Decarbonising economy is not such a big deal

To a lot of thoughtful people, Julia Gillard's plan to virtually ''decarbonise'' our economy represents one of the most radical attempts at reform in our history.

It will present a profound challenge to the Australian way of life, we're told, requiring changes to our lifestyle, spending patterns, taxation burdens and possibly even people's chosen field of employment.

As well as changing our everyday practices, it will change the structure of the country's fiscal and industrial systems and the way we trade with the rest of the world.

Fortunately, however, the adjustment needed to achieve a low-carbon economy won't be nearly as drastic as the thoughtful observers expect.

The first point is that the very reason economists advocate the use of the price mechanism is their confidence this will be the least-cost way to bring about the desired changes. Least-cost primarily refers to least reduction in the rate of improvement in our material standard of living (which reduction Treasury's modelling estimates to be less than 0.1 percentage points

a year, totalling about 0.5 per cent by 2020).

Something that has such a modest effect on our standard of living is unlikely to have much effect on our way of life. If it doesn't, that will be by design.

Decarbonising the economy isn't as radical as it sounds. It's not too much of an oversimplification to say the main change we need to achieve is just in the means we use to generate electricity.

It's not likely to involve any reduction in our use of electricity, nor much reduction in the rate of growth in that use. That's true despite all the talk about the higher price of electricity encouraging householders and businesses to use it less wastefully. By definition, wasting electricity contributes nothing to our standard of living.

The majority of the economy will be largely unaffected by carbon pricing. Get this: Treasury estimates that industries employing more than 90 per cent of the workforce account for less than 10 per cent of emissions.

Note, too, that Treasury expects about half the eventual reduction in emissions achieved by our big polluting industries to be brought about in other countries, where reducing emissions is cheaper. This, too, is a design feature intended to minimise the cost and disruption to our economy.

Remember that the decarbonising of the economy won't happen overnight. It will be brought about over the next 40 years. And much of it will happen relatively smoothly as electricity producers install emissions-efficient generators when their old power stations come to the end of their useful lives.

This is why it's so important to leave those producers in no doubt that the cost of emissions will be high and rising. Paradoxically, the more they believe that, the more their actions will cause it to be less true.

Tony Abbott claims the scheme obviously involves the end of the coal industry because Treasury's projections envisage coal accounting for less than 10 per cent of electricity production in 2050.

This is dishonest for several reasons. It ignores the 15 per cent of production expected to come from coal that's been subject to carbon capture and storage. More significantly, it ignores the high proportion of coal produced for export, including coking coal for steel-making. (And this guy calls Gillard a liar.)

Decarbonisation should also involve a major reduction in our use of fossil fuels for transport, of course. But, if the world price of oil keeps rising, over time that change will come about regardless of Gillard's carbon pricing.

The assertion that decarbonisation will bring marked and disturbing changes in our way of life reveals a lack of appreciation of how much things are always changing - especially over a period as long as 40 years.

Our spending patterns change over the years as we buy proportionately fewer goods and more services, as new electronic gismos are invented, as more women leave the home to work and as enterprising businesses dream up new services to sell us. Do we notice? Not really.

It's funny to have some critics asking why they're levying a new tax then giving back most of the proceeds (including by reductions in income tax) and then have others talking about significant changes in the tax burden and the fiscal structure.

The beauty of taxes that are used to change the relative prices people and businesses face is that you can then use the proceeds to reduce other, ideally more inefficient, taxes. This, too, is a design feature.

John Howard used the surge in company tax revenue associated with the resources boom to cut personal income tax five years in a row then proposed increasing it to eight years (with the Rudd government obliging). This significant change in the mix of taxes was brought about without anyone much noticing.

It's true the carbon price will cause employment in the small proportion of the economy that's emissions-intensive to grow less quickly than otherwise, while employment in the small proportion of the economy producing renewable energy grows more quickly than otherwise.

While ever the overall economy is growing, such modest changes in employment shares won't cause much angst. And get this: each year about 2 million people change jobs, including about 500,000 who change industries.

The structural change the carbon price will bring isn't likely to be all that history-making. According to Treasury, ''the changes to the Australian economy from pricing carbon are [projected to be] small by historical standards and small compared to the changes we are already seeing in our economy as it adjusts to accommodate the pressures of mining boom mark II''.

A carbon tax is nothing compared with an exchange rate that stays above parity with the greenback.

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Gillard's flawed scehme worth doing

In this far from perfect world, no reform that makes it into law is ever ideal. It's always flawed and internally inconsistent, a product of the compromise necessitated by our democracy. Of course, some reform attempts are more flawed than others. So the question for Julia Gillard's carbon tax package is: is it too flawed to be worth bothering with?

In this far from perfect world, no reform that makes it into law is ever ideal. It's always flawed and internally inconsistent, a product of the compromise necessitated by our democracy. Of course, some reform attempts are more flawed than others. So the question for Julia Gillard's carbon tax package is: is it too flawed to be worth bothering with?

With Kevin Rudd's carbon pollution reduction scheme in 2009, the compromise was negotiated with the Liberals. But they reneged at the last minute, sacking Malcolm Turnbull and turning to Tony Abbott because so many of them doubted that climate change was real.

The Greens, who were excluded from the negotiations, helped the Coalition vote it down in the Senate, arguing it would do too little to reduce emissions of carbon dioxide and other greenhouse gases and gave too much compensation to the big polluting industries. Knock this one back and they'd have to come up with something better.

With Gillard's package, the compromise has been done with the Greens and the independents. In the meantime, Abbott has had so much success arousing opposition to action on climate change that the continuing supporters of action aren't in a mood to be picky. They'll take what they can get.

But the question remains: is the new package worth all the angst it's causing? And is it much better as a result of the Greens' ministrations?

For starters, it's just a modified version of the Rudd scheme, not radically different. So the ''big polluters'' will still get as much compensation, if not more. But although most economists agree they're getting more compensation than is justified (those competing in export markets against foreign producers not burdened by a carbon tax do need some relief), most economists would also agree the compensation isn't likely to greatly diminish their efforts to reduce emissions.

Non-economists seem to think you can't get people to change their behaviour unless you punish them. Take money from them and they'll change their ways. Economists think the main way to discourage a particular activity is to raise its price relative to the price of other activities. You don't have to take money from them (the ''income effect'' as economists call it) to get them to respond to the changed price structure (the ''substitution effect'').

Most of the compensation will go to the ''emissions-intensive, trade-exposed'' industries, in the form of free emission permits. But each firm's compo will be based on the average emissions of firms in their industry. So those with above-average emissions, which they'll need to cover by buying extra permits, have a clear incentive to find ways to reduce their emissions.

But even those with average or below-average emissions also have an incentive to reduce emissions. Why? Because they'll be able to sell to other firms any of their free permits they don't need.

Thus, just as the Rudd scheme would have done more to discourage emissions than many people imagined, so this package will also discourage emissions.

Gillard's package is widely described as a carbon tax but, strictly speaking, it's an emissions trading scheme in which the price of emission permits is fixed for the first three years and permits made freely available, after which the price is set by auction, with an ever-declining quantity of permits made available each year.

So it's not hugely different from the Rudd scheme, which itself planned to start with a price fixed at $10 a tonne of carbon emissions in the first year. This time the price will start at $23 a tonne, increased in each of the two subsequent years by 2.5 per cent in real terms - an improvement.

The reductions in the trading scheme's cap on emissions - needed to reduce total emissions over time and thus likely to gradually raise the price of permits - will now be set by the government on the basis of recommendations by an independent climate change authority, chaired by a former Reserve Bank governor, Bernie Fraser. An improvement.

Another improvement is that the independent Productivity Commission, no soft touch, will review the levels of assistance provided to trade-exposed industries with a view to reducing them as other countries limit the emissions of their own industries.

The Rudd scheme was widely criticised because its guaranteed reduction in emissions to 5 per cent below 2000 levels by 2020 was considered too small. It's actually more demanding than it sounds because, without action, our emissions would grow a lot between 2000 and 2020. Achieving the 5 per cent target will require emissions in 2020 to be 23 per cent lower that they'd otherwise be.

However, both the old scheme and the new allow for the target reduction to be increased to 15 per cent or 25 per cent of 2000 levels if other countries tighten their own targets. The old scheme aimed to reduce emissions in 2050 to 60 per cent below 2000 levels, whereas the new one aims for 80 per cent below.

Rudd included transport fuels in his scheme while excluding cars and farm vehicles for three years and heavy road vehicles for one year. Gillard's scheme excludes cars and farm vehicles ''forever'' and imposes the equivalent of a carbon price - just 6 cents a litre - on aviation, mining and shipping, extending this to heavy road vehicles after two years.

But nothing is forever in politics and, in any case, does anyone expect the world price of oil to do anything but keep rising?

Gillard's scheme provides substantially more support for innovation, mainly through a $10 billion clean energy finance corporation, which will give a partial subsidy to those firms that win the assistance by proposing better schemes to reduce emissions.

Her scheme also includes (at the behest of an independent, Tony Windsor) a land-sector package worth $1 billion over four years, which will improve biodiversity (the preservation of species) and encourage more eco-friendly farming practices.

Gillard has roundly attacked Abbott's plan for ''direct action'' on climate change rather than ''putting a price on carbon'', but her package also includes direct action - such as buying out the hugely polluting brown coal power stations.

There's nothing wrong with a two-pronged approach in principle, so long as the direct measures aren't too wildly expensive per tonne of carbon avoided or just disguised handouts to rent-seeking industries (as the brown coal buy-out seems to be).

Rudd's flawed scheme was always worth doing; this one is better - just a bit.

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How influential are (economic) journalists?

Australian Conference of Economists, Canberra
Wednesday, July 13, 2011

I take my title, How influential are journalists?, to be a reference to economic journalists, particularly economic commentators. My answer has changed little since a paper I wrote on the topic was published in the Australian Economic Review in 1995: not nearly as influential as you might imagine. But in preparation for defending that view, let me make a few clarifying points.
First, economic journalists distinguish themselves sharply from business (formerly known as financial) journalists. We write about macro and micro issues, they write about the adventures of listed companies.

Second, economic journalists - those who specialise in writing about macro and micro issues, and usually bring some university-level economic training to bear - are relatively rare. There are a few at the ABC (eg Stephen Long), but most work for the quality press.

Third, the economic content in the press can be divided into reporting of news and commentary on that news. News covers such things as ABS statistics, RBA announcements and speeches, speeches by the treasurer and treasury heavies, government reports, the budget and mid-year reviews, and developments in financial markets. Most of that economic reporting is done from the Canberra press gallery. This means that, in practice (and unlike in the US and elsewhere) economic journalism tends to be a specialty within political journalism, making it more focused on political economy issues. Except for the quality press, much economic reporting is done by political reporters - which means, for instance, that if the opposition seems to be making political headway in criticising deficits and debt, the political journalists will take it a lot more seriously and uncritically than economic journalists would. Issues are judged on their political potency, not their economic merits.

Fourth, the role of the news media is much misunderstood by many people. They assume the media’s role is to give their audience a balanced picture of what’s happening in the world beyond people’s personal experience. In fact, because the media is directly or indirectly selling its news, we limit our reporting of what’s happening in the world to those things we believe our audience will find particularly interesting. This imparts considerable biases to what we report: we pay a lot more attention to bad news than good, to problems rather than solutions, and to conflict and controversy (so that, for instance, dissenters from the dominant view on climate change among scientists get a lot more space than their numbers warrant). The media are more interested in people than concepts, and more interested in concrete case studies than abstract principles. In political and economic reporting there is much resort to ‘race-calling’: which side’s doing well in the polls and which isn’t, which leaders are secure and which under threat; which economic indicators are up this month and which are down (or, for the share market and the exchange rate, which are a bit up or a bit down today). The media tend to pander to what they assume to be their audience’s prejudices: so rises in interest rates and the dollar are always good, falls are always bad. Deficits are always bad, surpluses are always good.

So, how influential are economic commentators? Well, not sufficiently influential to discourage their editors from the eternal race-call. They try to discuss indicators in a longer and broader context, but fight an uphill battle. Similarly, they stand against the political journalists’ misconceptions (eg references to the budget deficit as ‘Australia’s deficit’; the notion that the carbon tax package’s funding shortfall of ‘$4 billion over four years’ is a huge discrepancy, or belief that a budget surplus of $1 billion is significantly different from a deficit of $1 billion), but in this they don’t seem to have any impact on the political journalists’ judgements. They don’t have much success in resisting pressure for unending idle speculation about the timing and direction of the next move in the official interest rate.

Economic commentators, in sharp distinction to political commentators, don’t hesitate to take a position in the policy debate and to campaign for particular policies. It’s intended to be a constant and logically consistent position - not one that keeps adjusting so that whatever a government does can be criticised - based on their school of economic thought and personal values, not on partisan loyalties. The bane of an economic commentator’s life is people always trying to consign him or her to a party-political box. In the past most of them have tended to be pretty orthodox in their views - pretty rationalist - but some of us have been trying to offer a wider range of views. The commentators’ paper’s emphasis on race-calling means macroeconomic issues tend to crowd out microeconomic issues, which are often more important. The journalistic profession’s obsession with timeliness - with never being ‘off the pace’ - limits their ability to continue pursuing issues once the political caravan has moved on.

Economic commentators are not great original thinkers. They don’t keep up with the literature. As with most economists, most of the arguments they mount and policy solutions they espouse are pretty derivative. I’ve never deluded myself I’ve been giving the pollies policy advice that was significantly different to and superior to the official advice they were getting. Economic commentators spend a lot of time talking to senior econocrats, and much of what they write echoes the views of the particular econocrats they talk to. They don’t talk to academic economists as much as they probably should, mainly because so few academics keep up with the policy debate. My emphasis has been more on explaining economic policies to my readers than on telling pollies or central bankers how to run the country. And these days I’m trying to offer my readers a critique of economists and economics.

One factor that hugely limits the influence of economic commentators is that all of us read more for reinforcement of our existing views than for enlightenment. We generally avoid reading the opinions of people we know we’ll disagree with, though psychological studies find that, where we do persevere with an article that doesn’t fit with our views, it serves only to confirm the rightness of those views.

I guess that where the economic commentators all sing the same song, a song that’s being sung also by the econocrats and many academics, and we go on doing that for long enough, it is possible to make certain views the conventional wisdom among elite opinion. Of course, my opinion on the extent of our influence is hardly objective, but from my perspective it’s pretty limited.

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Give and take: The new tax is a piece of cake

Years ago, the Keating government had a problem with pensioners wasting taxpayers' money on prescriptions. Knowing their elderly patients got their prescriptions free, doctors were happily issuing ones their patients might or might not end up needing and pensioners were taking them to the chemist and getting them filled, just in case. Many of these often very expensive drugs were not used.

So the government decided to impose a nominal fee on pensioner prescriptions of $2 a pop, just to make people think twice about whether they'd be needed. But, anxious though it was to save big money by reducing the waste of taxpayer-subsidised pharmaceuticals, the government had no desire to leave pensioners out of pocket. It worked out the average number of prescriptions pensioners had filled, multiplied it by $2, and increased pensions by that amount.

I dredge up this story because it may help you understand something about Julia Gillard's planned carbon tax that many people find puzzling.

If Gillard is imposing a carbon tax to raise the price of electricity and gas, with some flow through to the prices of other items, so as to discourage us from using so much fossil fuel, why is she undoing the effect by giving us back most of the tax we'll pay as cuts in income tax and increases in pensions and family benefits?

What's the point of this money-go-round, as Tony Abbott calls it? How can it do any good?

Though the carbon tax will raise about $9 billion a year in revenue, raising revenue is not its primary purpose. Rather, its purpose is to change people's behaviour. And one of the most basic ideas in economics is that the best way to change people's behaviour is to change the prices they face. If there's some activity you wish to discourage, raise its price relative to all the other prices people pay.

When, after a cyclone, the price of bananas shoots up relative to the prices of other fruit, people tend to buy fewer bananas and more apples and oranges. When the price of beef rises more than other meat, people buy less beef and more chicken.

The thinking is that if you raise the price of fossil fuels and emissions-intensive goods relative to the prices of all the other things people buy, they'll change their spending in ways that reduce the use of fossil fuels.

It's not necessary to leave people worse off to get them to change their spending patterns. And since the primary purpose of the carbon tax is to change relative prices rather than to raise revenue, you may as well return the revenue to people by cutting income tax and increasing benefits.

(You can't give back all the revenue because you're using part of it for other purposes, so you favour low- and middle-income households and let higher-income households take it on the chin. Since your calculations about how much the carbon tax will cost people are based on averages, and not everyone fits the average, you give low-income households a bit more than the average so fewer of them are undercompensated.)

Now, you may say finding ways to cut your use of electricity and gas isn't as simple as buying apples rather than bananas, and you'd be right. There are ways to reduce energy use around the house, but I suspect the main way people will respond is by buying a more energy-efficient model the next time they're replacing an appliance.

If you think no amount of energy saving in the home is likely to bring about the degree of reduction in fossil fuel use we needed to achieve, you'd also be right.

People have an automatic tendency to apply government moves such as this to themselves and their homes but, in fact, the relative price change is directed mainly at the big industrial users of electricity and, more particularly, the generators of electricity.

It's when their existing power stations come to the end of their useful lives and are replaced by less-polluting generators that the big steps forward will be made.

The government claims the changes it will make to the income tax scale - lifting the tax-free threshold from $6000 a year to $18,200 - is a major reform, meaning about a million people will no longer have to submit tax returns.

Tony Abbott counters that it's a terrible change: "This is the first time in a generation that marginal tax rates have been increased." The bottom tax rate of 15 per cent is to be increased to 19 per cent, and the second rate of 30 per cent increased to 32.5 per cent.

Both sides are playing on the public's ignorance of the complexities of the tax system, in particular the operation of the "low-income tax offset" of $1500 a year, which lifts the present effective tax-free threshold from $6000 to $16,000, but is then clawed back after people's incomes exceed $30,000 a year, at the rate of 4? in the dollar.

Under the new arrangement, this offset will be cut to $445 a year and its rate of withdrawal cut to 1.5? in the dollar. When you take this into account, Labor's grand reform becomes a minor reform. Most of the million people aren't paying tax under the present system, they just have to put in a return to claim the offset.

As for Abbott, the change will involve no increase in anyone's effective marginal tax rate. All it means is that the hidden 4 per cent rate at which the offset is withdrawn will no longer be hidden.

The carbon tax is neither as good as Gillard claims nor as bad as Abbott claims. Funny, that.

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It will be neither as good nor as bad as we're told

So now, supposedly, we know exactly what to expect when, as seems likely, the carbon tax comes into effect on July 1 next year.

The average household's costs will increase by about $10 a week. All but the top 10 per cent of households will receive tax cuts and benefit increases to compensate them for this higher cost and two-thirds of households will be fully compensated.

Uncertainty over? Don't you believe it. Now begins the search for the devil in the details. And what a frantic, spine-tingling, imaginative search it will be, led not by seekers after truth but by all those who stand to gain by convincing us disaster is about to befall us and our economy.

There is much distrust of Julia Gillard and her assurances, particularly since she has broken her election promise not to introduce such a tax in this term. But how much trust can we place in her critics? Since the Coalition, in its day, has supported putting a price on carbon emissions, can we be sure Tony Abbott's change of heart isn't motivated primarily by desire to win back government?

We will be assailed by business people telling us how devastating the tax would be for jobs in their industry. Can we be sure they aren't exaggerating as they jockey for concessions? If we doubt the word of politicians, can we trust the predictions of business people?

This scheme is hellishly complex, so it contains much scope for apprehension, justified or otherwise. It is designed to change our behaviour without penalising most households - itself a puzzle to many people - so this will in time change the shape of the economy.

In truth, some industries will gain while others lose. We will hear at full voice from those fearing they will lose, while the winners stay mum, as do the great majority of industries that will be little affected.

Psychology sheds as much light on these questions as does economics. The safest prediction is that the tax won't be as bad as its critics fear, nor as benign as its defenders claim.

We can be sure of this because of humans' well-researched inability to accurately predict the future.

We almost always expect bad things to be worse than they prove to be and good things to be better than they prove.

And psychology teaches us another lesson: once the tax starts we will get used to it very quickly.

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Labour isn't inanimate. We're human.

When Dr Martin Parkinson gave a speech urging a renewed effort to lift the productivity of labour, the subeditors at the ABC knew just what he meant: Treasury secretary says we should work harder. Whoops.

That ain't what he meant. As the old slogan says, improving labour productivity involves "working smarter, not harder". Indeed, increasing productivity requires producing more from the same inputs. So increasing output by increasing labour inputs clearly doesn't do the trick.

The standard way to raise the productivity of labour is to supply workers with more and better machines to work with. But Parkinson is talking about something more demanding, more reforming than this. He wants a renewed round of microeconomic reform.

He's right in saying the rate of improvement in labour productivity has "slowed sharply" since the start of the new century. He argues only part of this is explained by the delay while the mining industry's partially installed production capacity comes on line.

So what kind of reform do we need to buck things up? Well, a lot of people think the answer's obvious. Peter Reith, a former Liberal minister for workplace relations, for instance: "Labour market issues are at the heart of productivity and, in the end, about living standards. Australia's productivity performance has been poor in recent years. We cannot pretend this problem does not exist."

Another Howard government luminary, Peter Costello, would be the first to agree. He once said: "We need a new dose of active, wide-ranging and vigorous industrial relations reform in this country. No single reform would boost productivity in the Australian economy to the same extent."

He said that in 2005, in support of John Howard's Work Choices reforms. But Work Choices is no more. First it was watered down by Howard himself when finally he realised how unpopular it was, then it was further dismantled by Julia Gillard's Fair Work Act. And Tony Abbott promised repeatedly that Work Choices was "dead, buried and cremated".

I suspect a lot of Liberals' consciences are troubling them over Work Choices. They share the belief of Reith and Costello that industrial relations is the one key reform that would fix productivity. They know it's politically difficult, but the Liberals have to stand for something and reversing the Fair Work Act is something worth fighting for.

If the Murdoch press is to be believed, there's mounting disaffection among employers at the way Fair Work has re-regulated the labour market. Union power is back, we read, and strikes and excessive wage settlements are on the way.

I remain to be convinced this is anything more than employers' paranoia. Big wage increases in the mining industry are only to be expected during a mining boom. It's actually the way market forces work to shift labour from declining industries to expanding industries.

It's hard to believe the union monster could be revived. Union membership in the private sector is down to 14 per cent. Strike activity is a fraction of what it used to be and still falling. And though it doesn't prove much (because, in the real world, all else never stays equal), wages are growing at an unworrying 4 per cent annual rate.

But is industrial relations reform the key to restoring our productivity growth? I doubt it's the magic bullet the Liberals are convincing themselves it is. And Parkinson's agenda for further reform included not a hint he thought it important.

Even so, I don't doubt that reinstating the weakening of workers' bargaining power against their clearly more powerful employers by frustrating collective bargaining and promoting individual contracts, tolerating summary dismissal of workers and removing legislative protection of wages and conditions would indeed raise the productivity of labour (not to mention enhancing profits at the expense of wages).

It would do so mainly by giving employers far more freedom to shift workers around - to hire and fire at will, to bring workers in or send them home, and to split their shifts, move them between branches, put them on rolling shift work and make them work on weekends and public holidays all without additional compensation.

In other words, removing most of the paraphernalia of industrial relations legislation would give employers almost the same freedom to economise on the use of labour as they already have in managing the inanimate raw materials and machines that contribute to the production process.

It would impart to the labour market the supreme "flexibility" that Parkinson and other economists extol as the sine qua non of economic efficiency.

There's just one small problem, one the economists' model ignores rather than highlights: unlike all the other "factors of production", . Every unit of the stuff comes with a human attached. And each human unit is a bit different.

This means labour can give you trouble that other raw materials can't. The worse you treat it, the more it looks for ways to get back at you. The worse you treat it, the more you have to spend supervising it to prevent shirking.

You can't give yourself a huge pay rise without making it think it's underpaid. You can treat it inconsiderately only when it's in plentiful supply. If it's in short supply, it will up and leave. Smart employers (and conservative politicians) understand this, dumb ones don't.

But all that's by-the-by. The real point is that humans are meant to be the object of the economic exercise. When you seek to raise productivity and material living standards by making people's working lives a misery of uncertainty and insecurity, damaging people's family lives and even their health, you confuse means with ends, harming people in the name of helping them.

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Immigrants and oldies share our growing work load

Most of the interest in this week's figures for the labour force in June was in what they told us about the strength of the demand for labour. But what's happening to the supply of labour is just as interesting.

With the trend figures showing total employment grew by 188,000 over the six months to December, but by only 38,000 over the past six months, it's clear the demand for labour is slowing. This suggests the economy itself is growing less quickly, reducing concerns about gathering inflation pressure - for the time being, anyway.

Even so, the rate of unemployment staying steady at (a healthily low) 4.9 per cent for the past four months says the demand for labour at least is keeping pace with the supply of it. Which means the supply must have slowed, too.

The labour force (all those people with jobs or actively seeking them) grew by 1.7 per cent to just over 12 million people in the year to June, which was down from 2 per cent growth the previous financial year.

This is in distinction to the earlier position because, as an article in the latest Reserve Bank Bulletin points out, the labour force has grown at an average rate of 2.5 per cent a year since 2005. That's fast - it's also an extra 1.4 million people. Where have they all come from?

The first source is more people of working age (those 15 and over) choosing to actually participate in the labour force. And the big increase has been among women, plus older workers choosing to delay their retirement.

To appreciate the full effect we have to go back a bit. Since 1980, the rate of participation by women aged 25 to 54 has increased by about 20 percentage points, while the rate for women aged 55 to 64 has risen by a remarkable 35 percentage points.

Female participation has been rising since the 1960s and is occurring in all the rich economies. It reflects changing social norms as well as economic factors. The proportion of women with post-school qualifications has risen from 7 per cent in the early 1980s to more than 25 per cent today - which is higher than the proportion for men. Why wouldn't these women want to use their qualifications in paid work?

The strong growth of employment in service industries has suited women, partly by providing more jobs with flexible working arrangements. Growing access to child care and paid maternity leave has also helped.

But the largest increase in participation has been for older workers. The change for men began in about 2000. Since then, the rate for males aged 55 to 64 has risen by more than 10 percentage points. This trend, too, is happening around the developed world.

In Australia there had been a trend towards early retirement (you can access your superannuation savings at 55), but this is reversing. One factor encouraging people to remain in the labour force for longer is greater longevity.

Another is increases in the qualification age for the age pension. Since 1995 the age for women has been gradually increasing from 60 to 65, the same as for men, and for both men and women it will increase from 65 to 67 between 2017 and 2024.

Other factors encouraging later retirement include more flexible work practices, such as greater willingness to allow older workers to work part time, and the rising share of jobs in the services sector, where employment is typically less physically demanding than in the traditional goods-producing industries.

And here's where psychology enhances oh-so-logical economics: more people are working longer because more of their mates are working longer. As social animals we have an instinctive urge to do what everyone else is doing.

Something to note about the rise in both female and older-worker participation, however, is that it's been accompanied by a decline in the average hours worked per worker. It's gone from 35 hours a week in 1980 to 32 hours today.

Why? Because women and older workers are more likely to work part-time. It also reflects a fall in the share of people working very long hours in recent years.

This means a bigger factor explaining the growth in the supply of labour has been the growth in the population of working age. It's been increasing at an average rate of 1.5 per cent a year since 1980. But annual population growth picked up markedly from the mid-2000s, peaking a more than 2 per cent in 2008, since when it's fallen back to the average.

Part of this is population growth is ''natural increase'' (more kids turning 15 than oldies dying) but most of it is net migration (more people come in than going out). The increase in net migration between 2004 and 2008 mainly reflected a higher intake of permanent and temporary skilled migrants and a huge rise in the number of overseas students.

The Howard government's switch of priority from family reunion to skilled migration helps explain why more than 80 per cent of the migrants who arrived in 2009-10 were of working age, compared to 70 per cent of the total population. The proportion of the labour force that had arrived in Australia in the previous five years rose from under 3 per cent in 1996 to 6 per cent in 2011.

In recent years the significance of the government's much-watched annual permanent immigration program has been overshadowed by the temporary immigration categories for skilled workers (employer-sponsored 457 visas), students and working holiday-makers (backpackers).

The number of 457 visa holders has doubled since the mid-2000s, though their share of total employment is still less than 1 per cent. Their numbers have fallen as a result of the global financial crisis, but are likely to go back up because of resources boom mark II.

The number of student visa holders has tripled over the past decade, accounting for most of the surge in net migration. Overseas students are permitted to work 20 hours a week while their course is in session and unlimited hours during scheduled course breaks.

Student numbers have fallen sharply, however, because of a tightening in entry rules, the higher exchange rate and the bad publicity in India.

Those who disapprove of high immigration should remember this - as should those economists who bewail the slowdown in net migration. A lot more overseas students won't avert our looming skilled labour shortages.

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BY 2020 ONLY THE RICH WILL BE AT HOME IN AUSTRALIA

IQ2 Debate Sydney City Recital Hall
Tuesday, July 8, 2008

Some of you who read my column may be wondering what on earth I’m doing on the side opposing this motion that, by 2020, only the rich will be at home in Australia. Don’t I care about inequality? Well, yes I do. Do I believe everything in the garden is rosy? No I don’t. I do believe the gap between high and low incomes is too wide and I’d be happy to see governments do more to redistribute income from high income-earners like me to lower income-earners like you. (No, I suspect few of you are low income-earners.)

So why am I opposing this motion? Because it’s too extreme; it’s way too pessimistic and it goes over the top. Think about it: by 2020, only the rich will be at home in Australia. Let me ask you: do you feel at home in Australia right now, or do you feel like an outcast? Are you rich? No, you’re not. But what this motion asserts is that, within just 12 years or less, you’ll be dispossessed. If you own your home now, within 12 years you’ll have lost it. If you’ve got any superannuation, it won’t have grown in the next 12 years, it will have disappeared. If you’re middle-class, educated and reasonably comfortable now, within 12 years you’ll have lost it all. You’ll by like a new migrant who isn’t sure he jumped the right way; who doesn’t feel at home in Australia.


Another question: what proportion of the population would you consider to be rich? The top 50 per cent? 20 per cent? 10 per cent? What about the top 2 per cent? To be in the top 2 per cent of taxpayers you have to be earning more than $180,000 a year. So let’s say the top 2 per cent. This motion is saying that, within 12 years, the remaining 98 per cent will be stuffed. Now, I don’t pretend to know what will happen in the next 12 years, but the other side is certain they know: you are going to be completely buggered.

I don’t believe that for a minute, and that’s why I’m opposing this motion. It takes a sensible argument - the gap between rich and poor is too wide - and goes way over the top, predicting death and destruction for everyone in the middle.

Let me make three points. First, don’t believe everything you read in the paper. (Except the Herald, of course.) By their intense focus on the amazing salaries of a relative handful of chief executives and rich businessmen they’ve left us with a quite exaggerated impression of how well everybody earning more than we are is doing. What happens to the incomes of about 2000 men (and the odd woman) may be big news, but it tells us little about what’s happening to the remaining 21 million of us.


Second, it’s naïve to assume, as our opponents do, that things just keep moving in the same direction forever. If they’ve been getting worse, they can only keep getting worse. History shows that’s not true. The economy moves in cycles - house prices move in cycles, home loan affordability moves in cycles, interest rate go up and then come down. I believe in the pendulum theory of history, under which things keep moving in one direction until there’s a reaction, and they start swinging back in the opposite direction, only eventually to go too far in that direction. The proposition that gap between rich and poor can only widen in the next 12 years reveals an ignorance of the way the world works.

Third, what will all the low and middle-income voters be doing while they’re being dispossessed by the top 2 per cent? Democracy protects us from such extremes because the rich will never have more votes than the bottom and the middle, and governments that want to stay in power must attract the votes of the non-rich. The notion that elected governments do nothing but pander to the rich and powerful is defies common sense.

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This very lucky country enjoys a good whinge

Another week, another batch of bad news, adding to the general impression things aren't going at all well in the economy. But the gloomy talk doesn't fit with the objective indicators. Will we snap out of it, or could we talk ourselves into genuine poor performance?

Undisputed winner of the Greatest Gloom award was the quarterly report of the Sensis business index. "Weak consumer spending and an uncertain economic outlook have caused business confidence in Australia to tumble to a low not seen since the global financial crisis ...," the report said, forgetting to mention it covers only small and medium businesses.

Business confidence fell from 44 per cent to 28 per cent, the second biggest drop in the index's 18-year history. Perceptions about the present state of the economy fell from plus 8 per cent to minus 7 per cent.

Support for the federal government's policies fell 16 percentage points to minus 41 per cent. Fully 53 per cent of small businesses said a carbon tax would have a negative impact on their business, while 41 per cent believed it would have no impact.

In earlier news, the Westpac-Melbourne Institute index of consumer sentiment fell by 2.6 per cent in June to its lowest level in two years. Comparing this June with June 2009 - when we were still expecting the financial crisis to result in a severe recession - people's expectation for general economic conditions are 98 now, whereas they were 85 then.

So the index's present weakness is explained by people's feelings about their own finances compared with a year ago. Whereas the rating was 82 in June 2009, today it's 76. And whereas feeling about the outlook for family finances over the coming 12 months was 114 then, it's less than 96 today.

Next we had a Newspoll survey which found 35 per cent of respondents expected their standard of living to get worse in the next six months, up 10 points on what people thought last December. The proportion expecting their living standard to improve dropped to just 12 per cent, with 51 per cent expecting it to stay the same.

You'll have noted that all this gloom is coming from surveys of how people feel. When you look at the objective indicators of the economy's performance you find a different story. While employment growth is slowing, we still have 260,000 more jobs than we did a year ago, most of them full-time. And unemployment remains at 4.9 per cent. The figures show growth is fairly well spread between the states, not just concentrated in the resource states.

Between the growth in employment and quite strong growth in wage rates, household disposable income rose by 8.3 per cent over the year to March. Over that period, the consumer price index rose by 3.3 per cent and the cost of living index for employees rose by 4.9 per cent. Does that sound like a squeeze on living standards to you?

We keep hearing about the weakness in retail sales, and it's true they grew by only 0.8 per cent in real terms over the year to March. But overall consumer spending grew by 3.4 per cent, a perfectly healthy rate.

The repeated claims we hear about how much difficulty people are having coping with the cost of living hardly fit with the ever-rising rate of household saving, which now exceeds 10 per cent of household disposable income.

It seems clear the economy's problems are more in the minds of consumers and business people than in their behaviour - though I'd be the last to deny that the way we feel can influence the way we act. Question is, why do so many people feel so bad and will this start having real effects?

Part of the problem may be a widespread lack of confidence in the Gillard government. Breaking down the Newspoll figures on expectations about the standard of living shows unsurprisingly that 45 per cent of Coalition supporters are expecting it to get worse.

More surprisingly, they're joined by 23 per cent of Labor supporters, with only 17 per cent expecting it to get better. Of course, the government's tactic of always echoing the punters' self-pity on the cost of living makes it its own worst enemy.

A related explanation is the undoubted success of Tony Abbott's scare campaign over a carbon price. Explaining the slump in consumer confidence, Bill Evans of Westpac says that "despite steady interest rates and falling petrol prices, concerns about the introduction of a price on carbon are rattling households". These concerns disproportionately affect low income earners. But you'd expect them to dissipate fairly quickly when, as seems likely, the issue turns from imaginings to reality in July next year.

The macro-economically literate understand the huge effect on the economy that's coming - and will come - from having our terms of trade at a 140-year high and from an amazing mining construction boom. They also understand that this income will spread throughout the alleged two-speed economy.

Is it possible the luckiest - and long the best macro-economically managed - country in the developed world could turn its prosperity to ashes?

I believe in the power of psychology, but I doubt it's that powerful. The resources boom will steam on no matter how the punters are feeling.

But it is possible we could go on feeling hard done by, even as we get richer and the economy's underlying structure gets stronger.

And if the non-mining economy hangs back in fear and confusion while the mining sector booms, at least that will make life a lot easier for the macro managers.

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The price we would pay for keeping the farm

According to the Greens, the mining industry is 83 per cent foreign-owned. And their anxiety is matched by Senator Barnaby Joyce's worries about foreigners buying up rural land in NSW. But how concerned should we be about "selling off the farm" and what could we do about it?

The Greens' claims have not gone unchallenged. According to the Minerals Council, official figures show mining is actually 71 per cent foreign-owned. The Greens say BHP Billiton is 76 per cent foreign-owned, but the correct figure seems to be 60 per cent.

No one's disputing, however, that Rio Tinto is 83 per cent foreign-owned and Xstrata is totally foreign-owned. And even if the mining industry overall is "only" 71 per cent foreign-owned, that's still a remarkably high proportion.

What's more, the funding for the present huge expansion in the mining sector, which is likely to continue for quite a few years, is safe to come mainly from foreigner investors. If so, their share of the ownership of our mining companies is bound to go higher.

So why don't we just pass a law prohibiting foreigners from buying Australian mines and farms - or at least limiting foreign purchases in some way?

Sorry, it ain't that simple. Before we did that, we'd need to be sure we were prepared to pay the price of keeping what's left of Australia in Australian hands.

All spending on new physical investment - whether on homes, business equipment, mines and other structures, or public infrastructure - has to be financed by saving. For every $1 billion we invest this year, the money has to come from somewhere and, in fact, it has to come from us saving $1 billion this year.

The saving can be done by households, by companies retaining some of their after-tax profits, or by governments raising more in revenue than they spend on recurrent purposes. There's just one escape clause: we can also finance our investment spending by using the savings of foreigners.

We can either borrow from them - thereby adding to Australia's foreign debt - or we can sell them some Australian asset: real estate, an existing business, shares bought on the stock exchange or the right to set up a new business with their own money.

If we borrow their savings, the money will have to be repaid in due course, and we'll have to pay interest to them. If, instead, we sell off part of the farm, the after-tax profits the foreigners make from their share of the business will belong to them. They can either reinvest those profits in the business (which will increase the amount of the farm they own) or take them out of the country.

The Greens estimated that, over the next five years, the foreign owners of our mining companies will be entitled to after-tax profits of $265 billion, but will reinvest four dollars in every five, taking home only about $50 billion.

I'm not sure how accurate those figures are, but they do illustrate a point about which everyone agrees: a very high proportion of the big profits foreigners are making from our mining sector is being ploughed back into expanding the sector.

Does all this shock you? It's been going on, year after year, pretty much since white settlement. Because this is a big country packed with natural wealth, but with a relatively small population, Australians have never saved enough to finance all the abundant opportunities for economic development and enrichment.

So we've always invited foreigners - first the British, then the Americans, then the Japanese and now, to some extent, the Chinese - to bring their capital to Australia and join us in fully exploiting our nation's potential.

In other words, we've always been a "capital-importing" country. We've almost always run a surplus on the capital account of our balance of (international) payments, with more foreign capital funds flowing in than Australian capital funds flowing out. These funds include borrowed money and money for the purchase of physical assets and businesses ("equity" capital).

(It's worth remembering, though, that in recent decades we have had a lot of Australian money flowing out as our superannuation funds have invested in foreign shares and bonds, and Australian transnational corporations have expanded abroad. So while the rest of the world has been acquiring more of Australia, we've be acquiring more of the rest of the world.)

If we almost always run a surplus on the capital account of the balance of payments, it follows as a matter of arithmetic that we run an exactly offsetting deficit on the current account of the balance of payments. Thus the capital account surplus allows our exports to exceed our imports and covers the cost of our net payments of interest and dividends to the foreign suppliers of capital.

But why have we always invited foreigners to bring their savings to Australia and participate in the economic development of our nation? Because of our impatience to be richer, our desire to raise our material standard of living.

And because, as part of that, we've always been confident we were getting our fair share of the benefits. Any profits the foreigners make, we tax. Any minerals they extract from our land, we charge them royalties (though, with world commodities prices so high at present, probably not enough, which is what the new mining tax is about). But the benefits of economic activity exceed the profits made. It also generates a lot of jobs, directly and indirectly. Those jobs go mainly to Australians and help feed their families.

We could perhaps borrow more from foreigners so as to reduce their ownership of our real estate and businesses, but there are limits to how far debt can substitute for equity and limits to how much debt the nation should take on.

So if we want to impose new restrictions on how much foreigners own, it's pretty safe to involve less economic development, slower economic growth than we were expecting and a more slowly rising standard of living.

That wouldn't worry me much, but many people would see it differently. Point is: don't imagine restricting foreign ownership would come without a price to be paid.

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West heads to a Greek tragedy, too

To boil it down, the reason Greece is in so much trouble is that every Greek wanted a government that did all the expensive things governments do, but none wanted to pay tax.

Greece's politicians did not have the courage to tell their people that, in the end, you cannot have one without the other.

The Greek government ran budget deficits for year after year, racking up more and more government debt, eventually doing dodgy deals to disguise the amount of that debt until - surprise, surprise - the day of reckoning arrived.

Greece is now in the hands of its bank manager and - another surprise - he is not inclined to be gentle or reasonable.

The ostensible reason the rest of Europe is more worried than sympathetic is Greece's membership of the euro currency group and the knowledge that a lot of their own banks have lent to its government. That, plus the fact that Ireland and Portugal are in similar dire straits.

Were Greece to default on its sovereign (government) debt, it could touch off a financial tsunami - driven as much by fear as logic - that swept up the whole of Europe and even reached across the Atlantic to America.

But, really, why should the major advanced economies of the world be so worried about the fate of a piddling country like Greece? Because their own noses are not clean. They are not as far down the track as Greece and the others, but they, too, have been running big budget deficits year after year, building ever-increasing government debt.

They, too, have not had the courage to tell their voters that government benefits have to be paid for with higher taxes.

Australia used the long boom before the global financial crisis to run successive budget surpluses and so pay off all our net federal government debt, but the United States, Japan, Britain, Italy and various other European countries continued building up big government debts.

Then, when the financial crisis struck, they borrowed huge sums to bail out their teetering banks and, to a lesser extent, to stimulate their deeply recessed economies. Put that on top of their existing high levels of debt and even the mightiest economies of the world are in too deep.

In most of the leading economies, the ratio of government debt to gross domestic product will have risen by 2014 to the region of 100 per cent of GDP, compared with 60 to 70 per cent before the crisis. Japan, which started with a high government debt ratio because of its 1990s economic crisis, will end up with a figure of about 240 per cent by 2014.

This explains the stern warning the Bank for International Settlements, the central banks' central bank, issued at the weekend. The major advanced economies should not just be worried about Greece, it said, they should be worried about themselves. If the huge debt levels of the major economies prompt the world financial markets to wonder if those debts will be honoured, so that the markets take a set against sovereign debt in general, the majors, too, will be in big trouble.

But as the British economist Dr Diane Coyle reminds us in her new book, The Economics of Enough, it is worse than that.

We have known for years that the major advanced economies are facing immense pressure on their budgets from the ageing of their populations. They are committed to generous pension payments and healthcare spending for their retiring baby boomers at a time when, for many countries, their populations will be falling.

The Organisation for Economic Co-operation and Development has estimated that, within a decade, the government of the average member country will need to borrow 5 per cent of gross domestic product a year more than it does at present.

The ideal way to get on top of your debts is to trade your way out. Keep the income coming in, hold down your expenses and use the difference to pay down the principal. What makes it hard is the continuing big interest payments you have to meet before you can reduce the principal. Once your bankers lose faith in you, they may well increase the interest rate you are paying to cover their heightened risk.

For governments it is even harder. If they start from a position of annual deficit, they have to slash spending and raise taxes just to return the budget to balance and so stop adding to the principal. To get the budget into surplus - and so have money to reduce the principal - they have to cut spending and raise taxes even further.

But the more governments cut their spending and raise taxes, the more they slow the growth of their economies. And the more slowly their economies grow, the more slowly their tax revenue grows and the higher is their spending on dole payments, making it that much harder to get back to surplus.

The trouble with bank managers is that when finally they lose patience with you, they become quite unreasonable, imposing requirements and restrictions that actually make it harder for you to repay your debt. And when the "bank manager" takes the form of a herd of anonymous traders in global financial markets, their actions can be destructive and even self-defeating.

No matter how deep the problems of the developed world, it will survive. But these seemingly prosperous countries - which have gone for many years falsely inflating their prosperity by borrowing from the future - are reaching their day of reckoning.

Even if they avoid another financial crisis, they are set for a protracted period of austerity and relative penury, with their economies growing only slowly for many years. They have not woken up to this yet, but they will.

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How to blow the boom: cocoon manufacturers

The fusspots are right when they say we must make sure the nation gains lasting benefit from the resources boom. But doing so is as much about what we shouldn't do as what we should.

The first thing to note is that, even if the boom were to end a lot earlier than the policy-makers expect, the main thing we will be left with is a very much larger mining sector, producing and exporting a lot more minerals and natural gas than we do at present - and earning a good living in the process.

The sceptics who fear we'll be left with nothing when the present sky-high prices fall back - as they will - need reminding that higher prices are just one way to make a quid. The other way is with increased volume. And that is what we'll end up with.

Mining will account for a lot higher proportion of gross domestic product than its present 9 per cent. It is true that, mining being so highly capital-intensive, its share of total employment is likely to be just a few per cent.

It is true - but irrelevant. What matters is how much income mining brings into the country. When that income is spent - by the companies, their employees, governments and shareholders - jobs are created somewhere in the economy. Where exactly? In the services sector, where else?

Those who worry about us suffering Dutch disease - in which the high exchange rate caused by a minerals boom wipes out the manufacturing sector, leaving us with nothing when the boom's over - are themselves suffering from various misconceptions.

For a start, as a matter of historical accuracy, the manufacturing industry in the Netherlands wasn't wiped out in the 1970s and is alive and kicking to this day. Industries are invariably more resilient than they fear they will be - especially when seeking special assistance from governments.

Next, we need to avoid the mercantilist fallacy that the only way to make a living is to sell things to foreigners. At least three-quarters of our workforce makes its living selling things to other Australians. The only reason we need exports is to pay for imports - but the money earnt by the miners will help us with that.

We also need to avoid the physiocratic fallacy that the only way to make a living is to produce something that can be touched. If that is true, please explain how the three-quarters of the workforce toiling in the services sector - from the Prime Minister down to the lowliest cleaner - make their living.

We won't wipe out our manufacturing sector but even if we did, there is no shred of doubt where the jobs would come from: the same place all the extra jobs created in the past 40 years have come from - the services sector.

Yet another point to remember is that, with the economy already close to full employment in the early stages of the resumption of the resources boom, and with the ageing of the population causing the demand for labour to outstrip the supply of it, the one thing we won't have to worry about in coming years is: ''Where will the jobs come from?''

No, the problem here is not the threat of mass unemployment; it's just the matter of making sure we don't pee too much of the proceeds of our resources' good fortune up against a wall.

Why is that a worry? Because that is what we've done in the past.

In terms of export income, our economy has been riding on a sheep's back or on a coal truck since its earliest days.

What we've never had is a vibrant manufacturing sector. Our economy has been too small to get sufficient economies of scale, too far from North Atlantic markets and too good at mining and agriculture (by definition, you can't have a comparative advantage in everything).

But, for most of the past century, we hankered after a big manufacturing sector like all the other rich countries had. So we erected huge tariff barriers and set up a manufacturing industry behind them, thus forcing Australians to pay a lot more for their manufactures than they could have paid had they been given access to cheaper imports.

In other words, we took a fair bit of the proceeds from our rural and mineral wealth and used it to cross-subsidise a manufacturing sector far bigger than could have stood on its own feet. And now, with all the cries about the high exchange rate, we are being asked to do it again.

Since old-style protection in the form of tariffs and import quotas is now so unfashionable, the industry's lobbyists - including its unions - are pushing for disguised protection in the form of tighter anti-dumping restrictions and handouts in the name of ''innovation''.

There is no denying our manufacturers will need to be - and will be - innovative in their efforts to survive in an era of high exchange rates. But the more governments yield to rent seeking by pretending to be subsidising ''innovation'', the longer it will take the industry to accept responsibility for its own destiny.

No, if ever there is a time when it is obviously stupid for rich countries to prop up their manufacturers against competition from developing Asia, it is now.

The obvious way to maximise our lasting benefits from the resources boom is to let secondary industry take its chances and put all our effort into boosting tertiary industry - with all its clean, safe, well-paid, high value-added and intellectually satisfying jobs.

And the obvious way to do that is to invest in a lot more education and training, thereby increasing the nation's human capital and the saleability of Australians' labour.

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Pop bubbles before they can cause havoc

Don't drop your bundle yet. It would be a brave person - braver than me - who denied any possibility of another global financial crisis.

Sure it's possible, but it's far from certain. And another financial crisis might be like we eventually realised the last one was: more North Atlantic than global.

The Bank for International Settlements is the central bankers' club. And central bankers don't warn of catastrophe if they really fear one's on the way. When things really are near crisis point, they are calm and reassuring.

So this is the world's bank manager issuing wayward clients with a stern lecture on the need to mend their ways. The bank is saying, don't assume the problems are limited to Greece, Ireland and Portugal. The big North Atlantic economies - the United States, Britain and much of Europe - have huge, unsustainable levels of government debt, and should the financial markets lose confidence in those countries' efforts to get on top of their debts, another crisis is possible.

It's preaching against the optimistic attitude in those countries that the crisis has passed and it's back to business as usual. No, no, back to the grindstone.

To that extent it's dead right: those economies face at least another decade of low growth as they grind away at reducing their public and private debts.

This is not a message aimed at us. We could be affected by another financial crisis but we're just as well placed to cope as we were with the first.

Our banks remain well supervised, with few loans to the worst-affected governments. Our government debt is laughably small compared with the US and Europe. Our interest rates are not too low.

If there's one lesson from the first crisis, it's that our fortunes depend much more on Asia than on Europe and America.

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Raising the bar on the dollar's change in fortune

You may not have noticed, but the econocrats have raised the bar on the amount of economics you need to know to follow the debate about the economy - or, at least, to follow what they are saying about it. The jargon phrase of the year is the "real" exchange rate.

Until recently, heavies from Treasury and the Reserve Bank were content just to say the exchange rate - the overseas value of the Australian dollar - had depreciated (gone down) or appreciated (gone up) by a certain amount.

This was a reference to the "nominal" exchange rate - the one they tell you about at the end of a news bulletin, the one you can find in the business pages and the one your bank will use if you want to change some Aussie dollars into US dollars, euros or whatever.

As its name implies, the "real" exchange rate is the nominal exchange rate adjusted for inflation. But it's not just our inflation rate that comes into the calculation, it's our rate relative to the inflation rate of the country whose currency we're exchanging for the Aussie dollar.

Actually, just to complicate it a bit further, when economists talk of the real exchange rate, they're usually referring to the real "effective" exchange rate. This is our exchange rate, not against the US dollar or any other particular currency, but against all the currencies of our major trading partners, with each partner's currency weighted according to that country's share of our two-way (exports plus imports) trade. In other words, our effective exchange rate is the trade-weighted index.

(Of the 22 currencies in the trade-weighted basket, the Chinese yuan gets a weight of almost 23 per cent, then the yen with 15 per cent, the euro with 10 per cent, the US dollar on 9 per cent, South Korean won on 6 per cent, India rupee on 5 per cent and so on.)

Whether they talk about the nominal exchange rate or the real exchange rate, economists always think in terms of the real exchange rate because they believe it's always real (inflation-adjusted) variables that matter.

It's the real growth in gross domestic product that's important, and real interest rates and real wage rates that influence people's behaviour. (When people pay too much attention to nominal variables, they're said to be suffering from "money illusion".)

Let's assume the nominal effective exchange rate stays stable for a period. If our inflation rate is higher than the average inflation rate of our trading partners, the real exchange rate is appreciating.

If our inflation rate is lower than the average for our trading partners the real exchange rate is depreciating.

Why? Because they are the adjustments necessary to ensure the prices of internationally traded goods and services end up being the same in all countries, as predicted by the theory of "purchasing power parity" (PPP) - economists' main theory about what determines the way exchange rates move.

When economists say a particular currency is overvalued by X per cent, or undervalued by Y per cent, it's the assumption of PPP they're using as the basis for their calculation. But the fact that economists are always making such calculations is a reminder that the actual market exchange rate of a currency can go for years being significantly at variance with where the PPP theory says it should be.

So if PPP holds in the real world, it can only be said to hold over the long term. In the shorter term, lots of other factors affect the way exchange rates move.

However, if we stick to the theory and assume there's an inexorable, "equilibrating" force (a force that moves everything towards equilibrium, or balance) moving every currency towards PPP, then countries that don't allow their currencies to float freely - by, for instance, fixing their currency to that of another country - will find their inflation rate adjusting to move their real exchange rate in required direction.

Thus if you're holding your currency's value too low (according to PPP), you'll end up with an inflation rate that's a lot higher than your trading partners' rates, which will cause your real exchange rate to appreciate. Many economists would say this is China's problem at the moment.

All this is great fun if you like fancy analysis (as economists do), but does it matter? It matters to the economy - and to a lot of business people - because our real effective exchange rate is the best measure of the "international competitiveness" of our export and import-competing industries.

And thanks to the huge appreciation in the nominal exchange rate brought about by the foreign exchange market's response to the sky-high prices we're getting for our coal and iron ore, our real effective exchange rate is the highest it's been since the mid-1970s and about 40 per cent higher than its average since the dollar was floated in 1983. In other words, it's a long time since our tradeables industries were less competitive internationally than they are today. This isn't a great problem for our miners, because the world prices they're getting are so high at present, nor is it a great problem for our farmers, whose prices for many items are high, too.

But it is a big problem for our manufacturers and the producers of our two biggest services exports: tourism and education. Actually, both manufacturing and tourism are import-competing industries as well as export industries. They're getting wacked.

Remember this, however: because economists are so obsessed by prices, they often forget to make it clear they're talking about international price competitiveness. When you're exporting undifferentiated, bulk commodities - whether mineral or agricultural - price competition is the main game.

But for more sophisticated products, there's plenty of non-price competition. You can compete on quality, stylishness, reputation, reliability, service and so forth. You can cater to niche markets the big boys don't bother with. Such "business models" can allow you to have higher prices and still make sales.

Since there's nothing sensible the authorities can do to lower our exchange rate - real or nominal - and since it looks likely to stay high for many moons, the more our hard-pressed tradeables industries focus on non-price competition, the better they'll survive.

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Primary products are setting us up well

For many years - most of the second half of the 20th century - it looked like Australia was on the wrong tram. In a world of ever-more high-tech, sophisticated manufactured goods, we were hewers of wood and drawers of water. To put it less biblically, we paid for our imports mainly by growing things in the ground or digging stuff out of the ground.

We were stalled in primary industry while the rest of the developed world had moved up the ladder to secondary or even tertiary industry. They were doing a lot more ''value-adding'' than we were. The prices we were getting for our agricultural and mineral exports were steadily declining, whereas the prices we were paying for all the manufactures we imported were rising inexorably.

At the time of the Sydney Olympics, when the dollar was heading down towards US 50 cents, visiting business leaders berated us for being an ''old economy'' with few IT start-up companies. That was when it started turning around. The old-economy talk evaporated within a few months with the arrival of the sharemarket Tech Wreck. And not long after, the prices we were receiving for our coal and iron ore took off, lifting the value of our dollar in the process.

Over the past 11 years, the prices we're getting for our exports are up by 7 per cent, whereas the prices we're paying for our imports are down by 9 per cent. Why? The governor of the Reserve Bank, Glenn Stevens, explained it in a speech last week.

''Hundreds of millions of people in the emerging world have seen growth in their incomes and associated changes in their living standards, and they want to live much more like we have been living for decades. This means they are moving towards a more energy- and steel-intensive way of life and a more protein-rich diet,'' he said. ''That fact is fundamentally changing the shape of the world economy.''

We're witnessing a ''large and persistent change in global relative prices''. The world is paying a lot more for the commodities we export - energy, the main ingredients of steel, and food - relative to the prices of everything else, but is also charging a bit less for the manufactures we import.

So whereas it looked for so long that we were backing losers, now it's clear we're in the winners' circle. And we look likely to stay there for many moons. We've had plenty of commodity booms in the past, of course. Prices shoot up, then crash back to earth. And no one imagines the prices we're getting for coal and iron ore will stay at their present stratospheric levels for long.

Even so, this boom seems likely to last a lot longer - say, a decade or more - than previous booms. Indeed, it has already lasted a lot longer than we're used to. Past booms have been based on a cyclical (and thus temporary) upswing in the developed world's demand for our commodity exports, whereas this one is based on a structural (and thus longer-lasting) change in the world economy: the rapid industrialisation and urbanisation of the two most populous economies, China and India, with various other developing countries following in their wake.

Only the natural environment's inability to cope is likely to halt this development. So it will survive the temporary speeding-ups and slowing-downs of the Chinese and Indian economies. And though coal and iron ore prices are bound to fall, they're unlikely to fall back all the way. They should remain a lot higher than they were throughout most of the past century. If so, our dollar is likely to stay high rather than revert to its average level of about US70? since it was floated in 1983.

Another thing that makes this time different is the huge surge of investment in new mines and natural gas facilities. This is likely to run for a decade or more, and will be the main factor driving the economy's growth. It's the main reason the Reserve Bank keeps warning that interest rates will need to rise, even though consumer spending isn't all that strong.

But it's not just our miners who are doing well. The rapidly rising wealth of developing Asia is increasing its demand for more protein-rich food. That increased demand is raising the price of food. We've already heard a lot - and will hear a lot more - about rising world food prices. This is invariably presented as a terrible thing - a ''crisis'' - and to many people it is. But it's not a bad thing that the people of Asia can now afford to eat better. And it certainly ain't a bad thing for our farmers. Now you know why, for once, farmers aren't whingeing about the high dollar. Again, only environmental problems will inhibit their ability to clean up.

Consumers throughout the developed world are experiencing a rise in the prices of food, energy and raw material-intensive manufactures, which lowers their standard of living. That includes Australian consumers, though we enjoy the spill-over benefits of living in an economy that's a major global supplier of raw materials.

In economics, however, there are no benefits without costs (leading to a net gain in this case, or a net loss in others). The world having seriously changed its mind about the value of the raw materials we supply to it, we must now rejig our economy to fit.

We're getting a very much bigger mining sector and a revitalised agricultural sector, but we can't be good at everything and so the manufacturing sector's share of the economy will shrink. For us, it's back to the future.

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Let punters beware of business carbon claims

Sometimes I suspect many business people regard it as quite ethical to lie and mislead the public, provided they're lying in the shareholders' interests. And when you're laying it on thick to pressure some government into giving you a special deal or an exemption from some measure, you're always doing it for the shareholders. What's in the nation's interests - and whether your special deal would damage the nation's interests - is not your concern.

Often, any special concession you screw out of the pollies will come at the expense of those businesses and industries that don't get a similar concession, but there seems to be an honour among thieves that requires those who'd lose from the success of another industry's lobbying to keep their traps shut.

For a rival industry to point out how exaggerated or self-serving the lobbying industry's claims are is just not done. Governments - and the citizens, taxpayers and consumers whose interests they represent - are regarded as fair game. If the totality of business's success in ducking its responsibilities leads to the country being badly governed, that's just bad luck for the country.

Businesses on the make invariably seek to pressure governments by putting the frighteners on the public. And this means they often claim the government measure they're objecting to would lead to huge job losses. This has the additional advantage of frightening their own employees, and so getting the union to join them in the fight.

In the old days, businesses would pluck some big-sounding figure out of the air, but these days the fashion is to pay one of Canberra's many firms of economists-for-hire to do some ''independent'' modelling.

Any economist who can't juggle the assumptions until they get the kind of findings their client is hoping for isn't trying. And economists have no code of ethics that might inhibit them in making sure their customers are happy with the ''independent report'' they paid for.

If you come up with a big-sounding figure for supposed job losses, you can be reasonably sure the media will trumpet the figure in shocked tones. You can also be sure few if any journalists will subject your claims to examination to see how credible they are. Why spoil a good story? I didn't say it, they did. If it's wrong, blame them, not me. All I'm doing is acting as a messenger, recording both sides of the debate. It's not my job to act as a censor.

(This is tosh. Messengers don't decide which messages they'll deliver and which they won't; which they'll shout from the rooftops and which they'll whisper. Every aspect of the reporting and editing process involves judgments about what goes in and what hits the cutting-room floor. It's clear the media is often happy to pass on to its paying punters without comment information it either knows is misleading or hasn't bothered to inquire into.)

With Julia Gillard, the Greens and the independents busy deciding on the precise form their hybrid carbon tax/emissions trading scheme will take, it's open season for industries lobbying for special favours.

Last week it was the turn of the Australian Coal Association, which produced a report prepared by the economic consultants ACIL Tasman claiming that putting a price on ''carbon'' (greenhouse gas emissions) would lead to the loss of 4700 jobs by 2020-21 from existing coalmines in NSW and Queensland. Counting the flow-on effects to other industries would increase the loss to 14,100.

As well, applying emissions pricing to potential new mines would eliminate 25 to 37 per cent of potential new jobs. This, too, would cause much larger losses to the wider economy when flow-on effects were taken into account.

I suspect the key assumption driving these results is the assumed rise in the real price of carbon. After starting at $19 a tonne in 2012-13, it would leap to $47 a tonne in 2016-17, reaching $57 a tonne in 2021-22. But these figures are pure supposition.

The next thing to remember is that almost all the estimates of ''lost'' jobs you see don't involve any actual decline in the number of people employed in an industry. Rather, they refer to the extent to which employment grows by less than it otherwise would.

Whether deliberately or through ignorance, this distinction is almost always lost in translation - as the ''independent'' consultants surely know it will be. But if these job ''losses'' were labelled more carefully the punters would find them much less alarming.

We're in the early stages of a resources boom, which will involve the establishment of new coalmines and the expansion of existing mines. It's no doubt true the imposition of a significant carbon price will cause there to be less expansion than otherwise. But the notion we could see a lot of out-of-work coalminers is fanciful.

If I had enough money I'd happily pay for every industry lobby group in the country to commission an ''independent'' report on the wider, multiplier effects of their industry. I reckon they'd add up to a mighty lot more than 100 per cent of gross domestic product or total employment.

So never take notice of such claims. They're mere puffery. In the coalminers' case they're built on the assumption that money not invested in mining would be left under the bed rather than invested in some other value-adding and job-creating activity. And that everyone who loses their job as a result of the closure of a mine never works again.

In any case, 4700 job ''losses'' may sound a lot, but in the context of an economy of 11.4 million workers, with hundreds of thousands of people moving between jobs and total employment growing by at least 250,000 a year, it's microscopic.

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Resources boom has mined a rich seam for everyone

If you haven't said it yourself, I bet you've heard others saying it: ''Resources boom? What resources boom? Whoever's benefiting from it, I'm not. None of it's come my way.''

Is that what you think? Well, don't kid yourself. Whether or not you realise it, you almost certainly have benefited from the boom.

But how have people who don't work in or near the mining industry - and don't live in Western Australia or Queensland - benefited from the miners' good fortune in being paid way higher prices for their coal and iron ore?

Short answer: everyone's benefited because, as Marx observed, in the economy everything's connected to everything else. Or, to put it in economists' lingo, we're all benefiting because of ''the circular flow of income''.

When I spend my income buying something from you, my spending becomes your income. Then, when you spend your income, that becomes the income of someone else and so on, round and round.
How do you know the notes in your wallet didn't start in the hands of a mining company? You don't. Some of them probably did.

The governor of the Reserve Bank, Glenn Stevens, observed in a speech this week that the higher prices the miners are getting have improved our ''terms of trade'' - the prices we receive for our exports relative to the prices we pay for our imports - by about 85 per cent above their 20th century average.

This constitutes an increase in the nation's real income because the same quantity of exports now buys a great quantity of imports. And Mr Stevens estimates the additional income is equal to at least 15 per cent of our annual income (gross domestic product). Although a substantial fraction of that income accrues to foreign investors who own large stakes in many of our resource companies, what's left still represents a very large boost to national income.

Let's trace the extra income going to the mining companies. Some of it would be going to the people employed in the mines, who've had big pay rises in recent years. This wouldn't be a major factor, however, because mining, being so highly capital-intensive, employs less than 2 per cent of the workforce.

Even so, Stevens estimates that, to produce a dollar of income, the mining companies spend about 40¢ on acquiring ''non-labour intermediate inputs'' - goods and services bought from other businesses.

''Apart from the direct physical inputs, there are effects on utilities, transport, [and] business services such as engineering, accounting, legal, exploration and other industries. It is noteworthy that a number of these areas are growing quickly at present,'' Mr Stevens says.

Most of those businesses would be Australian but many would be from other states. Remember, there are no trade or currency barriers between our states, so a lot of trade occurs across state borders.

Once the costs of producing the mining companies' output, and their taxes , are taken into account, the remaining revenue is distributed to shareholders or retained. While a significant proportion of the earnings distributed goes offshore, local shareholders also benefit.

Who are those local shareholders? We are. Most of us are shareholders in the mining industry through our superannuation schemes. We don't get this income directly to spend now - it's in our super. ''Nonetheless, it is genuine income and a genuine increase in wealth,'' Mr Stevens says.

His rough estimate suggests that about 10 per cent of our superannuation assets - $130 billion - is invested in resource companies. And this 10 per cent has been providing a healthy return: over the past year alone, the average return on resources company shares has been about 20 per cent.

A good proportion of the earnings retained by companies is being used to fund the construction of new mines and natural gas facilities. Mr Stevens estimates that about half the demand generated by these projects - for construction and manufacturing - is filled locally.

In contrast to the operation of mines, the construction of them is labour-intensive. Workers are being attracted from all over Australia, which creates job vacancies in the parts of Australia from which they come and also puts upward pressure on the wages paid to people in the relevant occupations - whether or not they make the move. Now let's think about all the taxes the mining companies pay. The federal government's company tax takes 30 per cent off the top of the companies' profits (after granting the companies generous deductions for the depreciation of their assets).

It was booming company tax collections that prompted the Howard government to offer cuts in personal income tax for eight years in a row. So if you've enjoyed any of those tax cuts you can't claim to have had no benefit from the resources boom.

The mining companies also make big royalty payments to their state governments as a price for all the publicly owned resources they pull from the ground. But even if you don't live in WA or Queensland you've still benefited.

How so? The proceeds from the federal government's goods and services tax are divided between the states using a complicated formula that has the effect of spreading the royalty proceeds proportionately between all the states and territories.

Yet another less-than-obvious way the proceeds from the resources boom have been spread around the economy is via the exchange rate. The primary reason our dollar is so high at present is the high prices we're getting for our exports of minerals and energy. And the high dollar has reduced the price of imported goods and services.

So every business that buys imported equipment or components is benefiting from the resources boom, as is every consumer who buys imported stuff - which is all of us. If you've taken an overseas holiday, for instance, you've benefited. If you've taken a local holiday you've probably benefited, too, because foreign competition is holding down local prices.

If you've bought petrol, you've benefited (because the higher dollar has reduced the effect of the rise in the world price of oil).

Now, if you say our non-mining export and import-competing industries have been harmed by the boom-caused rise in the dollar, that's true. In economics, nothing that has benefits comes without costs.

So it's fair enough for those people in the adversely affected industries to argue that, for them, the costs of the resources boom have outweighed the benefits.

But they're a minority. For the great majority of us, the benefits have far outweighed the costs.

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Great cities inspire us to reach for the sky

As I'm sure you've heard, for the first time in human history more than half the world's population lives in cities. In the developing countries, particularly China, the urban population is growing by 5 million a month. In rich and poor countries alike, cities are a magnet. But why are people so keen to crowd into congested, expensive cities?

The explanation has to be primarily economic, but most economists studiously ignore the spacial dimension of economic activity. There is, however, a notable exception: Professor Edward Glaeser, of Harvard University, is one of the world's leading experts on urban economics.

In his new book, Triumph of the City, Glaeser proclaims cities to be humans' greatest invention. Why? Because they make us rich. ''Urban density provides the clearest path from poverty to prosperity,'' he says. People who live in big cities not only earn a lot more than those who don't, they're more productive.

Cities are ''the absence of physical space between people and companies''. This closeness generates ''economies of agglomeration''. Producing a product close to a large market cuts costs by allowing large-scale production and reducing distribution expenses. The bigger the city, the greater the scope for firms to specialise in particular fields. Firms know they'll have less trouble finding the labour they need in a big city; workers come to cities knowing there'll be plenty of good jobs.

Historically, big cities often arose because they were convenient hubs for national or international trade in particular products. Many developed their own manufacturing industries - garment-making in New York, cars in Detroit, for instance. But such areas of strength can be challenged by changes in technology. Big reductions in the cost of transport and communications have brought about ''the death of distance'' and shifted much manufacturing to developing countries where labour is cheaper.

Detroit has never recovered from greater competition with Japanese and other Asian carmakers. Its population is less than half what it was. New York lost most of its manufacturing industry, but began reinventing itself in the 1970s. Today, more than 40 per cent of Manhattan's payroll is the financial services industry.

This experience leads Glaeser to emphasise a different driver of the benefits of cities: knowledge.

''Humans are an intensely social species that excels, like ants or gibbons, in producing things together. Just as ant colonies do things that are far beyond the abilities of isolated insects, cities achieve much more than isolated humans,'' he says.

''Cities enable collaboration, especially the joint production of knowledge that is mankind's most important creation. Ideas flow readily from person to person in the dense corridors of Bangalore or London, and people are willing to put up with high urban prices just to be around talented people, some of whose knowledge will rub off.''

Cities magnify humanity's strengths. Because humans learn so much from other humans, we learn more when there are more people around us. Urban density creates a constant flow of new information that comes from observing others' successes and failures. Cities make it easier to watch, listen and learn.

Pundits have predicted that improvements in information technology will make urban advantages obsolete. Once you can learn from Wikipedia in Gilgandra, why pay Sydney prices?

''But a few decades of high technology can't trump millions of years of evolution,'' Glaeser says. ''Our species learns primarily from the aural, visual and olfactory clues given off by our fellow humans. The internet is a wonderful tool, but it works best when combined with knowledge gained face to face, as the concentrations of internet entrepreneurs in Bangalore and Silicon Valley would attest.''

An experiment challenged groups of six students to play a game in which everyone could earn money by co-operating. One set of groups met for 10 minutes' face-to-face to discuss strategy before playing. Another set had 30 minutes for electronic interaction. The groups that met in person co-operated well and earned more money. The groups that only connected electronically fell apart, as members put their personal gains ahead of the group's needs.

This fits with many other experiments, which have shown that face-to-face contact leads to more trust, generosity and co-operation than any other sort of interaction.

Cities, and the face-to-face interactions they engender, are tools for reducing the ''complex-communication curse''. Long hours spent one-on-one enable listeners to make sure they get it right. It's easy to mistakenly offend someone from a different culture, but a warm smile can smooth conflicts that could otherwise turn into flaming emails.

Glaeser says the ''central paradox of the modern metropolis'' is that proximity has become even more valuable as the cost of connecting across long distances has fallen. His explanation is that the declining cost of connection has only increased the monetary returns to clustering close together. Before, high transport costs limited the ability to make money quickly from selling a good idea worldwide. ''The death of distance may have been hell on the goods producers in Detroit, who lost out to Japanese competitors, but it has been heaven for the idea producers of New York, San Francisco and Los Angeles, who have made billions on innovations in technology, entertainment and finance.''

So what do you have to do to be a successful city? Well, first, you have to overcome the three main costs of cities: disease, crime and congestion. After you've achieved clean water (solved the sewerage problem), the harder goals are safe streets, fast commutes and good schools.

Cities thrive when they have many small firms and skilled citizens. Industrial diversity, entrepreneurship and education lead to innovation. Innovation allows cities to overcome setbacks and stay prosperous.

''Human capital, far more than physical infrastructure, explains which cities succeed,'' Glaeser concludes. ''Infrastructure eventually becomes obsolete, but education perpetuates itself as one smart generation teaches the next.''

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