The four industries with most clout in Canberra

Like most, I believe in democracy. But I also believe in capitalism, and though the two have usually been seen in the West as a good fit, of late I'm having doubts.

Every society has to use some system for organising production and consumption, and I know of none better than leaving it largely to private enterprise.

For the most part, markets work well in bringing buyers and sellers together and satisfying their respective needs. Markets' reliance on people pursuing their own interests does a good job in encouraging efficiency and innovation.

The funny thing is, when capitalism is working well it's the capitalists themselves who get taken advantage of. They keep coming up with new ways of making a fortune - railways, electricity, motor cars, the telephone, radio, television, the internet - but in the end competition causes most of the start-up companies to go broke and leaves most of the benefit not with the capitalists but their customers. It comes in the form of access to affordable transport, power, entertainment or communication.

Of course, as the global financial crisis so painfully reminded us, markets are far from perfect and it's folly to leave them inadequately regulated. Markets are actually a creation of government, and governments have to continuously supervise them to ensure they don't run off the rails.

It's this need for continuous government involvement that can cause problems. Can we be sure government intervention is always aimed at benefiting customers rather than making life easier for the few big companies that dominate many of our markets?

Then there's democracy. What if it becomes too easy for capitalists to take advantage of the institutions of democracy to get the rules of the game bent in their favour? Of all the columns I wrote last year, the one that drew the biggest reaction was called ''The four business gangs that run America'', quoting a book by Professor Jeffery Sachs of Columbia University. Sachs wrote that four key sectors of US business exemplified the takeover of political power in America by the ''corporatocracy'': the military-industrial complex, the Wall Street-Washington complex, the Big Oil-transport-military complex and the healthcare industry.

I ended the column by saying that ''fortunately, things aren't nearly so bad in Australia''. It's true, they're not. But, in a paper to be issued on Wednesday, ''Corporate power in Australia,'' by Dr Richard Denniss and David Richardson, of the Australia Institute, we're reminded that things here are far from ideal.

The authors argue that ''big business exerts influence through campaign contributions, influence over university funding, sponsorship of think tanks and in other ways''.

The four most disproportionately influential industries in Australia, they say, are superannuation, banking, mining and gambling.

Employers in Australia are required by law to remove 9 per cent of employees' pre-tax wages and deposit it in a superannuation account the employees can't touch until they retire. The industry has now persuaded the Labor government to gradually increase this to 12 per cent.

Thus the government has compelled almost all employees to become the customers of a particular industry.

The average management fee paid by Australians with a retail super fund is about 2 per cent of their fund balance each year.

So someone with a balance of $100,000 is paying a fee of about $2000 a year, or nearly $40 a week. This is more than the average Australian pays for electricity. After the compulsory contribution rate is raised to 12 per cent, these annual fees will have increased by a third.

To be fair, the government is working to oblige the super industry to give its captive customers a better deal. But it is encountering - and yielding to - much push-back from the industry.

According to the authors, our big four banks are among the eight most profitable banks in the world, with the International Monetary Fund saying we have the world's most profitable banking system.

Over the years, the big four have been allowed to acquire or merge with 15 of their rivals, with the authorities continuing to insist the industry is competitive.

Since the global financial crisis, the big four's market share has risen from 74 per cent to 83 per cent, the authors say.

Both sides of politics profess to be highly disapproving when the banks seek to protect their profit margins by failing to pass on all of a cut in the official interest rate.

But the pollies rarely match their words with deeds. Their efforts to increase competition are quite timid and some measures actually make life easier for the banks.

Last year the mining industry accounted for more than a fifth of all the profit made in Australia, even though it had a much smaller share of the economy. This was mainly because the royalties charged by the state governments failed to capture enough of the market value of the minerals the largely foreign-owned miners were being permitted to extract.

When the Rudd government tried to correct this with a resource super profits tax, the industry set out to bring about its electoral defeat, Tony Abbott saw his chance and sided with the industry, and Julia Gillard backed off rapidly, settling for a new tax that seems to be raising little revenue.

Gambling is a small industry, but incredibly lucrative, partly because it's so tightly regulated. Whether it's the way the O'Farrell government is accommodating James Packer's ambition to expand in Sydney or the way Gillard welched on a written agreement with Andrew Wilkie under pressure from the licensed clubs, the industry's political power is apparent.

When politicians worry more about pleasing certain industries than about serving the people who elect them, we have a problem.

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Why voters seen the economy as in bad shape

Despite last week's excitement, Julia Gillard's early announcement of the election date is unlikely to change much. It's certainly unlikely to change many voters' perceptions on a key election issue: her ability as an economic manager.

It's long been clear from polling that the electorate doesn't regard the government as good at managing the economy.

Why this should be so is a puzzle. As Gillard rightly claimed last week: "As the global economy still splutters, unlike the rest of the world we have managed our economy so we have low inflation, low interest rates, low unemployment, solid growth, strong public finances and a triple-A rating with a stable outlook from all three of the major ratings agencies."

I've said elsewhere that part of the reason for this yawning gap between perception and reality is that many people's perception of how well the economy's being managed proceeds not from independent observation but from their political alignment. Once I know who I'm voting for I then know whether or not the economy's travelling well.

But there's another part of the explanation: the public's inability to distinguish between cyclical and structural factors. Most of the bad news we heard last year was structural in nature, meaning it changed the shape of the economy rather than its overall size, adversely affecting some parts but favourably affecting others and having little effect on most.

But such analysis is too subtle for most punters. To them, all news is cyclical: good news means the economy's on the up and up; bad news means it's going down and downer.

Add the media's inevitable predilection for trumpeting bad news, underplaying good news and totally ignoring anything that doesn't change, and structural change can't help but be perceived as an economy in trouble.

The resources boom is the classic case of structural change. It's in the process of giving us a bigger mining sector and bigger non-tradeable services sector, but a relatively smaller manufacturing sector and internationally tradeable services sector.

The mechanism that brings much of this about is the high dollar. It harms all export- and import-competing industries, but benefits everyone who buys imports (which is all of us). It marginally benefits three-quarters of our industries, which are non-tradeable (they neither export nor compete against imports) but do buy imported supplies and equipment.

Now consider the recent performance of unemployment. Over the year to December, the unemployment rate rose from 5.2 to 5.4 per cent.

Admittedly, the rate at which people of working age were participating in the labour force by holding a job or actively seeking one fell from 65.3 to 65.1 per cent. This decline in participation is probably explained mainly by some people becoming discouraged in their search for a job.

Even so, it's surprising people became a lot more worried about unemployment last year. Why did they? Because they get their impressions about the state of the labour market not from the official statistics but from stories on the TV news about people being laid off from factories.

If voters were more economically literate they'd respond to this news by thinking, "Gosh, isn't manufacturing being hit hard by the high dollar - but fortunately I don't work in manufacturing and only 8 per cent of workers do." What many actually thought was: "Gosh, maybe I could lose my job, too."

Thus was a structural problem affecting only a small part of the economy taken to be a cyclical, economy-wide problem.

It's a similar story with the much-publicised tribulations of the retailers, which arise from their need to adjust to various structural problems, such as the inevitable end to the period in which household spending grew faster than household income, and the rise of internet shopping.

With all the silly talk about "the cautious consumer" and with punters blissfully unaware that retailing accounts for only about a third of consumer spending, all the highly publicised complaints of the Gerry Harveys helped convince the public not that the retailers have their own troubles but that the economy must be going down the tube.

Then there's the contribution of the unending fuss about "debt and deficit", in which the government has been completely outfoxed by the Liberals.

Although every economically literate person knows Australia doesn't have a significant level of public debt, the opposition has had great success exploiting the public's ignorance of public finance and of just how big the economy is ($1.5 trillion a year) by quoting seemingly mind-boggling levels of gross public debt.

With much of this argy bargy being reported by political rather than economic journalists - how many times have you heard talk of "the economy's deficit"? - it's hardly surprising the public has acquired an exaggerated impression of the economic significance of the budget deficit.

Ironically, the budget deficit is a case where a cyclical (temporary) problem has been taken to be a structural (long-lasting) one.

But Labor has to accept much of the blame for this bum rap. Rather than standing up to the nonsense the Libs were talking, it took the path of least resistance, purporting to be just as manic as they were. Then came Gillard's foolhardy decision to take a mere Treasury projection of the budget outcome in three years' time and elevate it to the status of a solemn promise.

By now, the voters' majority perception that the economy's in bad shape and Labor isn't good at managing it is deeply ingrained.

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Gillard talks tough in election year

THIS is shaping up as an unusual election year - and not because Julia Gillard has announced the election's date eight months in advance. With luck it won't be the trip to fantasyland the politicians on both sides usually take us on, in which they pretend to be able to solve all our problems without pain and we suspend disbelief.

Predictably, Gillard's unprecedented step in naming the date in her speech to the National Press Club on Wednesday almost totally diverted the media's attention from everything else she said. This is a pity because the rest is worthy of note. It was a lot more honest than you'd expect to hear from our politicians in an election year.

On our overblown whinges about the cost of living, Gillard was braver than this government has been before. Try this: ''The price we pay for electricity and gas has increased by 120 per cent in the last decade and 26 per cent in the last two years.

''Despite low inflation and low interest rates, we still feel these pressures on living standards.'' A subtle way of reminding people to put their one legitimate complaint (which it took Labor far too long to challenge) into the context of low price rises generally.

Here's something more sophisticated: ''Superannuation returns are only just beginning to recover from the hit delivered by the global financial crisis. Capital city housing prices have not grown at all in the past 12 to 18 months, compared to the average yearly gains of 8 to 10 per cent in the years before the GFC.

''These two impacts have us worried that our dreams of financial security are harder to achieve than ever before. Today, we save over 10 per cent of household income. In the years before the GFC, we used to save nothing as a nation.'' (She means Australian households as a whole saved nothing. Add in the public and corporate sectors and the nation saved a lot.)

But here's the stab of reality: ''It was a phase that could not last.''

Indeed it couldn't.

Next, some frank talk about the strong dollar. Our dollar has appreciated about 60 per cent in the past three years, she said. This presented a challenge to our economic diversity and international price competitiveness.

So what's the answer? ''Economic orthodoxy prescribes that falling terms of trade [the prices of exports relative to the prices of imports] and falling interest rates will result in a fall in the value of a currency.

''But even though our terms of trade peaked around 15 months ago and interest rates have been falling, our dollar is now actually higher.''

And ''over the coming year or two we expect to move beyond the peak of the investment phase of the mining boom''. (I expect it to come sooner than that.) ''Ordinarily, economists would tell you this change, bringing with it a lessening of demand for [foreign] capital, would be associated with a reduction in the Australian dollar that would assist export-exposed industries like manufacturing, tourism and [other] services that are exported, like education.

''However, just as the dollar's strength has persisted in this period of declining terms of trade and interest rates, we need to be prepared if it persists despite a lessening of demand for [inflows of financial] capital.''

It's all true. The sad fact is, economists do not have a good handle on what drives a country's exchange rate.

What's more, ''we cannot control a number of factors that have kept our dollar strong: like the weakness in the global economy, the close-to-zero interest rates of many nations and the increasing view that Australia is something of a safe haven''.

Good point. Remember, the exchange rate is a relative price. Our economic prospects may not be brilliant, but as long as they're better than for the other developed countries our currency may well stay stronger than theirs.

So Gillard isn't promising or predicting any marked decline in the dollar. She's warning our export and import-competing industries to adapt to a higher-than-comfortable exchange rate.

''Where we can make a difference is to other factors that matter for competitiveness and economic diversity. So we can and must focus on increasing skills, building a national culture of innovation, rolling out the national broadband network, investing in infrastructure, improving regulation and leveraging our proximity to, and knowledge of, a rising Asia into a competitive advantage.'' (I fear we're spending far more than we should on broadband.)

Next, a frank reminder of how skint the government is (and will be) because the recovery in the economy since the mild recession of 2009 hasn't led to the usual strength of recovery in tax collections.

''Revenue to government for every [dollar] of gross domestic product has been at its lowest since the recession of the early 1990s. In other words, for a given amount of economic income generated, less money is finishing in the public purse, to be used for the Australian people.''

Though the government has stuck to its medium-term fiscal strategy and spending is tightly constrained, she said, the amount collected from all sources - but particularly from company tax - is significantly lower than economists forecast.

This was part of a trend being felt worldwide and involves both domestic and global factors. ''The domestic factors include our nation being in the investment phase of the mining boom, not its peak production phase; the new saving and consumption approach of families; the slowdown in capital gains and the lack of profitability of many firms in trade-exposed areas due to the high dollar.''

Some of these factors were cyclical (temporary) and some would be longer lived.

Now for the election-year punch line: ''With pressure on revenue, it is the wrong time to be spending without outlining long-term savings strategies which show what will be forgone [not foregone, Julia] in order to fund the new expenditure.''

Gillard confirmed her intention to spend big on disability and school education. ''In the lead-up to and in the budget we will announce substantial new structural savings that will maintain the stability of the budget and make room for key Labor priorities.''

In a pre-election budget?

That will be new.

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Outlook for economy not bright

As far as the economy's concerned, 2013 will be the year when many people's dreams come true. For at least the past two years, many of us - business people and consumers alike - have been convinced the economy is slowing and generally in bad shape.

Trouble is, until recently the hard statistics on the state of the economy have persistently refused to confirm this pessimism.

But now there's good news for the fearful. The nation's economists are as agreed as they ever get that this year the economy will slow, with the rate of unemployment likely to rise towards 6 per cent. Gloomy news will abound. Yippee.

The problem is that the great surge of investment in the construction of new mines and natural gas facilities seems close to its peak. It is unlikely to fall away dramatically, but it should at least reach a plateau and may fall back a little.

All these years of expanding our production capacity is now producing growth in the quantity of our exports of mineral and energy but, at present, this won't be sufficient to replace the impetus we have been getting from the growth in spending on new mines.

And the rest of the economy is not likely to be growing fast enough to fill the vacuum. Business confidence has been poor for some time and, apart from mining, business investment in expansion has been weak and is expected to stay weak.

Normally, a fair bit of the economy's growth comes from the building of new homes, in line with the growth in the population. But in recent years the housing sector has been surprisingly weak. We haven't had as much building of new homes as usual, nor renovation of existing homes, nor buying and selling of existing homes.

Just why housing has been weak for so long is hard to know. It hasn't been a lack of population growth. But the absence of steadily rising house prices is both a consequence and a cause of the weakness.

Housing activity is at last starting to pick up, but it is unlikely to be particularly strong this year.

Next in this tour of the dark side is what many business people regard as the clincher: lack of consumer confidence. Consumers are going through a period of great caution, we have been told repeatedly, and so aren't spending much.

One small problem: so far this hasn't been true. It is true consumer confidence has been surprisingly weak, but it is not true this has led to weak growth in consumer spending. It is also true households are saving a much higher proportion of their incomes than they did for many years.

But the rate of household saving has been steady for several years, meaning consumer spending has been growing at the same rate as household disposable incomes. And since household income has grown reasonably strongly, so has consumer spending.

So how do we account for the tales of woe from retailers? It is simple. Contrary to popular impression, only about a third of all the money consumers spend is spent in the shops of retailers. The retailers have been doing it tough because the share of the consumer dollar going to them has been declining.

With the dollar so high, imports have been cheaper and we have been spending a lot more on overseas holidays and imported cars. To a small but growing extent, our retailers have suffered as we are using the internet to access the cheaper prices charged abroad. And with fewer new homes being built and fewer people moving homes, fewer of us have been buying new furniture and furnishings.

What interests me, however, is why the gloom of so many business people and consumers has so far greatly exceeded the reality. Why people's perceptions of the state of the economy have been so much worse than what the hard facts tell us.

It may be that people have attached too much local significance to all the gloomy news we have been hearing from abroad about troubles with the euro and the Americans' fiscal cliff, but I believe a big part of the explanation is political.

Many business people seem to be sitting on their hands until the political atmospherics improve. They say the period of minority government has damaged confidence, but this is code for their impatience to see the back of Julia Gillard.

At least with business people their measured lack of confidence accords with their reluctance to invest in expanding their businesses. With consumers, the standard measure of their confidence compiled by Westpac and the Melbourne Institute has proved an unreliable guide to their actual behaviour.

If you delve into that index you discover that people intending to vote Liberal are far more pessimistic about the economy than those intending to vote Labor. I suspect it will prove a better indicator of who will win this year's election than of the prospects for consumer spending.

Another part of the explanation for the discrepancy between perception and reality is surely that the tribulations of certain industries - notably manufacturing and retail - have mistakenly been taken as symptomatic of the whole economy.

But not to worry. The economists assure us 2013 will be the year when reality finally aligns with our negative perceptions. Not being a pessimist myself, however, I see two grounds for hope.

One is that if all the economists are sure the economy will slow, there must be a good chance they are wrong yet again.

And remember the light at the end of the tunnel: come the election, God will be back in his Liberal heaven and all will be right with the world.

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The four business gangs that run America

IF YOU'VE ever suspected politics is increasingly being run in the interests of big business, I have news: Jeffrey Sachs, a highly respected economist from Columbia University, agrees with you - at least in respect of the United States.

In his book, The Price of Civilisation, he says the US economy is caught in a feedback loop. "Corporate wealth translates into political power through campaign financing, corporate lobbying and the revolving door of jobs between government and industry; and political power translates into further wealth through tax cuts, deregulation and sweetheart contracts between government and industry. Wealth begets power, and power begets wealth," he says.

Sachs says four key sectors of US business exemplify this feedback loop and the takeover of political power in America by the "corporatocracy".

First is the well-known military-industrial complex. "As [President] Eisenhower famously warned in his farewell address in January 1961, the linkage of the military and private industry created a political power so pervasive that America has been condemned to militarisation, useless wars and fiscal waste on a scale of many tens of trillions of dollars since then," he says.

Second is the Wall Street-Washington complex, which has steered the financial system towards control by a few politically powerful Wall Street firms, notably Goldman Sachs, JPMorgan Chase, Citigroup, Morgan Stanley and a handful of other financial firms.

These days, almost every US Treasury secretary - Republican or Democrat - comes from Wall Street and goes back there when his term ends. The close ties between Wall Street and Washington "paved the way for the 2008 financial crisis and the mega-bailouts that followed, through reckless deregulation followed by an almost complete lack of oversight by government".

Third is the Big Oil-transport-military complex, which has put the US on the trajectory of heavy oil-imports dependence and a deepening military trap in the Middle East, he says.

"Since the days of John D. Rockefeller and the Standard Oil Trust a century ago, Big Oil has loomed large in American politics and foreign policy. Big Oil teamed up with the automobile industry to steer America away from mass transit and towards gas-guzzling vehicles driving on a nationally financed highway system."

Big Oil has consistently and successfully fought the intrusion of competition from non-oil energy sources, including nuclear, wind and solar power.

It has been at the side of the Pentagon in making sure that America defends the sea-lanes to the Persian Gulf, in effect ensuring a $US100 billion-plus annual subsidy for a fuel that is otherwise dangerous for national security, Sachs says.

"And Big Oil has played a notorious role in the fight to keep climate change off the US agenda. Exxon-Mobil, Koch Industries and others in the sector have underwritten a generation of anti-scientific propaganda to confuse the American people."

Fourth is the healthcare industry, America's largest industry, absorbing no less than 17 per cent of US gross domestic product.

"The key to understanding this sector is to note that the government partners with industry to reimburse costs with little systematic oversight and control," Sachs says. "Pharmaceutical firms set sky-high prices protected by patent rights; Medicare [for the aged] and Medicaid [for the poor] and private insurers reimburse doctors and hospitals on a cost-plus basis; and the American Medical Association restricts the supply of new doctors through the control of placements at medical schools.

"The result of this pseudo-market system is sky-high costs, large profits for the private healthcare sector, and no political will to reform."

Now do you see why the industry put so much effort into persuading America's punters that Obamacare was rank socialism? They didn't succeed in blocking it, but the compromised program doesn't do enough to stop the US being the last rich country in the world without universal healthcare.

It's worth noting that, despite its front-running cost, America's healthcare system doesn't leave Americans with particularly good health - not as good as ours, for instance. This conundrum is easily explained: America has the highest-paid doctors.

Sachs says the main thing to remember about the corporatocracy is that it looks after its own. "There is absolutely no economic crisis in corporate America.

"Consider the pulse of the corporate sector as opposed to the pulse of the employees working in it: corporate profits in 2010 were at an all-time high, chief executive salaries in 2010 rebounded strongly from the financial crisis, Wall Street compensation in 2010 was at an all-time high, several Wall Street firms paid civil penalties for financial abuses, but no senior banker faced any criminal charges, and there were no adverse regulatory measures that would lead to a loss of profits in finance, health care, military supplies and energy," he says.

The 30-year achievement of the corporatocracy has been the creation of America's rich and super-rich classes, he says. And we can now see their tools of trade.

"It began with globalisation, which pushed up capital income while pushing down wages. These changes were magnified by the tax cuts at the top, which left more take-home pay and the ability to accumulate greater wealth through higher net-of-tax returns to saving."

Chief executives then helped themselves to their own slice of the corporate sector ownership through outlandish awards of stock options by friendly and often handpicked compensation committees, while the Securities and Exchange Commission looked the other way. It's not all that hard to do when both political parties are standing in line to do your bidding, Sachs concludes.

Fortunately, things aren't nearly so bad in Australia. But it will require vigilance to stop them sliding further in that direction.

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Behavioural economists smarten up government

SINCE it's the summer hols, let me ask you a few personal questions. Do you sometimes fail to read every word of the official letters you get? Do you put off filling in forms or delay paying parking fines or taxes? Are you ever less than scrupulously honest on government forms?

If so, I have news: the economists are on to you. Actually, it's the behavioural economists, and their thing isn't to punish you but just make it easier for you to be a good boy or girl.

Behavioural economics is particularly suited to politics and public policy because it's the study of how people make decisions in real life, not how they'd behave if only they were "rational", which they aren't.

When David Cameron became Prime Minister of Britain he did something new, setting up a "behavioural insights team" within his cabinet office. Its job was to apply the insights of behavioural economics (most of which come from psychology) to government operations and see if they improved things.

The team decided to start with the related problems of fraud (people claiming benefits they aren't entitled to), error (people inadvertently giving wrong information) and debt (people not paying what they owe the government).

Earlier this year the team issued a report on how it was getting on. It estimated fraud was costing British taxpayers about $14 billion a year. Error was costing $6 billion and unpaid debt up to $5 billion a year.

Traditional attempts to combat fraud, error and debt have tended to assume people rationally weigh up the personal costs and benefits of non-compliance by comparing the amount they expect to gain with the probability of being caught and the size of the punishment.

The usual approach seeks to increase compliance either by increasing the penalties or increasing the chance of being caught.

But humans don't behave like that. The vast majority of people don't commit fraud or avoid paying debts. And they don't because they have a strong sense of moral obligation, justice and fairness, which is shared by those around them.

So maybe you can reduce non-compliance by finding ways to reinforce such social norms. And maybe people give wrong information or end up doing the wrong thing for much less sinister reasons of mere human fallibility.

After scouring the academic literature, the team has come up with seven insights that should help increase compliance, which it is now testing using randomised controlled trials.

The seven have one thing in common: rather than ordering people to do things they don't like doing, they seek to go with the grain of how people behave.

Insight one is: make it easy. Make it as straightforward as possible for people to pay tax or debts. For instance, you can spell out in order the steps people need to take to do what's required of them.

Or you can make it easier for people to submit a tax return by pre-filling the form with information the government already knows. With computers and online forms, this is now much easier to do - as our Tax Office has shown. It also reduces error.

Insight two is: highlight key messages. Draw people's attention to important information or actions required of them, for example, by highlighting them upfront in a letter.

Eye-tracking research suggests people generally focus on headings, boxes and images, while detailed text is often ignored, the report says. The front pages of letters receive nearly 2? times the attention back pages do.

Britain's Inland Revenue has a program offering doctors an opportunity to bring their outstanding tax payments up to date before official action and penalties. When it compared its usual letter with a simplified version using plain language, key messages and required actions highlighted at the top of the letter, the response rate jumped from 21 per cent to more than 35 per cent.

Insight three: use personal language. Personalise language so people understand why a message or process is relevant to them. New technology is making it easier and cheaper to address mass mail-outs to people by name. Giving people a name and number to contact may get a better response than pointing to a general helpline.

Sometimes Inland Revenue needs people to contact it to arrange repayment of tax credits they weren't entitled to. It's been trialling different versions of the letter it sends. People in the control group were sent a letter simply stating the phone number to call, and 13 per cent responded. Others were sent a letter framed as a personal message urging them not to overlook the opportunity to get in touch. That one had a response rate of 24 per cent.

Insight four: prompt honesty at key moments. Ensure people are prompted to be honest at the start of forms rather than the end.

Most people are honest most of the time. Most people, rightly, think of themselves as honest, the report says. And, because we have an inherent desire to be consistent with our self-image, well-placed reminders should encourage greater honesty, the report says.

Insight five: tell people what others are doing. To take advantage of and reinforce social norms, highlight the positive behaviour of others. Provided it's true, for instance, tell people that "nine out of 10 people pay their tax on time". This can correct mistaken perceptions.

Inland Revenue experimented with letters designed to get people to increase their tax debt payments. Compared with the control letter, those quoting the national social norm produced a 5 percentage-point improvement in the response, those quoting the social norm in your postcode got an improvement of more than 11 points and those quoting the norm for your town produced an improvement of more than 15 points.

Insight six: reward desired behaviour. Actively incentivise behaviour that saves time or money. Sometimes just saying thank you helps. Or you can put people's names in a prize draw. Rewarding good behaviour may work better than punishing bad behaviour. But be careful the use of rewards doesn't crowd out intrinsic motivation - doing the right thing because it's the right thing to do.

Finally, insight seven: highlight the risk and impact of dishonesty. Emphasise the risk of getting caught, but also the consequences of my dishonesty for the welfare of others.

You think economists give airy-fairy, impractical advice to governments? Not the new breed of behavioural economists.

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Exertion, not avoiding it, makes us happy

Forgive me for saying so, but don't you think you'd be better off going for a run - or even a brisk walk - than reaching for another mince pie? (The ones my wife made this year were irresistible.)

Chances are you don't think it. Or maybe you think it, but you don't intend to act on it. If you can't take a day off on Boxing Day, when can you?

I hate to say it, but humans have a slothful streak. We want to live comfortable, enjoyable lives and we assume the less physical effort this involves the better. But one of the most unremarked and remarkable discoveries of our times is that it doesn't work like that.

As a writer about economics, I suppose I'm required to be an advocate of progress. But I'm learning progress can be a tricky beast. Sometimes it involves moving away from the practices of the past as far and as quickly as possible. But occasionally we discover we need to retrace our steps.

A major element of humankind's progress - of our civilisation - has been our unrelenting efforts to take the effort out of all we're required to do to live our lives. That story begins with our discovery of first stone, then metal tools. It progresses to our discovery that settling in one spot and farming crops and animals was a lot safer, more comfortable and prosperity-inducing than hunting and gathering.

Fast forward to the industrial revolution, which began in the second half of the 18th century. It, too, was fundamentally about taking the physical effort out of work, first with the discovery of steam power, then later, electricity and the internal combustion engine - all of them powered by the burning of fossil fuels.

Along the way we invented a multitude of ways to mechanise work - from the spinning jenny to the typewriter - thereby greatly reducing the number of workers needed to produce a given quantity of goods and services or, looking at it another way, allowing a given number of workers to produce a much greater quantity of goods and services.

Whichever way you look at it, our unceasing search for new and better ''labour-saving'' devices has greatly increased the productivity of our labour - the quantity of goods and services the average worker is able to produce in an hour - and this explains why our material standard of living is many times higher than it was at the time of white settlement in Australia.

Usually, this is what economists portray as the object of this grand exercise, making ourselves richer. But it's equally true that a central element of the exercise has involved taking the physical exertion out of work. We haven't ended up doing a lot less work than we used to, but our work has become much less physical and much more mental, requiring us to be a lot better educated and trained.

More recently - and particularly with the advent of the information revolution - we've moved from taking the physical effort out of work to also taking it out of leisure. We drive when we could walk or ride around our suburbs at the weekend. For home entertainment we no longer sing or recite to each other, but turn on some electronic device. And the commercialisation of sport means not only that we watch professionals rather than playing ourselves, but needn't even leave the house to watch a game.

This is where we've overreached, however. This is where nature is striking back. Combine the way machine-produced food has never been more enticing, more plentiful or as cheap with the success of our efforts to strip physical exertion from work and leisure, and you get an obesity epidemic.

And it's not just that. As each year passes the medicos uncover ever more evidence of the many ways our lack of exercise is contributing to our ill-health, including heart disease, type II diabetes, high blood pressure, cancer, depression and anxiety, arthritis and osteoporosis.

To put it more positively, and to borrow a slogan from the American College of Sports Medicine, exercise is medicine. This is what I find so remarkable, so surprising.

Recent research by medicos in Texas has found that previously sedentary women who began moderate aerobic exercise a third of the way into their pregnancy had significantly fewer caesarean deliveries and recovered faster after the birth.

Research by Dick Telford and colleagues at the Australian National University has found that primary school children who are more physically active and leaner get better academic results and, even more so, that primary schools with fitter children achieve better literacy and numeracy.

Research quoted on the Exercise is Medicine website says active people in their 80s have a lower risk of death than inactive people in their 60s.

Regular physical activity can reduce the risk of recurrent breast cancer by about half, lower the risk of colon cancer by more than 60 per cent, reduce the risk of Alzheimer's, heart disease and high blood pressure by about 40 per cent and lower the risk of stroke by 27 per cent. It can decrease depression as effectively as Prozac or behavioural therapy.

According to the site, a low level of fitness is a bigger risk factor for mortality than mild-to-moderate obesity. And regular physical activity has been shown to lead to higher university entrance scores.

But here's the bit I like best (and know from experience is true): research shows that exercise makes you feel better, reducing stress, helping you sleep better and feel more energetic. The unexpected truth is that it's exertion, not the avoidance of it, which makes you happy.

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Workers attacked because of economy's success

THE most despicable behaviour of 2012 must surely be the return of big business people trying to make Australia's employees feel guilty about their high wage rates. Chief executives aren't overpaid but ordinary workers are? Yeah, sure.

It makes you wonder whether our business people are knaves or fools: are they knowingly talking nonsense or are they simply economically illiterate?

I'm genuinely not sure. I realised long ago it's possible to be a highly successful business person and yet not know enough to pass a high school economics exam. I could name names, but I won't.

Of course, business people would be perfectly justified in arguing the reverse: it's possible to be the most learned economist in the country yet be a total dud as a manager.

All this proves is that, contrary to popular impression, economics and business management are separate skills. The macro economy is not just a company writ large.

Chief offenders among the big business people saying stupid things about wage rates are the miners. In seeking to explain why the fall in coal and iron ore prices from sky-high to merely unusually high has prompted them to start cancelling projects for new mines, they complain that Australia has become a "high-cost" place to do business.

In part this is an unjustified whinge about the mining tax; in part it's a complaint about the continuing high dollar. The miners are justified in reminding us that all export and import-competing industries are adversely affected by a high exchange rate, including them.

For the most part, however, it's a complaint about the way wage rates for mine and construction workers have shot up in recent years. Remember, the West Australian miners were in the vanguard of those using John Howard's WorkChoices to force their workers on to individual contracts and get rid of (admittedly, often unreasonable) unions.

It's been the miners leading the campaign by business and the national dailies to reverse the direction of Fair Work and bring back individual contracts. So, the miners want us to believe it's the Fair Work Australia changes and the power they put back into the hands of the unions that explain the rapid rate at which the miners' wage bill has been growing.

If you believe that, you know nothing about economics, starting with the laws of supply and demand. What we've had in Western Australia - and Queensland - is a host of miners, big and small, desperate to expand their existing mines and build new ones and get the projects finished while world prices stay high.

So, you've got a sudden surge in demand for labour in remote and inhospitable parts of the country where few workers live, coming from companies that have never put much effort into training their own young workers.

Demand for labour has shot way ahead of supply as miners race their competitors to get their projects under way. What happens in any market when demand runs ahead of supply? The price goes up. One of the things the higher price does is attract resources from other parts of the economy.

If there are unions present, they will use their improved bargaining power to extract big pay rises from employers anxious just to get on with it. If there are no unions present, much the same thing happens as employers try to outbid their local rivals and also suck in labour from other states.

Only an economic ignoramus could imagine wages wouldn't have risen in the absence of unions.

But there's nothing new about the tactic of trying to make Australian workers believe there's something illegitimate about the high wages they're paid. In the protectionist era it was a favourite tactic of manufacturers demanding higher tariffs on imports.

Their argument was that, if workers in Asian sweatshops were getting $2 an hour and ours were getting $15, ours were being overpaid by $13 an hour. If that makes sense to you, go to the bottom of the economics class.

The first point is that the cost of labour is just part of the total cost of any product, though it's true that labour costs are the biggest element in the prices of simple, labour-intensive items such as textiles, clothing and footwear.

Countries such as Germany and Sweden have very high hourly wage costs, yet manage to hold their own in international markets for sophisticated manufactures. How? By compensating for high wage costs by having much better-trained workers, better capital equipment, longer production runs, smarter managers, higher quality, better service or other non-price selling points.

More fundamentally, it's possible but not common for the general level of a country's wages to be too high because the union movement has too much power. A rich country's wage rates are very high - way higher than a poor country's rates - because a country's wage rates invariably reflect that country's material standard of living (income per person).

And, as a general rule, what determines a country's standard of living is the level of (as opposed to the annual rate of improvement in) its labour productivity.

How does a country achieve the high level of productivity that eminently justifies the high incomes its people are paid? By investing in good infrastructure, in the education and training of its workers and in the latest capital equipment, then ensuring its business and political leaders are highly capable.

One test of its political leaders is whether they let lazy business people and self-centred unions con them into making the country's consumers or taxpayers subsidise the continued existence of businesses unable to find a way to compete on the international market.

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Adding the environment to the national accounts

Over the eight years to 2010-11, gross domestic product increased by 28 per cent, whereas Australia's net energy use increased by 18 per cent. So our "energy intensity" - energy used per $1 of GDP - is falling at the rate of 1 per cent a year.


In 2010-11 we produced 89 per cent of our total energy supply domestically, with the remaining 11 per cent being mainly imported oil. This took our total annual supply of energy to almost 19,000 petajoules. Of this we exported 71 per cent - mainly coal, uranium and natural gas.

Turning from energy to water, the price charged to households rose by 17 per cent in 2010-11, while the amount of water consumed by households fell by 8 per cent. On average, households were paying $2.44 a kilolitre. Of total water consumption of more than 13,000 gigalitres, 54 per cent went to agriculture and 33 per cent to the rest of industry, leaving just 13 per cent going to households.

Turning from water to land, Victoria's 23 million hectares of rateable land are valued at more than $1 trillion. Residential land accounts for 83 per cent of this total value, even though it accounts for only 5 per cent of the state's total area.

How do I know all this? Because I've been reading the "energy account", the "water account" and the "land account (Victoria, experimental estimates)", each published by the Bureau of Statistics in the past few weeks.

You may think from the examples I've given that the sort of information contained in these "accounts" is mildly interesting. But this exercise is really important and, to those of us who worry about the ecological sustainability of economic activity, even exciting.

You've seen me bang on before about the need for us to stop thinking of the economy being in one box and the environment in a completely separate box. The economy can't sensibly be separated from the environment because it exists within the natural environment - the ecosystem, if you prefer.

The economy depends on the ecosystem for its continued existence. It draws renewable and non-renewable natural resources and "ecosystem services" (such as photosynthesis and other natural processes) from the natural environment, then pumps all manner of pollution and waste back into the ecosystem.

It's clear that if our neglect of the ecosystem as we run the economy causes damage or depletion to the ecosystem, a point could be reached where the malfunctioning of the ecosystem inflicts damage and loss back on the economy. We could get into an adverse feedback loop between the economy and the environment.

This, of course, is exactly what's worrying us about climate change. The extensive burning of fossil fuels is causing emissions of carbon dioxide and other gasses which, partly because the clearing of land has reduced the role of forests as carbon sinks, are building up in the atmosphere, trapping in heat and interfering with the world's climate.

I fear climate change is just the first and most pressing instance of adverse feedback between the economy and the environment. If so, we need to become a lot more conscious of the interaction between the two.

But how did we get into the habit of thinking of the economy in isolation from the environment? The rest of us fell into the habit because that's the way the economists have always thought of it.

In the second half of the 19th century, when economists were setting in concrete their way of conceptualising the economy and analysing its workings, it made sense for them to conclude the environment could be excluded from the model without any great loss of relevance.

At the time, global economic activity was quite small relative to the vastness of the natural world. They couldn't know how hugely economic activity would grow, with a rapidly multiplying global population and an ever-rising worldwide average material standard of living.

Nor could they know how damming rivers, irrigating crops and sinking bores would interfere with the water cycle, how clearing land, running farm animals and growing crops would interfere with soil quality, or how ever-improving fishing technology would almost denude our oceans of fish.

Another problem was that their model was built on the role of market prices in co-ordinating economic activity. Many aspects of the natural environment, vital though they were to the functioning of the economy, weren't privately owned and didn't have a market price, so were "external" to the model.

Yet another part of the reason we've fallen into the habit of ignoring the environment when we think about the economy is that this is the way we've constructed our economic indicators - our gauges of how it's travelling. The chief gauge is the "national accounts" with their bottom line, gross domestic product.

We've taken to sharing the macro-economists' obsession with GDP, a measure of market production of goods and services during a period and the income generated by that production. It's a good indicator of employment prospects, but it takes no account of the using up of natural resources, nor of the cost of the damage economic activity is doing to the ecosystem.

But though economists may be stuck in their ways, the world's national statisticians aren't so hidebound. The concepts, classifications and accounting rules needed to calculate the national accounts in member countries have long been set down by the United Nations Statistical Commission. Earlier this year the commission decided to introduce a system of integrated environmental and economic accounting. This will involve developing environmental accounts on a comparable basis to the existing economic accounts, so they can be combined to give a more comprehensive picture of how the economy is affecting the environment and the environment is affecting the economy.

This "system of environmental-economic accounting" - SEEA - is a huge project, involving the measurement of various environmental dimensions not presently measured and the conversion of physical measures - such as petajoules and gigalitres - into dollar values.

Our Bureau of Statistics is at the forefront of this international development. Its recently published energy, water and land accounts are stepping stones in this great advance.

Publishing integrated economic and environmental accounts won't magically solve all our environmental problems, but it will make it much harder to forget these two aspects of our existence are inextricably joined.

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Making sense of the budget surplus saga

I hate to burden you with a topic as earnest as the budget deficit so close to the holidays - I had hoped to write about the idea of giving someone a goat for Christmas - but the saga of whether the Gillard government will manage to get its budget into surplus this financial year has reached farcical proportions.

A few weeks ago we learnt from the national accounts that the economy's rate of growth slowed to 0.5 per cent in the three months to September. When some parts of the media concluded the most significant implication of this news was that it increased the likelihood of the budget balance not returning to surplus (which it does) I realised the public debate was running off the rails.

Contrary to the impression we are being given, the budget balance is a means to an end, not an end in itself. We don't run the economy to balance the federal government's budget. And when we get our quarterly report on how the economy's travelling, the primary question is not what it tells us about the government's performance or it political prospects.

The budget was made to serve the economy, not the other way round. And the economy was made to serve us. So the primary question to be asked when we receive the quarterly report card is what it implies for us. Is our material standard of living improving more slowly than we'd prefer? Is inflation getting worse? Is the economy growing fast enough to stop unemployment rising?

These things matter because they matter to us and our lives. It's only because they matter to us that they also matter to the fortunes of the governments we re-elect or toss out. So the economic implications of the budget balance come first, the political implications are very much secondary.

Trouble is, for both the public and the media, the political implications of the budget balance are deceptively simple, whereas the economic implications are complicated and, to many, incomprehensible.

Politically, the only thing people think they need to know is that anything called a deficit must be bad and anything called a surplus must be good. Most political reporting about the budget balance is based on this assumption.

The opposition has been reinforcing this simplistic reasoning unceasingly from the moment in 2009 it became clear the global financial crisis had pushed the budget balance into deficit. Its success explains why, in the election campaign of 2010, a foolhardy Julia Gillard took a mere Treasury projection that the budget would be back in surplus by 2012-13 and elevated it to the status of a solemn promise.

Economically, however, it ain't that simple. From an economic perspective, budget deficits are bad in some circumstances, but good in others. Similarly, budget surpluses are good in some circumstances but bad in others.

How could this be so? It's because national government budgets operate at two quite different levels. At one level the government's budget is the same as that for a business or a household: it's a forecast of how much money will be coming in and going out during a year. You use budgets to ensure things go to plan and you don't get in deeper than you can handle.

At another level, however, the budgets of national governments are quite different from other budgets. Because they're so big relative to the size of the economy - equivalent to about a quarter - what's happening to the economy has a big effect on the budget. But the budget is so big it can also be used to affect what happens to the economy.

This is something few non-economists seem to understand. People who focus solely on the political implications of the budget, assume that if the budget moves from surplus to deficit this could only be because the government has chosen to spend more than it is raising in taxes. If the budget moves from deficit to surplus, this could only be because the government has chosen to spend less than it's raising in taxes.

Not so. The other reason budgets go from surplus to deficit is that when the economy turns down, this causes tax collections to slow or even fall and government spending (particularly on unemployment benefits) to grow rapidly. Similarly, the other reason budgets go from deficit to surplus is that the economy speeds up, causing tax collections to grow rapidly and spending on unemployment benefits to fall as more people find jobs.

This automatic deterioration in the budget balance is what happened after the financial crisis hit business and consumer confident so hard. In this case, the descent into deficit was good, not bad. Why? Because it represented the budget helping to break the economy's fall during the downturn.

What complicates matters was Kevin Rudd's decision to use a temporary burst of government spending to stimulate the economy out of its downturn. At this point we had the economy making the budget balance worse automatically, but also the government choosing to add to the worsening as a way of hastening the economy's eventual recovery.

But just as the budget balance deteriorates automatically when the economy turns down, so it improves automatically when the economy recovers and resumes its growth. Treasury's projection the budget would be back in surplus by 2012-13 was based mainly on its assumption of a strong recovery in tax collections.

This hasn't been happening, thus making the return to surplus unlikely. From an economic perspective, it's the weak recovery that's worth worrying about, not the delayed return to surplus. From an uncomprehending political perspective, however, that won't save Gillard from a caning.

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Executives put their salaries ahead of shareholders

For almost as long as big business has been crusading for a lower rate of company tax, I've been puzzling over its motives. Why are these people fighting for something of little or no benefit to their domestic shareholders and likely to be quite unpopular?

The willingness with which our economic establishment has gone along with the calls for lower company taxes is one of the great mysteries of the year. . Now the Organisation for Economic Co-operation and Development has signed up as an urger in its latest report on Australia.

But as David Richardson demonstrated on Saturday in his technical brief for the Australia Institute, claims that a lower rate of company tax would lead to more investment, faster economic growth and higher employment are surprisingly weak when you bother to examine them.

The puzzle doesn't end there, however. If lower company tax was of benefit to shareholders, it wouldn't be surprising to see big business arguing for it, even if it was of little or no benefit to the wider economy. But even this motivation doesn't hold.

The push for lower company tax is enthusiastically pursued in the United States, and this wouldn't be the first reform push we'd imported holus-bolus from there. Just one small problem: we have a full dividend imputation system that the Yanks don't have.

It wouldn't be all that surprising if many economists - and many punters - weren't quite on top of how dividend imputation affects the push for a lower company tax rate. It would be amazing, however, if our chief executives didn't understand it. You'd also expect a lot of investment professionals - fund managers, their myriad consultants, stockbrokers - to know the score.

The point is simply stated: when the rate of company tax is 30 per cent, the recipients of fully franked dividends are entitled to a refundable tax credit worth 30 per cent of the grossed-up value of the dividend.

So if your marginal tax rate is 46.5 per cent, the extra income tax you have to pay on your grossed-up dividend falls to a net 16.5 per cent. In this way the double taxation of dividends is eliminated.

Now let's say the big business lobby succeeds in persuading the government to cut the company tax rate to 25 per cent. With an unchanged dividend, the refundable tax credit falls to 25 per cent and the remaining tax to be paid rises to 21.5 per cent.

Only if companies were to respond to the lower company tax rate by increasing their dividend payouts sufficiently, would domestic shareholders not see themselves as having been made worse off.

The introduction of dividend imputation led to a reduction in listed companies' efforts to minimise their company tax because Australian investors much prefer to hold the shares of companies paying enough tax to allow them to fully frank their dividends. Companies unable to deliver fully franked dividends can expect their share price to be marked down accordingly.

This is particularly true of Australian super funds, which are able to use imputation credits to largely extinguish the 15 per cent tax they pay on their annual investment earnings. (This tax quirk probably explains why our super funds are overinvested in shares and underinvested in fixed-interest areas.)

When you remember the way our chief executives bang on endlessly about shareholder value being their sole and sacred objective, you can only wonder why they pursue a cut in the company tax rate so fervently.

They're always distributing league tables showing our 30 per cent company tax rate as the equal seventh-highest among the 34 countries in the OECD. They never point to tables showing the combined effect of the company tax rate and the top personal tax rate. If they looked at it from this domestic shareholders' perspective, we'd fall to being just the 15th highest, with the US and Britain well above us.

For a long time I wondered whether the Business Council - many of whose members are largely foreign-owned - was championing the interests of foreign shareholders rather than locals.

It's true many foreign shareholders in Australian companies would benefit from a lower company tax rate because they're not eligible for imputation credits. One of the main reasons for the continued existence of company tax is to ensure the foreign owners of Australian businesses pay their fair share of Australian tax.

But not even all foreign shareholders would benefit from lower company tax. Americans (who account for more than a quarter of the stock of foreign investment in Australia) would gain nothing because the company tax rate they pay when they bring dividends home is already higher than our 30 per cent (for which they get a deduction). They wouldn't gain, but our Treasury would lose.

So what is big business on about? In his paper for the Australia Institute, Richardson argues it's a case of company executives pursuing their own interests, not those of the shareholders they profess to serve. (Economists call this a principal-and-agent problem.)

A lower rate of company tax would make companies' after-tax profits bigger, thus making their chief executives look more successful and probably leading to an increase in their remuneration.

It would also allow companies to retain and reinvest more after-tax earnings. This would make their companies bigger - which would probably also justify bosses being paid higher remuneration.

We already know chief executives play such self-seeking games because of all the mergers and takeovers, which rarely leave shareholders better off, but invariably leave the instigating chief executive more highly paid.

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The case against a lower company tax rate

One of big business's greatest disappointments this year was its failure to persuade the Gillard government to cut the 30 per cent rate of company tax. On business's economic reform wish-list, cutting company tax is second only to getting more anti-union provisions back into industrial relations law.

So you can be sure business will be campaigning for lower company tax in the months leading up to next year's federal election.

I'm sure many business people regard the benefits of lower company taxation as so obvious as to be self-evident but, in economics, you have to spell out just why you believe a lower tax rate would make the economy a better place.

Presumably, the argument is that lower company tax would encourage greater investment in business activity, thus making the economy grow faster and create jobs.

It's surprising there's been so little debate of this proposition among supposedly argumentative economists - until now. On Saturday, the Australia Institute will publish on its website a technical brief by David Richardson, "The Case Against Cutting the Corporate Tax Rate".

According to Richardson, company tax has the great virtue of being a tax on profit. If you don't make a profit, you don't pay the tax. So company tax doesn't add to the cost of doing business, meaning the imposition of the tax makes no difference to the profitability of business activities. And, since the tax is applied at the same rate to profits from all business activities, it should have no effect on decisions about which activities to pursue, or how much activity to undertake.

"By contrast, many other taxes are payable whether or not the company makes a profit," Richardson says. "For example, the iron ore royalty rate in Western Australia will soon be 7.5 per cent of the value of the iron ore mined. If the mining company receives $100 a tonne, pays $7.50 in royalties and has expenses of $95 a tonne, it will run at a loss ... There is no way a profit-related tax can do that."

In exposing this logical flaw in the argument that the rate of company tax affects the amount of business activity undertaken, Richardson quotes the Nobel laureate Joseph Stiglitz from a book he published this year, The Price of Inequality: "If it were profitable to hire a worker or buy a new machine before the tax, it would still be profitable to do so after the tax ... what is so striking about claims to the contrary is that they fly in the face of elementary economics: no investment, no job that was profitable before the tax increase, will be unprofitable afterward."

Richardson reminds us that, according to elementary economics, investment will continue until the return on the marginal investment is just equal to the cost of capital. This is true whether you evaluate the investment on a pre-tax or post-tax basis. Why? Because, although company tax will reduce the return on the investment, it will also reduce the (after-tax) cost of capital. If returns are taxed, interest costs become tax deductible.

Richardson notes that the economists Gravelle and Hungerford, of the US Congressional Research Service, who reviewed the empirical evidence that might or might not support claims that lower company tax increases economic growth, debunk the notion.

It's widely argued that because Australia is a "capital-importing country" and needs a continuous inflow of foreign equity investment, we need to keep our company tax rate competitive if we're to attract all the funds we need. Since other countries have been lowering their rates, we must lower ours.

But Richardson says Gravelle and Hungerford showed "there was no convincing empirical evidence that suggested international capital flows were influenced by corporate tax rates. The differences among Organisation for Economic Co-operation and Development [member countries'] rates tend to be so small as to hardly matter compared with other factors".

He says a good deal of foreign investment in Australia comes from Asian countries with much lower company tax rates than ours. In 2011, China was the third-highest foreign investor in Australia by value during the year, while India was fifth, Singapore was sixth, Thailand 12th and Malaysia 14th.

"The simple point is that Australia attracts investments originating in the very economies that are supposed to have more competitive taxation systems," he says.

Note that the US accounts for 27 per cent of the accumulated stock of foreign investment in Australia, Britain for 23 per cent and Japan for 6 per cent.

An argument against cutting our company tax rate is that, because of the way double-taxation agreements between countries work, where foreign investors in Australia come from countries whose company tax rate is higher than ours - such as the US - they gain no advantage from our lower rate. What they save in payments to our taxman just increases their payments to their own taxman.

When, at a tax summit last year, the ACTU expressed opposition to a cut in company tax, business and its economist supporters retorted that, when you work it through, the burden of company tax ends up being borne mainly by wage earners.

That is, businesses pass the burden of company tax on to their customers in the form of higher prices, and most customers are wage earners. Didn't the unionists know this? Why were they so ill-informed?

It's true that, being inanimate objects, companies don't end up paying tax: only people pay tax. So the burden of company tax must be shifted to customers, employees or shareholders, or some combination. But determining just who, in practice, ends up shouldering the burden of a tax is notoriously hard.

It's true, too, there's been a rash of studies purporting to show it's the workers who end up carrying the can. But the Congressional Research Service report criticised those studies and showed their results were unrealistic.

One study, for instance, estimated a 10 percentage-point increase in the corporate tax rate would reduce annual gross wages by 7 per cent. But when Richardson applied that rule to our economy, he found it was saying such a move would increase company tax collections by $22.5 billion and reduce wages by $49.6 billion.

Pretty hard to believe. Incredible, in fact. The economic case for a lower company tax rate is surprisingly weak.

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Poverty rises as you move from the centre

In Bill Bryson's fascinating book, Shakespeare, he says we know remarkably little about the man, and most of what we think we know has been dreamt up by overenthusiastic scholars. But of at least one point he was sure: in Shakespeare's London, rich and poor lived side by side. A case, I guess, of the rich man in his castle, the poor man at his gate.

They don't make cities like that anymore. Or rather, modern cities seem to be a lot more socially segregated, with the rich tending to live together on one side of the tracks and the poor living on the other.

Research undertaken some years ago by economists at the Australian National University found Australian cities had become more divided, and there is much American research to similar effect. But a research report to be issued on Wednesday has found something a bit different. It is Promoting Inclusion and Combating Deprivation, by Professor Peter Saunders and Dr Melissa Wong, of the Social Policy Research Centre at the University of NSW.

They conducted a survey of 6000 people drawn at random from around Australia in May 2010. They got more than 2600 responses, which they divided into six categories according to where people lived: inner metropolitan area, outer metropolitan, large towns (more than 25,000 people), larger country towns (more than 10,000 people), small country towns (fewer than 10,000 people) and rural areas.
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Not surprisingly, they found there were poor, socially disadvantaged people living in all areas. But they also found a strong correlation between where people live and how likely they are to be socially disadvantaged. As the degree of population concentration declines, the rate of social disadvantage tends to increase. To be blunt, the further out you go from the centre of big cities, the higher the proportion of poor people you find.

After allowing for family size, the average disposable income of households was $970 a week. But inner metropolitan households averaged 12 per cent above this, whereas rural households averaged 14 per cent below. (Of course, if some locations have a higher proportion of retired people, the average income will be lower.)

In inner metropolitan areas, the proportion of households living in poverty (that is, with incomes below half the median income) was 12 per cent. It rose to 12.4 per cent in outer metropolitan, 12.6 per cent in large towns, 14.8 per cent in larger country towns and 16.8 per cent in small country towns, dropping a little to 15.5 per cent (still the second highest rate) in rural areas.

Those poverty rates were calculated by the researchers. When the survey respondents were asked whether they considered themselves to be living in poverty, their answers followed pretty much the same pattern.

What's notable, however, is that their subjective assessments were about 2 percentage points lower than the calculated rates. So, unlike many of the rest of us, the genuinely poor don't seem to be feeling particularly sorry for themselves.

But poverty – how much money you have to spend – is not the only dimension of social disadvantage. And there's been controversy over the unavoidable arbitrariness of where poverty lines are drawn. So Saunders and his colleagues have put much work into developing a different approach, one based on people's access to 24 items that a majority of Australians responding to an earlier survey regard as the "essentials of life".

The items include a substantial meal at least once a day, warm clothes and bedding, a washing machine, a decent and secure home, roof and gutters that don't leak, a separate bed for each child, presents for family or friends at least once a year, being able to buy medicines prescribed by a doctor, and up to $500 in savings for an emergency.

When you assess the respondents to the latest survey according to their access to these essentials you find the same story: deprivation tends to rise as you progress from inner metropolitan to rural. The highest levels of deprivation are in social functioning (such as regular social contact with other people) and risk protection (such as car insurance).

All very interesting, but also worrying. Higher rates of social disengagement in smaller communities cast doubt on the happy notion that, in the country, everyone knows each other and everyone looks after each other. But it's not surprising that, the further out you are, the less your access to public services such as dentists and childcare. Nor that unemployment rates are usually much higher.

It's possible the socially disadvantaged tend to gravitate to the country – say, because rents are lower. The greater probability, however, is that people living further from the centre are more likely to suffer disadvantage because of the deficiencies of the areas in which they live.

The trouble is, disadvantage breeds disadvantage. Whatever problems you have of your own, they're likely to be compounded if a lot of the people around you have similar problems.

"Once population decline and poverty become entrenched in an area, further problems emerge that act as barriers for those who remain," the researchers say. "The result is that, increasingly, where one lives (or is born) has a major impact on one's life chances."

It follows that, as governments seek to reduce social disadvantage, they should see the disadvantaged not just as individuals needing help, but also as people living in disadvantaged areas – people unlikely to get far unless something is done to improve conditions in their district.

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Economics and wellbeing: beyond GDP

Economic Society, Sydney, Tuesday, December 11, 2012

We had been hoping to have a speaker willing to argue that GDP was good enough to guide our policy decisions without need for modification or supplementation, but he’s unable to attend - which is a pity because I would have been interested to hear his arguments. In the absence of someone in the audience willing to argue that position, I think there’s a lot we can agree on. Where we’re likely to differ is in our degree of enthusiasm for the beyond-GDP project and how exactly we should go about developing a supplementary measure or range of measures.

Starting with the ‘agreed facts’, as the lawyers say, I doubt there are many if any economists who need to be lectured by greenies or lefties on the various reasons why GDP is an inappropriate measure of wellbeing or social progress. We all know about defensive expenditures and so forth. Further, we all know GDP was never intended or designed to be such a measure.

And I think all of us here tonight can agree that GDP is a reasonable measure of what it was designed to measure - production and income - and that the continued calculation of GDP is vitally important as an aid to the management of the macro economy. So no one here wants to abolish GDP.

It’s worth noting, however, that the 2009 report of President Sarkozy’s Commission on Economic Performance and Social Progress - the Stiglitz, Sen, Fitoussi report - did offer some significant criticisms of GDP just from a quite conventional, narrow, material wellbeing perspective. It noted that GDP had given Americans in particular an exaggerated impression of how well they were doing in the years leading up to the GFC, with company profits overstated because they were based on asset values inflated by a bubble and with a lot of the growth built on consumers and governments spending money they’d borrowed rather than earnt. It argued that in measuring material wellbeing, the focus should be shifted from production (GDP) to real household income and consumption, since household income can grow at a different rate to GDP. It further argued that income and consumption should be judged in conjunction with households’ net wealth, and that focusing on median income rather than average income is a better, easy way to take at least some account of the distribution of income.

A lot of the report’s criticisms can be met merely by switching from GDP to another aggregate published each quarter in the national accounts (but given almost no attention): real net national disposable income - ‘rinndi’. This measure switches from production to disposable income, takes account of the depreciation of manmade capital, the effect of movements in our terms of trade and the truth that, particularly for an economy with a huge net income deficit like ours, national product is a more appropriate measure than domestic product.

As you may know, I’ve been banging on about the limitations of GDP, and the need for it to be supplemented by a better, broader measure of wellbeing for some time. I was greatly reinforced in this view by the report of such luminaries as Stiglitz and Sen. For more than a year now, Fairfax Media has commissioned Nicholas Gruen to prepare such a broader measure, the Herald-Age Lateral Economics wellbeing index, for publication a few days after the quarterly national accounts.

The HALE index starts by turning GDP into real net national disposable income - rinndi - but then it adds adjustments for as many wider aspects of wellbeing as Nicholas could find decent measures of: the value of the net depletion of natural resources (after allowing for new discoveries), the estimated cost of future climate change, the gain in human capital from all levels of education and training, changes in income inequality, the gain or loss from various measures of the nation’s health and the state of employment-related satisfaction.

If you’re interested in getting your teeth into what a beyond-GDP measure of wellbeing might look like, we’re happy to explain and defend the HALE index. I asked Nicholas to come up from Melbourne tonight for that purpose. We don’t make any claim the index is a complete measure of every dimension of wellbeing, we don’t claim there’s nothing about its methodology that’s open to debate, but we do claim it’s an honest attempt to measure broader wellbeing - welfare, if you like - not some lefty attempt to think of as many negatives as possible to subtract from GDP.

The most obviously debatable part of the methodology is the decision to produce a single, modified-GDP figure for wellbeing. We know Stiglitz and Sen opted for the ‘dashboard’ approach - produce a range of relevant indicators of the various dimensions of wellbeing - rather than a single magic number. And we know the Bureau of Statistics, with all the effort it has put into its MAP project - Measures of Australia’s Progress - is also very much in the dashboard, they-can’t-be-added-up camp. So what are the reasons to prefer a single measure and, once you’ve decided to go down that track, how on earth do you add them together?

These are questions Nicholas, as the designer of the index, is far better qualified to respond to than I am. But I do want to say something from a more psychological, behavioural economics, political economy perspective. Why is it so many people have fallen into the habit of treating GDP as though it was a measure of social progress, even though it isn’t? The first part of my explanation is that economists, by their behaviour rather than their conceptual understanding, have led the uninitiated - politicians, business people, the media - into assuming GDP is the only indicator that matters because they get so excited about it so often, and don’t get so excited about anything else.

They say that what gets measured gets managed, and what doesn’t get measured doesn’t get managed, so if you accept there’s more to our wellbeing that just GDP (or even rinndi) that’s the first reason for wanting to publish something to sit beside GDP. In terms of human psychology, part of the reason for the great attention GDP gets is that new figures are published so frequently and that they’re always changing to an interesting extent.

Finally, we know from the findings of neuroscience that, contrary to our assumption of rationality, humans have surprisingly limited mental processing power and can’t weight up more than one or two dimensions of a problem at the same time, which - among many other implications - means humans are irresistibly attracted to bottom lines - to ‘net net’, as they say in the markets. People want a bottom line, will probably pick one by default, and GDP looks likes it is one. Dashboards may be more methodologically pure, but in a world of human frailty and limited attention, they just don’t cut it.

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The hidden truth about interest rates

The prize for journalistic innovation of 2012 must surely go to whoever thought of a way to turn a cut in the official interest rate from good news to (the much more valuable) bad news: abandon the media's eternal assumption that everyone's a borrower and let the grey-power lobby bang on about the evils of lower deposit rates.


It's such an improvement on the standard good-into-bad transformation: bleating about the greedy banks not passing on all the rate cut to people with mortgages.

If we keep down this track we can turn all rate stories into bad news: as Reserve Bank board meetings approach you hold the mike up to all the professional urgers predicting death to the economy if rates aren't cut. Then, when the Reserve obliges, you pass the mike to whingeing oldies.

I suppose it's a good thing for the media to discover at long last that interest rates are a two-way street; that though borrowers gain from lower rates, savers lose. And that there are actually a lot more savers than borrowers.

There's just one problem with the newly fashionable bleeding for retired depositors: it doesn't necessarily follow that a cut in the banks' interest rates for people with home loans leads to similar cuts in rates paid to depositors - a point the grey-power lobby didn't bother making clear to a newly sympathetic media.

There are probably few more underreported topics than what's happening to deposit rates. The banks don't mention them in their press releases announcing cuts for borrowers, and the media rarely press the banks to be more forthcoming.

But even if some of the big four banks shave their deposit rates, I doubt they all will. And those that do are not likely to cut them by as much as the 20 basis points they're lopping off mortgage rates.

Why not? Well, if the media had been reporting the whole affair conscientiously, rather than turning it into a comic-book contest between good guys and bad guys, ripoff merchants and impoverished victims, you'd already know why.

The reason the banks haven't been cutting deposit rates the way they've been cutting mortgage rates goes to the heart of their reason for not passing on official rate cuts in full. Since the onset of the global financial crisis in 2008, the banks have been locked in a battle to attract deposits from ordinary Australian savers.

This battle has forced up the rates being paid to depositors. Whereas before the crisis the rates on at-call savings accounts were about 100 basis points below the official interest rate, today they're on par with it. And whereas term-deposit "specials" were below the equivalent rates paid in the wholesale market (bank bills), today they're about 150 basis points above them.

So, savers ought to be the last people complaining about the way events have transpired since the financial crisis changed the rules of the game. They're laughing all the way to the bank.

Indeed, the higher rates being paid to depositors (relative to where the official rate happens to be), are by far the greatest reason the banks have been imposing "unofficial" rate rises on home (and business) borrowers and now are passing on only about 80 per cent of the official rate cuts. The lesser reason is the higher rates they have to pay on their foreign "wholesale" borrowings.

In other words, it's not the banks that are supposedly ripping off poor home buyers, it's the whingeing retirees. The banks' cost of borrowing has increased, and all they've done is pass the higher cost on by cutting mortgage rates by less than the fall in the official rate.

But that doesn't give people with mortgages a licence to feel hard done by. Why not? Because, as the Reserve's deputy governor, Dr Philip Lowe, reminded us yet again last week, the Reserve has cut the official rate by more than it would have, just to ensure home buyers get the desired degree of rate relief. They haven't been short-changed.

On the face of it, the banks have done nothing wrong. They've merely passed on their higher cost of borrowing, leaving their "net interest margin" (the gap between the average rate they charge and the average rate they pay for funds) at about 230 basis points, virtually unchanged from what it was immediately before the crisis.

But it's not that simple. The question we need to ask is the one the media rarely do: why has the banks' cost of borrowing risen so much since the crisis? And why has a deposit-seeking war broken out among them?

Short answer: because the crisis revealed them to be dangerously dependent on foreign wholesale borrowing for their funds. So, the sharemarket and the credit rating agencies have forced them to lift their reliance on "stickier" retail deposits to about 54 per cent of their total funding.

But this means running a bank is now less risky than it was before the crisis. This, in turn, means their risk-adjusted rate of return on capital no longer needs to be as high as it was.

So, the degree of competition among the banks is sufficient to force them to give depositors a much better deal, and sufficient to have them wanting to preserve their profitability (and their chief executives' remuneration packages) relative to the others, but insufficient to force down their rates of return the way the textbook says should happen.

In all the millions of angry words the media have spilt on the topic this year, the hidden truth is that home borrowers have little to complain about and depositors even less - save for the small truth that our banks remain far more profitable than they need to be.

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Economy slowing, not dying

To hear many people talk, the economy is in really terrible shape. Trouble is, we've been waiting ages for this to show up in the official figures, but it hasn't. This week's national accounts for the September quarter are no exception.

You could be forgiven for not realising this, however, because some parts of the media weren't able resist the temptation to represent the figures as much gloomier than they were.

One prominent economist was quoted (misquoted, I trust) as inventing his own bizarre definition of recession so as to conclude the economy was in recession for the first nine months of this year.

Really? Even though figures we got the next day showed employment grew by 1.1 per cent over the year to November, leaving the unemployment rate unchanged at 5.2 per cent? Some recession.

What the national accounts did show - particularly when you put them together with other indicators - is that the economy is in the process of slowing, from about its medium-term trend growth rate of 3.25 per cent a year to something a bit below trend.

That's not particularly good news - it suggests unemployment is likely to rise somewhat - but it hardly counts as an economy in really terrible shape.

The accounts show real gross domestic product growing by 0.5 per cent in the September quarter and by 3.1 per cent over the year to September - which latter is "about trend".

This quarterly growth of 0.5 per cent follows growth of 0.6 per cent in the previous quarter and 1.3 per cent the quarter before that. So that looks like the economy's slowing - although the figures bounce around so much from quarter to quarter it's not wise to take them too literally.

But the accounts contain a warning things may slow further. We always focus on the growth in real gross domestic product, which is the quantity of goods and services produced during the period (and is the biggest influence over employment and unemployment).

But if you adjust GDP to take account of the change in Australia's terms of trade with the rest of the world, to give a better measure of our real income, you find "real gross domestic income" fell by 0.4 per cent in the quarter to show virtually no growth over the year.

Leaving other factors aside, this suggests our spending won't be growing as fast next year, leading to slower growth in the production of goods and services (real GDP) and thus slowly rising unemployment.

Our terms of trade are falling back from their record favourable level because of the fall in coal and iron ore export prices as the first stage of the three-stage resources boom ends. (The second stage is the mining investment boom and the third is the rapid growth in the quantity of our mineral exports.)

For some time the econocrats and other worthies have been reminding us that, when ever-rising export prices are no longer boosting our incomes, we'll be back to relying on improved productivity - output per unit in input - to lift our real incomes each year.

This makes it surprising we've heard so little about the figures showing that GDP per hour worked rose by 0.7 per cent in the quarter and by a remarkable 3.3 per cent over the year. Again, it's dangerous to take short-term productivity figures too literally, but at least they're pointing in the right direction.

They also put a big question mark over all the agonising we've heard about our terrible productivity performance.

This week's figures confirm what we know: some parts of the economy are doing much worse than others. Business investment in plant and construction rose by 2.6 per cent in the quarter and 11.4 per cent over the year - though most of this came from mining, with investment by the rest of business pretty weak.

One area that isn't as weak as advertised is consumer spending, up by 0.3 per cent in the quarter and 3.3 per cent over the year - about its trend rate. The household saving rate seems to have reached a plateau at about 10 per cent of disposable income, meaning spending is growing in line with income.

Investment in home building grew 3.7 per cent in the quarter, suggesting its chronic weakness may be ending, thanks to the big fall in interest rates. Adding in home alterations, total dwelling investment was up 0.7 per cent in the quarter, though still down 6.3 per cent over the year.

The volume (quantity) of exports rose 0.8 per cent in the quarter and 4.7 per cent over the year, whereas the volume of imports rose 0.1 per cent and 3.5 per cent, meaning "net exports" (exports minus imports) are at last making a positive contribution to growth. This suggests we're starting to gain from the third stage of the resources boom, growth in the volume of mineral exports. The greatest area of weakness was spending by governments. Government consumption spending was down 0.4 per cent in the quarter (but still up 3.5 per cent over the year). Government investment spending fell 8.2 per cent in the quarter and 7 per cent over the year even though, within this, investment spending by government-owned businesses was strong.

All told, the public sector made a negative contribution to GDP growth of 0.5 percentage points in the quarter, and a positive contribution of just 0.3 per cent over the year - obviously the consequence of budgetary tightening at both federal and state levels.

This degree of contraction isn't likely to continue. But a strong reason for accepting the economy is slowing somewhat is the news from the labour market.

Don't be fooled by the monthly farce in which unemployment is said to jump one month and fall the next. If you're sensible and use the smoothed "trend estimates" you see unemployment steady at 5.3 per cent since August.

Even so, the economy hasn't been growing fast enough to employ all the extra people wanting work, causing the working-age population's rate of participation in the labour force to fall by 0.4 percentage points to 65.1 per cent.

And we know from the labour market's forward-looking or "leading" indicators - surveys of job vacancies - that employment growth is likely to be weaker in coming months.

That's hardly good, but it ain't the disaster some people are painting.

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Wellbeing index gives better picture of mining boom

DON'T believe the doomsayers.This week's national accounts indicate the economy is slowing to something a bit below trend but the critics of the great god gross domestic product are right: it is a quite inadequate and often misleading measure of the nation's progress.

This is why, for more than a year, the Herald has commissioned Dr Nicholas Gruen, principal of Lateral Economics, to calculate a broader index of wellbeing, which we have published within a few days of the release of the Bureau of Statistics' quarterly national accounts, with GDP as their centrepiece.

Our purpose has been to supplement rather than supplant the official figures, which have valid - if narrower - uses and were never intended to be treated as the nation's all-encompassing bottom line.

The Herald-Lateral Economics wellbeing index uses the national accounts to produce a modified version of GDP called "net national disposable income". This adjustment takes account of the annual depreciation (using up) of man-made capital and of the income earned within Australia which isn't owned by Australians.

It also shifts the focus from the value of the nation's production to how much disposable income the nation's households have available to spend on consumption or save, in the process allowing for the change in the prices of our exports relative to the prices of imports.

To this figure the index adds adjustments for the value of the net depletion of natural resources (after allowing for new discoveries), the estimated cost of future climate change, all levels of education and training, changes in income inequality, various measures of the nation's health and employment-related satisfaction.

All this means the index is well placed to help answer a question on many people's minds: what will we have to show for the resources boom?

Unlike GDP, the wellbeing index takes account of the loss of the minerals dug up and sent overseas, not just the export income earned from doing so. It also takes account of the loss of real income we have suffered from the end of the first stage of the boom: the marked decline in the world prices of coal and iron ore during the three months to the end of September.

This was the main factor that converted the growth of 0.5 per cent in GDP during the quarter - a measure of the quantity of goods and services produced in the economy - to a fall of 0.7 per cent in our net national disposable income.

But the accounts confirm that Australian households are continuing to save the high proportion of their disposable incomes. So that is proof we have been saving rather than spending some of our windfall gain from the boom.

But the broader index shows we have also increased our investment in the education and training of our workforce. So much so that, despite the fall in export prices, the index rose by 0.2 per cent during the quarter.

We should be using our good fortune to raise the value of workers' labour and improve their lives in the years ahead - and the wellbeing index shows we are.

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