate has proceeded from the proposition that the federal budget equals the economy. So let's see if we can get through a discussion of our economic policy challenges without further mention of that instrument.

The most obvious disappointment about this campaign is both sides are pledging to do nothing serious in the coming three years about the greatest and most pressing threat to the economy: climate change.

Left unchecked, climate change is likely to destroy or significantly damage much of our stock of private and public physical capital. To avoid the small cost of growth forgone as we tackle the problem, we're willing to risk incurring much greater losses.

Because of both sides' unwillingness to impose on voters unpleasantness roughly akin to the introduction of the goods and services tax, they're willing to waste taxpayers' money on ineffective incentive schemes while also causing the cost of eventual action to be higher than it need be. (That's assuming we wake up before we reach the point where the damage has become irreversible.)

At a more conventional level, the glaring need neither side seems to have noticed, much less wanted to do anything about, is what could be called our productivity deficit: after perking up mightily in the 1990s, our rate of productivity improvement - measured as output per hour of labour - slumped throughout the noughties.

What should we be doing to lift our productivity performance? That's what we should have been debating over the past five weeks. Failing that, it's a question we should be setting our minds to during the coming parliamentary term.

One reason we haven't had more soul-searching over the productivity deficit is that its adverse effect on our rate of economic growth - and continually rising material living standard - has been offset by the resources boom.

National income has been growing strongly because the world has been paying so much more for our coal and iron ore and because investment in new mines and facilities has been so strong. This looks likely to continue for some years yet.

But with this easy prosperity come two challenges: cyclical and structural. The mildness of the recession means we're already close to full employment, so it may not be long before the Reserve Bank is struggling to control a booming economy with interest-rate rises.

Neither public nor politicians has any real understanding of the way being at full employment constrains our ability to press ahead with every job-creating project we dream up. We're locked in a deficient-demand world view.

The structural problem has two elements: worrying about the perceived Dutch Disease problem (the temporarily high exchange rate wipes out other export industries, particularly manufacturing and tourism, so we're left with a vacuum when the resources boom ends) and deciding how to ensure we gain some lasting benefit from all the extra revenue flowing into government coffers.

If we're not careful we could end up with the same disastrous solution to both problems: pumping a lot of taxpayers' money into propping up declining manufacturing industries in the name of "value-adding". Their weak performance in this campaign suggests both sides are capable of such madness.

Our non-mining future lies in high-value services, not manufacturing, so the right answer is to increase our public (and private) investment in education, training and research. All such investment should raise our productivity in due course.

We all know our present social and economic infrastructure leaves much to be desired. We'll need to put a lot more money into it but this campaign's obsession with that thing I promised not to mention again suggests that, whoever wins, we won't be spending (and thus borrowing) as much as we need to.

Infrastructure investment adds to demand in the short term but also adds to supply (production capacity) in the medium term and productivity improvement (output per unit of input) in the longer term.

So, remembering our full-employment constraint, a great challenge facing the economic managers will be to (temporarily) constrain consumer spending to make room for more business investment and public infrastructure spending.

How? Good question. Maybe we could speed up the phased increase in compulsory superannuation saving.

Remember, however, that part of the solution to inadequate infrastructure is to use the existing infrastructure more efficiently. That means better pricing of it (with the net proceeds from that pricing also helping to fund additional investment). But better pricing requires a little political courage, something neither side has displayed in this campaign.

One area where supply-side reform is urgently needed is housing, where housing construction has fallen well behind the formation of additional households, forcing up house prices and rents. We need to remove the state and local governments' obstructions to medium-density housing and the release of serviced land.

The issue of population growth and immigration was raised in the campaign but not properly debated because both sides were just using it to dog-whistle about boat people.

The unthinking advocates of high immigration need to understand it makes a negative contribution to productivity improvement (by worsening the ratio of physical capital to labour) and demands increased investment in business equipment, housing and public infrastructure.

Unless the goal is growth for its own sake, it's a dumb way to go about raising material living standards (except those of the immigrants). It also greatly increases our difficulty in achieving targets for the reduction of our emissions of greenhouse gases.

It's all very well for the advocates of high immigration to say the underlying problem is one of inadequate infrastructure, not immigration as such. What do they propose to do about it - abolish the states? Who will pay for the extra infrastructure (on top of the existing backlog) and how will it be financed? By privately issued, but heavily publicly subsidised (and at least implicitly government-guaranteed) infrastructure bonds? That'll fix it. Not.

We do need to undertake a careful, evidence-based examination of what is a "sustainable" population, in which the economists, technological optimists and natural scientists box it out. All sides need to confront the elements of truth in the other sides' positions.

All this is what Julia Gillard and Tony Abbott should have debated over the past five weeks, but didn't. Whoever wins, the economy will lose.

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Both sides fall victim to budget humbuggery

It's not just Tony Abbott who has been running from a debate on the economy. Both he and Julia Gillard have avoided serious discussion of the economy in this election.

Federal election campaigns usually focus on the economy, but this time both sides have been obsessed with something much narrower; the federal budget.

Managing the economy involves concern about inflation, unemployment, interest rates and - conventionally - what is needed to promote economic growth and further raise our material standard of living.

Promoting economic growth is about reforming government intervention in markets, reforming the tax system so it does less to discourage or distort economic activity, devoting sufficient resources to education, training and research, and ensuring adequate provision of infrastructure.

These days, it also involves taking steps to ensure the malfunctioning of the natural environment doesn't impose great costs and disruption on the economy - through climate change and other problems.

In that agenda, the federal budget is just a management tool, a means not an end in itself. And yet that's what it has become in this campaign.

Abbott's mantra has been his promises to ''end the waste, repay the debt, stop the new taxes and stop the boats''. The last of those is clearly non-economic, but the first three aren't so much economic as budgetary.

Why this diversion? Because, when you haven't thought much about the future or aren't game to broach in an election campaign the unpopular changes you know are needed (such as Gillard on climate change), all that leaves is the state of the economy.

Trouble is, it's going quite well. We have inflation and unemployment back under control. Interest rates are lower than they were at the last election.

Of all the developed economies, the one with the least cause for worry about the size of its budget deficits and the amount of its government debt is Australia. But the punters don't know that, and ''deficit'' and ''debt'' have such negative connotations they're an easy way to scare the untutored.

Most of the debate on deficits and debt has been silly and plays on voters' unsophistication. Both sides have solemnly promised what neither may be able to deliver: a budget surplus in three years time. Economists are hopeless at forecasting the economy, but projections of budget receipts and payments depend on those forecasts.

Though neither side is willing to admit it, should the world economy dip back into recession and China's demand for our exports falter, the budget will still be in deficit - as, in those circumstances, it should be.

Whether we return to budget surplus in three years or five matters little to the well-being of Australians. So great are the uncertainties that Gillard's promise of a surplus of $3.5 billion in 2012-13 and Abbott's promise of $6.2 billion are indistinguishable.

The squabbling over the costs of each side's promises is literally unreal. While, unsurprisingly, Treasury and the Department of Finance have a monopoly over the ability to produce costings they agree with, their record in predicting the ultimate cost of new policies is quite poor.

Both sides have made many expensive promises in this campaign, many of them involving waste. Both sides claim to have identified savings sufficient to cover the cost of their promises (and more in Abbott's case).

But if they were as worried about deficits and debt as they claim to be, they would have devoted all of those savings to reducing them.

What has passed for economic debate in this campaign has been dominated by narrow thinking, humbuggery, false precision and pseudo importance. Heaven help us.

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Labor deserves credit, not death at ballot box

We may live in a globalised world but it hasn't made our election campaigns any less parochial and inward-looking. Perhaps in an effort to raise Australians' economic literacy, the Economic Society recently sponsored a national tour by Professor Joe Stiglitz, a Nobel prize winner and one of the world's most illustrious economists.

Some brave soul asked him if he'd learnt anything while he was here. Well, he said politely, there were a few things that had puzzled him. He couldn't understand why we didn't know the success of the Rudd government's budgetary stimulus - explained by its size, timing and design - was the envy of the other G20 countries.

He couldn't understand why we were so worried about budget deficits and debt when our accumulated federal government debt was about 5 per cent of gross domestic product, whereas just one year's budget deficit in the US was 10 per cent of its GDP. And he couldn't understand why so many people were opposed to requiring the mining companies to pay a fair price for the use of our resources.

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Now more than 50 Australian economists have issued a statement saying they're ''convinced by the evidence that the co-ordinated policies of the Australian Labor government have prevented the Australian economy from a deep recession and prevented a massive increase in unemployment''.

Economic management is the dominant issue in almost every election campaign and I don't imagine it's much different in other countries. But that Labor could be in danger of losing the election after doing such a good job of guiding the economy through the worst global recession in 70 years is remarkable.

The usual pattern is for governments to be re-elected until finally they preside over a recession, when they're promptly tossed out. That's true of the Whitlam government (recession of the mid-1970s) and the Fraser government (recession of the early '80s). It's also true of the Hawke-Keating government (recession of the early '90s) although, thanks to the miscalculations of John Hewson, Paul Keating's execution was delayed until 1996.

The exception to the rule is John Howard. After more than 11 years he was tossed out without presiding over a recession. Indeed, the economy was booming at the time.

I have to admit that, back in 2007, I thought this wasn't a good election for Kevin Rudd to win. A recession was overdue, it was bound to occur within his first term, he'd get the blame and be tossed out after only three years. Right risk; wrong logic.

Much more than in the past, this downturn was very much the cause of external factors, in the form of the global financial crisis. But to the surprise of close observers, including the government and its econocrats, the recession proved to be so mild and short-lived many people have concluded there wasn't one. I'm sure many people who don't follow these things closely have since concluded the whole thing was a media beat-up.

(The media didn't invent the collapse of various local fringe financial institutions, nor the 0.8 per cent fall in real gross domestic product in the December quarter of 2008 and the weak growth in later quarters, nor the 230,000 rise in unemployment and the bigger rise in underemployment, nor the much tougher borrowing conditions for small business, nor the present weakness in retail sales and home building as the effects of budgetary stimulus have worn off.)

Many factors contributed to the mildness of our recession: the absence of serious banking problems, the strong growth in immigration, China's rapid bounce-back following its own massive stimulus, and the Reserve Bank's 4.25 percentage point cut in the official interest rate.

But like most (although, of course, never all) economists, I have no doubt about the central role of the Rudd government's large, early and carefully targeted budgetary stimulus. Its impact is clear from the statistics, including the remarkably early recovery in business and consumer confidence.

Most voters aren't interested in that kind of causal detail, of course. By their usual simple standard - did you or didn't you preside over a noticeable recession? - the government has passed with flying colours. So why isn't it coasting to an easy election win?

Partly because of its chronic inability to explain and defend its policies. But also because, if anything, the government has been too successful at staving off the usual symptoms of recession. There's little sense of gratitude, or even relief, because the period of fear - of losing your job, of wondering whether you might lose your home, of watching your kids spend months seeking a job - was too brief.

Our adversarial political system means the opposition always needs to find fault with the government's performance. It would dearly love to have been able to berate the government for its failure to hold off recession and prevent a huge rise in unemployment.

In the absence of that, however, the Liberals have switched to the claim that Labor has been on an unnecessary spending spree. It has racked up a frightening level of government debt to be left to our grandchildren and, if that wasn't bad enough, most of the money has been wasted.

There has been waste. Trying to spend money quickly means a degree of waste is inevitable. But with the willing help of sections of the media, the Libs have left voters with a quite exaggerated impression of the extent of that waste.

We're being asked to believe Rudd and Julia Gillard invented government waste. It never occurred under Howard and would never occur under an Abbott government.

But in all the hypocritical talk of waste, a far more important form of waste has been forgotten: the waste of material production and the waste of human well-being had the rise in unemployment not been stopped at 675,000 souls and been allowed to reach the 1 million originally feared.

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Blowing the whistle on unfair costings game

I refuse to dignify the parties' predictable squabbling over the cost of each other's promises by taking it seriously. I don't know who's right and I don't much care. There are more important things to worry about. It's a three-yearly farce that drips with hypocrisy and fake importance.

I'm not sure why the parties always fall to furious arguing about Costing Blunders. Perhaps it's always started by the government of the day - because it's seeking to exploit the advantage of incumbency - and whoever's in opposition feels obliged to muddy the water by sniping back at the government.

These arguments are so arcane I'm sure the swinging voters at whom election campaigns are aimed take zero interest. So perhaps the pollies carry on about costs because it makes them look active and responsible, while distracting journalists from inquiring into more important matters.

It's the gross unfairness of the game that turns me off. Governments have year-round access to Treasury and the Department of Finance to get their costings done by the experts, using a process of iteration: "If you do it that way, minister, it will cost you 2X, but if you change this detail here the cost falls to X."

Governments pepper the econocrats with what-if questions in the weeks before the start of the election campaign. So only if they really cock things up are their costings ever found wanting when their promises are submitted to the people who costed them in the first place.

Oppositions, on the other hand, get no access to such official advice. They have to hunt for clues as to what things cost or pay an accounting firm big bucks to do their costings and, likely as not, get them wrong because the relevant information is so closely held by the econocrats.

This game of both sides submitting their promises to the econocrats for costing arose from Peter Costello's Charter of Budget Honesty. He knew it was stacked in the government's favour. Labor whinged repeatedly about the unfairness of it all and sought to minimise the (high) risk of embarrassment by submitting its costs at the very last minute.

In power, however, Labor's reforming zeal evaporated and it has delighted in turning the screws on the Libs as they did on it. And these guys wonder why they have lost so many supporters and are struggling to win what should have been their easiest-ever election.

Lemme give you a tip, Wayne: "We're no worse than the other lot" isn't a great rallying cry.

In opposition Labor lacked the courage to challenge this unfair arrangement but, fortunately, the Natural Party of Government had no such inhibitions. It has used the occasion of the leak of a flaw in its costings (more likely to have come from Labor than the econocrats) to refuse to submit further promises.

Good. If oppositions refuse to play ball, some government will be obliged to introduce a fairer system if it wants to stay in this silly game.

Because they're not in government with the econocrats' advice on tap, all oppositions have difficulty saying how they would pay for their promises. They are never game to give the honest - and quite satisfactory - answer: if we win, Treasury will tell us how - that's what it's paid to do.

Treasury and Finance know where all the waste is. They also know how to tweak promises in ways that greatly reduce their cost.

So great is the pollies' proclivity for solving problems with a chequebook, however, that neither side has been able to stick to its vow to find savings to cover all the cost of its promises over the "forward estimates" (that is, until June 2014).

They searched out a loophole: promise to spend money beyond the forward estimates. According to my colleague Jessica Irvine's estimates, by last Wednesday Labor had made promises worth $6.6 billion in this never-never land, while the Libs had IOUs worth $6 billion.

No doubt both figures are higher by now. It's remarkable to think the punters' votes are being bought with promises to spend money after the next election.

While we're on the subject of government spending - when have we been off it ? - I trust you noted Tony Abbott giving notice at his campaign launch that, should he win, he'll pull the standard trick of incoming governments: declare a fiscal crisis and introduce a horror budget.

He said he would set up a "debt reduction taskforce" in his first week to "get to the bottom of Labor's waste and mismanagement, to see the real state of the government's books and to prepare a comprehensive plan to start repaying Australia's $90 billion debt". In one month an economic statement would be issued "outlining Australia's risks and opportunities and the new government's response to them".

It's known in the trade as Doing a Mother Hubbard. You come to office, discover to your horror the cupboard is bare, and say you have no choice but to break promises and make emergency spending cuts you didn't mention in the campaign.

It's a harder trick to pull off these days because the Charter of Budget Honesty's "pre-election economic and fiscal outlook" statement, signed off by the econocrats early in every campaign, is designed to ensure everyone knows the latest state of the books.

But Abbott would claim the extent of wasteful spending was far worse than expected. In politics, a wasteful program is one your heartland supporters have no interest in.

That's the point. Though some effort would be made to reduce net spending, the objective is to cut out your predecessors' pet programs and replace them with your own.

Should Abbott win, he's already taken out fiscal insurance.

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Miners moan, but we need our fair share

It's easy to forget that the future of the minerals resource rent tax - the most significant tax reform since the goods and services tax was introduced a decade ago - hangs on the outcome of this election.

Should Tony Abbott win, he won't proceed with introducing the mining tax in July 2012, meaning he won't proceed with most of the tax concessions the new tax would pay for.

Labor has justified the tax as necessary to give Australians a fairer share of the profits from mining the now hugely more valuable coal and iron ore deposits the community owns. Exploitation of these resources is subject to royalty charges levied by state governments, but these payments have failed to keep up with the resources' higher market value.

Against this, the Liberals have claimed this "great big new tax" would do great damage to the mining industry and hence the economy. The big three mining companies - BHP Billiton, Rio Tinto and Xstrata - initially agreed with this claim, but dropped their objections after the incoming Julia Gillard did a deal with them that significantly watered down the original "resource super profits tax".

However, the smaller coal and iron ore mining companies - which weren't part of the deal - now believe (correctly) they were dudded by the big boys and have continued their opposition, claiming the tax means "families will be hurt with job losses in every community across Australia".

It's not hard to see why miners would object to paying more tax, but the tax was recommended by the Henry tax review and it is hard to see why these eminent economists would advocate a tax that could damage the economy.

The very reason for levying a tax on the "economic rent" derived from mining (that is, on the "super-normal profit" earned in excess of the "normal profit" needed to keep the mining companies' resources employed in the mining business) is to ensure the tax does not discourage mining activity.

Indeed, the review argued that, as well as raising revenue that could be used to reduce other, less efficient taxes, the resource rent tax would tax the resources sector more efficiently. That is, over time it would lead to a bigger mining industry, not a smaller one.

As originally proposed, the tax had three main advantages in terms of encouraging the efficient allocation of resources. First, using an increase in the tax on immobile resources (such as minerals) to finance a reduction in the tax on internationally mobile resources (such as financial capital, via company tax) would improve Australia's ability to compete against other countries in attracting foreign investment.

Second, using the tax to effectively replace state royalties would do much less to discourage mining activity. Royalty payments are inefficient because they're levied either on the volume of minerals mined or on their market price. This means royalties take no account of the cost of mining the minerals, which varies with the quality of the mineral being mined and how hard it is to get at.

The effect is to discourage the mining of low-grade deposits and discourage miners from continuing to mine the more costly, deeper-down minerals once the less costly stuff near the top has been won.

Third, the royalty system does nothing to recognise the high risks involved in setting up a mine. You can spend a lot of money, then discover it isn't profitable after all. The royalty system ignores all your costs, but starts charging you from the first tonne you manage to produce.

The great (but much misunderstood) beauty of the original resource super profits tax was it went as close as it practically could to the symmetrical treatment of profits and losses. You'd pay 40 per cent tax on your net profits, but if you incurred a net loss the government would cover 40 per cent of it. If you couldn't immediately deduct the 40 per cent from other mining tax payable, you could carry it forward, with its real value preserved by indexation to the long-term bond rate. If you abandoned the mine as unprofitable, the taxman would refund 40 per cent of your indexed accumulated loss.

Many critics of the tax got terribly muddled over this unfamiliar arrangement, accusing the government of using the (risk-free) long-term bond rate to measure the economic rent, when everyone knew you should use the risk-adjusted rate of return.

They failed to see it was the government guarantee of 40 per cent of losses that took account of risk. This recognition of risk meant fewer firms would be discouraged from undertaking risky investments by the tax system's failure to make adequate allowance for those risks.

So, as originally designed, the mining tax was highly efficient in its effect on the allocation of resources. Trouble was, it would have raised more than double the revenue Treasury originally estimated. That was the real thing bugging the big three companies.

Gillard should have responded merely by halving the rate of the tax from 40 per cent to 20 per cent. Instead, she cut it to an effective 22.5 per cent and butchered its design for good measure. In the process, she greatly reduced - but didn't eliminate - its efficiency benefits.

Originally, the tax involved a complete, up-front rebate of state royalties; now all you'd get is a deduction against any mining tax you owe. Originally, the tax applied to all minerals; now it applies only to coal and iron ore, with an exemption for those firms owing less than $50 million in mining tax. Originally, 40 per cent of losses were guaranteed by the government; now 7 percentage points have been added to the bond-rate "uplift factor" (which arbitrarily leaves some projects better off and some worse off).

It was always the case that virtually all the new tax was to have been paid by the big three companies; in some years, more than all. In other words, excluding the other minerals and the coal and iron-ore tiddlers may actually have saved the government revenue. If so, those other firms are worse off under the changes. They'd remain subject to all the drawbacks of the state royalty system. And fewer mining projects are likely to be started because their potential promoters will find the prospect of early losses more daunting.

Even so, a butchered mining tax would be better than no mining tax.

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Gillard's Law of economics at a crass roots level

Frederick Taylor, the American inventor of "scientific management" a century ago, believed workers were dumb and lazy. So the tasks they were required to perform had to be broken down into the simplest of steps and they needed to be closely supervised. The only way to motivate them was by paying piece rates - what today we'd call "performance pay".

I'm sure Julia Gillard would never admit to regarding "hardworking Australians" as dumb and lazy. But she believes school teachers need to be spurred to greater effort by "a bonus payment under a new performance framework".

This is in addition to her plan for rewards of up to $100,000 to the 1000 schools that each year show the most improvement in attendance, literacy and numeracy or, in the case of high schools, year 12 results and the number of students going on to further education, training or work.

Top performers, about 10 per cent of teachers, would receive annual bonus payments of between $5400 and $8100, determined by the achievement of their students, their contribution to the school community and their participation in extracurricular activities.

I doubt the wisdom of this idea. I can understand why company boards feel they need to pay executives extra money to get off their backsides but teachers are meant to be professionals and it's a strange way to treat professionals.

Gillard professes to hold teachers in great respect (do I feel an election coming on?) but I suspect many of them would be amazed to hear it.

It's said the one thing economists agree on is: incentives matter. Trouble is, most economists assume the only incentives that matter are monetary. It wouldn't occur to them that offering teachers money for "contributing to the school community" contains a contradiction.

Teachers contribute to the school community and take part in extra-curricular activities because they want to. I've seen teachers putting extraordinary amounts of their time and effort into preparing kids for a school play, coaching debating teams and so forth. They do it because they regard the activity as worthwhile and of benefit to their kids, but also because they enjoy doing it.

It would be nice to think these intrinsic motivations - doing things for their own sake - could be pepped up by adding money (an extrinsic motivation, where you do things because of external benefits they bring). That's what economists assume can be done. Gillard, clearly, has started thinking like an economist.

But as I discuss in my new book, The Happy Economist (Allen & Unwin), psychologists have discovered it doesn't work that way. Economists have something called Gresham's Law: bad money drives out good. It turns out monetary motives drive out non-monetary motives.

Once you start paying people to do good works the selfish, materialist mentality takes hold and they stop doing those things unless they're paid. People who did good works because it made them feel good about themselves no longer feel that way. Those who contribute to the school community without winning a bonus may be discouraged in their well-doing.

So, should this scheme be implemented, don't expect a surge in School Spirit (as it was called at my school) and don't be surprised if it leads to a decline in teachers' second-mile contributions.

If I'm right, we will have discovered Gillard's Law.

This crass attempt to motivate teachers is symptomatic of the election campaign. More than ever it's been obsessed by money: budget deficits, public debt, wasteful spending. The only major non-monetary issue has been our intense objection to foreigners entering our territory without permission.

Both sides conduct their campaigns on the assumption we're quite selfish and mesmerised by money. For individuals, both sides have rolled out monetary bribes: cash for clunkers, higher family benefits for the parents of teenagers, incentives for age pensioners to do paid work, a more generous paid parental leave scheme. For marginal electorates, a new road or building.

Although it's been hidden by the negativity of this campaign and its obsession with budgeting, the underlying assumption of both sides is that the job of governments is to continually raise our material standard of living because this is what will make us happy.

They seem oblivious to the evidence, recounted in my book, that decades of rising living standards have done nothing to increase people's happiness or "subjective well-being".

It's time politicians reached a more enlightened view of what they could do to increase national happiness. They could start by rethinking their attitude to work.

The economists' model assumes we work only for the money it brings us. The rationale for Work Choices was: give employers more freedom to hire and fire, to call people in to work at times when it best suits the business without penalty payments, and the greater efficiency with which labour is deployed will raise our material standard of living to the benefit of all.

In truth, most people gain a lot of satisfaction from their work. That satisfaction can be diminished if people become less secure in their jobs and in the hours and days of the week they'll be required to work. An understanding of this seems implicit in Labor's opposition to Work Choices and in Tony Abbott's promise not to reintroduce it.

But why not make that understanding explicit? If work is a primary source of our happiness - as the evidence says it is - why not encourage employers to see the provision of secure, satisfying work as an end in itself, a primary reason for the existence of the business?

Why not help employers see that happy workers contribute more to the success of the business (or the school) - as the evidence increasingly says they do?

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