Treasury thinks the unthinkable: tax rises

Note well: the secretary to Treasury, Dr Martin Parkinson, has provided voters with the only no-bulldust budgetary advice they're likely to get between now and the federal election. Everything they get from the politicians - on both sides - will be straight from vote-chasers' fantasy land.

Even much of the media believe their interests lie in feeding their customers more of the self-delusion they prefer to hear rather than reminding them of the harsh realities of fiscal arithmetic.

In a speech last week, Parkinson noted the community's demand for the sort of "superior goods" governments provide - such as healthcare, aged care, disability assistance, education and social welfare - will only continue to rise.

That's because demand for superior goods grows faster than our income grows. Using that term is an implicit admission the community's demands are legitimate rather than populist.

"At the same time, the taxation base is weaker than we had imagined in the mid-2000s," he says. "With hindsight, it is apparent that part of revenue collections then reflected a temporary bubble in the economy."

Translation: perhaps it wasn't smart to award ourselves eight income-tax cuts in a row. (Some of us don't need to rely on hindsight for that judgment.)

"The take-out message is that the days of large surpluses being delivered by buoyant tax receipts are behind us ... tax receipts are expected to remain substantially lower - around $20 billion per annum lower at the Commonwealth level alone - than pre-crisis projections.

"The outcome is that ... we face, as a community, a widening gap between the demands we are placing on government and what we are prepared to pay to fund government."

Now get this: contrary to every impression the pollies will be giving you, "we will not be able to meet these demands for new spending by increasing the efficiency and effectiveness of existing government spending alone (although this is important in its own right)".

"Nor can we rely solely on our existing tax bases, as these are expected to deliver less revenue as a proportion of gross domestic product ... What will be required - of governments at all levels - to meet the community's demand for new spending, will be more revenue or significant savings in other areas."

That's the news the national dailies didn't think fit to print: the Treasury secretary, high priest of economic rationalism, has countenanced higher taxes and even new taxes.

All this is a blow to those people anxious to see both sides of politics commit to introducing the national disability insurance scheme at an extra cost of $8 billion a year (closely followed by those people anxious to see both sides commit to introducing the Gonski reforms to education at an extra cost of $5 billion a year).

So what on earth can we do? Limiting our focus to the disability scheme, how could we possibly find that kind of money?

Well, one possibility not to be dismissed lightly is using an increase in the Medicare levy to pay for it. But as Dr Richard Denniss and David Richardson of the Australia Institute suggested last week, there's another, less obvious source of revenue: reform the concessional tax treatment of superannuation to make it more effective and less inequitable.

Using the savings to pay for the disability scheme would strike a double blow for fairness.

It would take money disproportionately from the well-off (the top 5 per cent of income earners get 37 per cent of cost of the super tax concessions) and give it to some of the most disadvantaged people in our community: the disabled and their carers.

The Treasury secretary is telling us we have to make hard decisions about our priorities; we can't afford all the things we'd like to do. Just so.

So consider this: within a few years, the rapidly growing revenue forgone on super tax concessions is projected to equal the cost of the age pension itself: $45 billion a year.

That's way more than the feds spend on education, almost twice what they spend on defence, and more than twice what they spend on the family tax benefit or on Medicare.

We can afford to shower this largesse on the better-off 60 per cent of the population of pension age while the disabled get screwed?

The grossly underpaid financial services industry and the direct beneficiaries of the super concessions argue they're justified by the consequent saving to the taxpayer in reduced pension payments.

But as best Denniss and Richardson can determine it, it costs the taxpayer $2 for every $1 saved. That's an overall average, of course. People at the top would save a lot more than $2 for every $1 they gave up, while many towards the bottom would save less than they gave up. (We should know the exact distribution, but the government won't tell us, for some reason.)

It's not hard to see why the super tax concessions offer other taxpayers such a rotten deal. As a supposed incentive to people to make their own provision for retirement they're hopeless.

Most of the people who receive it save no more than they're compelled to, while people at the top of the tree are hugely rewarded for saving they'd do anyway. The less your ability to save, the smaller incentive you're given, and vice versa.

For those organisations urging us to spend big on worthy causes, the "take-out message" from Parkinson's sobering assessment of our scope for greater spending is clear: don't waste your breath unless you're prepared to get your hands dirty and suggest a good way to pay for it.

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Rise of multinationals threatens our tax collections

As the world's centre of economic gravity shifts towards Asia, the process of globalisation - the breaking down of barriers between countries - is speeding up. This means there's no shortage of challenges looming for our political leaders.

They'll pop up in many areas, but in a speech earlier this month the boss of Treasury's revenue group, Rob Heferen, outlined those affecting taxation. He says our present tax system, which relies heavily on taxing income - whether of individuals (48 per cent of total federal tax revenue) or companies (22 per cent) - will come under increasing pressure.

Since the introduction of full dividend imputation in the late 1980s - under which Australian shareholders get a tax credit for the company tax already paid on their dividends - the main purpose of company tax has been to tax profits earned by foreign shareholders.

But globalisation is increasing the "mobility" of capital (and to a lesser extent, labour), making it easier to shift to countries where tax rates are lower. Heferen says this is particularly true for multinational companies (including Australian multinationals), which now account for about a quarter of global production.

Multinationals have considerable latitude in choosing where to locate their production, making them more sensitive than other businesses to the tax rates that apply to them. Of course, many other factors will also influence such decisions: the quality of the labour force, the adequacy of the infrastructure, the rule of law, access to raw materials and access to markets for their products.

Multinationals also have some latitude in deciding in which country they'll declare their profits, notwithstanding rules that attempt to limit profit-shifting. In the case of profits, tax is likely to be a primary driver, maybe the primary factor.

"So setting tax policy to deal with multinational enterprises is an increasingly difficult task," Heferen says. "Policy should support innovation and attract investment, but also help uphold the integrity of the corporate tax system."

Because of the greater competition for foreign investment, policy makers must take into account how other countries tax multinationals, as well as the wide range of successful tax planning strategies available for companies to use.

You can see these difficulties in rules about "transfer pricing". "When a firm 'trades' with itself across borders, we want to ensure it is using the prices an independent party would have paid, rather than manipulating prices to gain a tax advantage," he says. "But this principle can be very difficult to enforce in practice. There are many goods which are either proprietary [in house] or rarely traded, so there may be no market price for the asset."

Then there's the effect of financial innovation. It's now easier than ever to move funds between countries at little cost and to re-characterise financial assets from debt to equity or vice versa. These options place further pressure on the system and help firms seeking to minimise their worldwide tax.

This matters because Australia, like many countries, treats debt and equity differently for tax purposes. The problem is compounded by countries using different definitions of debt and equity.

Another problem arises from the increasing role of intangible assets - such as brands, copyright and other intellectual property, customer lists and internal processes - which are often the result of much spending on research and development or marketing.

Investment in intangible assets is growing faster than investment in tangible assets such as machines and buildings. Since intangibles have no fixed, physical form, it's much easier to relocate them to low-tax countries. Pfizer and Microsoft have moved much of their research and development to Ireland.

Going the other way is the taxation of natural resources. Unlike other resources, these are immobile. You can either develop the site or leave the stuff in the ground. And the profitability of their exploitation often depends on natural factors: the quality of the ore, or how easily it can be got at.

Because world prices are still so high, our largely foreign-owned miners are making profits far in excess of those needed to make these projects a worthwhile investment.

Taxing the gap between profit and the level needed to induce investment won't discourage investment and this is part of the rationale behind the Minerals Resource Rent Tax.

Research suggests other small, open economies like us have configured their tax systems to rely less on income taxes and more on taxes levied on less internationally mobile bases, such as resource rents, land and consumption.

"However, raising taxes on some immobile bases, most notably consumption, may also have implications for the fairness of the system, its social acceptability and the ability of the government to redistribute income," Heferen says. On the other hand: "In the longer term, if we opt to keep relying on mobile bases for a high proportion of revenue, we may see increased risks for tax-base erosion and stronger disincentives for capital investment and for individuals to acquire productivity-enhancing skills."

So, is there any way around this unpalatable choice? Heferen says one answer may be finding a different base for company tax.

The standard choice is between a "residence" base (you tax Australian companies on their world-wide income, but don't tax foreign companies operating in Australia) and a "source" base (you tax all companies just on their income from production in Australia, but don't tax Australian companies on their income from foreign production).

Like most countries, we've chosen the source base (though, strangely, not for capital gains). But some leading academics have suggested we move to a "destination" base, where we'd tax companies' profits on sales they made to Australian final consumers, regardless of where production occurred.

In practice, this would be a source-based tax, but with adjustments made for exports and imports. It would eliminate the incentive for companies to shift their location or their earnings to other countries.

This seems a strange approach for a country like ours, with our mineral exports being so profitable, but maybe this could be fixed with adequate resource rent taxes.

And Heferen says we shouldn't "underestimate the power of structural change in the global economy to shape policy in new and unexpected ways".

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Self-funded retirees are kidding themselves - and us

One thing that gets me going is comfortably-off people who feel sorry for themselves: those who complain how hard it is to get by on $150,000 a year, or retired people who profess to be "self-funded".

Someone once asked me why I was so disparaging of self-funded retirees when, from what they could see, I was going to end up as one myself. It's true. Or, rather, it's true my superannuation is too generous for me to get even a smell of the age pension.

But I'd never claim that made me "self-funded". Why not? Because I know damn well other taxpayers have contributed mightily to funding the vastly bigger private pension I'll end up on.

The other thing that annoys me about the self-proclaimed self-funded is their motive for making this false claim. They say it because they've got their hand out. I'm too well-off to get the pension, therefore you owe me.

So how about a seniors' card that entitles me to pay next-to-nothing on public transport not because I'm poor but just because I'm old? How about charging me the same nominal fee for pharmaceuticals you charge pensioners but deny to the working poor?

The so-called self-funded - the Howard government's favourite charity - enjoy all these perks. But they don't seem to realise that, the more successful they are with their begging bowl, the less true their claim becomes.

The notorious superannuation "reforms" Peter Costello announced in 2006, which centred on making super payouts tax free for people 60 and over - and which successive governments will have to laboriously unpick at great political cost in coming years - included significantly liberalising the means test on the age pension.

Suddenly, there was a sharp fall in the number of people not receiving the pension and a sharp jump in the number receiving a part-pension. But did all those with their mouths now firmly clamped on the pension teat stop referring to themselves as "self-funded"? I doubt it.

The way the numerous spruikers for the super industry tell it, governments impose iniquitous taxes on those independent, prudent, frugal, virtuous souls who struggle to save for their retirement. Rubbish.

For working people, all the additional income we earn is taxed at rates of 19?, 32.5?, 37? or 45? in the dollar depending on how much we earn. But the 9 per cent - eventually to be 12 per cent - of our salary that employers are required to pay into superannuation is taxed at a flat rate of just 15? in the dollar. Ditto for extra contributions made through "salary sacrifice".

So super contributions are, in fact, taxed concessionally. Just how concessional varies inversely with your need - the higher your income, the more you save per dollar. People like me save 30? in tax on every dollar they put into super (plus the 1.5? Medicare levy). What's more, income earned on money in super funds is also taxed at no more than 15 per cent, no matter how high your income.

Super is taxed in a way that yields little benefit to the needy, but grossly favours the better off. As someone said, for he that hath, to him shall be given.

The cost to the federal budget in revenue forgone is huge and rapidly rising. It was $30 billion last financial year and is projected to reach $45 billion by 2015-16.

But whenever this unfairness is pointed out, those who benefit (including those who benefit by managing super funds or providing advice to them) are quick to fly to the defence. It's terribly unfair to look at the gross cost of the super tax concessions without taking into account the saving to the budget from all those people who won't be getting the pension.

A study by Richard Denniss and David Richardson, of the Australia Institute, Can the Taxpayer Afford "Self-funded Retirement"?, to be released today, advises that by 2015-16, the $45 billion forgone on super concessions is expected to equal the cost of the age pension itself. (It will dwarf federal spending on education or on Medicare, and be almost double what we spend on defence.)

So just how much will the super concessions save us on pension payments? Treasury could have estimated this but, if it has, it hasn't been made public - presumably because its paucity would cause too much embarrassment to a government game only to nibble away at super's unfairness to those whose interests Labor (and Bruce Springsteen) professes to represent.

Even so, Denniss and Richardson give us a fair idea. Treasury does project that, by 2047 - 35 years' time - the proportion of people of pension age not receiving the pension will have risen by just 3 percentage points to about 20 per cent.

The main effect of all the concessions will be to increase the proportion of people receiving only a part-pension by 15 percentage points to about half of those on the pension.

From this, the authors estimate the saving on the pension bill in 2047 will be about $14 billion a year in today's dollars. That's only about half what the super concessions are costing - meaning the other half represents clear cop for the better-off superannuants (including my good self).

Treasury estimates that just the top 5 per cent of income earners collect 37 per cent of all super concessions. The authors quote a representative example of someone on the top tax rate retiring with a payout of $780,000, 60 per cent of which comes from tax concessions.

So, please, let's have a bit less hypocrisy on the great favour well-off retirees are doing the taxpayer.

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Union lion bearded in its den

Fair Work Australia's monumental rebuff to the Transport Workers Union in its dispute with Qantas strikes a blow to the credibility of claims the Fair Work Act is some kind of conspiracy against employers.

The commission (which is what Fair Work Australia is in all but name) had no choice last week but to support Qantas management because, in both its tactics and its demands, the union was being so bloody-minded.

That's true even though, by grounding its planes worldwide and locking out all its staff last October, Qantas management could come up with no more creative solution to its bargaining problem than to be as bloody-minded as some of its unions.

This was not so much a win for "managers' right to manage" as the commission's commonsense judgment that all the industrial parties needed to face up to the harsh commercial realities threatening the survival of their business.

Here we had a union demanding 5 per cent annual pay rises at the same time it was fighting to prevent its employer from turning to cheaper sources of labour. That makes sense? These guys needed their heads examined.

Qantas's long-running disputes with three of its unions represent the only times Fair Work Australia has agreed to impose arbitrated resolutions so far in its brief existence. Remembering the way the old arbitration system had degenerated by the time we abandoned it in the mid-1990s, it's been vitally important to limit use of compulsory arbitration to cases of the greatest intransigence.

The whole point of the move from the centralised system to bargaining at the enterprise level was to get employers and unions dealing with each other face-to-face and responding their workplace's particular circumstances, rather than the old game of unions pulling on a strike to oblige the referee to intervene and impose a compromise.

It will be a pity if the commission's refusal last week to split the difference in the old way encourages other militant employers to seek to resolve disagreements with their workers the chaos-causing Qantas way.

Even so, the commission's refusal to go anywhere near splitting the difference provides powerful evidence it can be trusted to adjudicate issues sensibly in a system that hasn't swung the balance too far the unions' way.

Perhaps this explains why the national dailies - which, in their campaigning against the evils of Fair Work, seem to find another story about union atrocities for the front page most days - weren't greatly excited by the employers' big win last week.

The trouble with two such influential organs distorting their reporting of industrial relations so persistently and to such an extent is that between them, they can leave the public with a grossly exaggerated impression of the extent of union misbehaviour and the deleterious effect of Fair Work.

Read too much of that stuff and you come away thinking the union movement has risen from its deathbed to pose the greatest threat to our continued prosperity. Remember, union membership is down to 18 per cent of the workforce (from 50 per cent in 1982) and 14 per cent of private sector workers.

Another figure to keep in mind next time you read about the union monster poised to eat the economy's lunch: more than 80 per cent of enterprises don't have a union presence.

Two labour lawyers, Dr Anthony Forsyth, of Monash University, and Professor Andrew Stewart, of Adelaide University, note in their submission to the Fair Work review that "the concerns about union activities that so animate certain employers in the resources, manufacturing and construction sectors are very far removed from the issues confronting businesses in other parts of the economy".

"For the small to medium enterprises that predominate in sectors such as retail and hospitality, both unions and indeed collective bargaining are largely absent. Their concerns are much more likely, in our experience, to revolve around the costs and 'inflexibilities' imposed by the award system, and the renewed exposure to unfair dismissal claims that the Fair Work Act has brought."

So far, Fair Work has failed in its aim to greatly increase the extent of collective bargaining, with the proportion of employees covered by collective agreements increasing from 39.8 per cent of the workforce in 2008, to just 43.4 per cent in 2010.

Forsyth and Stewart argue many of these new agreements are effectively non-union instruments drafted by employers to replace the individual workplace agreements formerly available under Work Choices.

"Such agreements may be presented as 'collective', and they do require the endorsement of a majority of employees to be registered under the Fair Work Act - but only rarely are they the product of anything that could be said to resemble a bargaining process," they say.

Genuine collective bargaining is likely to be confined mainly to large, unionised workplaces in the public sector and to some sections of the private sector.

Much of the bitter complaint about Fair Work comes from the miners. Forsyth and Stewart say what some employers in the resources sector are seeking is a capacity to manage their businesses without the involvement of unions, and to undertake projects entirely free of any threat of industrial action.

"These aspirations are simply not compatible with the principle of freedom of association ... Indeed, to allow them to be fully realised would involve restrictions on the taking of industrial action, or on union rights of entry, that would go far beyond anything envisaged by the Howard government, even during the Work Choices period," they say.

Talk of Fair Work having unnecessarily bolstered "union power" should not only be kept in proportion, but also understood in the context of a broader ideological agenda that is profoundly antithetical to the principle of collectivism, they conclude.

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The tricky truth about the jobs figures

If you want to know what's happening to employment, there's the hard way and the easy way to find out. But, in any case, can you believe the official figures?

Economists, the markets and the media prefer to do it the hard way, using the "thrills and spills" method. The "seasonally adjusted" figures we got from the Bureau of Statistics this week showed total employment across Australia rose 14,000 last month.

But the previous month it fell 28,000. So, did the economy take off in July having collapsed in June? Maybe, but employment grew 28,000 in May, following growth of 13,000 in April. So, is the economy going up and down like a yo-yo?

Maybe. Last month the unemployment rate fell to 5.2 per cent from 5.3 per cent the previous month. But that was up from 5.1 per cent in May, which was itself up from 5.0 per cent in April. Then again, April was down from 5.2 per cent in March.

Confused? Precisely. The hard way gives you thrills and spills from one month to the next, which makes it hard to work out what's really happening.

The easy way to do it is to take the bureau's advice and look instead at it its "trend" figures. These are the seasonally adjusted figures smoothed out to remove statistical "noise" - unexplained variability that probably doesn't prove anything.

Guess what? The trend figures make it easy to do what we want to do: identify the trend. Is employment going up, down or sideways?

They show that, over the first seven months of this year, employment has been growing at an average rate of 10,000 jobs a month. Is that a lot or a little? Well, it's been sufficient to hold the rate of unemployment virtually unchanged at 5.2 per cent. (Remember, since the labour force keeps growing, we have to create jobs just to hold unemployment steady.)

Is an unemployment rate of 5.2 per cent good or bad? Well, most economists would tell you it's about as good as it gets. They regard the rate of full employment as being about 5 per cent or a little lower.

But here's where the doubts arise in many people's minds. I get more emails from readers querying the reliability of the job figures than any other subject.

"One can't help gain the impression that the definition of employment is being gradually liberalised for political purposes, i.e. to make the figures look more impressive," says one. "An individual is now assessed as being 'employed' if they work just one hour each week," says another.

Many people have a deeply held belief that the way we measure employment and unemployment has been tampered with by governments in recent times to make things appear better than they are.

When unemployment fell to much better levels under the Howard government, this notion used to pop up in the minds of Labor voters. Now Labor's in power it pops up in the minds of Liberal voters.

I don't know where this notion came from, but it's factually wrong. It didn't happen. No government of any colour has changed the way employment and unemployment are measured in the past 30 years. I wrote this when Howard was in power and I'm writing it again now.

One reason the pollies haven't fiddled the figures is that the Bureau of Statistics, which enjoys a high degree of independence of the elected government, would never let them. Had any pollie ever tried to twist the bureau's arm, you'd remember the monumental row this would have created.

No, the definitions the bureau uses are set by international statistical convention. And the convention hasn't changed significantly in many decades. No one has changed the rules.

So, does that mean we can take the official figures as gospel truth? Sorry, life ain't that simple. There's a saying in Canberra: when you're trying to explain something and you face a choice between a stuff-up and a conspiracy, go for the stuff-up every time.

The trouble with the official figures is not that the definition of unemployment has been changed, but that it's unrealistically narrow and always has been. It's true a person is classed as being employed if they work just one hour each week.

Of course, very few people who do work do so for as little as an hour or three. Nor is it correct to imagine everyone working part-time would prefer to have a full-time job. Some would; many - particularly full-time students, the semi-retired and parents looking after young children - wouldn't.

So the real question is: how many part-time workers would prefer to be working more hours than they do? The answer in May this year was 890,000. Note, however, that other figures suggest only a bit over half of those people wanted full-time jobs. The rest (roughly 400,000) were people working part-time who just wanted a few more hours a week.

The 890,000 "under-employed" workers account for 7.4 per cent of the labour force. Add to them the 625,000 workers officially defined as unemployed (the ones giving an unemployment rate of 5.2 per cent) and you get a "labour force underutilisation rate" of 12.6 per cent.

How do I know that? I read it in the same bureau publication (which you can find on its website) that told me this week the official unemployment rate in July was 5.2 per cent. The bureau calculates underemployment every three months, but publishes the figure each month.

I think that, whereas the official unemployment figure understates the true size of the problem, the underutilisation figure overstates it (because part-timers who'd like to work a few more hours a week don't have a big problem). That's why my rule of thumb has long been that to get a more realistic idea of the extent of unemployment you should take the official figure and double it.

But if you're trying to get at the truth (as opposed to trying to prove the political party you hate is doing a terrible job), remember two points. First, if you double today's unemployment rate you should double all the earlier rates you compare it with.

Second, remember the trajectory of the higher figure should move pretty much in line with that of the lower figure. So if the official unemployment figure is stable, it's reasonable to assume the more realistic figure is too.

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IS A ‘STEADY-STATE’ ECONOMY FEASIBLE?

Walter Westman Lecture on Science, Humanity and the Environment International House, University of Sydney, Wednesday, August 8, 2012

I was pleased to attend the first of these Walter Westman lectures, in 2008, given by my friend Steve Hatfield-Dodds, and I’m honoured to deliver this year’s lecture. I want to talk about economic growth - a topic of concern to many people who think deeply about science, humanity and the environment - and specifically about whether it would be feasible for us to move to a ‘steady-state’ economy.

Virtually all our business people, economists and politicians believe it to be not just possible but desirable for the economy to continue growing forever - and the faster the better. They regard the achievement of growth as one of the most important objectives of government, and they have no doubt this is in accord with the wishes of almost everyone in the electorate.

Why do they regard economic growth as such a good thing? Because when the economy’s generation of income - and its production of goods and services, which is the same thing, and is conventionally measured by the growth in real gross domestic product - grows faster than the population is growing, income per person is rising, meaning that, on average, our material standard of living is rising. Doesn’t that sound good to you?

But the advocates of growth believe it brings with it many other advantages. They argue that the richer we get, the more easily we can afford to spend money on fixing the environment. They argue that rising real incomes should also directly benefit the poor and, as well, that when incomes are rising it’s easier to get agreement to redistributing income in favour of the poor. They further argue that growth in the economy is necessary to create the additional jobs needed to provide employment for a growing population of working age.

So why do an increasing minority of people oppose continuing economic growth? Because of their belief that unending economic growth is ecologically unsustainable and, indeed, physically impossible. They see the global economy as a sub-system of the global ecosystem, which is of fixed size. If the ecosystem can’t grow, then there must be a limit to the extent to which the economy can grow within it. They look at all the damage economic activity has done and is doing to the natural environment - the damage to soil, forests, waterways and fish stocks, the destruction of species and, most obvious and pressing, the emission of greenhouse gases - and they conclude we must be close to the ‘limits to growth’. To press up to those limits or even exceed them must surely damage the natural environment to such an extent that huge, possibly irreparable damage is done to the economy, not just the environment.

That’s the most fundamental, pressing reason for wanting to call a halt to growth, but there’s a supporting reason from the ‘science of happiness’. Psychologists and a few economists studying what they prefer to call ‘subjective wellbeing’ have concluded that once people’s incomes reach a certain fairly modest level, further increases do little or nothing to raise the ‘aggregate happiness’ of the people in a country. This is because we so quickly adapt to any change in our material circumstances, with improvements soon being taken for granted as we aspire to something bigger and better.

But it’s also because, as studies show, what makes everyone but the poor happier as individuals is not an increase in our income along with everyone else’s, but an increase in our income relative to everyone else’s. It’s this that would feed our desire to feel superior to others and also permit us to demonstrate that superiority to the world by means of our superior possessions. The trouble with such aspirations, however, is that they involve a zero-sum game: I can advance my position in the pecking order only at the expense of the positions of all the people I pass. Such status competition - such consumption competitions - is socially wasteful: it uses up a host of scarce economic resources without making any net addition to total happiness. For the managers of the economy, this creates two problems. First, all they can ever do is raise incomes overall; there’s nothing they can do to raise the relative incomes of everyone in the economy. So their growth-favouring policies do little or nothing to increase the community’s subjective wellbeing - which must surely be the justification for their efforts. Second, it means that, for an affluent economy such as ours, most of the annual increase in our real incomes that the economic managers have laboured to produce is dissipated on the socially wasteful purchase of ‘positional goods’ - goods and services whose purpose is to demonstrate to others our superior position in the social order. For me, this is a powerful reason for not being too dismayed by ecologists’ insistence that we can no longer afford economic growth: if so, we won’t be giving up all that much.

This brings me directly to my topic: is a steady-state economy - and economy that doesn’t grow - feasible? First I’ll examine the reasons people argue it isn’t feasible, then I’ll examine what we’d need to do to make it feasible.

The growth imperative is so deeply ingrained in our thinking, so much an assumption underlying so much of what we say - even what I say - that many people imagine the economy is like a bicycle: if you stop going forward you lose your balance and fall off. Fortunately, the analogy isn’t apt. Though many people would have to adjust their thinking in a steady-state economy, it wouldn’t collapse just because it wasn’t growing. What would cause deep problems, however, is if the economy was steadily shrinking, particularly if prices were falling.

There’s obvious truth to the argument that when incomes are growing it’s easier to afford to repair the environment. But that argument becomes dubious when we reach the point where the growth itself is adding to the environmental damage. We have to destroy the environment to afford to save it? It’s hard to imagine how the environment could end up ahead on that deal.

There’s more truth to the argument that when incomes are growing it’s easier to give the poor a better deal, including by redistributing income from the better-off to the less well-off. It’s factually correct - in Australia, though not in America - that real growth in national income over the years has led to real growth in the incomes of households at the bottom of the distribution, as well as in the middle and at the top. What’s also true, however, is that incomes at the very top have been growing much faster than all other incomes. I think advocates of a steady-state economy have to accept that, yes, the absence of growth would increase the political resistance to greater redistribution in favour of those at the bottom. But just because growth makes greater redistribution easier doesn’t necessarily mean redistribution happens. It hasn’t happened sufficiently to prevent the gap between rich and poor widening significantly over the past 30 years or so, notwithstanding all the growth we’ve enjoyed.

The strongest anti-steady-state argument is that we need economic growth to provide employment for our growing population of working age. It’s pretty much the only argument I get from the ecologically aware economists I talk to. But I don’t think it’s insurmountable. The first reservation is that, were it not for immigration, our working-age population wouldn’t be growing (as is the case for most of the advanced economies and will soon be the case for China). We could adjust our net migration to keep the working-age population steady. The second reservation is that, even if our working-age population was growing, we could respond to the problem by job-sharing. Here I’m not only referring to the idea of two or more part-time workers sharing the one full-time job, but to the more fundamental solution that rather than continuing to take the continuing improvement in the productivity of labour in the form of ever-higher real wages, we could do what the futurists of the 1960s and 70s expected we’d do and take it in the form of shorter working hours.

Before I turn to the more positive question of how we’d go about achieving a steady-state economy, we should clarify an issue I probably should have raised much earlier. In all that follows I’ll be leaning heavily on the leading thinker in the area of steady-state economics, Professor Herman Daly of the University of Maryland. There’s enormous terminological confusion between scientists and economists on what exactly they mean by the word ‘growth’. Scientists take it to mean something very different from what economists do, which means much of what little debate passes between them flies over the heads of the other side. I’m sure the ground of disagreement between them would be greatly reduced if only this terminological confusion could be ended.

What ecologists want is an end to growth in the ‘throughput’ of natural resources. If you think of the economy as a machine, we put inputs in one end of the machine, and take outputs out of the other end. To an ecologist, the inputs of concern to them are natural resources and ‘ecosystem services’; the outputs of concern to them are an equivalent amount of waste - in the form of landfill, sewage and all the many types of pollution, including greenhouse gases. In conformity with the laws of thermodynamics, the ecologists worry as much about the emission of waste - and the ecosystem’s ability to absorb that waste - as they do about the using up of natural resources. This is why what they seek is an end to growth in the throughput of such resources. I think many of them imagine this would be achieved if GDP ceased to grow.

But the economists conceptualise things very differently. To them, the inputs to the economic machine aren’t just natural resources, but also the other economic resources: labour and capital - physical capital in the form of machines, structures and infrastructure. (The input from ecosystem services is ignored.) To their eyes, the output from the economic machine isn’t waste (it gets ignored) but all manner of goods and services. What real GDP measures is the growth in the output of goods and services over time. (Since those of us who work earn our income from our contribution to the output of goods and services, real GDP also measures the growth in real income.)

So what is it that causes GDP - output of goods and services - to grow? Two things. First, any increase in the throughput of economic resources: natural resources, but also labour and capital. But, second - and this is the bit that goes straight over the heads of most ecologists - any increase in the efficiency of the economic machine at turning inputs into outputs. Economists call this ‘productivity’, which they define as output per unit of input. The productivity of the economic machine increases almost continuously each year, and has done since the start of the industrial revolution. What causes ‘multi-factor’ productivity to improve is the continuing pursuit of economies of scale, the increasing specialisation of labour, the rising knowledge and skill of the workforce, and technological advance: the invention of better machines and better ways of doing things. Now get this: over the long term, productivity improvement accounts for the lion’s share of our rising real income per person and our rising material standard of living.

The point is that when economists hear people say they want an end to growth, they assume that means they want an end to productivity improvement. They find this prospect appalling. But this is not what ecologists want. All they want to stop is growth in the throughput of natural resources - which isn’t something most economists would relish, but isn’t nearly as frightening. And this means GDP could still increase, provided that increase came from improved productivity, not increased use of natural resources.

Clearing up this misunderstanding allows us to envisage more clearly what a steady-state economy would look like. It would be an economy that didn’t get bigger in its impact on the environment - that was ecologically sustainable - but did get better, in terms of the quality of our lives. It would be an economy that didn’t grow, but it wouldn’t be an economy that was stagnant, that never changed. It wouldn’t be an economy where people had to stop striving - to build a better mousetrap, write a symphony or find the cure for cancer. Many economists instinctively fear a steady-state economy would stifle the incentive to innovate. But that fear’s not justified. Indeed, you could argue that, with the quantitative route to improvement blocked off, the qualitative route would gain more attention. Herman Daly’s way of making the distinction is to say economic growth (pushing more resources through a physically larger economy) is bad, but economic development (squeezing more welfare from the same throughput of resources) is fine.

But how would we go about reorganising the economy so that we no longer increased the throughput of natural resources? It wouldn’t be easy, but nor would it be terrifically hard. It actually represents nothing more than a design problem - one the economics profession is well-equipped to solve, should we decide to give it that task. We’d still have a capitalist, market economy where market forces continued to determine economic outcomes and to drive the push for greater efficiency in resource use, within the framework set by government. The big difference would be the government adding a new constraint to the operation of market forces: a limit on the consumption of natural resources.

How would we achieve that limit? By using the same ‘economic instrument’ we’ve already begun using to limit the burning of fossil fuels: a system of tradable permits. You impose a cap on the total quantity of a certain class of natural resource permitted to be consumed in a year, and auction to producers permits to use the resource up to the cap. The more efficient firms are at doing what they want to do while using fewer natural resources to do it, the less they have to spend on permits - thus harnessing market forces to help reduce the use of those resources. Firms that discover they have more permits than they need are able to trade them for money with firms that discover they need more permits than they have. By such means the burden of limiting resource use to the cap is transferred to those firms able to reduce their resource use most cheaply, thereby limiting the loss of income to the community involved in achieving the limit on resource use. As firms became more efficient at reducing their natural resource use - including by the invention of new technological solutions to the problem - it would possible, if desired, to lower the cap and, hence, the quantity of resources used, at no increased cost to the community.

The purpose of such a cap-and-trade scheme would be, of course, to raise the price of natural resources - and the prices of goods with a high natural-resource component - relative to the prices of all other goods and services. In line with the most orthodox economics, it’s this change in relative prices which would motivate producers and consumers to reduce their resource use, and do so with minimum loss of economic efficiency. Economists believe changes in relative prices are very effective in bringing about changes in the behaviour of producers and consumers.

This process would, of course, lead to a once-off increase in the general level of consumer prices, which might be quite a significant increase. Many of you would be concerned about the effect on the cost of living, particularly for pensioners and low income-earners. But, as with our present carbon tax, once the cap-and-trade scheme had brought about the desire changed in relative prices, the proceeds from the sale of permits - analogous to the proceeds from a carbon tax - are available for use to reduce the rates of other taxes - the obvious one being income tax - and increase the rates of pensions and benefits such as the family allowance, thereby compensating households for the increase in their cost of living. So I don’t see a reason to be concerned about the effect of the move on the welfare of low income-earners. Such a re-jig of the tax system would be a classic example of what environmental economists mean when they call for the burden of tax collection to be shifted from taxing ‘goods’ (such as labour and capital) to taxing ‘bads’ (such as greenhouse gas emissions and the consumption of natural resources). You raise the same amount of total tax revenue but, in the process, you discourage activities you want to discourage rather than activities you don’t want to discourage.

Raising the prices of natural resources relative to the prices of other resources - labour and capital - could be expected to have various desirable side-effects. First, it would increase the economic incentive for people to recycle natural resources and repair rather than replace appliances with a high materials-component.

Second, changing the relative prices of economic resources could be expected to change the focus of the private sector’s continuing search for greater efficiency - economising, if you like - in the use of economic resources and, hence, improved productivity. For all the time since the Industrial Revolution, most of the economising effort - including most technological advance - has been, quite logically, directed towards economising in the use of the most expensive resource: labour. But if we were to make natural resources more expensive than labour - particularly if the scheme involved a fall in the main tax on labour, income tax, thereby lowering its effective cost - this should mean a lot more entrepreneurial effort would be directed towards reducing the economy’s despoiling of the natural environment.

There are many more implications of a steady-state economy I could explore, but that’s enough to be going on with. Is a steady-state economy feasible? Yes it is.

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For true productivity gains, co-operate don't fight

When Peter Reith replaced Labor's Industrial Relations Act with the Workplace Relations Act in 1996, he changed the act's principal objective from the "prevention and settlement of industrial disputes" to "providing a framework for co-operative workplace relations". I'm not sure the Howard government always lived up to that ideal, but it was certainly the right idea.

John Howard was fond of saying we should emphasise the things that unite us, not the things that divide us. Again, I'm not sure he always lived up to that, but it was the right idea - particularly for relations between bosses and workers.

The principal objective of the Fair Work Act is to provide a "balanced framework for co-operative and productive workplace relations that promotes national economic prosperity and social inclusion". That's even better.

At a time when so many of our industries are under so much pressure to change from so many sources - the high dollar, the prudent consumer, the digital revolution, the deregulation of world airlines - we need all the co-operation we can get between employers and unions.

Most economists have rejected the claims of some that our seemingly poor productivity performance over the past decade can be blamed on the Fair Work Act that came into full effect only at the start of 2010.

But that's not the same as saying the act is without fault. And it's certainly not to deny the need for our industrial relations to be as conducive as possible to improved productivity.

If we were to believe all we see and hear, we'd conclude relations were pretty bad at present. I'm not convinced that's true. More likely, a handful of highly publicised, bitter disputes has provoked a lot of tough talking on both sides of the fence, and left us with the impression things are worse than they really are. Even so, too much of the debate about Fair Work has focused on whether it's got the balance right between the adversaries, and not enough on how much it's helping to turn adversaries into partners.

There are plenty of people who've always hated the unions, and plenty who've always hated the bosses. All of us can be lured into playing that game but, in all our interests, we need to resist the temptation. It's self-indulgent at a time when we need to pull together.

For industrial relations to become more co-operative, and hence more productive, we need give and take on both sides.

What managers need to accept is that workers are entitled to reasonable treatment. Managers want to do well out of their association with a business; so do workers. And, to adapt a quote, the economy was made for man, not man for the economy.

There are plenty of ways to improve the productivity of labour - and certainly, to cut the cost of labour - that involve making life more uncertain, insecure, unpleasant and even unhealthy for workers. If that's what "flexibility" means, it's hardly surprising workers resist it. Good managers resist the temptation to go down that shortcut to supposed prosperity.

Many proposals to "outsource" production or resort to contract labour aren't about two-way flexibility but about cutting costs by escaping existing in-house arrangements over pay and conditions. Good managers need to do better than that.

Australia's workers are relatively highly paid, with good conditions. This is a good thing, not a bad thing. It's certainly nothing to try to make workers feel guilty about. As any economist will tell you, our high pay rates are justified by our relatively highly educated and skilled workforce, by the high-quality capital equipment it works with, and by the sharing of this nation's considerable wealth.

The goal of management should not be finding ways to escape these high costs, but finding ways to defend our high wage rates with high productivity. In this endeavour they're entitled to full co-operation from their workers.

What workers need to accept is that the world economy is changing rapidly and as it changes we must change. Businesses must respond to the changing commercial pressures on them, or they will fail.

In a capitalist economy, businesses need to earn an adequate return on the shareholders' funds invested in them. In the final analysis, managers are paid to ensure their business remains profitable. They will do whatever it takes.

Such profits are not illegitimate, and they're not available to be plundered by workers demanding excessive wage rises or refusing to change in response to the changing pressures on the business.

Workers and their unions simply cannot pretend the pressures for change bearing down on the business are a problem for management, but not for them. The more they resist a creative response, the more managers will go around them in the search for cheaper labour.

Change - painful change - can't be avoided by attempting to strongarm management into including guarantees of job security in enterprise agreements. Guess what? There are no guarantees in an ever-changing market economy.

Much of the change being imposed on various industries will inevitably involve redundancies. The most workers can expect is decent redundancy pay, the avoidance of excesses designed to impress the sharemarket, and a preference for redundancies to be voluntary.

Professor Paul Gollan, of Macquarie University, argues the key to greater co-operation in the workplace is giving workers greater "voice" - formal arrangements within businesses by which employees are consulted, given their say and encouraged to propose improvements and "add value". Studies confirm such processes are associated with greater productivity.

Senior managers' "prerogative" - about which I say more in my little video on the website - is to ensure their staff is fully informed about the challenges facing the business.

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Fair Work debate fans the fighting mood

THE most disappointing thing about the review of the Fair Work Act and the reaction to it is the way they push industrial relations towards being more adversarial rather than less.

At time when so many businesses face unusually challenging pressures for structural change, we need more co-operation between the industrial partners, not more class struggle and barracking from the sidelines.

The standard approach to industrial relations reform is to see it as about "getting the balance right". There's a fundamental conflict of interest between labour and capital, we think, plus a wide difference in bargaining power, so the objective is to ensure the eternally battling parties are fairly evenly matched.

That's the public policy objective, of course. If you're on one side or the other, your objective is simply to get the rules changed in a way that gives you the drop over the other side.

The conventional view is that, with its attempt to install individual contracts as the chief form of bargaining and marginalise the unions, WorkChoices pushed the balance too far in the direction of employers.

So it was fair enough - particularly after voters seemed to reject WorkChoices so decisively - for Fair Work to push the balance back the other way. The review's job was to decide whether the balance had now been pushed too far the other way.

The trouble with the review is that it didn't do much more than adjudicate the rival claims, legal section by section. With two of the three members of the review being lawyers - and one a judge - you couldn't have expected anything else.

Although the media portrayed the employer groups' reaction to the review as angry, I suspect they were quite pleased. They won more points than they expected to, while the unions won fewer.

One trouble with the traditional approach to regulating industrial relations - supervise a fair fight - is that it's reinforced by all our other adversarial institutions. It comes naturally to lawyers, but also to politicians.

There's nothing Julia Gillard and Labor would love more than a rematch on industrial relations and there are plenty of urgers on the Liberal sidelines spoiling for a punch-up.

For once, however, Bruiser Abbott isn't tempted, judging correctly that such a them-and-us contest would greatly favour "them". Electorally, WorkChoices is still toxic.

Should Abbott win the election, it will be interesting to see what gap emerges between his pre-election rhetoric and his post-election policies. Many of his backers are hoping for a yawning chasm.

Just as the traditional industrial relations approach is adversarial, so the IR experts are highly factionalised. Most academic experts long ago chose sides between the unions and the employers. Trying to find experts who can see both sides of the argument is one of the trials of my job.

Wherever there are adversaries, there you can expect to find the media, doing their best to increase the fun by amplifying the conflict. What's new is to have the national dailies taking sides in their reporting, with the union side of the story virtually unmentioned.

Whenever there's a brawl, it's hard for interested bystanders to resist the temptation to join in. I suspect that's the story with big business leaders: they're not greatly affected, but they know whose side they're on.

Consider the results of last week's CEO Pulse survey of 96 chief executives. Fully 82 per cent of them think Fair Work is having a negative impact on productivity. That's for the whole economy. For their own industry, it's down to 60 per cent. And for their own business? Down to 51 per cent, with 45 per cent saying it's having no effect.

Coming from people with such obvious alignment, that tells me we don't have a lot to worry about. It reveals the classic survey gap between first-hand experience and the general impression people have picked up, mainly from the media.

My guess is a few big, militant unions are taking every advantage of Fair Work to make unreasonable demands. And they're being vigorously opposed by a few equally militant, unreasonable big businesses.

But we shouldn't allow people with a vested interest in conflict to misdirect us. The real problem with Fair Work is that it's not doing as much good as it could be at a time when bosses and workers need to pull together.

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We've come a long way on industrial relations

In all the argument about the rights and wrongs of Julia Gillard's Fair Work Act, it's easy to forget we've been making radical changes to our industrial relations and wage-fixing system since the late 1980s.

Since the labour market is such an integral part of the economy, it's reasonable to suppose those changes have made a significant contribution to the economy's markedly improved performance over the past two decades.

What you can't do is look at the macro-economic record and confidently attribute this improvement or that deterioration to either the Fair Work Act or the Work Choices regime that preceded it.

Why not? Because, particularly if you're talking about our weak productivity performance, the timing doesn't fit. Also because neither regime was or has been in force long enough to be sure they've had much effect on anything. Changes take time to make a mark.

But, above all, because when you take just one factor and use it to explain some particular development in the economy, you're unconsciously assuming ceteris paribus - all else remains equal. And in the real world, that's never true. For all you know, the development may be explained by some other factor, or combination of factors.

So whenever you see a protagonist in the debate confidently claiming the slowdown in productivity can be blamed on the industrial relations approach they oppose, know they're talking prejudice, not reasoned analysis.

As this week's review of the Fair Work Act reminds us, we've been overhauling our industrial relations and wage-fixing system for ages. For most of the time since Federation we operated under a uniquely antipodean system of federal and state "conciliation and arbitration".

In theory, all strikes were illegal because the system made them unnecessary. In practice, strikes were frequent, but short.

In theory, the commission running the system would provide conciliation to differing employers and unions, trying to help them reach an agreement. If this didn't work it would compulsorily arbitrate to impose a solution, usually roughly splitting the difference. In practice, disputes were almost always settled by arbitration. Unions would pull on a strike to get the umpire to intervene and impose a decision.

In theory, wage rises were controlled by the commission in a "national wage case", making them nationally uniform for all workers subject to particular "industrial awards", on which the system was built. In practice, you could get pay rises other ways, including by breaking out of the system if you had enough muscle. Some increases would "flow on" from one key award to all awards.

Get the feeling it wasn't working very well? The first attempt to restore order was to limit wage rises to those awarded by the national wage case, where wages were indexed to the consumer price index.

But indexation was abandoned in 1987 and wage rises were awarded in exchange for the removal of "restrictive work practices" (inefficiencies). Awards were restructured to reduce demarcations between people on different awards at the same workplace and to make awards more flexible.

In 1991, the commission introduced "enterprise bargaining" between unions and employers at the level of the individual workplace. It applied a "no-disadvantage [to employees] test" before ratifying agreements. In 1994, with a new Industrial Relations Act, a more formal system of collective bargaining at the enterprise level was introduced, the national wage case was ended and replaced with a system of small annual "safety net" award wage increases for workers unable to negotiate an increase.

All that happened under the Hawke-Keating government. From early 1997 the Howard government's Workplace Relations Act promoted the use of individual contracts (subject to the no-disadvantage test) by introducing "Australian workplace agreements", increased the emphasis on enterprise bargaining by reducing the content of awards to 20 "allowable matters" and reduced union power by outlawing compulsory unionism and making strikes legal ("protected") only during the negotiation of new agreements.

The Howard government's second major set of changes, Work Choices, took effect in 2006. It moved from a federal to a national system, sought to make individual contracts the main form of wage agreement by removing the no-disadvantage test, greatly increased the restrictions on unions where employers persisted with collective bargaining, and largely sidelined the commission.

After much criticism, in May 2007 John Howard significantly watered down these provisions by restoring a version of the no-disadvantage test and reinstating close scrutiny of individual contracts before approval.

Labor's Fair Work Act didn't really take effect until the start of 2010. It ended legislative recognition of individual contracts and restored collectively bargained enterprise agreements as the main form of wage-fixing. It largely restored the role of the commission under the cutesy title, Fair Work Australia. It reformed the award system, reducing more than 3000 federal and state awards to 122 simpler and less prescriptive "modern awards".

Some silly partisans have tried to blame Fair Work for our weak performance on the productivity of labour, but the figures don't bear this out. Productivity improved fastest under the Keating government's regime and the early years of the Workplace Relations Act, but then slowed and the weakness continued under both Work Choices and Fair Work. In any case, this ignores the huge effect of the special factors affecting productivity in mining and utilities.

But productivity isn't the only test of improved labour market performance. What about strikes? Working days lost per 1000 employees averaged 232 a year in the last days of arbitration, 176 under Labor's first Industrial Relations Act, 96 under its second act, 54 under Howard's Workplace Relations Act, 13 under Work Choices and 18 under Fair Work.

Some have blamed Fair Work for the small jump in days lost last year but most of this is explained by disputes involving the O'Farrell government and NSW public servants, who aren't covered by Fair Work.

Despite employer complaints, the minimum wage grew in real terms by less than 9 per cent over the 11 years to 2012. It dropped from 62 per cent of median full-time earnings in 1997 to 54 per cent in 2010.

The review of the Fair Work Act concludes that, since it came into force, "important outcomes such as wages growth, industrial disputation, the responsiveness of wages to supply and demand, the rate of employment growth and the flexibility of work patterns have been favourable to Australia's continuing prosperity, as indeed they have been since the transition away from arbitration two decades ago".

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No one knows how we'll pay for disability scheme

You may not have noticed, but last week was among the most significant of the Gillard government's term. The commitments made may do great good, but they will also cause much pain and gnashing of teeth in the years ahead.

Last week the nation made it crystal clear to its political leaders - federal and state - it wanted them to get on with implementing the national disability insurance scheme. After decades of turning a blind eye to the difficulties faced by the disabled and their carers, last week conscience struck.

Fine. You're a believer; so am I. But the scheme is very expensive: when fully implemented in 2018, an additional $8 billion a year. Or, as the politicians and the media usually prefer to put it, $32 billion over four years.

To give you an idea, $8 billion a year is more than will be raised each year by the carbon tax or more than twice what will be raised by the new mining tax.

So how will the disability scheme be paid for? No one has any idea. The pollies were arguing about that very question when - urged on by the same radio shock jocks who on other days rail against "debt and deficit" - the electorate put a rocket under them: Just do it!

That's why I have reservations. We behaved like a teenager with his first pay packet who goes out and buys a car on the never-never, without a moment's thought about how he'll fit the repayments into his budget.

Perhaps this was the only way an increasingly self-centred nation was ever going to commit to something so caring but expensive. Had we dwelt on how much it would cost and how we'd be paying for it, we might have made an excuse and passed on.

Even so, the accountant in me remains uneasy. Sometimes in politics, good deeds aren't born of the purest motives. The Productivity Commission report that recommended the scheme called for the pilot programs to begin in 2014.

I suspect Julia Gillard brought it forward a year because she wanted to be seen doing something worthwhile - and something that didn't have Kevin Rudd's fingerprints on it. She committed to spending just $1 billion over the four-year trial phase.

If Gillard has a clear idea of how she would afford the scheme when fully implemented, she's given no hint of it. All we know is that, contrary to the commission's advice, she expects the states to bear some of the cost.

I suspect she's fingered the states as a red herring, intending to draw attention away from her own lack of forethought. That's where we got to last week. She put the wood on the premiers to make a small contribution to the cost of their state's pilot scheme, but many declined. This could have been the usual story - whenever the feds require the premiers' co-operation, their hands go out: What's it worth to you?

If that was the premiers' motivation, I'm sympathetic. Though the states are responsible for provision of many costly public services - law and order, roads and transport, schools and hospitals - their taxing powers have been greatly constrained by the High Court, leaving them heavily dependent on the feds.

John Howard's decision to grant them the full proceeds from the goods and services tax was intended to solve their problem, but it's no longer the "growth tax" it was. Our consumer spending no longer outstrips our income the way it did, and an ever-growing proportion of our spending goes on items excluded from the tax, particularly private education and health.

So the premiers can't reasonably be expected to stump up for anything much. And, indeed, it's the feds who'll have to come up with a solution to their chronic revenue problem. This week a poll shows 84 per cent of respondents oppose increasing the rate of the GST to 12.5 per cent.

But only the Liberal premiers jacked up last week. The remaining Labor state and territory leaders played along. So maybe it wasn't the standard premiers' money-motivated bail-up.

There isn't a politician in the country with the courage to openly oppose the disability scheme. Gillard's lack of courage comes in telling us how she proposes to pay for it. Maybe she's decided she'll worry about that only if she wins the next election.

Tony Abbott's more likely to win it, of course. I suspect the hard-heads on his side had been intending to relegate implementation of the full scheme to the status of an "aspiration" to be afforded only when finances permit.

That now would be a lot harder to do, following the surge of public pressure that forced the premiers of NSW and Victoria to back down after just a day or so. Such forceful expressions of the public's will stay burnt on politicians' brains long after you and I have forgotten them.

Abbott's shadow treasurer, Joe Hockey, is saying it would be cruel to offer hope to the disabled when there was no guarantee the money could be found. In contrast, his more slick-tongued finance spokesman, Andrew Robb, says the full scheme would be introduced in 2018, but this "probably would require the removal or scaling back of other programs".

Don't forget Abbott would first have to cover the cost of abolishing the carbon tax and the mining tax. This is a man who professes to believe taxes must go down and may never go up. Now he's got to find a further $8 billion a year in spending cuts.

I find it hard to believe this would happen. But whatever happens, I foresee much pain and gnashing of teeth.

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TALK TO BIBLE MEANS BUSINESS

Sydney, Monday, July 30, 2012

Thanks for inviting me to be your discussion starter tonight. I’m not sure how much help I’ll be in your continuing exploration of the hypothesis that ‘there are identifiable values that contribute to the resilient prosperity of a culture’, but I’m happy to give you some observations to spark off - even if they convince you that I’m not on about what you’re on about.

On the question of business ethics, let me just say my strongest feeling on the subject is that businesses ought to be built on the principle of treating people well: producing a product you can be proud of, giving customers value for money, doing the right thing by suppliers and shareholders, and treating employees well. This means developing a high degree of mutual trust and loyalty between management and workers, putting effort into making employees’ work satisfying and fairly paid, giving them a degree of autonomy in their work and using these things - rather than KPIs and performance pay - to keep workers motivated, hard working and committed to the company’s objectives. I’m a great believer in emphasising intrinsic rather than extrinsic motivation: doing things well for their own sake, not for any external, monetary or status rewards good work may bring. I really believe it should be a high priority to make work more satisfying. I don’t believe in treating ‘em mean to keep ‘em keen. That’s not ethical - and it’s certainly not Christlike.

Much as most people hate change, this doesn’t mean aiming for a workplace that never changes in response to advances in technology, changing customer needs, competitive pressures (or a continued high exchange rate). Businesses must change, and sometimes - as now for many industries, including mine - change needs to be rapid and sweeping, with a lot of people losing their jobs. The ethical position is not to avoid change or even minimise it, but to bring it about in a considered and reasonable way, with never-ending explanation of why it’s necessary, consultation about the best response and considerate treatment of people who lose their jobs or have their jobs changed or moved. The ethical position is not to bluntly assert management’s right to manage without adequate explanation, and pull on a stand-up fight with the unions (or to ride roughshod over workers who are un-unionised). I believe there’s growing evidence that running businesses in this pro-people way leads to higher productivity and profitability. But even if there were no such evidence it would still be the right thing to do.

The other thing I wanted to say is to propose the notion of ‘balance’ as one of the values that contributes to resilient prosperity. A closely related value or virtue in my mind is ‘self-control’. One of the most useful ideas in economics is the notion of trade-offs and optimisation (rather than maximisation) leading to balance or equilibrium.

The world consists of many desirable, but conflicting, objectives. They’re in conflict mainly because of opportunity cost: we never have sufficient resources to satisfy all our desires, so we’re forced to choose. The world also consists of useful but rival means to achieve our objectives; again, we have to choose. It’s rarely the case that best outcome - the one yielding the most utility or satisfaction or prosperity - comes from choosing all of one and none of the others. The best outcome almost always arises from some combination of the conflicting objectives or the rival means to achieve objectives. This is what puts much of the challenge into life - including business life: finding the most desirable, optimising combination of conflicting objectives. We may profitably spend much of our lives seeking to improve the trade-offs we face. And the best trade-off may change over time as our preferences change and the environment in which we make our choices changes.

So the thing we’re seeking is the right balance. For many years my motto as a commentator has been Hard Head, Soft Heart. I want to think carefully and logically about how the world works and what I want out of life. But just as I don’t want to lead a life driven by instinct and emotion, so I don’t want to lead a life devoid of emotion. Emotion is very important; it’s emotion that makes us human. Take away emotion and we become calculating machines. We need emotion because it determines our preferences and goals - our ‘ends’ - but we need rationality, logic to determine the most efficient means to achieve our ends. So I think hard head, soft heart ought to be everyone’s motto. After all, who wants to be soft-headed or hard-hearted?

Such a motto helps us get the right balance in our lives. And one of the big risks and failings in life is lack of balance - going overboard in one direction or the other. Market economies - and the theory of market economies, conventional economics - tempt us to go overboard in the direction of self-interest, depersonalisation and materialism. Market economies are motivated by - powered by - self-interest, they encourage us to be terribly conscious of our needs and emotions, but to avoid thinking about the needs and emotions of the people we deal with, many of whom we don’t know. Market economies and conventional economics, with their focus on efficiency, tempt us to prioritise our material needs at the expense of our social, relational and spiritual needs. The material aspect of our lives is very important - no one could deny it - but there are other aspects of our lives that are also important. And, particularly for people in a country as affluent as ours, I find it hard to see how we can make increasing our material standard of living such a high priority - personally and as a government objective. That’s why I trust your definition of ‘prosperity’ is wider than just material prosperity. It needs to take account of the state of the natural environment (still material), but also the treatment of people: the fairness with which material prosperity is distributed, and the extent to which the pursuit of material comfort comes at the expense of people’s relationships and their spiritual life. For what does it profit a man if he gains the whole world and loses his own soul? True prosperity involves trade-offs, optimisation and balance.

I want to finish with an observation about a paradox at the heart of the market economy: for an individual to do well in that economy, he or she has to put a great amount of effort into resisting its blandishments. Its advertising and other marketing tempt us to eat too much, drink too much, spend too much and save too little, borrow more than we can handle, and sit round being entertained when we should be working, studying or exercising. Success in a market economy is reserved for those people who exercise all the virtues advertisers urge us to set aside: disciple, restraint and the ability to delay gratification - in short, self-control.

Don’t you think it’s strange that to succeed in a capitalist economy you have to be so good at not doing what the capitalists urge you to do? And that’s just material success. Making sure the temptations of modern life don’t damage your relationships with your spouse and your family - or with God - requires an even higher level of conscious effort.

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Smarter pricing would improve productivity

The debate over our seemingly weak productivity performance has come full circle, reverting to the explanation the big end of town was happy to accept under John Howard: almost all the weakness is explained by the special circumstances of the mining and utilities industries, which are nothing to worry about.

According to estimates by Reserve Bank researchers, after you exclude mining and utilities, labour productivity in the market sector improved at annual rates of 1.8 per cent over the 20 years to 1994, 3.1 per cent over the 10 years to 2004, and 1.7 per cent over the seven years to 2011.

However, Labour productivity in mining fell by 6.3 per cent a year over the past seven years because much higher prices justified the exploitation of harder-to-get-at deposits and because of spending on new mines that have yet to start producing.

Productivity in utilities (electricity, gas and water) fell by 5.5 per cent a year over the period, mainly because additional investment to improve the reliability of supply in the electricity and water industries has done little to increase output.

Note that a deterioration in our productivity performance isn't always a bad thing. Improved productivity is a means to an end, not an end in itself. The end is a higher material standard of living, and improved productivity is just one way for us to get richer. Another is for higher world prices to make uneconomic mineral deposits profitable to exploit. How could that be a bad thing, even if it does wreck our productivity figures?

And avoiding power blackouts and extreme water shortages is surely part and parcel of enjoying a high material living standard. If that requires us to invest in more power stations and higher-capacity power lines to cope with peak electricity demand - or requires us to build desalination plants to ensure we don't run out of water during severe droughts - what of it? Would it be better to go without to keep our figures looking good?

That's pretty obvious. But Dr Richard Tooth, of Sapere Research Group, and Professor Quentin Grafton, a water economist at the Australian National University, have separately advanced a more sophisticated argument: we could have avoided the expense of all that extra utilities investment had we been smarter in the way we set the prices of those commodities.

Starting with electricity, it has long been the case that we've needed to invest in sufficient generating and distribution capacity to cope with occasional peaks in demand that far exceed the average level of demand. These days, the peak comes on hot summer days. As household aircon has become cheaper and more ubiquitous, the peaks have shot ever higher than average demand, which is actually declining a little.

It costs a fortune to install the extra capacity - particularly the power-cable capacity - needed to ensure a lot of people turning on their aircon just a few days a year doesn't lead to the thing every state government dreads: blackouts.

But all this capital spending - and the political pain of 18 per cent increases in power bills - could have been avoided had state governments got on with installing smart meters in homes. This would have allowed prices that vary with the time of day. Significantly higher prices at the time of year when people are tempted to put on their airconditioner would prompt many to think twice. It would also be easy to encourage big industrial users to reduce their demand for relatively brief periods when household aircon was full blast.

The case of water is more complicated. Water bills are composed of a fixed charge plus a usage charge that varies with how much water you use. In (simple) theory, the usage charge should reflect the long-run marginal cost of an extra unit of water. The fixed charge is whatever additional amount is needed to cover the water company's full costs (including a reasonable return on capital).

However, the usage charge is usually too low to have much effect on consumption behaviour. And the simple theory doesn't apply well to commodities that have to be stored rather than produced to order, such as water.

As usual, in the last drought we relied on water restrictions, but they weren't sufficient to fix the problem (you can only police the water use that can be seen from the street, which means restrictions don't work well with business users) and we ended up building desal plants, only to mothball them when the drought broke.

The economists' study of the price elasticity of demand for water leads them to argue that, had user charges been raised high enough, supply could have been better conserved and desalination avoided.

User charges could have been increased to the point where they raised more revenue than was needed, thus allowing the fixed charge to be a subtraction from the total user charge. Dr Tooth argues such an arrangement would have been fairer in its treatment of low-income users.

If all those jumping on the productivity bandwagon were more genuine in their concern to raise efficiency, they would have a lot more to say about efficient pricing.

The most bizarre (and pathetic) political statement of last week was Wayne Swan's response to news the annual inflation rate had fallen to 1.2 per cent, the lowest in 13 years: "While the moderation in ... inflation is certainly welcome, many households continue to face cost of living pressures." And these guys wonder why they're not getting the appreciation they deserve.

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OK gloomsters, let's run some worst-case scenarios

In the long boom before the global financial crisis, when economists convinced themselves they'd achieved the Great Moderation and everyone was confident the good times would roll on forever, anyone who thought they saw a problem looming was either ignored or dismissed as a fool.

In the North Atlantic economies' continuing agonies since the crisis, it's been roughly the reverse. Excessive optimism has swung to excessive pessimism and anyone who thinks they see a problem looming gets a microphone and loud speaker stuck in front of their face.

Now it's the people who don't think the end is nigh who tend to be ignored. Our cyclical switch to pessimism is being compounded by the media's natural bias in favour of bad news and the tendency of people who dislike the Gillard government to believe everything in the economy has gone to hell.

One person who thinks things aren't as bad as they're being painted is Glenn Stevens, governor of the Reserve Bank. He gave a speech this week in which he begged to differ with the doomsayers. The cogent arguments he advanced deserve more attention than they've been given.

When it comes to dark forebodings, first prize goes to fears of a break-up of the euro. But worries about a hard landing in China are now coming second. Stevens examines the figures and concludes they show "Chinese growth in industrial output of something like 10 per cent, and gross domestic product growth in the 7 to 8 per cent range. To be sure, that is a significant moderation from the growth in GDP of 10 per cent or more that we have often seen in China in the past five to seven years."

But not even China can grow that fast indefinitely and there were clearly problems building up. It's far better the moderation occurs, he argues, if this increases the sustainability of future expansion.

What's more, the Chinese authorities have been taking well-calibrated steps in the direction of easing macro-economic policies, as their objectives for lower inflation look like being achieved and as the likelihood of slower global growth affecting China has increased.

Next he responds to the pessimists' greatest fear of disaster in the domestic economy: a collapse in house prices. He's not convinced they're overvalued by our historical standards. And while, expressed as multiples of annual household disposable income, they seem very high compared with American prices, they are within the pack of other developed countries. It's the US that seems out of line.

But Stevens emphasises he's not saying there's no possibility house prices will fall. "It is a very dangerous idea to think that dwelling prices cannot fall," he says. "They can, and they have." But the ingredients you'd look for as signalling an imminent crash seem even less in evidence now than five years ago.

"Even though we don't face immediate problems, we should ask: what if something went wrong?"

OK, so let's look at some worst-case scenarios. If the thing that goes wrong is a "major financial event" emanating from Europe, he says, the most damaging potential transmission channel would be if there were a complete retreat from risk, capital market closure and funding shortfalls for financial institutions.

This would be a problem for many countries, of course, not just us. But in that event the Aussie dollar might decline, perhaps significantly.

"We might find that, in an extreme case, the Reserve Bank - along with other central banks - would need to step in with domestic currency liquidity, in lieu of market funding. The vulnerability to this possibility is less than it was four years ago; our capacity to respond is undiminished and, if not actually unlimited, is not subject to any limit that seems likely to bind."

An alternative version of this scenario, if it involved the sort of euro break-up about which some people speculate, could be a flow of funds into Australian assets. In that case our problem might be not being able to absorb that capital. But that means the banks would be unlikely to have serious funding problems.

If the thing that went wrong was a serious slump in China's economy, the Aussie would probably fall, Stevens says, which would provide expansionary impetus to the Australian economy. But more importantly, we could expect the Chinese authorities to respond with stimulatory measures.

"Even if one is concerned about the extent of problems that may lurk beneath the surface in China - say in the financial sector - it is not clear why we should assume that the capacity of the Chinese authorities to respond to them is seriously impaired.

"And in the final analysis, a serious deterioration in international economic conditions would still see Australia with scope to use macroeconomic policy, if needed, as long as inflation did not become a concern, which would be unlikely in the scenario in question."

Next, what if house prices did slump after all? In such a scenario people typically worry about two consequences. The first is a long period of very weak construction activity, usually because an excess of housing stock resulting from previous over-construction needs to be worked off. But we've already had a long period of weak residential construction and it's hard to believe it could get much weaker at the national level.

The second common worry is about what a slump in house prices would do to the balance sheets of the banks and other lenders. But this scenario is regularly covered by the Australian Prudential Regulation Authority in its "stress-testing" of the banks.

"The results of such exercises always show that even with substantial falls in dwelling prices, much higher unemployment and associated higher levels of defaults, key financial institutions remain well and truly solvent."

Stevens points out that a lot of the adjustments we're complaining about at present - including households' higher and more normal rates of saving, a more sober attitude towards debt, the reorientation of the banks' funding away from short-term foreign borrowing, and weak house prices - are strengthening our resilience to possible future shocks.

"The years ahead will no doubt challenge us in various ways, including in ways we cannot predict. But what's new about that? Even if the pessimists turn out to be right on one or more counts, it doesn't follow that we would be unable to cope.

"Acting sensibly, with a long-term focus, has as good a chance as ever of seeing us through," Stevens concludes.

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Industry captures regulation of taxis

Does changing the government make much difference? Both sides of politics always assure us it will. But judging by the infrequency with which we do it, we seem doubtful.

At the state level the national swing from Labor to the Coalition is almost complete, providing a good opportunity to test the question. And a good test is the regulation of industry.

Despite both sides' protestations of undying concern for the welfare of ordinary voters, it gets harder to avoid the suspicion that governments regulate industries for the benefit of the businesses rather than their customers.

Take the case of taxis. We've been dissatisfied with the service provided by taxis for many a moon. They're expensive, but often don't offer good service: they're too hard to find at certain times, they don't turn up or take far too long to arrive; too many drivers don't know where to go, or are unfriendly.

But the outgoing Labor governments did far too little to improve the position. It got so bad in Victoria the Baillieu government promised action and appointed Allan Fels, the former chairman of the Australian Competition and Consumer Commission, to conduct an inquiry.

The taxi industry is highly regulated by state governments. What's the goal of this regulation? It's supposed to be to ensure we're provided with a safe and reliable taxi service at a reasonable price. In practice, the goal has evolved into the protection of a highly lucrative financial investment, the taxi licence plate.

Since about the time of the Depression, governments have sought to control the number of taxis by issuing a limited quantity of licence plates. Initially, and for many years, these licences were issued free to people wanting to drive taxis.

Because the supply of licences was limited relative to the demand for them, licence plates became valuable in their own right. They exist in perpetuity, and people who'd been given one by the government were able to sell it to someone else.

That someone may be a person who wants to drive a taxi, but doesn't have to be. And ownership of taxi plates doesn't imply ownership of the car to which those licence plates are screwed. You can "assign" (rent) the plates to a taxi operator for a fee, who buys the car and puts it on the road. Operators may drive the car themselves, or they may get others to do the driving.

Thus did the taxi licence plate transform into a valuable financial investment, with an active market in their purchase and sale. According to Professor Fels's interim report, the value of plates has been rising for years and Melbourne plates now change hands for up to $490,000 a pop.

Licences are assigned to operators for a fee of about $35,000 a year, thus yielding a direct return to their owners of about 7 per cent. Allow for capital gain and the overall return rises to about 16 per cent a year.

Not a bad investment. Now get this: according to the Fels report, in 1985 only about 4 per cent of Victorian taxi licences had been assigned to others. By 1998, about 45 per cent of metropolitan licences had been assigned. And by December last year it was up to about 70 per cent.

Because assignment fees are so high, not enough income is left for taxi operators and even less for drivers. Taxi fares are controlled by the government and the need to pay drivers more - they get an average of about $13 an hour, according to Fels - is often used to justify fare increases.

But every time fares increase so do the assignment fees charged by the licence owners, justifying a further rise in value of licences.

Fundamentally, however, what causes the rising value of licences is their growing scarcity relative to demand. Who is it that limits the number of licences on issue? The government. Who does this benefit? The owners of licence plates. The industry is being regulated largely for the benefit of absentee landlords, so to speak.

Taxi drivers get a terrible deal. They generally get 50 per cent of their take, but they're not employees and have to bear many costs themselves. They get no workers compensation cover, no holidays or superannuation and have to pay the goods and services tax.

Is it any wonder the quality of drivers is often poor, turnover is high and it's hard to get recruits? And yet most of our complaints about taxis relate to the performance of drivers.

Fels's key proposal in Victoria is for the government to issue new taxi licences to any qualified person for a fee of $20,000 a year. New licences would not be transferable and issued only to owner-drivers.

This would make it easier for drivers to become owners. It would force the existing licence plate owners' assignment fee down to $20,000 a year, still leaving them a reasonable return, but lowering the capital value of their plates to about $250,000.

Taxi operators would benefit from the lower assignment fees and this would allow the drivers' share of their take to be raised to 60 per cent. This, in turn, would justify making greater demands on drivers, including requiring them to pass a more stringent street and location knowledge test.

Now you see why licence-plate owners are opposing these reforms so vigorously. We'll see if Ted Baillieu stands up to them with any more fortitude than his Labor predecessors.

The specifics of taxi regulation in NSW differ somewhat from those in Victoria but the general principles are much the same - as are the complaints from taxi users. Will Barry O'Farrell try harder than Labor to fix things? So far he hasn't even called for a report.

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Reserve turns spotlight on dark side of innovation

There are few words in the business bible more holy than "innovation". And I'm a believer in its great virtue. But, like many things in economics, sometimes what's usually a good thing can be a bad thing - even a terrible thing.

In a speech on banking, the deputy governor of the Reserve Bank, Dr Philip Lowe, drew attention to the dark side of innovation in the financial sector and advocated closer regulation of it. Here's what he said, with my interpolations.

"Over many decades, our societies have benefited greatly from innovation in the financial system. Financial innovation has delivered lower cost and more flexible loans and better deposit products."

It has provided new and more efficient ways of managing risk, he says, helped our economies to grow and our living standards to rise.

"But financial innovation can also have a dark side," he says. "This is particularly so where it is driven by distorted remuneration structures within financial institutions, or by regulatory, tax or accounting considerations."

Ain't that the truth. Distorted remuneration structures go a long way to explain the origins of the global financial crisis. People paid commissions to give home loans to people who couldn't possibly pay them off. People on Wall Street hugely rewarded when their bets pay off, but suffering no great personal loss when their bets blow up.

People who invent toxic products and flog them to their own clients. Credit rating agencies paid handsomely to give toxic products triple-A ratings.

Because (for reasons I'm yet to fully understand - or meet anyone who does) remuneration in the financial sector is so eye-wateringly gargantuan - enough to make chief executives envious - it attracts many of our brightest minds, who could be advancing the frontiers of science or managing the economy, but instead spend their days finding ways around financial regulations, tax law and accounting conventions.

I suppose you'd have to be hugely rewarded to devote your life to making such an antisocial contribution.

Lowe says problems can also arise where the new products are not well understood by those who develop and sell them, or by those who buy and trade them.

"Over recent times, much of the innovation that we have seen has been driven by advances in finance theory and computing power, which have allowed institutions to slice up risk into smaller and smaller pieces and allow each of those pieces to be separately priced," he says.

"One supposed benefit of this was that financial products could be engineered to closely match the risk appetite of each investor. But much of the financial engineering was very complicated and its net benefit to society is debatable."

Many of the products were not well understood, he says, and many of the underlying assumptions used in pricing turned out to be wrong. Even sophisticated financial institutions with all their resources [all those highly paid, super-bright people] didn't understand the risks at a micro-economic nor a system-wide level.

"As a result, they took more risk than they realised and created vulnerabilities for the entire global financial system."

Just so. We live in an era when it's the height of fashion to see much of the management task as managing the many and varied "risks" to which businesses are subject. It's a useful way of thinking.

One way to manage risk is to spread it very thinly between a large number of people. All insurance policies are longstanding examples of this approach. Another approach is to join together people facing opposite risks. For instance, a contract between someone who stands to lose if the dollar falls and someone who stands to lose if it rises.

The market has developed lots of "plain vanilla" derivatives that allow firms to swap their interest-rate or foreign-exchange risks in this way. This is socially beneficial innovation.

But when derivative contracts become far more complicated than that, there can be problems. Risk management can itself be risky. It's hard to escape the risk of human fallibility in all its forms: the risk that people (even professionals, let alone punters) don't really understand the risks they're taking on; the risk of people's judgment being clouded by greed or hubris (nothing's gone wrong so far and that's because I'm so smart).

Then there are all the previously non-existent risks you create when you invent assets for which there's no market price, but for which you calculate a price using a fancy mathematical formula. All such synthetic prices are built on a host of explicit and hidden assumptions.

Forget that small fact and you can come horribly unstuck, as we've already discovered in the global financial crisis to our huge and far-from-over cost - as witness, Europe.

The question is, how can society obtain the benefits that financial innovation delivers while reducing the risks it entails? Lowe concedes this won't be easy, but sees a way forward in greater public sector oversight of areas where innovation is occurring.

"I suspect that the answer is not more rules, for it is difficult to write rules for new products, especially if we do not know what those new products will be, and the rules themselves can breed distortions," he says.

But one concrete approach is for supervisors [such as our Australian Prudential Regulation Authority] and central banks to pay very close attention to areas where innovation is occurring: to make sure they understand what's going on and to test and probe institutions about their management of risks in new areas and new products.

"Ultimately, supervisors need to be prepared to take action to limit certain types of activities, or to slow their growth, if the risks are not well understood or not well managed," he concludes.

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