Far too much economic news for our own good

Ian Macfarlane, the former governor of the Reserve Bank, thinks Australians get too much news about the economy, and this surfeit actually worsens the decisions we make about investments.

At the risk of being drummed out of the economic journalists' union, I suspect he's right. But I'll let him do the talking (he was delivering the Mosman Address at Mosman Art Gallery on Friday night).

Over the past couple of decades the public has been inundated with economic statistics, he says. "The newspapers and magazines are full of economic news, television reporting is saturated with it, there are special radio and television programs devoted to it."

It's true this is a worldwide phenomenon, but it's more pronounced in newspaper coverage in Australia. Foreign visitors often express surprise at how much economic coverage there is in Australian papers, particularly on the front page.

A few years ago the Reserve compared the coverage of central bank monetary policy decisions in three countries: the US, Britain and Australia. It looked at three comparable papers in each country, including The Australian Financial Review, The Australian and The Sydney Morning Herald.

Adding up the number of articles in the three days surrounding two successive monthly monetary policy meetings, it found 35 in the US, 46 in Britain and (wait for it) 131 in Australia. Looking just at articles on the front page, there was one each in the US and Britain, but 14 in Australia.

Why is there so much more economic coverage in Australia than elsewhere? Maybe because there's not much other news to report.

"We are not an international power or trouble spot, we are not engaged in major wars, we do not have racial riots, civil insurrections or sectarian violence. And the private lives of our politicians are not as lurid as British ones (or a recent American president). So instead our newspapers are taken up with recent figures on employment, interest rates, the consumer price index or the budget," Macfarlane says.

[There's an alternative explanation, however. In the US and Britain the link between changes in the official interest rate and changes in mortgage interest rates is quite loose, whereas here it's direct and immediate.]

"With the media competing so strongly against each other, there is inevitably a bias towards sensationalism. While Australia has a few experienced and thoughtful economic commentators who are world class, it also has a multitude of eager beavers who are mainly concerned with tomorrow's headlines," Macfarlane says.

"They try to extract the maximum amount of coverage out of each ephemeral piece of news - monthly or even daily figures are invested with a significance well beyond their actual information content."

Interest rates don't merely rise, they "soar", the exchange rate "dives" or "plunges" and budgets "blow out". The reader is left with the impression of constant action and turmoil. The recurring television image is of people in dealing rooms or on the floors of futures exchanges shouting at each other.

Another feature, he says, is the tendency to concentrate on pessimistic news. It's the nature of all journalism - not just economic - that its practitioners seek to expose a disaster or a conspiracy.

No one ever wins a prize in journalism by pointing out that things are proceeding relatively smoothly and uneventfully, hence the tendency to find bad news and mistakes in policy, and to label every minor glitch as a crisis (the most overworked word in journalism).

"At the margin I believe all this news tends to make us less confident, less secure and less happy than if we had less of it," he says.

But does all this information make us better at doing our jobs or investing our savings? Macfarlane says a broad range of information is better than a narrower one, but more frequent information about a particular thing may stop us seeing the wood for the trees.

More frequent information also exposes us to the "narrative fallacy" - our need to tell a story about why a movement in an economic variable occurred, even if it's just a small daily movement in the exchange rate or the sharemarket. Often the movement is just random noise, but we can't say that.

Macfarlane says several financial advisers have told him that, among their clients, those who spend the most time tracking daily movements in their portfolio do worse on average than those who review their portfolios less frequently.

Research has shown that most people exhibit "loss aversion" - they experience more unhappiness from losing $100 than they gain in happiness from acquiring $100.

So the more often they're made aware of a loss the more unhappy they become.

If the sharemarket rises by 6 per cent a year that, plus dividends, is a reasonable return. But on average the market would fall on about 47 per cent of days and rise on 53 per cent. This suggests a net fall in happiness despite the satisfactory return. Reviewing the market monthly rather than daily would produce a smaller proportion of losses, making us happier.

Behavioural finance research shows that, because we suffer from myopia as well as loss aversion, investors who get the most frequent feedback take the least risk and thus earn the least money.

In listing the false signals given by the rule that two successive quarters of falling real gross domestic product constitute a "technical" recession last Monday, I missed one. No one knew it at the time, but the Bureau of Statistics' latest estimates show the economy contracting by 0.02 per cent in the September quarter of 2000 and then by 0.4 per cent in the December quarter. So, a recession on John Howard and Peter Costello's watch? No, just a stupid rule.

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Quest to make uni fees a heck of a lot fairer

One measure in the May budget's tightening up on ''middle-class welfare'' drew surprisingly little debate: the decision to cut the rate of discount offered to people who pay off their university HECS debt up front from 20 per cent to 10 per cent.

When the higher education contribution scheme was introduced in the late 1980s, the discount for paying up front was 25 per cent. Now it's falling to 10 per cent. And the discount for making voluntary repayments of $500 or more is to be cut from 10 per cent to 5 per cent.

Wayne Swan says the move will save the government almost $300 million over four years and will make the scheme fairer.

But why would it save that much? And how would it make things fairer? That the shock jocks didn't bother debating these questions probably means people bright enough to go to uni don't ring up talkback radio.

It is a bit of a puzzle. The first question is, why would the government give any discount to people paying their HECS up front rather than paying it off over the years as their income rises and the taxman extracts it from their pay packet?

Well, the government's better off getting the money up front rather than having to wait maybe 10 or 15 years for it all. So it makes sense for the government to give people an incentive to pay up front.

But, if that's the case, why does it make sense to reduce the incentive? Surely the rational response to a reduced incentive for early payment would be for fewer people to pay up front. And if that's the case, wouldn't that leave the government's coffers worse off rather than better off?

Well, it seems the econocrats are expecting some of those who'd otherwise pay up front to be put off, but not many. But see what this means? They're not expecting a rational response to the move.

This is one case where the econocrats aren't proceeding under the assumption we're all like Homo economicus - economic man - carefully calculating and self-interested in all we do.

And I've no doubt they're right: there won't be a rational response to the cut in the discount. Why not? Because paying HECS up front has never been a rational thing to do. It follows that the response to the cut in the discount isn't likely to be rational, either.

Perhaps we should start from the beginning. The wider community benefits when young people go to university and get a degree. But the greatest benefit goes to the graduate. On average, possession of a degree causes workers to earn a lot more over their working lives.

So HECS was introduced to require graduates to make a greater - though still far from full - contribution towards the cost of their education, reducing the subsidy they receive from other, less fortunate taxpayers.

You can think of higher education as an investment. You make an initial outlay (the main cost being not for fees or books, but the income forgone while you study rather than work) in return for lifetime earnings that are higher than they would have been.

According to one study in 2002 by Professor Jeff Borland, of the University of Melbourne, uni graduates earn an average of almost $10,000 a year more than high school graduates do. After allowing for the initial outlay, this was equivalent to an investment return of about 20 per cent a year.

That was without including HECS. Allowing for HECS (which was then at a lower rate than it is today), cut the annual return to about 14 per cent - still a very good deal.

But wouldn't charging fees discourage bright young kids from poor families from going to uni and bettering themselves? That was the risk. But HECS was carefully designed (by Professor Bruce Chapman, of the Australian National University) to avoid this happening.

Rather than simply levying tuition fees, the government would allow people to defer payment of the fees until they'd graduated and were earning a reasonable salary. Then they'd have to pay a small proportion of their salary in repayments, with the proportion rising as their salary grew.

So the government was, in effect, lending students the cost of their uni fees. It didn't charge interest on the loan, but did index the value of the balance outstanding to the inflation rate. In other words, it changed people a real interest rate of zero.

By contrast, any loan you get during your life from a bank or finance company will involve a high real interest rate and a fixed repayment schedule that takes no account of how hard or easy it is to meet the payments (it's not ''income-contingent'' like HECS is).

See what this means? HECS is the best loan - the cheapest money - you're ever likely to get. So the rational response is not to pay it off any earlier than you have to, thereby avoid having to borrow as much commercially for other purposes or being able to keep more money in the bank earning interest.

This is true even with a discount - 25 per cent, let alone 10 per cent - for repaying the loan up front.

(You can check this by working out the ''present value'' of the debt by discounting the flow of repayments over the life of the loan, so as to take account of ''the time value of money''. Don't know what all that means or how to do it? Go to uni and do an economics or business degree and they'll tell you.)

But if it makes no sense to do the government a favour and repay HECS debts up front, why do people do it?

I doubt if many students do it. It's much more likely to be well-off parents who do it (one of whom is very well known to my good self) so their little darlings don't have to worry about being in debt.

If this is the motive of those people who pay HECS up front, they're unlikely to be

deterred by a cut in the rate of discount.

Thus the government probably will make significant savings.

And since those savings will come from the pockets of well-off parents, it's probably right to see this measure as an attack on middle-class welfare that will make the scheme fairer.

A last point: in the real world, a lot of the things we don't do aren't strictly ''rational'' - but all that does is make us human.

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Sympathy for those on $150,000, but...

One thing I despise about public life in Australia today is the way power-chasing pollies and self-promoting media personalities seek to advance themselves by encouraging people living during the most prosperous period in our history to feel sorry for themselves. Apparently, the soaring cost of living is absolutely killing us.

So forgive me but, just this once, we're going to worry about other people's problems, not yours.

Years ago, long before I became a journalist, I used to do the tax return of a lecturer in social work. One day he dumbfounded me by remarking that it wasn't good enough to measure poverty in money terms.

I was just a simple accountant; what on earth was he on about? How else could you judge it?

It's taken me a long time to realise he was on to something. Part of the trouble with economics is its confident assumption that all problems worth worrying about can be measured in dollars.

The economist Professor Peter Saunders, of the University of NSW, is probably Australia's leading expert on poverty. But in his latest book, Down and Out, he argues that poverty - lack of income - is just one aspect of the broader problem of social disadvantage. The other aspects are deprivation and social exclusion.

''Social disadvantage'' refers to a range of difficulties that block life opportunities and prevent people from participating fully in society. Although poverty is a factor contributing to disadvantage, the root causes of disadvantage extend beyond the lack of money and need to be identified and tackled separately.

Saunders offers the example of Leah, a single parent born in North Africa, now living in the south of Israel, leading a harsh and miserable life dominated by men.

Giving Leah money could help her a lot, but unless something is done about the underlying causes of her problems - lack of education, exposure to discrimination, lack of voice in events that affect her, induced depression, unwise choices and bad luck - there will be little prospect of relieving the disadvantages she experiences and preventing them from being transmitted to future generations.

Do you really think there are no Leahs in Australia?

''Cycles of poverty that result from an inadequate education that restricts employment prospects and constrains earnings will not be prevented by income transfers alone, but also require efforts to raise human capital in ways that can provide the foundation for economic independence and improved social status,'' Saunders says.

One of the most important determinants of social disadvantage is where you live. This is true not only of which country you live in, but also of where you live within a country. ''Increasingly, where one lives can have a powerful impact on access to employment, on the ability of a given level of income to support a particular standard of living and on the availability and effectiveness of services to address disadvantage,'' he says.

Tony Vinson, a former professor of social work, has written that ''when social disadvantage becomes entrenched within a limited number of localities, the restorative potential of standard services in spheres like education and health can diminish.

A disabling social climate can develop that is more than the sum of individual and household disadvantages and the prospect is increased of disadvantage being passed from one generation to the next.''

Historically, poverty has been measured by setting a level of income and saying everyone who falls below that line is poor. But such ''poverty lines'' can be set in fairly arbitrary ways - half of the median income is a common measure, for instance - and so are open to argument.

The concept of ''deprivation'' has been developed to try to measure poverty more directly. It seeks to identify what is an unacceptable standard of living by using community views to specify the items and activities that are regarded as normal or customary in a particular society at a particular time.

Surveys show that the list of items Australians regard as the ''essentials of life'' include such things as medical treatment if needed, warm clothes and bedding if it's cold, a substantial meal at least once a day, and the ability to buy medicines prescribed by a doctor. By contrast, the concept of ''social exclusion'' focuses on how relationships, institutions, patterns of behaviour and other factors (including lack of resources) prevent people from participating fully in the life of their community.

Australian research has divided social exclusion into three domains: disengagement, service exclusion and economic exclusion. Indicators of disengagement include: no regular social contact with other people, children don't participate in school outings, children have no hobby or leisure activity, and unable to attend wedding or funeral in the past 12 months.

Indicators of service exclusion include: no access to a local doctor or hospital, no access to dental treatment, no childcare for working parents, no aged care for frail older people, and no access to a bank or building society. Indicators of economic exclusion include: not having $500 in savings for use in an emergency, having to pawn or sell something in the past 12 months, not having spent $100 on a special treat in the past 12 months, and living in a jobless household.

The groups with the highest risk of facing ''deep exclusion'' are (in declining order) unemployed people, public renters, lone parents, indigenous Australians and private renters.

So that's how the other half lives. What a pity these people have no idea what a struggle it is trying to make ends meet on $150,000 a year.

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This time it's a recession we don't have to have

Though nothing is certain in the unpredictable world of the national accounts, it's highly unlikely we'll see a second, successive quarter of ''negative growth'' when the figures for this quarter are released in early September. Which, in a way, will be a pity.

Why? Because even if the hiccup caused by our natural disasters had spread itself over two quarters - after the 1.2 per cent contraction in the March quarter - not even the most ignorant journalist or most excitable market trader would have believed the consequent ''technical recession'' was a real recession.

The reason the rule about two successive quarters of falling real gross domestic product amounting to a ''technical'' recession (whatever that is) won't lie down and die is its handiness: it's simple to judge, objective and involves minimum waiting.

The reason it should bite the dust is that it's a completely arbitrary rule of thumb containing no science, which is perfectly capable of telling us we're in recession when we're not, or failing to tell us we're in recession when we are.

It's also unreliable in another sense because it's based on the Bureau of Statistics' first estimate of the quarterly change in GDP, which is subject to heavy revision in subsequent months and years. (Keep reading.)

It was because all the contraction after the global financial crisis was crammed into a single quarter (the fall of 0.9 per cent in the December quarter of 2008) that the Rudd government got away with the claim that we avoided recession even though, in truth, we had a mild recession involving a rise in unemployment of almost 2 percentage points.

Kevin Rudd, Ken Henry & Co timed their stimulus packages with the clear (if unacknowledged) objective of ensuring there weren't two quarters of contraction in a row. They did this in the belief that, whatever the realities of the situation, the fuss the media would make about ''technical recession'' would be certain to further damage business and consumer confidence and make the talk of recession self-fulfilling and the downturn deeper.

They were right and they deserve a medal. They understood - as few macro-economists do - the central role the management of our animal spirits plays in determining the severity of downturns.

They also understood that the effectiveness of cash splashes and other give-aways is determined as much by their effect on how people feel about the future as by the size of the increase in spending they immediately bring about.

Once the second successive quarter had been avoided, the government happily trumpeted the (false) news that we'd avoided recession - no doubt believing it was merely reinforcing the more confident outlook.

But no good deed goes unpunished. The opposition was happy to accept the no-recession line but, in a novel twist on the post-hoc-ergo-propter-hoc fallacy, turned it back on the government, arguing that all the money Labor spent trying to moderate a recession was obviously wasted. (The fallacy says, since A preceded B, therefore A caused B. The opposition's version was, since there was no recession, therefore there was no need for all the spending to stop it happening.)

Not many people remember it was the old two successive quarters rule that lured Paul Keating into making his hugely resented remark about the recession we had to have. Though, in 1990, Keating and Treasury had been assuring us we were in for no worse than a ''soft landing'', by the time the national accounts for the June quarter showed a contraction of 0.9 per cent, most people needed no convincing we were in deep trouble.

Even so, Keating persisted with his denial. But by late November, on receiving the September quarter accounts showing a whopping contraction of 1.6 per cent, he realised the game was up and (to his eternal regret) decided to brazen it out, preferring to be seen as a conniving knave rather than the miscalculating fool he really was.

At his news conference to respond to the accounts, his opening words were: ''The first thing to say is, the accounts do show that Australia is in a recession. The most important thing about that is that this is a recession that Australia had to have.''

But here's the joke. Remember what I said about initial estimates being subject to heavy revision? By now, the first of his successive contractions has been revised from minus 0.9 per cent to plus 0.4 per cent. The second has been revised from minus 1.6 per cent to minus 0.4 per cent.

So applying the two-quarter rule to the bureau's by-now reasonably accurate estimates, Keating confessed to a recession that didn't exist. Except, of course, that at the time everyone knew from the evidence that it did - and they were right.

Since, according to the latest estimates, the economy grew in the following, December quarter, it wasn't until early September the next year - nine months later - that the two-quarter rule was signalling the arrival of recession.

A rule of thumb that throws up so many false negatives - in 1990-91 and 2008-09 - is a rule that should be ditched. The economist Saul Eslake has road-tested a different rule, showing it has produced no false signals. It defines recession as ''any period during which the rate of unemployment rises by more than 1.5 percentage points in 12 months or less''.

But I prefer the definition offered by David Gruen, of Treasury: ''A sustained period of either weak growth or falling real GDP, accompanied by a significant rise in the unemployment rate''.

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GDP hot air gives Hockey hiccups

See how long it takes you to figure this one out: if something falls by 50 per cent, then rises by 100 per cent, where is it? Answer: just back where it started.

If you had to think about it you need to be careful what conclusions you draw from this week's national accounts showing the economy - real gross domestic product - contracted by 1.2 per cent in the March quarter.

Thanks to economists' obsession with growth, we focus almost exclusively on the percentage change in GDP and its components from one quarter to the next, but if you don't have a good feel for how percentage changes work you risk bamboozling yourself.

(Speaking of which, remember that, though the percentage increase needed to get you back to par is always bigger than the original fall, the smaller that fall the less spectacular the subsequent rebound.)

Now try this reaction to the national accounts from Joe Hockey: ''If the mining boom has a cough the Australian economy can suffer pneumonia. The economy is increasingly reliant on the mining boom.''

It's a snappy soundbite for the telly, but it's nonsense. Indeed, it's roughly the opposite of what the national accounts are telling us.

For a start, the problem during the March quarter wasn't the mining boom, it was the weather. Is our economy heavily reliant on the weather? Our farmers are, but the rest of the economy isn't (well, not until we're finally screwed by climate change).

For another thing, what happened last quarter wasn't a cough that shows we've got pneumonia, it was a hiccup that isn't worth worrying about. Remember, 98.8 per cent of the economy was still there in the March quarter.

All that happened was that flooding and cyclones temporarily disrupted our production of coal, iron ore, agriculture and tourism. The disruption to mining in particular led to a decline of 27 per cent in the volume of coal exports during the quarter, causing the volume of all exports to fall by 8.7 per cent.

But today, two months after the end of the March quarter, we know the bad weather has stopped, most mines are working again, farmers have replanted and the rebuilding of houses, roads and other infrastructure has begun. Export volumes recovered in the month of March and further in April.

The natural disasters are estimated to have subtracted 1.7 percentage points from real GDP growth during the quarter. But Wayne Swan is expecting a rebound of about 1 percentage point in the present quarter and a further rebound in the September quarter. This is why Hockey's pneumonia is no more than a hiccup.

The rebound will come for three reasons: production will return to normal; some firms will work overtime to catch up on lost production and there will be much rebuilding and purchasing of new equipment.

Note that, thanks to our obsession with rates of quarterly change, part of the rebound is simply arithmetic. The government estimates the various natural disasters subtracted $6.2 billion from the real value of production in the March quarter, but will subtract only $3.1 billion in the June quarter. If so, this reduction in a negative represents a positive contribution to the growth in real GDP in the June quarter.

The point is, when the economy contracts in a quarter, you have to investigate the causes before you decide the economy has pneumonia and needs to be hospitalised. In this case, the causes are transitory - and self-correcting - rather than lasting.

Another clue is that the economy suffered a weather-caused shock to its supply side (production of goods and services) rather than weakness in its demand side (spending on goods and services).

A weakness in demand is more likely to be deeper-seated and longer-lasting, requiring the economy's demand managers - the government and the Reserve Bank - to adjust the settings of the instruments they use to influence the strength of demand: respectively, fiscal policy (the budget) and monetary policy (interest rates).

What makes Hockey's talk of pneumonia so opposite to the truth is, when you look past the temporary supply problem you see demand growth is quite healthy. Consumer spending grew by 0.6 per cent in the March quarter (and by 3.4 per cent over the year to March), with government spending on consumption items growing by 1.4 per cent (4.6 per cent for the year).

Turning to investment spending, spending on new or altered housing grew by 4.6 per cent (annual, 6.6 per cent) and business investment in new equipment and structures grew by 2.9 per cent (annual, 4.5 per cent).

That leaves public sector investment spending, which fell by 0.7 per cent (annual, minus 6 per cent) as the fiscal stimulus continued to be withdrawn. (Overall, the withdrawal of stimulus trimmed 0.4 percentage points from GDP growth during the quarter.)

Adding this up, ''domestic final demand'' grew by a whopping 1.3 per cent during the quarter and by 3.3 per cent over the year. Allowing for a fall in the level of business inventories (much of it probably caused by the natural disasters), ''gross national expenditure'' - which is domestic demand proper - grew by a healthy 0.8 per cent during the quarter and by 3.1 per cent over the year.

This healthy growth ain't surprising since total employment grew by almost 50,000 during the quarter.

As the secretary to the Treasury, Martin Parkinson, pointed out this week, though the mining sector gets most of the headlines, it accounts for only about 8 per cent of GDP (and an even smaller proportion of total employment). So that leaves 92 per cent of the economy that's not mining but is doing fine.

It's true that, of late, much of the growth in the economy has been coming, directly and indirectly, from mining. But it's rare for all parts of the economy to be growing at the same rate, so it's common for one sector - often it's been housing - to account for much of the growth in a particular period. That doesn't mean we'd catch pneumonia were that sector to falter.

Consider this: if the sky-high prices we're getting for coal and iron ore were to suddenly collapse, that would be a blow, but it would also bring about changes that encouraged other sectors to grow faster: the high exchange rate would fall, the Reserve Bank would cut interest rates and the budget wouldn't be as contractionary, taking longer to return to surplus.

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Mouse is mightier than the stores

Well-mannered newspapers don't spend a lot of time talking about themselves. Even so, you've no doubt heard that the future of newspapers - though not news or journalism - is under great challenge from the arrival of the internet.

Much classified advertising has moved to the net and now some display advertising is going.

Some readers are moving to the net, smartphones and tablets such as the iPad.

As you may imagine, these are anxious times for newspaper managers and print journalists.

It's dawned on me, however, that what the internet is doing to the media is just for openers.

You wait until you see what it does to retailing over the next decade or two.

Retailers have been complaining lately about people buying more stuff on the internet - and thus being able to avoid paying goods and services tax on purchases of less than $1000 - but I doubt if this does much to explain their present weak sales.

A report by Southern Cross Equities shows that by last year local online retailers had a 4 per cent share of total retail sales.

This was up from 2 per cent in 2005, but it's still not a lot.

Yet come back in 10 years and it may be a very different story.

Buying things in shops has many advantages. You're able to see, touch and even try on what there is to choose from. You can seek further information from a live human. There's less worry about the security of your payment and being able to return goods that prove unsatisfactory.

So why would people buy online? Partly because, if you know what you want, it's very convenient. You avoid having to find a park at crowded shopping malls and avoid unwanted human contact.

But a new study by Ben Irvine and colleagues at the Australia Institute, The Rise and Rise of Online Retail, finds that online shoppers give ''saving money'' as their primary reason. ''Bargain hunters'' outnumber ''mall haters'' five to one.

When bricks-and-mortar retailers also run a website they tend to charge the same prices on both. If they didn't, more of their customers would switch to online. Add the cost of postage (and ignore the cost in time and money of travelling to their shop) and it's often not particularly attractive to buy from local retailers online unless you find one offering a much lower price.

It's when people browsing prices on the internet compare prices being offered on overseas sites that they find large savings, sometimes up to 50 per cent - savings that make the freight costs well worth paying. This is true for books, DVDs, music, shoes, electronic goods and much else.

People are amazed to find that global corporations are selling the identical goods at quite different prices in different countries.

As a very broad generalisation, prices tend to be low in the United States and high in Australia, with British prices somewhere in between.

Our retailers and others try to justify these differences by reference to freight costs, differences in taxes, the high Aussie dollar and much else, but they never can.

Many people imagine prices are based on the cost of manufacture and distribution, plus a reasonable mark-up. But, in economists' speak, this is just looking at the supply curve.

You also have to take account of the demand curve, which shows the prices customers are
''willing to pay''.

Taking this into account means prices are set at the highest level ''the market will bear''. Charging different prices in different markets (whether those markets are in different countries or are different segments of the same country's market) is a long-standing business strategy.

You maximise your profit by charging whatever price - high or low - is the most the people in each market or market segment are willing to pay.

Economists call this ''price discrimination'' and regard it as perfectly reasonable.

Now here's something the economists won't tell you: people are willing to pay higher prices in Australia because that's what they're used to. People are willing only to pay lower prices in the US because that's what they're used to.

As every economics textbook will tell you, however, the trick to successful price discrimination is you have to be able to keep the markets separate, otherwise people in high-price markets will switch to buying in lower-price markets.

Guess what? The internet has broken down the geographic (and knowledge) separation between national markets. So the game is up for country-based price discrimination. It will take a while but, as e-commerce spreads, our greater ability and willingness to buy from countries with lower prices will force Australian retail prices down, particularly website prices. (The day may come when people who want personal service in a shop will have to pay a premium above the internet price.)

This will be an enormously painful process for retailers and their employees (welcome to the club). And also for the firms that own and rent out retail space.

It will be painful because it's wrong to imagine Australian retailers charging twice as much for the identical product as US retailers charge are therefore making twice the profit.

Why not? Because, over the many decades this price difference has existed, Australian retailers' cost structures have adjusted to fit (just as broadsheet newspapers' staffing levels increased to absorb most of the ''rivers of gold'' flowing from their classified ads). In particular, the rent paid by retailers would be much higher.

The internet is changing the world to make it work more like economics textbooks have always assumed it worked.

It's intensifying price competition over other forms of competition, such as marketing, and slowly bringing to reality a concept beloved of economists: ''the law of one [worldwide] price''.

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Coles and Woolies loom as Big Tobacco's rivals

What do the big foreign-owned mining companies have in common with the big foreign-owned purveyors of cancer sticks? A lot of money to con punters and pressure pollies, and a lot of weak arguments.

One argument the two industries have in common is that the resource super-profits tax and the plain packaging of cigarettes lack any proof they will work and have never been adopted anywhere in the world. Great argument: it has not been done before, therefore you shouldn't do it.

This is the poor little stupid Australia argument. We should always merely follow the lead of other countries because we're not smart enough to dream up anything good ourselves. Its logic is foolproof: if it has never been done before there's no evidence it works, and if we never try it there never will be.

But if the idea's so unlikely to work, why are the global giants fighting so hard to stop it being tried? Why not leave the stupid Aussies to stew in their own juice? Perhaps because the rest of the world is watching our ''experimental legislation'' and if it works - as it's most likely to - other, bigger countries will copy it.

The big miners claimed the supposedly retrospective introduction of the super-profits tax would increase Australia's ''sovereign risk''. The big tobacco-pushers claim plain packaging would rob them of their brands and infringe ''international trademark and intellectual property laws''.

They've claimed they'll contest the issue to the fullest extent of the law - this I do believe - and are crying bitter tears over the ''billions of dollars'' this will cost taxpayers in legal fees and compensation to the injured companies.

From what the experts say, however, the companies' legal case seems weak. About the only people convinced they'll succeed in this are from the libertarian Institute of Public Affairs. (If the institute isn't receiving tax-deductible donations from the tobacco industry, I'll be happy to record its denial.)

Libertarians are tireless fighters for private property. They're willing to pay taxes pretty much only to the extent they're necessary to finance government actions to protect private property from being stolen or overrun by foreign invaders.

But I find it curious the institute is so ready to extend its attitude towards the protection of physical property to the protection of intellectual property such as patents, copyright and trademarks. Protection of intellectual property involves much more overt intervention in the market. It's the nanny state creating monopolies and conferring them on private firms.

This intervention can be justified only by acknowledging the existence of market failure (something libertarians are usually most reluctant to do) and then being satisfied the intervention won't make matters worse.

You're actually giving some firms a licence to charge higher prices (by constraining their competitors from copying them) and recent history is full of instances of industries successfully lobbying the nanny state to extend intellectual property rights in ways that benefit the rights-holders at the expense of the public interest.

Yet another argument put up by tobacco companies is that plain packaging will backfire and lead to increased smoking because taking away the companies' distinctive branding (though not their brand names) will lead to greater price competition. Lower prices would lead to higher consumption, which would defeat the object of the exercise and actually increase smoking rates among young people. (Just why this would be a bad thing the companies don't explain. Cigarettes aren't bad for you, are they?)

I suppose when you're fighting to defeat some government measure it's always handy to have some argument it would be counterproductive, but this is a strange argument for them to be running. If there were an outbreak of price competition in response to plain packaging, the government could fix the problem easily by increasing its tobacco excise and forcing the retail price back up to where it was. This would be a nice outcome. The extra tax revenue would, in effect, be coming from the companies, leaving smokers no more out of pocket than before the new arrangement.

Though in these circumstances industries on the make usually lay it on pretty thick, the companies have made no attempt to claim the price war would send them broke, oblige them to lay off thousands of workers or move to China. This is a tacit admission that their degree of profitability - on their own admission, fattened by the ability branding gives them to charge higher prices - is so great it would survive a price war.

After examining the companies' rates of return relative to competitive norms, Dr Richard Denniss, executive director of the Australia Institute, estimates about half their profits - $500 million a year - flows from the premium prices charged for ''branded'' tobacco.

The companies say they fear the increased price competition would come from illegally imported tobacco, with smuggling ''spiralling out of control''. But Denniss thinks it's more likely to be the reactions of the big two supermarket chains the companies are worried about.

At present, the ban on tobacco advertising effectively protects the established players from having to compete with new entrants to the market. Apart from starting a price war, advertising would be the only way you could draw smokers' attention to your arrival in the market. (This is advertising doing what it suits economists to assume it always does: not using allusions and illusions to entice people to buy, but merely informing potential purchasers of your availability and price.)

But when plain packaging robs the established players of their last legal form of marketing, it would be a lot easier for Coles and Woolworths to enter the market with their own cheaper, imported no-frills brands.

Being done over by Coles and Woolies? Couldn't happen to a nicer bunch of blokes.

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East moves west - more than a miner miracle

You'd need to be living under a rock not to have heard that the world's centre of economic gravity is moving from west to east - towards us. But most of us are yet to appreciate the full ramifications of this change in the globe's economic geography.

The shift is occurring because of the re-emergence of China and India as major economic powers. Why re-emergence? Because in the 18th century - before the West's industrial revolution - the two accounted for almost half of gross world product.

By 1990, China and India's share of world gross domestic product was down to less than a 10th. Today it's about a fifth and expected to be more than a quarter by the end of this decade. By 2030 it may be as much as a third.

Everyone knows the rapid industrialisation and urbanisation of these two countries is the cause of our present resources boom. But as Treasury points out in its annual sermon (otherwise known as budget statement No. 4), there's more to it.

''As China and India continue to develop, the growing cities now driving demand for Australia's mineral resources will be populated by an increasingly wealthy and upwardly mobile middle class, with incomes and tastes to match,'' Treasury says.

''Increasing consumer purchasing power and changing spending patterns will open up new, often unforeseen, opportunities for Australia - well beyond those flowing from the current mining boom.''

One study has estimated that the number of middle-class consumers in Asia could increase by more than 1.2 billion people by 2020. If so, these projections would mean that by the end of this decade Asia would have more middle-class consumers than the rest of the world combined, with China surpassing the United States as the world's single largest middle-class market in terms of dollars.

By 2030, with India following China's lead, the world could have gone from mostly poor to mostly middle class, with two-thirds of the world's middle-class consumers living in our region.

(Like all projections by economists, this one confidently assumes the natural resources and ecosystem services needed to make this possible will be readily obtained - presumably, from another planet. But let's not allow ecological realities to spoil our happy economic analysis.)

In poor countries, spending on basic goods typically accounts for quite a high share of GDP, with household incomes barely covering the necessities of life. Then, in the early stages of economic development, a surge in investment spending causes consumption's share of GDP to fall quite sharply.

In time, however, continued growth allows a larger middle class to devote more money to purchasing luxury goods and services, both in absolute terms and as a share of household spending. As a result, consumer spending's share of GDP recovers as economies reach middle-income status.

China's consumption-to-GDP ratio has declined markedly in recent decades, reaching a low of only 35 per cent in 2009. (Our proportion is about 55 per cent, which is lower than it used to be because of our much higher investment in new mining capacity.)

But China is fast approaching income levels where consumption often turns, and the Chinese government is focused on reforms to foster higher growth in household incomes and to rebalance the economy towards domestic demand. So Treasury says there's considerable scope for a strong rise in the consumption ratio in the medium term.

We know from the earlier experience of countries such as Japan and South Korea in travelling down this road that as the amount of consumer spending grows its composition changes. As they become more affluent, people devote a higher proportion of their spending to services and consumer durables.

The early stages of such a shift are already evident in China. Since the early 1990s, its urban households have devoted a declining proportion of their spending to food and increasing proportions to medical services, transport and communication, and education, recreation and culture.

If you divide urban households into four groups according to their incomes, you find that, as incomes rise, households devote smaller and smaller proportions to food, and bigger and bigger proportions to services.

Urban households constitute a large and growing proportion of China's 400 million households (Australia has 8.5 million). Just over the past 10 years, the proportion of urban households owning a car has gone from virtually none to 12 per cent. The proportion owning microwave ovens has gone from 16 per cent to 58 per cent.

And get this: the number of computers owned per 100 households has gone from eight to 70, while the number of mobile phones has gone from 16 to 188. So ''new technology'' goods are spreading faster than household appliances.

On the ladder of goods and services to which people with growing incomes aspire, after consumer durables come culture, tourism and advanced education.

On overseas tourism, China and India's sheer population size mean they're starting to overtake those countries formerly dominant in providing tourists, the US, Britain and Japan. In 1995, about 4.5 million people from mainland China and 3 million from India travelled abroad for business and leisure.

By 2009, China's travellers had increased tenfold to 48 million, meaning it was close to catching up with the US and Britain. India had experienced a three- to four-fold increase to 11 million travellers a year.

And all this before the rise of the middle class has really got going.

Australia, of course, is already getting its cut. China and India's share of our education exports has risen sharply. China's share of our wine exports is now five times larger than it was five years ago. Tourist arrivals from China have more than trebled in the past decade - overtaking Japan in 2008-09 - and are catching up with those from the US.

Of course, not all the opportunities created by Asia's rising middle class will fall within areas of our comparative advantage. And to maximise even those opportunities that do fit our bill we'll need to continue to change and innovate. Competition with other countries will be fierce. As their own education systems improve, a smaller proportion of Chinese and Indians may seek education abroad.

And Treasury says it's not possible to forecast the exact mix of goods and services that will be demanded, let alone the shape of the global economy that will best service these demands. You can say that again.

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Stop crying poor and fix the climate mess

Like most people, I'm an instinctive optimist. In any case, I see no margin in pessimism. If you concluded the world was irredeemably wicked, or destined for certain destruction, what would be left but to curl up and die? Since we can never be certain the end is nigh, much better to keep living and keep plugging away for a better world.

I confess, however, I've needed all my optimistic instincts to avoid despair over the hash we're making of the need to take action against global warming. We're exhibiting everything that's unattractive about the Australian character.

We pride ourselves that Aussies are good in a crisis, but until the walls start falling in on us we couldn't reach agreement to shut the door against the cold.

This week's report from the Climate Commission - established to provide expert advice on the science of climate change and its effects on Australia - tells us nothing we didn't already know, but everything we've lost sight of in our efforts to advance our own interests at the expense of the nation's.

Its 70 pages boil down to four propositions we'd rather not think about. First, there is no doubt the climate is changing. The evidence is overwhelming and clear.

The atmosphere is warming, the ocean is warming, ice is being lost from glaciers and ice caps and sea levels are rising. Global surface temperature is rising fast; the last decade was the hottest on record.

Second, we are already seeing the social, economic and environmental effects of a changing climate. In the past 50 years the number of record hot days in Australia has more than doubled. This has increased the risk of heatwaves and associated deaths, as well as extreme bushfire weather.

The sea level has risen by 20 centimetres since the late 1800s, affecting many coastal communities. Another 20-centimetre increase by 2050 is likely, on present projections, which would more than double the risk of coastal flooding.

Third, these changes are triggered by human activities - particularly the burning of fossil fuels and deforestation - which are increasing greenhouse gases, with carbon dioxide the most important of these gases.

Fourth, this is the critical decade. Decisions we make from now to 2020 will determine the severity of climate change our children and grandchildren experience. Without strong and rapid action there is a risk climate change will undermine society's prosperity, health, stability and way of life.

That scientists still need to repeat these long-established truths is a measure of how much we've allowed short-sighted and selfish concerns to distract us from the need to respond urgently to a clear and present danger.

In this we haven't been well served by our leaders. The Labor government's decline dates from Kevin Rudd's loss of nerve after the defeat of his carbon pollution reduction scheme in the Senate in late 2009, following the success of the Coalition's climate-change deniers in overthrowing Malcolm Turnbull and replacing him with a man whose record showed him willing to take whatever position on climate change he thought would advance his career.

Had Rudd the courage of his professed convictions, he would have taken the question to a double-dissolution election, fighting in defence of his "great big new tax on everything". Instead he dithered, eventually yielding to pressure from those in his party - including Julia Gillard and Wayne Swan - wanting to put the government's survival ahead of its duty.

Oppositions play a vital role in a parliamentary democracy and opposition leaders are given considerable licence. They're not expected to speak the unvarnished truth. Dishonest scare campaigns have long been used by both sides.

I don't like using the L-word, but Tony Abbott is setting new lows in the lightness with which he plays with the truth. He blatantly works both sides of the street, nodding happily in the company of climate-change deniers, but in more intellectually respectable company professing belief in human-caused global warming, his commitment to reducing carbon emissions by 5 per cent by 2020 and the efficacy of his no-offence policies.

He grossly exaggerates the costs involved in a carbon tax, telling business audiences they'll have to pay the lot and be destroyed by it, while telling the punters business will pass all the costs on to them. He forgets to mention that most of the proceeds from the tax will be returned as compensation to businesses and households.

He repeats the half-truth that nothing Australians could do by themselves would reduce global emissions, while failing to correct the punters' ignorant belief that Australia is the only country contemplating action. Last week's news that Britain's Conservative coalition government has pledged to cut emissions by half within 15 years is ignored. Economists call this mentality "free-riding"; the old Australian word for it is "bludging".

But it's far too easy to blame our failure to face up to climate change just on our hopeless politicians. Our increasingly partisan media have failed to hold Abbott to account over his duplicity. Many have sought to increase circulation or ratings by joining in the fear-mongering and denial. The media's love of controversy has led them to give doubters of the science of climate change a credibility they don't deserve against the weight of scientific opinion.

Australians are proud of their inbuilt bulldust detectors, but on this issue they seemed to have turned them off, happily believing whatever self-serving nonsense is served up to them. The one thing humans are meant to care about above all is the survival of their young. Yet people with the highest standard of living in history are whingeing that they couldn't possibly afford to pay a bit more for their electricity.

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Labor's lick and promise to beached job-seekers

You have to feel sorry for pollies in government. While economists (who have a built-in bias against government intervention) are forever pressing them to cut government spending, and the punters are perpetually refusing to pay more tax, everyone is urging them to do something about an endless number of genuinely worthy causes.

How can they win? They can't. Unfortunately, rather than limiting the number of problems they know they can afford to tackle, they have a tendency to want to give the appearance of fixing every problem they're asked to fix.

Take one of the budget's highlights, its package of measures to raise the workforce participation of welfare recipients of working age. With the exception of the package to assist the mentally ill, it's hard to think of a worthier cause.

It ticks so many boxes. We know the mining construction boom will soon create widespread shortages of skilled labour and even unskilled labour. So getting people off welfare and into paid employment - adding to the supply of labour - really helps us cope with the boom in a non-inflationary way. What make sense economically also makes sense socially. I have no doubt that getting these people into jobs is the best thing we could do to advance their wellbeing. I don't doubt that most of them would be delighted to have a job and be normal, even a job that isn't so wonderful - and even though more than a few of them have slipped so deep into the Slough of Despond they aren't thinking straight.

Only the ignorant and prejudiced would imagine people enjoy not having to work, being on the outer of society and living on a pittance. But even these misguided fools - of whom there are many - would be gratified to know the supposedly lazy had been put back to work.

Julia Gillard has said we will need to find 2 million extra workers in coming years. It so happens there are 2 million social-security recipients of working age: in round figures, 800,000 people on the disability support pension, 450,000 on sole-parent benefits (most with preschool children), 600,000 on the dole (most of them unemployed for more than a year) and 150,000 on the carer payment.

Of course, many of these people - the seriously disabled, for instance - aren't capable of working no matter how much they'd like to. And there are other sources of potential workers on which employers can draw: people who delay their retirement and mothers who can do paid work or more paid work. But as unemployment falls, those still out of work are the highly disadvantaged. About a third of those on the dole have been out of work for more than two years, and most of these "very long-term unemployed" have less than year 12 qualifications.

So a major investment in training, work experience in ordinary jobs, mentoring, childcare and health and disability services will be needed.

Gillard makes a good start in the budget with wage subsidies for the very long-term unemployed, vocational training and mentoring for teenage sole parents, and more help from Jobs Services Australia providers for early school-leavers to complete their education.

But the scale of these measures is pathetically small: 10,000 wage subsidies a year to share between more than 200,000 very long-term unemployed, and the teenage mums who get special help account for just 3 per cent of all those on sole-parent benefits.

Those measures that are on a large scale - such as 11 months a year of intensive job search activity for all very long-term unemployed and quarterly interviews with all disabled people under 35 who have some capacity to work - are the ones least likely to get results.

The 11 months of intensive activity - equivalent to two days a week - will be funded to the tune of just $1000 a person. Whoopee-do.

One good move is to make it more attractive for sole parents on the dole to do part-time work by cutting the rate at which their benefits are withdrawn from 60c in the dollar to 40c. But the cost of this will be paid for by the sole parents themselves. Those presently on the sole-parent benefit will be moved on to the dole once their youngest child reaches 12 (instead of the Howard government's 16), causing them to lose $56 a week.

Similarly, the cost of the measure making it more attractive for unemployed youths on the youth allowance to do part-time work will be more than covered by the decision to move unemployed people aged 21 off the dole and on to the youth allowance, causing them to lose $42 a week. The rationale for the latter move is to remove a financial disincentive for 21-year-olds to stay in education. Fair enough. But the government could have achieved the same effect by increasing the youth allowance for low-income students to the level of the dole.

It would be nice to believe the cuts in benefits to some of the most disadvantaged people were motivated by penny-pinching, rather than a desire to be seen punishing people widely regarded as the undeserving poor. (That news of the "crackdown" was leaked to the Murdoch tabloids does make you wonder.)

There is a range of likely outcomes from all this: employment gains and better skills for a small percentage of people on social security, financial pain for those whose payments are cut, and little change (apart from inconvenience) for the majority of those social-security recipients who have some potential to work.

Lacking enough money to actually fix the plethora of problems they're asked to fix, pollies have a tendency to spread the money they've got very thinly, so that none of the problems gets fixed. Everything gets a lick and a promise.

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Adapt or die: the high dollar is here to stay

The big ''known unknown'' facing the economy is how long commodity prices and the Aussie dollar will stay so high. That's why some people worry so much about the Chinese economy coming unstuck.

But while the new secretary of the Treasury, Dr Martin Parkinson, acknowledges the risks facing China's economy, his ''central scenario'' is that commodity prices and the Aussie will stay high for a long time.

This means that, though he declined to actually say the words in his speech to the Australian Business Economists in Sydney this week, he's no believer in ''Dutch disease'' - the idea that resources booms lead to a high exchange rate, which wipes out other export and import-competing industries before the boom collapses and leaves you high and dry.

No, Parkinson has a tough message for manufacturers and others asking for assistance to help them cope with the excruciatingly high dollar: get used to it. Adapt.

There are risks facing the Chinese economy, but they are short-term risks around a positive long-term outlook. ''Our central scenario, outlined in the budget, is one of solid medium-term growth for Australia,'' he said, fuelled by high commodity prices and a mining construction boom.

The global economy is undergoing a transformation unprecedented in the last 100 years. Global strategic and economic weight is moving inexorably from the Western advanced economies towards the emerging market economies. And the pace of this transformation is faster than many expected.

The key emerging markets from our perspective are China and India, which together account for slightly more than a third of the world's population. They're growing rapidly and should continue to do so. China should overtake the United States to become the world's largest economy by 2016 and, in turn, be overtaken by India by mid-century.

''There is nothing pre-ordained about these growth paths, and size does not automatically confer economic or strategic weight,'' Parkinson said. ''But these transitions - whether smooth or rocky - have important implications for Australia. Indeed, they constitute probably the most significant external shock Australia has ever experienced.''

Urbanisation and industrialisation in China and India have resulted in strong demand for our energy and mineral resources. The resulting improved terms of trade have increased our real income as the purchasing power of our exports increased.

Looking ahead, a growing Asian middle class will boost demand for our commodities, and for our services exports - education, tourism and professional services - and for niche, high-end manufactures.

But these developments expose our economy to increased macro-economic volatility and, more importantly, to a difficult adjustment process. That's Parkinson's point: it's not just China and India that are economies in transition, it's us, too.

Our terms of trade are now at 140-year highs and the budget assumes they fall back only slowly, by about 20 per cent over 15 years. As for the Aussie dollar, it can be expected to move roughly in line with the terms of trade over the longer term. It's therefore expected to also remain persistently high.

''The implications of a sustained increase in the terms of trade and a persistently high exchange rate are significantly different to those of a temporary shock - particularly for the structure of the economy,'' Parkinson said.

Most Australian businesses are well equipped to deal with short-term exchange rate volatility, but this sustained shift ''will challenge a number of existing business models''.

''Inevitably, this will see calls for support for producers that are suffering from a lack of competitiveness due to a 'temporarily' high exchange rate,'' he said, before going on to explain why such calls should be resisted.

Higher resource prices will see capital and labour shift towards the mining sector, where they are more valuable. This shift will be facilitated by the appreciation of the exchange rate, which shifts domestic demand towards imports and reduces the competitiveness of exports and import-competing activities.

Manufacturing and other trade-exposed sectors that aren't benefiting from higher commodity prices will come under particular pressure, but all sectors will be affected. The longer-term shift away from parts of the traditional manufacturing sector, which began in the middle of the last century, will continue - though it would be wrong to assume all manufacturing will be adversely affected.

And while mining and related sectors (including the mining-related part of manufacturing) can be expected to continue to grow - drawing resources from the rest of the economy - they will be overshadowed by the longer-term shift towards the services sector.

This change to our economy - its structural evolution - reflects a prolonged shift in our comparative advantage that began in the second half of last century, as rapidly industrialising Asian countries emerged as labour-abundant (read cheap-labour) competitors.

The latest phase in this evolution is raising understandable concerns in people's minds: how are the benefits of the boom shared throughout the community? Will our manufacturing sector be ''hollowed out'' and ''lost forever'' leaving us as ''nothing but a quarry''? What if the boom suddenly stops, as all previous booms have?

''Concerns like these are being reflected in calls for measures to protect sectors threatened by the structural shift in our terms of trade,'' Parkinson said. ''They drive calls for strengthening anti-dumping legislation, intervention to deliver a lower exchange rate and increased industry assistance.''

Why is there so much discomfort in the community about this transformation? Because it involves change and change is often difficult. Because the short-term costs of adjustment are concentrated in particular sectors. But also because what's happening - the longer-term structural nature of the change - is not well understood.

People need to be reminded, for instance, that a higher exchange rate helps spread the benefits of the resources boom through the community by reducing the price of imported goods and services.

They need to be reminded the economy is always changing - far more than we realise. Each year, about 300,000 businesses are born and a similar number die. About 2 million workers start new jobs and a similar number leave their jobs. And about 500,000 workers a year change industries.

The gravity point of world trade is shifting closer to us, giving us the opportunity to become a lot richer.

''However, if we are to take advantage of these opportunities it is likely to require more change in the structure [of the economy] and, perhaps more importantly, in the mindset of Australian businesses and the skill sets of Australian workers.''

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Tough love or kindness - a taxing dilemma

Something very important is at stake in this year's budget and the opposition's response to it: the shape of Australia's welfare state. Will it continue to be needs-based, or will we progressively make benefits universal - available to everyone regardless of income?

Historically, people on the conservative side of politics have strongly supported means-tested benefits, whereas people on the left have been attracted to the idea of universally available benefits, thus removing the ''stigma'' attached to the receipt of benefits.

These days, however, we're witnessing a strange role reversal where the Liberals move away from needs-based benefits and Labor seeks to return to them.

Our means-tested welfare system is an inheritance from the Menzies era. The Whitlam government introduced universal health benefits in the shape of Medibank and began phasing in a non-means-tested age pension. The Fraser government was conflicted: it dismantled Medibank and restored a watered-down means test, but introduced a more generous, non-means-tested family allowance.

The Hawke-Keating government restored Medibank as Medicare, but put a lot of effort into tightening up means-testing, imposing it on the family allowance and making considerable savings to the budget.

Then came John Howard, the great disciple of Menzies, who spent all his 11 years introducing what economists have come to disparage as ''middle-class welfare''. He introduced an only lightly means-tested family tax benefit, repeatedly increasing it. He added an extra benefit for single-income families - Part B - which was means-tested only to the extent that mothers who did any paid work were rendered ineligible.

He inherited the means-tested childcare benefit but, rather than abolishing it, he added the non-means-tested 30 per cent childcare tax rebate on top. So whereas the first measure carefully excluded better-off families, the second brought them back onto the public teat.

He did something similar for the self-proclaimed ''self-funded retirees''. Older people judged too comfortably off to receive the age pension were given a special senior Australians tax rebate and a seniors health card that entitled them to pay what pensioners pay for pharmaceuticals, $5.60 a pop, rather than the $34.20 even the poorest working family pays.

Perhaps the biggest move in the direction of middle-class welfare was the decision to make superannuation payments tax-free for people 60 or older. Before, how much income tax you paid was a function of the size of your income; now it's also a function of your age. Old comfortables don't pay it, young strugglers do.

Rather than introducing paid maternity leave, Howard brought in the baby bonus, payable without means-testing to women who hadn't been in paid work as well as those who had.

He introduced a non-means-tested 30 per cent tax rebate on private health insurance and changed the formula for grants to private schools in a way that produced winners and losers, then let the losers keep the extra to which they weren't entitled.

The Rudd-Gillard government has been under continuous pressure from economists to roll back Howard's middle-class welfare. One of its first acts went the other way: fulfilling an ill-judged election promise, it increased the childcare tax rebate from 30 per cent to 50 per cent. It has also kept a promise not to change the winners-but-no-losers formula for grants to private schools. But most of its other actions have gone in the Hawke-Keating direction of tightening up means-testing. It imposed a cut-off of $150,000 a year on eligibility for the family tax benefit Parts A and B, the baby bonus, tax rebates for dependants and soon the paid parental leave payment.

The $150,000 a year sometimes applies to a couple's combined income, but often it applies just to income of the ''primary earner''. To avoid adding to the problem of high effective marginal tax rates (where the rate of gradual withdrawal of a benefit as income rises adds on to the rate of tax on the additional income), it's a ''sudden-death cut-off'': on $150,000 you get the benefit, on $150,001 you don't. Because of the sudden-death nature of the cut-off, it was set at a very high level. Even today, only about the top 17 per cent of households have pre-tax incomes of more than $150,000. And only the top 4 per cent of individuals earn more than $150,000. Arithmetically, there's no way people on these incomes can be said to be in the middle; they aren't rich as James Packer is rich, but they are undoubtedly high income-earners.

The $150,000 hasn't been indexed for inflation since it was announced in 2008 and the decision last week was to leave it unindexed until July 2014. This means the level of the cut-off is actually falling in real terms, removing more people from receiving the benefit as the years pass. The budget's other main move to reduce benefits to the comfortably off was the decision to phase out the tax rebate for dependent spouses under 40 and without children.

Tony Abbott and the Liberals have attacked these measures, condemning them as ''class warfare'' and ''the politics of envy''. Abbott has yet to say whether he will oppose them in the Senate, but his party's longstanding opposition to Labor's attempt to impose a means test on the private health insurance rebate suggests he will.

Much is at stake. You may think you pay a lot of tax, but people in almost every other developed country pay a lot more than we do, even the Kiwis. The single greatest reason for our relatively low level of taxation is our inheritance from Menzies of a lean and mean welfare system: low, flat-rate, means-tested benefits. Most other developed countries pay former-income-linked, universal benefits and have high taxes and huge government debt to show for it.

We can take our welfare system in whatever direction we choose, mean or generous. But the more generous we make it, the more tax we'll end up having to pay.

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Gillard's budget critics run for cover

One reason governments aren't nearly as "tough" as economists and others urge them to be is their knowledge that when the going gets rough - when the losers from that toughness start vigorously objecting - the urgers will be missing in action.

The reaction to last week's budget offers a good example. On budget night every petshop galah was complaining it wasn't tough enough - a "missed opportunity", the last Julia Gillard will get before the next election.

What they were on about was the need to roll back all the middle-class welfare John Howard inserted into the budget.

But there was a fair bit of rolling back in the budget and, on day two, when battlers on more than $150,000 a year (egged on by the media) were screaming blue murder, claiming to be on middle incomes and insisting "$150,000 a year isn't rich", almost all the previous day's urgers were out to lunch. (The media are always accusing the pollies of spin, but the media often put their own spin on the pollies' words. Neither Labor nor any politician would be stupid enough to claim people on more than $150,000 a year were "rich" rather than just comfortable, but the media happily put that emotive word into the pollies' mouths.)

Our small army of taxpayer-subsidised commentators from the libertarian think tanks - the Institute of Public Affairs in Melbourne and the Centre for Independent Studies in Sydney - had surprisingly little to say (with the honourable exception of the centre's Jessica Brown). Presumably, they were too busy preparing another jihad against "churning". You get the feeling Labor cops more criticism for its slowness to roll back middle-class welfare than Howard got for putting it there (here the economist Saul Eslake is the honourable exception). Certainly, the smaller-government brigade is a lot tougher on the government for its timidity than it is on the opposition for its blatant populism and inconsistency.

And if some of the measures proposed in the budget fail to get through the Senate, just watch as economists and media commentators blame it all on the Greens, not the Libs.

But I'm fairly confident most of the measures will get through. I have a feeling they were selected to be acceptable to the Greens and lower-house independents.

Against that, however, the failure of the pure at heart to offer the government any support in its battle with rent-seeking punters, an increasingly partisan media and an unprincipled opposition is a good way to increase the likelihood that those with the balance of power will decide the issue has become too hot so they dare not risk supporting the reforms.

It's funny commentators who last year were claiming Gillard's minority government would be incapable of achieving any reform are now berating it for this "missed opportunity". What were they hoping for: a truckload of tough measures that didn't stand a chance of getting through?

What the two attitudes have in common is they both frame Gillard as a loser. We know about Aussies' love of cutting down tall poppies, but here we're seeing something darker: if someone's down, why not join all those who are kicking them.

It's surprising how those who profess to care so deeply about the good government of the country see so little need to help a weak government be stronger. With our reform advocates it's all care but no responsibility.

As for the notion that governments can only do unpopular things in their first budget after an election, I don't think it applies to minority governments.

In any case, a look at the budget figures makes it clear Gillard is sailing close to the wind in being sure of achieving a small budget surplus in 2012-13 and keeping that surplus in the following few years.

There's a high likelihood that, to increase her margin of safety (and meet her pledge to limit real spending growth to 2 per cent a year), Gillard will need to achieve further spending cuts in her next two budgets - whether she fancies the idea or not.


Last Monday I wrote that the Reserve Bank governor's pay (I should have called it his total remuneration package) of $1.05 million a year had jumped 85 per cent in the past five years. This calculation was based on information in the Reserve's annual reports.


Now the chairman of the Reserve's remuneration committee writes that the figures used in this calculation are not comparable because of the changed accounting treatment of non-cash benefits. He says the cumulative pay rise over the period was in fact 34 per cent.


I have been unable to confirm his calculation from publicly available information. I am puzzled by it because the figure used as the base for my calculation, $570,000, was described in the Reserve's 2005 annual report as the governor's "remuneration package", which included "cash salary, the Reserve's contribution to superannuation, housing assistance, motor vehicles, car parking and health insurance and the fringe benefits tax paid or payable on these benefits".


The letter the previous chairman of the remuneration committee wrote to the Treasurer in September 2009 (made public because of a freedom-of-information request) advised that the value of the governor's total remuneration package had risen by 33 per cent just between 2008 and 2009.


I note that the incorporation into the governor's base salary of "other allowances (including motor vehicle)" worth $44,600 a year - which also included an unused entitlement to spouse travel, valued at $25,800 a year - led to a commensurate increase in his employer's superannuation contribution, which is made at the rate of 21.3 per cent.

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Lousy budget? Don't be fooled by harsh critics

If you listen to the economists and commentators complaining the budget wasn't tough enough - a "missed opportunity" - and involves budget deficits higher than earlier expected, you could easily conclude it's a weak effort that does little to keep the economy on the right track. But you'd be misled.

It's true the budget's estimate of an underlying cash deficit of $49.4 billion for the financial year just ending is about $8 billion higher than expected in November. And the estimated deficit for the coming financial year of $22.6 billion is about $10 billion higher than earlier expected.

But just about all of that deterioration is caused by a weaker-than-expected economy, not by government spending decisions. The government's expected tax collections over the two years have been cut by $16 billion as a result of all the natural disasters locally and in Japan, the appreciation in the dollar (which cuts the foreign earnings of Australian companies) and the lingering effect of the recession we supposedly didn't have, which left many companies with losses (which they are now charging against their more recent profits, thus reducing their liability for company tax).

So these setbacks can't be blamed on a government that isn't trying.

It's also true that, though Wayne Swan - or more likely, Penny Wong - achieved savings worth $22 billion over four years (with two-thirds of the savings coming from spending cuts and the remainder from the temporary flood levy and cuts in "tax expenditures" or concessions), these have been offset by new spending programs worth about $17 billion over four years.

Net savings of $5 billion over four years isn't a lot to write home about. That's what the critics were saying.

But here's another truth: Swan is expecting this year's deficit of $49.4 billion to turn into a surplus of $3.5 billion in 2012-13, just two years' time. And that would be the fastest turnaround ("fiscal consolidation") in the 44 years that records go back.

Sound like a weak effort to you? It's a turnaround equivalent to 3.8 percentage points of gross domestic product - 2.1 points in the coming year and 1.7 points in 2012-13.

This means that, in the simple way most economists (including those at the Reserve Bank) measure it these days, the "stance of policy" is highly contractionary.

During the recession we supposedly didn't have, the turnaround in the budget balance, from a surplus of $19.7 billion in 2007-08 to a peak deficit of $54.8 billion (4.3 per cent of GDP) in 2009-10, represented the budget being highly stimulatory, helping to prop up the private sector and minimise the downturn in the economy.

Now, however, it's doing the reverse. The budget's net contribution to demand is negative - contracting rather than expanding - thus leaving more room for private sector demand to expand without generating as much inflation pressure.

With high coal and iron ore prices doing so much to increase the nation's income and a massive mining construction boom getting under way, this fiscal (budgetary) contraction won't be sufficient to remove all inflation pressure, so the Reserve is likely to continue making its "monetary policy" more contractionary by raising interest rates. The fiscal contraction, however, should give the Reserve less to do.

Back to the point: if the budget's such a weak effort, how come the deficit will turn to surplus so quickly? First, it's because, contrary to the impression many people have gained, more of the deterioration in the budget balance was "cyclical" (caused by the downturn in the economy, otherwise known as the budget's "automatic stabilisers") than it was "structural" (caused by the government's explicit decisions to stimulate the economy with higher spending or tax cuts). Second, it's because the government has stuck to the highly disciplined strategy it imposed on itself at the time it was worsening the budget balance with its discretionary stimulus.

The first part of the strategy was to ensure all the stimulus spending measures were temporary. Once the designated amount of money had been spent, they would stop.

So the stimulus would be withdrawn automatically; it wouldn't be necessary to make an explicit decision to turn off the tap. This means the budget would return to surplus automatically as the recovery in the economy caused a cyclical recovery in the budget's tax collections and a fall in spending on dole payments.

That's how it would work in principle. To make sure it also worked in practice, the other part of the strategy was for the government to exercise special restraint in its spending and taxing decisions until the budget was well back into surplus.

It pledged to "allow the level of tax receipts to recover naturally as the economy improves", which means it swore not to have any further tax cuts for the duration. So it promised to put the proceeds from bracket creep into improving the budget balance.

On the other side of the ledger, it pledged to limit the real growth in its spending to 2 per cent a year. This is lower than the natural rate of growth in spending if left to its own devices, so many critics were sceptical that Labor would have the discipline to achieve it.

Well, so far the government is on track to achieve it. The budget expects real growth in spending of 0.7 per cent in the year just ending, 0.5 per cent in the coming "budget year", minus 0.1 per cent in 2012-13 (the year of the promised return to surplus) and 1.9 per cent in each of the following two years. That's average real growth of 1 per cent a year over the coming four financial years. It compares with average growth of 3.7 per cent a year over the 10 years before the financial crisis, when Peter Costello controlled the purse strings.

This says the Labor government's record on fiscal responsibility isn't bad. It's true, however, that the speed with which the budget is expected to return to surplus is owed also to the return of the resources boom. So one critic has written that "the inadequacy of Wayne Swan's fourth budget has left Australia highly vulnerable to the gathering risks in the global economy, punting everything on our China luck continuing to hold".

It's true that, should China fall in a hole, our return to budget surplus would be greatly delayed. But can you spot the weakness in that argument? If our boom evaporated, the need to get back to surplus ASAP would also evaporate.

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Despite apparent contradictions, Swan shows courage

Julia Gillard and her government may be suckers, but they deserve an even break. Every budget contains things to criticise but, overall, this one is good. We were warned it would be tough and it is - especially on the better-off.

It could have been more excruciating - economists are hard to please when it comes to inflicting pain - but it's tougher and more courageous than all but the first of the 12 budgets the now-sainted Peter Costello delivered.

Wayne Swan plans to tighten up on people with company cars, private health insurance and family trusts. He will get at those who pay their university fees up-front, mothers who stay at home and wealthier couples with dependent children and older workers using salary sacrifice to supplement their super.

Not only is this the first budget in nine years not to include a tax cut, it imposes the temporary flood tax levy. Tony Abbott will be righteous in his condemnation - but the man's so relentlessly negative he would have ripped into the budget whichever way Gillard jumped, adjusting his criticism to fit.

So why is a government that is travelling so badly in the polls, and without a majority in either house, proposing so many unpopular measures? Because there's nothing like having your back to the wall to focus the mind.

This government, in both its incarnations, got nowhere trying to be popular and to avoid offending anyone who matters. What it desperately needs is respect. The way to win it is to be seen as willing to make the hard decisions needed to secure our future.

Whatever the voters' immediate reaction, I suspect in time there will be a grudging recognition that Gillard has guts.

But what exactly is the problem? Why the obsession with the returning the budget to surplus? And what's the tearing hurry - why must it happen in 2012-13 without fail?

It's true Gillard's motive for hastening the return to surplus is heavily political. She upgraded a forecast to a promise in the election campaign and is afraid of what the opposition would say if it wasn't kept, whatever the reason.

Even so, the justification for a quick return is soundly economic - especially if you don't like paying higher interest rates.

The trouble for Gillard is it's a complicated and confusing story. Swan says the deep cuts in spending are necessary to return the budget to surplus because the economy isn't as strong as expected and tax revenue is weaker than expected, which seems contradictory. If the economy's not travelling strongly, what's the hurry? It's that the causes of the present patchiness - the lingering effects of the financial crisis, the recent natural disasters and maybe even the weakness of retail sales - are temporary.

Come next year, the economy's likely to be roaring ahead, fuelled by sky-high commodity prices and a huge mining construction boom that surely will run and run.

So the faster Swan can get the budget back to surplus and keep it growing (paying off the public debt in the process), the more the budget acts as a counterweight to the booming private economy, thus easing inflation pressure as the economy starts running out of production capacity.

This will reduce the need for the Reserve Bank to apply its own brakes: higher interest rates. But here's another apparent contradiction: economists are predicting the Reserve will raise rates again within a month or two. Will this prove Swan was lying or that his budget has failed?

No. Improvements in the budget balance aren't a perfect substitute for higher rates in the struggle to stop the economy's demand growing faster than its ability to supply. But the greater the improvement in the budget balance, the fewer rate rises will be needed.

To ensure this commodity boom doesn't end in tears and and that it ends with something to show for it, we need to, first, keep demand and supply growing in tandem and thus avoid inflation pressure and, second, increase our savings from the proceeds of the boom and, third, ensure the extra jobs go to our own people rather than immigrants.

The early return to surplus helps with the first two objectives; the budget's new programs to improve vocational training and increase the workforce participation of disadvantaged workers helps with the third.

Not a bad effort.

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Stevens sells his moral authority

Everyone who's seen The Godfather knows how the Mafia works: it's more than happy to do you a favour, but once it has it owns you forever. Our coterie of grossly overpaid chief executives and directors operates much the same way.

They're a mutual pay-raising society - you raise my pay and I'll raise yours - and more than a year ago they induced the governor of the Reserve Bank, Glenn Stevens (a most estimable fellow in every other respect), to join their club.

Stevens accepted the recommendation of the Reserve board's "remuneration committee" that his salary be raised to $1.05 million a year. This is at least double what the heads of federal departments get, and far more than almost all other central bank chiefs get.

It's about five times what the US Federal Reserve chairman, Ben Bernanke, gets. Stevens's pay has jumped 85 per cent in five years, equivalent to annual rises of 13 per cent.

This compares with a former governor's "line in the sand" many years ago setting 4.5 per cent a year as the maximum non-inflationary pay rise for ordinary mortals (a limit that these days would be too high because of our weaker productivity growth).

The price of Stevens's admission to the lowest rung of the indefensible-salaries club is the loss of his - and the Reserve's - moral authority on the question of excessive pay rises for punters. (He also forfeits the ability to be at all critical of the example set by his fellow club members.)

The chances of skilled-labour shortages turning into a general round of excessive wage increases in the next few years are high. If that happens, Stevens has lost the ability to fight it with "open-mouth operations" in the way his predecessor, Ian Macfarlane, sought to talk down the housing boom in 2003 - with some success. No, Stevens will be left with only one instrument: higher interest rates. And consciousness of his self-inflicted impotence in the moral suasion department may lead him to raise rates just that little bit higher than otherwise.

If so, he will have added injury to his insult to wage slaves. The more some workers seek a fraction of the percentage wage settlements Stevens has been accepting, the more others of them will be priced out of a job.

But how does it come about that Stevens is now paid so much more than other central bank bosses? The rest have boards composed largely of economists and public servants. Pretty much only in Australia is the board composed largely of business people.

So what more is natural than this group of chief executives and professional board members seeking to run chief-executive remuneration at the Reserve the way they run it on money-obsessed private-sector boards? And what is more natural than them cutting a nice guy like Stevens in on the easy dosh?

Studies by psychologists show that people engaged in ethically dubious practices are commonly anxious to convince others - and themselves - that "everyone's doing it". And now the governor's just as morally compromised as I am. Told you.

The Reserve's delay in making Stevens's pay rise public - or even privately informing the Treasurer - for almost a year suggests it knew full well it was out of line with "community expectations" and had done something to be ashamed of.

The arguments members of the Reserve's "remuneration committee" have offered in defence of their actions are characteristically weak. The Reserve has to compete with "lucrative offers in the financial sector" to retain staff, we're told.

At the level we're talking about, that's rubbish. These guys aren't real bankers, they're economist bureaucrats who know a lot about monetary policy, but not much else. They could never run a real bank; some could run a dealing room or be a chief economist.

If any of the Reserve's top people have had "lucrative offers" lately it would be nice hear about them. I'll bet they haven't. Even if they had, they wouldn't be tempted.

Anyone who hangs in at the Reserve long term, and thinks they have a shot at being governor, is motivated by something no private-sector job can offer: the knowledge you're playing a significant role in steering the Australian economy. As a bonus, you get to sign banknotes.

It's true salaries need to be reasonably competitive with the financial sector much lower down in the Reserve hierarchy. That's where good young people are often tempted away - especially since the intellectual firepower needed to progress up the Reserve's ranks is formidable.

But that's the joke. In line with the ethic of the indefensible-salaries club, lower salaries aren't increased commensurately. It's demigods only. Little trickles down.

Asked how the yawning gap between Stevens's and Bernanke's salaries could be justified, one genius on the "remuneration committee" argued it was all about how much you could earn after you ceased being governor. Bernanke would command $250,000 a speech. That's a market-forces argument?

In truth, retiring Reserve governors - who have excellent superannuation - can earn vastly higher incomes by accepting all the positions on boards they're offered. Their inside knowledge allows them to become professional directors overnight - and help jack up other top people's salaries. The only constraint is their personal ethics.

It seems clear the Remuneration Tribunal intends to raise the salaries of federal department heads to reduce the gap with Stevens's $1.05 million, on the grounds of comparable responsibilities.

So we start with a bulldust market-forces argument and progress to fairness arguments. When workers argued this way in the old days it was called "comparative wage justice" and every economist condemned it as economically irresponsible. The demigods live by different rules.


Letter From Donald McGauchie to the Treasurer - 18 September 2009


Letter From the Treasurer to Donald McGauchie - 15 September 2010


Letter From Jillian Broadbent to the Treasurer


Letter to the Editor, May 12:

I write as chairman of the Reserve Bank Board's Remuneration Committee to correct a misinterpretation in a recent article by Ross Gittins (BusinessDay, 9/5) that claims there had been an 85 per cent increase in the remuneration of governor of the Reserve Bank Glenn Stevens between 2005 and 2010.

The cumulative pay rise over that five-year period was, in fact, 34 per cent. The numbers used by Gittins are not comparable owing to the changed accounting treatment of non-cash benefits between 2005 and 2010.

Roger Corbett, chairman, Remuneration Committee, Reserve Bank Board


Last Monday I wrote that the Reserve Bank governor's pay (I should have called it his total remuneration package) of $1.05 million a year had jumped 85 per cent in the past five years. This calculation was based on information in the Reserve's annual reports.

Now the chairman of the Reserve's remuneration committee writes that the figures used in this calculation are not comparable because of the changed accounting treatment of non-cash benefits. He says the cumulative pay rise over the period was in fact 34 per cent.

I have been unable to confirm his calculation from publicly available information. I am puzzled by it because the figure used as the base for my calculation, $570,000, was described in the Reserve's 2005 annual report as the governor's "remuneration package", which included "cash salary, the Reserve's contribution to superannuation, housing assistance, motor vehicles, car parking and health insurance and the fringe benefits tax paid or payable on these benefits".

The letter the previous chairman of the remuneration committee wrote to the Treasurer in September 2009 (made public because of a freedom-of-information request) advised that the value of the governor's total remuneration package had risen by 33 per cent just between 2008 and 2009.

I note that the incorporation into the governor's base salary of "other allowances (including motor vehicle)" worth $44,600 a year - which also included an unused entitlement to spouse travel, valued at $25,800 a year - led to a commensurate increase in his employer's superannuation contribution, which is made at the rate of 21.3 per cent.

Monday May 18

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