CAN AUSTRALIA BECOME THE FOOD BOWL OF ASIA?

RAS Hot Topic Debate, Sydney Showground, Tuesday, March 26, 2013

Can Australia become the food bowl of Asia? Short answer: probably not. Longer answer: not without either a lot of taxpayer subsidy (which is unlikely to be forthcoming) or without a lot more economic reform than rural voters have shown any sign of being willing to accept.

I suspect I’ve been invited here today as the anti-hero, the economic rationalist bad guy for everyone to boo and hiss. That’s OK; I’m happy to help provide the entertainment. But before I get on with it you should know that my father grew up on a dairy farm in the Lockyer Valley of Queensland and my mother grew up on a cane farm in North Queensland.

There’s little doubt the continued rapid economic development of Asia will produce a huge middle class over coming decades who’ll want to eat a lot more Western foods. It’s highly unlikely the Asians will be able to meet their own increased demand, so Asia will become a major food importer. A big part of the reason the Asians won’t be able to supply their own food demand is that they’ve really stuffed up their agriculture, and climate change will make it much worse.

When Asian demand grows much faster than world supply, the effect is to raise world food prices. But as supply eventually catches up, world prices fall back, leaving only those countries and farms that have been able to increase their production with a lasting benefit. Asia’s increasing demand is already pushing world prices higher - or higher than they otherwise would be. And I don’t doubt they’ll go a lot higher. If so, that will be a free lunch for Australian farmers: without increasing their production much if at all, they will - for a time - get much higher prices for what they do produce.

But for us to become the food bowl of Asia requires us to greatly increase the volume of rural production. What I doubt is whether we’ll be able to much increase our production. Why not? Because there are too many obstacles to increased production and farmers and their political representatives show so little sign of being willing to pay the very real prices needed to overcome those obstacles.

The first obstacle is that, partly because we didn’t have the scientific knowledge and partly through wilful neglect, we, too, have stuffed up our fragile farming land, degrading our soil, water table and rivers, and using lots of chemicals that have adverse side-effects - chemicals that will, in any case, become hugely more expensive. We need a lot more water pricing and other economic reforms to get on top of these obstacles to higher production.

The next big obstacle is that climate change will make farming conditions much worse, shifting the rain north and increasing the frequency and severity of extreme weather events such as droughts, cyclones and floods. So far, however, farmers and the National Party have found it easier to deny the existence of climate change and hope it goes away.

The final obstacle to greatly increased farm production is the sector’s very weak productivity performance over several decades. Increasing productivity involves a lot of changes many farmers won’t like: greater investment in on-farm innovation and automation, involving the application of much more equity capital by big companies and Chinese investors. This, in turn, involves more farm consolidation and more agribusiness, but fewer family farms and farm employment. The continued provision of drought relief serves to perpetuate the existence of small, inefficient, badly managed farms. Governments should be promoting productivity by investing in agricultural research and development, but instead they’re wasting taxpayers’ money on the eternal pipe dream of Northern Development, from the Ord River scheme to the Alice Springs to Darwin railway. All of us dream of the free lunch. But a better motto for agricultural dreamers is: no gain without pain.

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Labor and Liberals must end budget dishonesty

An immediate federal election is the last thing we need unless we're happy for it to be a fiscal lucky dip. Both sides have much work to do yet to provide voters with adequate information on the cost of their policies and election promises and how they'll be paid for.

Labor must deliver this mainly in the budget; the Coalition must release its facts and figuring no later than early in the election campaign proper. And don't be in any doubt: it's a tall order for each of them.

There are three reasons why this is so.

First, both sides say they're committed to returning the budget to surplus during the next term of Parliament, with the Libs claiming to be able to do it earlier and better than Labor.

Second, the relatively recently discovered structural weakness on the revenue side of the budget is a problem for either side.

It will be a particular problem for the side that wins the election, of course. But, to the extent Treasury takes account of this weakness in its revenue forecasts and projections in the budget and the pre-election update, it will be a problem for both sides during the campaign.

Third, in their very different ways, both sides have made some very expensive promises. So, at a time when revenue growth is likely to be unusually weak, both sides are promising to be particularly generous in increasing spending or cutting taxes, while also losing little time in returning the budget to surplus.

To remind you, company tax, the mining tax and other taxes on profits are being hit by the fall in export prices, plus the dollar's failure to drop down as expected. Income tax collections are being hit by the way eight tax cuts in a row have reduced the extent of bracket creep.

And collections from the GST are being hit by the end of the era where consumer spending grew much faster than household incomes and by the shift in spending towards those items excluded from the tax, particularly private health and education spending.

In theory, this is a problem for the states, not the feds. In reality, all major revenue problems common to the states end up on the feds' plate.

Because Labor's in government, and because most of its big promises are already enshrined in legislation, its moment of truth will come in the budget. In particular, it will have to demonstrate convincingly how it will cover the cost of the twin centrepieces of Julia Gillard's re-election pitch: the National Disability Insurance Scheme (costing about $8 billion a year by 2018) and the Gonski education-funding reforms (costing about $6.5 billion a year by the end of the decade).

Gillard and Wayne Swan have promised to spell out in the budget the "structural savings" they will make to fully fund this additional spending. "Savings" may include reductions in tax concessions ("tax expenditures") as well as cuts in conventional expenditure, but "structural" means the savings must continue - and grow - over many years.

Rest assured, the opposition and the commentariat will hold Labor to account on this score. And one thing this means is that it won't be nearly sufficient for Swan to show how these two ever-more-expensive policies will be funded merely for the coming four years. If it takes up to six years for them to reach their full yearly cost, that's how far into the future Swan's figures must go to show he has that cost covered.

Further, credibility will be attained only if, unlike the past two or three budgets, this one involves no resort to creative accounting: no shifting of spending from the budget year back to the previous, almost-ended year, no use of Swan's "fiscal bulldozer" to push spending commitments off beyond the forward estimates where they can't be seen, and no exploitation of loopholes in the definition of the underlying cash balance, including funding spending on the national broadband network off-budget.

As for the Coalition, if it is to come clean with voters there must be no repetition of its utterly dishonest performance in the 2010 election campaign, where it refused to have any of its promises properly costed by the econocrats, claimed its costings had been "audited" by an accounting firm when it had done little more than check the arithmetic, and only after the election was revealed to have published costings that were wrong by up to $11 billion.

This time, there will be no excuse if the Coalition fails to use the services of the Parliamentary Budget Office. And with all the provisions of its own charter of budget honesty in operation, should it try the old stunt about being shocked to discover a big black hole when it saw the books, we'll know it is fudging. It won't be Ju-liar, it will be Tony-liar.

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How what's hurting most is also what saved us

While many business people see the economy as badly performing and badly managed, our econocrats see it as having performed quite well and better than could have been expected. Why such radically different perspectives on the same economy?

Partly because business people - particularly those from small businesses - view the economy from their own circumstances out: If I'm doing it tough, the economy must be stuffed. By contrast, macro-economists are trained to ignore anecdotes and view the economy from a helicopter, so to speak, using economy-wide statistical indicators.

A bigger difference, however, is that business people are comparing what we've got with what we had, whereas the economic managers are comparing what we've got with what we might have got, which was a lot worse.

Business people know everything was going swimmingly in the years leading up to the global financial crisis of 2008-09, but in the years since many industries - manufacturing, tourism, overseas education, retailing, wholesaling - have been travelling through very rough waters.

The econocrats, however, have a quite different perspective: whereas the rest of us love a good boom, those responsible for managing the economy view them with trepidation. Why? Because they know they almost always end in tears and recriminations.

Particularly commodity booms. As a major exporter of rural and mineral commodities, we've had plenty of these in the past. They've invariably led to worsening inflation, a blowout in the trade deficit and ever-rising interest rates, followed by a recession and climbing unemployment. The latest resources boom was the biggest yet, involving the best terms of trade in 200 years, leading to a once-a-century mining investment boom. It could have - even should have - led to a disaster, but it didn't.

The macro managers' primary responsibility is to maintain "internal balance" - low inflation and low unemployment - which involves achieving a reasonably stable rate of economic growth. No wonder commodity booms make them nervous.

So how have they gone? As Dr Philip Lowe, deputy governor of the Reserve Bank, said in a speech this week, over the three years to March, economic output (real gross domestic product) has increased by 9 per cent, the number of people with jobs has risen by more than half a million and the unemployment rate today is 5.4 per cent, the same as it was three years ago.

Underlying inflation has averaged 2.5 per cent over the period, the midpoint of the medium-term inflation target. "So over these three years we have seen growth close to trend, a stable and relatively low unemployment rate and inflation at target," he says.

And that's not all. The investment boom hasn't led to a large increase in the current account deficit. There hasn't been an explosion in credit. Increases in asset prices have generally been contained. And the average level of interest rates has been below the long-term average, despite the huge additional demand generated by the record levels of investment and high commodity prices.

So "we have managed to maintain a fair degree of internal balance during a period in which there has been considerable structural change, a very large shift in world relative prices, a major boom in investment and a financial crisis in many of the North Atlantic economies", Lowe says.

So how was this surprisingly OK performance achieved? Well, that's the funny thing. The two factors that have done so much to make life a misery for so many businesses - the high dollar and increased household saving - are the very same factors that have been critical to our good macro-economic performance.

The high dollar brought about by the resources boom has reduced the ability of our export industries to compete in the international market and reduced the competitiveness of our import-competing industries in our domestic market, making life very tough for many of them.

For a while, many hoped the dollar's rise would be temporary, but now "there is a greater recognition that the high exchange rate is likely to be quite persistent and firms, including in the manufacturing sector, are adjusting to this", Lowe says.

"Many are looking to improve their internal processes and address inefficiencies. They are focusing on products where value-added is highest and where the quality of the workforce is a strategic advantage. We hear from businesses right across the country that they are looking for improvements and that many are finding them."

But here's the other side of the story. Had we not experienced the sizeable appreciation, he says, it's highly likely the economy would have overheated and we would have had substantially higher inflation and substantially higher interest rates.

"This would not have been in the interests of the community at large or ... in the interests of the sector currently being adversely affected by the high exchange rate." And it's unlikely we would have avoided a substantial real exchange-rate appreciation, with it coming through the more costly route of higher inflation. (The real exchange rate is the nominal exchange rate adjusted for our inflation rate relative to those of our trading partners.)

Next, the rise in the net household saving rate from about zero to 10 per cent of household disposable income since the mid-noughties represents about an extra $90 billion a year being saved rather than consumed by households.

This reversal of the long-running trend for consumption to grow faster than household income explains much of the pain retailers and wholesalers have been suffering. We've had more retail selling capacity than we've needed, forcing shops to fight for their share of business.

But had households spent that extra $90 billion a year on consumption, it's likely there would have been significant overheating. The exchange rate would have been pushed up, the trade balance would be worse and there would have been more borrowing from the rest of the world.

"And both inflation and interest rates would have been higher. I suggest that these are not developments that would have been warmly welcomed by most in the community," Lowe concludes.

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Economists show racism alive and well in Oz

Australians aren't racist - and even if some people are, you and I certainly aren't. It's true, of course, that many of us are terribly stirred up about the arrival of so many uninvited boat people. And both sides of politics vie to be seen as harsher in their treatment of these interlopers. Then there's Julia Gillard's new-found concern about foreigners getting to the head of the jobs queue.

But this has nothing to do with racism. Gillard reassured us in the 2010 election campaign that we should say what we feel in the asylum-seeker debate without being constrained by self-censorship or political correctness.

"For people to say they're anxious about border security doesn't make them intolerant. It certainly doesn't make them a racist," she said.

It may surprise you that racial discrimination has long been a subject of study by economists - particularly American economists and particularly as people's "taste for discrimination" relates to the labour market.

Two economists from the University of Queensland, Redzo Mujcic and Professor Paul Frijters, will publish the results of a natural field experiment on Thursday in which trained "testers" of different ethnic appearance got on buses in Brisbane, discovered their travel card wouldn't work, but then asked the driver to let them to make the trip anyway.

Various testers did this more than 1500 times. Overall, the driver agreed in almost two-thirds of cases.

But whereas the success rate for testers of white appearance was 72 per cent, for testers of black appearance it was just 36 per cent.

Testers of Indian appearance were let on 51 per cent of the time, whereas those of Chinese, Japanese or Malaysian appearance were allowed to travel about as much as Caucasians were.

On average, bus drivers were 6 percentage points more likely to favour someone of the same race. Black drivers tended to be the most generous, accepting in 72 per cent of cases, compared with 54 per cent by Indian drivers and 64 per cent by Asian and white bus drivers.

If you think that's interesting, try this: to test the importance of how people were clothed, the testers were then dressed in business suits with briefcases. The success rate of whites rose by 21 percentage points and the combined rate for blacks and Indians rose to 75 per cent.

Next, the testers were dressed in military clothes. The success rate of whites rose by 25 percentage points while the combined rate for blacks and Indians rose to 85 per cent.

As a follow-up, the researchers then conducted a random survey of bus drivers at selected resting stations in Brisbane, presenting them with pictures of the same test subjects and asking the bus drivers whether they would let them on or not with an empty travel card.

Some 80 per cent of the bus drivers at resting stations indicated they would give free rides to Indian and black test subjects, even though in reality less than 50 per cent were let on.

Indeed, bus drivers said they would let on white subjects 5 percentage points less often than black subjects, whilst in reality white test subjects were favoured at least 40 percentage points more than black testers.

The main reason given for not letting someone on was it was against the rules, while the main reason to let someone on was it was no burden to do so.

It's all a bit disturbing - if not so surprising - but how do we make sense of it? And what's it got to do with economics?

Frijters, perhaps Australia's leading exponent of "behavioural" economics, is developing an economic theory of groups: the different types of groups and how and why they form. All of us feel an affinity with a range of groups. Businesses and government agencies are groups, but there can be groups within those groups; working teams as well as sporting teams. Mixed in with all this are in-groups and out-groups - people we want to associate with and people we don't.

Often we form groups so as to co-operate in achieving some goal. And groups often involve reciprocation - I do you a favour in the expectation that, when my need arises, you'll do me one.

So Frijters explains the results of his experiment in terms of group behaviour. "People with Indian or black complexions are more likely to be treated as an out-group and less worthy of help compared to Caucasians and Asians," he says.

"The reason bus drivers were more reluctant to give black and Indian help-seekers a free ride was that they did not personally relate to them."

When testers were sent to bus stops in military clothes this made them appear to be patriots, defending the same community as the bus driver. So the drivers' original out-group reaction could be overcome by in-group clothing.

The more favourable treatment of testers in business dress suggests the "aspirational groups" of the bus drivers include people richer than themselves, people with more desirable visual characteristics. That is, people the drivers regard as part of their in-group.

If all this sounds more sociological or to do with social psychology than with economics, it is. But that's the point of behavioural economics: to incorporate insights from other social sciences into economics.

And what have groups got to do with economics? That's simple: the objective of many groups is to give their members greater control over economic resources.

Frijter's new book, An Economic Theory of Greed, Love, Groups and Networks, written with Gigi Foster, will be published this month.

Can't wait.

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Tax facts contradict voters’ perceptions

Is Labor a big taxing, big spending government, as Tony Abbott and his Liberal colleagues claim, or has it been taxing us a lot less than the Howard government did, as Wayne Swan claims? As with many conflicting claims by pollies, it depends on how you interpret the figures.

In truth, the Libs always make such a claim against Labor because it plays into the electorate's deeply ingrained stereotypes about the strengths and weaknesses of the two parties.

Most people believe Labor is better when you want it to spend money helping you, whereas the Libs are better when you want them to keep taxes down.

But we need to come to a more evidence-based conclusion than that. On the face of it, it's easy to believe Gillard Labor is a big taxer when you remember it's introduced two major new imposts, the carbon tax and the mining tax.

But it ain't that simple because both taxes were part of packages where much of the proceeds of the new tax was used to cut other taxes. Money from the carbon tax was used to exempt certain export industries from paying it and to finance a small income tax cut for all individuals earning up to $80,000 a year.

The expected proceeds from the mining tax were used to fund a big instant tax write-off for small business, a refund of the tax on super contributions for employees earning up to $37,000 a year and to cover the loss to the taxman when compulsory super contributions are raised from 9 per cent to 12 per cent of wages.

So that argument doesn't wash. Going the other way, however, the Libs are right when they remind us that much of the cumulative $150 billion worth of "savings" Swan likes to boast about constitutes reductions in tax concessions rather than cuts in government spending.

Whenever Swan claims to be a lower taxer than the Howard government, the Libs reply indignantly that tax collections have risen hugely under Labor. As with so many of the claims politicians on both sides make, this is literally true, but calculated to mislead.

It's true that, from the total tax collections of $278 billion in 2007-08 (John Howard's last budget), collections first fell to $261billion in 2009-10 (thanks to the global financial crisis) but, on the latest best guess, are to rise to about $335 billion this financial year. That's a net increase of $57 billion, or 20 per cent, over the five years since Howard's last budget.

Convinced? You shouldn't be. Such a comparison looks worse than it is because it ignores the effect of inflation. If we subjected the Howard government to the same trick, we'd say tax collections increased by $163 billion, or 140 per cent, over 12 years.

No, we should, at the very least, allow for inflation and look at the real increase in tax collections. By my rough figuring, using the implicit price deflator for gross domestic product, the real increase in tax collections is about 10 per cent.

That's not too terrible over five years. But the usual way to evaluate the growth in taxes is to compare them with the size of the economy (measured by nominal GDP) at the time.

This is the way the Organisation for Economic Co-operation and Development and many other official bodies do it and was the way the Howard government was happy to have itself measured.

It represents a way of assessing the burden of taxation relative to the overall economy's capacity to bear that burden.

Doing it this way shows tax collections have averaged about 21per cent of GDP over Labor's five years.

By contrast, they averaged 23.4per cent of GDP over the Libs' 12 years, and a remarkable 24 per cent over their last six years.

This is the basis for Swan's claim to be taxing us more lightly than Peter Costello did, and the numbers are on Swan's side.

The truth is that Costello was our highest-taxing treasurer ever, although for much of his time he tried to hide the fact by pretending the goods and services tax had nothing to do with the feds.

In 2004-05 and 2005-06 tax collection reached a record 24.2per cent.

Of course, although politicians often like to pretend everything that happens in the economy happens because they made it happen, the truth is that much of what happens is caused by factors beyond their control.

A big part of the reason the Libs' raised so much tax is that they presided over the first half of the resources boom, before the GFC. And much of the reason Swan has taxed us more lightly is that some taxes haven't fully recovered from the GFC, the second half of the resources boom hasn't been as lucrative as the first, export prices have now fallen back a long way and, to make things worse for the taxman, the fall in export prices hasn't led to a fall in the dollar.

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Why tax revenue is falling short of budget

Try this quick quiz: which matters more, the growth in ''nominal'' gross domestic product or the growth in ''real'' GDP? Sorry, it was a trick question. The right answer is a favourite reply of economists: it depends.

If your interest is in how fast the economy's growing (or not growing), the answer is real GDP - GDP after allowing for the effect of inflation. But if your interest is in how fast the federal government's tax receipts are growing the answer is nominal GDP - GDP before allowing for inflation.

Why is nominal the right answer for tax receipts? Because, as Treasurer Wayne Swan keeps saying, ''we live in the nominal economy through the prices we pay and the incomes we earn''. As part of this, the income tax we pay is based on our nominal income and the indirect taxes we pay are based on our nominal spending.

Fine. If you didn't know the growth in nominal GDP is the best guide to the growth in tax revenue before, you do now. But why has Swan been making so much of this in recent days? Because it's the main reason why, despite all his savings measures (and creative accounting), the government won't be able to keep the promise it made in the 2010 election campaign to get the budget back to surplus this financial year.

That promise was based on a Treasury projection for 2012-13 included in the 2010-11 budget. But tax collections simply haven't grown as strongly as Treasury projected they would, and the main reason they haven't is that nominal GDP has been behaving strangely.

We're used to assuming that, if the economy's growing in real terms (which it has been), the government's tax revenue will be growing at least as fast and probably faster. (Why faster? Because almost half the feds' tax collections come from personal income tax, which grows extra strongly because, in the absence of the indexation of tax brackets, it's subject to ''bracket creep''.)

When economic events are proceeding normally, the distinction between nominal and real GDP doesn't matter much. Obviously, the difference between nominal and real GDP is the inflation rate, and if inflation is running within the Reserve Bank's 2 per cent to 3 per cent target range, the two totals should be moving pretty much in parallel.

To put it another way, nominal GDP should be growing at a reasonably steady 2.5 percentage points or so faster than real GDP. But we learnt from last week's national accounts for the December quarter that, for the first time on record, the past three consecutive quarters have seen nominal grow by less than real, not more. Since real GDP grew by 1.9 per cent, nominal GDP should have grown by about 4 per cent. Instead it grew by a pathetic 1.6 per cent.

Swan noted in a recent speech to business economists that nominal has grown by less than real for only four short periods in the 53 years since the Bureau of Statistics began producing quarterly national accounts.

The last time nominal was really weak was in the global financial crisis. Before that it was the Asian financial crisis of 1997-98 and, before that, the Menzies government's credit squeeze in 1961. In all but the credit squeeze episode, the explanation was the same: a sharp fall in global commodity prices led to a sharp deterioration in our ''terms of trade'' - the prices we receive for our exports relative to the prices we pay for our imports.

Ah. Whenever we talk of inflation, people think automatically of the main measure of inflation we use, the consumer price index. But in fact there are many measures of inflation, most of the others being derived from the national accounts.

The difference between nominal and real GDP is measured not by the CPI but by the ''implicit price deflator'' for GDP. When the economy's travelling normally, there shouldn't be much difference between the GDP deflator and the CPI and other measures of the change in the price of domestic spending.

But ''normal'' means when our terms of trade aren't changing much. When they're improving or deteriorating sharply, the GDP deflator and measures of domestic-spending inflation really part company.

Why? Because domestic spending includes the prices of imports but excludes the prices of exports, whereas GDP and its deflator exclude the prices of imports but include the prices of exports.

It works out that nominal GDP will grow very much faster than real GDP when our terms of trade are improving sharply, but nominal may even grow more slowly than real when our terms of trade are deteriorating sharply - as they were last year. But why wasn't Treasury expecting

the terms of trade to deteriorate and allowing for this in its projections of tax revenue? It was, and it has been - for most of the past decade, in fact. But it wasn't budgeting for the deterioration to be as fast as it's been, particularly in the September quarter.

That was the first problem with its revenue forecasts. The second, less obvious, one was this: on the basis of past behaviour, Treasury (and everyone else) was expecting any deterioration in the terms of trade to be accompanied by a similar fall in the exchange rate.

To everyone's surprise, the dollar has stayed up. This means the prices of imports haven't risen in the way you'd have expected, causing domestic inflation to be lower than expected. This, in turn, has meant nominal incomes haven't risen as fast as could have been expected.

So this factor, too, helps explain why tax collections haven't risen as fast as forecast. The latest estimate is that tax collections will fall about $10 billion short of what was forecast in the budget last May.

The last thing to say is that by no means all federal taxes are closely aligned with nominal GDP. The strongest relationship is with taxes on profits - company tax, income tax on unincorporated businesses and the two resource rent taxes. These account for about a third of total tax revenue.

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FROM BIG DATA TO KNOWLEDGE

Talk to NatStats 2013 Conference, Brisbane, Thursday, March 14, 2013

I want to make a contribution that’s a bit offbeat and a bit challenging, but hope is constructive. This conference is based on a proposition that’s simple, seemingly obvious and even admirable: the better information we give people, the better will be the decisions they make. Indeed, I imagine that’s a proposition that guides the whole of the bureau’s work. And if you were to challenge me to state my own ‘mission statement’ as an economic commentator, I don’t think I could do any better: my objective is to contribute to making my readers as well informed as possible, in the belief that the more knowledgeable they are the better off they are and, as part of this, the better decisions they’ll be able to make.

But the older I get and the more I read, the more I conclude it isn’t nearly that simple. We proceed on the assumption that everyone’s well-intentioned, rational and focused, and all they’re lacking are better data. I’m afraid not all of us are well-intentioned (even if our motives aren’t merely self-serving, they can vary greatly from those the data-providers assume), we’re often far from rational in the way we use data and make decisions, and, whether we’re acting as part of an organisation or in our private lives, modern life is far too complex for us to want to be focused on information gathering and evaluation prior to every decision, even if that were possible, which it isn’t.

The Nobel-prize winning psychologist Daniel Kahneman has demonstrated how many of our decisions are made unconsciously and how many lack any kind of rational logic. The illustrious German psychologist Gerd Gigerenzer, of the Max Planck Institute, has gone further and argued that, in many circumstances, people make better decisions if they don’t allow themselves to be confused by reviewing too much data. It would be comforting to believe that, however relevant these findings are to the behaviour of individuals and their private decisions, they wouldn’t apply to the detailed and careful decision-making processes of big companies and government agencies. It would be comforting, but to believe it you need a lot more faith in the perfectibility of human nature - or the infallibility of organisations - than I possess.

Let me offer a few examples to remind you of the realities we are dealing with - of how far data and information can be from knowledge. A recent Buttonwood column in The Economist magazine invited readers to answer two test questions. First, suppose you had $100 in a savings account that paid an interest rate of 2 per cent a year. If you leave the money in the account, how much would you have accumulated after five years: more than $102, exactly $102, or less than $102? And, second, would an investor who received 1 per cent interest when inflation was 2 per cent see his spending power rise, fall or stay the same?

A survey of Americans over 50 found that only half of them could answer both questions correctly. This and many similar surveys demonstrate a remarkably low level of financial literacy - even practical numeracy - among the population. You may think it indicates the need for a lot more financial education. That wouldn’t be an easy thing to bring about but, in any case, it’s doubtful whether it would work. The Economist goes on to say that a report by the Federal Reserve Bank of Cleveland failed to find evidence that financial education programs lead to greater financial knowledge and better financial behaviour. A survey of American students found those who had not taken a financial course were more likely to pay their credit card in full every month (thus avoiding interest charges) than those who had.

If you think that’s bad, try this: consumer enthusiasm for learning about finance is limited, even among those with a pressing reason to want to know more. When a free online financial literacy course was offered to struggling credit-card borrowers, less than half a percent of them logged on to the website and just 0.03 per cent completed the course. The Economist observes that those who choose to be educated about finance may be those who are already interested and relatively well-informed about it.

Statistical agencies such as the ABS are, in the main, wholesalers of statistical information. While in principle it’s open to any member of the public to look up information on the bureau’s website, in the main the users of the bureau’s services are professionals rather than amateurs: people with training in the use and interpretation of statistics employed by government agencies, corporations and universities. Among the professional users of the bureau’s services are journalists, some of who have training in the interpretation of statistics, but many of whom don’t. The news media are the retailers of statistical information; we take it from the bureau, interpret it and communicate it to ordinary members of the public. When other government agencies, businesses and academics do further processing of the bureau’s data, it’s still usually the media that on-sell it, so to speak, to the public. That’s our role in the process: we convey statistical information to ordinary members of the public in their private capacity. This may involve alerting particular business people or public employees to the existence of certain statistical facts but, for the most part, I’d expect such people to do their own analysis and consult their own experts before making decisions on the basis of something they’d read in the paper or heard on TV.

That’s the context in which I work as user, repackager and on-seller of the bureau’s data output. And in this position I needed to be forever cognisant of the cognitive limitations of my audience and the almost infinite scope for misunderstanding. I’m not sure how much of what I’m about to say will be of use to you but, since I’ve been asked, let me get down to the nitty-gritty about the use of statistical data - big or otherwise - by journalists.

The commercial media are in the business (literally) of telling their audience things that will interest them. We find that when we tell people things they probably need to know, but are rather dull, we don’t sell many copies. The stories we write are called stories precisely because humans are a story-telling animal: people have an infinite interest is stories. Stories about what? In the main, about other people. Our audience isn’t particularly interested in concepts and analysis, it’s interested in people. This presents a major problem for economic journalists because, although economics is about the way people live and work, it deals with ‘the daily business of life’ in a way that’s highly conceptual and analytical, using aggregate statistics that seem most impersonal and hard to empathise with. It’s well known people aren’t particularly moved by, say, a story reporting the death of 5000 people in a flood in Bangladesh, or even a story saying unemployment has risen by 10,000 in the past month. In the philosopher Peter Singer’s book about personal giving to worthy causes, The Life You Can Save, he quotes well-known psychological research about the largest number of people in a news story that readers are able to empathise with. The answer turns out to be one. This explains why so many overseas aid agencies have a photo of just one person in their ads, why they use sponsorships of individual children to raise money, even though that money will probably go to the whole family or even the village. It also explains why so many news stories about government policy changes or stories from Australian Social Trends are built around a ‘case study’ and photo of just one person or family. And just think of what this focus on individuals means for journalists writing about inflation figures, unemployment figures or national accounts aggregates.

Many journalists - including political journalists, though not specialist economic and business journalists, thank goodness - come from Artsy, literature backgrounds where their maths is weak (they’re never sure how to work out a percentage change) and they find numbers a bit frightening. They generally steer clear of statistical data, and when they do quote a figure they not infrequently get it wrong. If so many journalists find data off-putting, what does that say about our audience - many of whom would nonetheless have a university education?

In my use of data I force myself to quote as few figures as possible. I try to round numbers wherever I can (which makes them both easier to mentally absorb and easier to remember) and rarely take any number out to more than one decimal place (which also avoids spurious accuracy). I try to use vulgar fractions rather than percentages and am always saying things like ‘more than a third’ and ‘almost half’. This aids comprehension and recollection, but also is less off-putting because it uses words rather than numbers. Research by Gerd Gigerenzer, who has done a lot of work on the comprehension of numbers, leads him to go even further and favour the ‘two people in five’ approach. One of my rules is that every number must be adequately labelled. In particular, it’s important to make it clear whether it refers to a stock or a flow. I’m a stickler for ‘percentage points’ rather than ‘per cent’ when that’s what I mean. I always try to make it clear when I’m taking about changes in the share of some total - eg a fall in manufacturing’s share of total employment doesn’t necessarily mean it now employs fewer people.

What we’re talking about here is avoiding a cognitive bias psychologists call ‘the curse of knowledge’ - the unconscious assumption that, if I understand something, everybody else does too. Take it from me - they don’t. But I suspect many statisticians suffer from the curse of knowledge. If you want to be a good communicator of statistical data, you need always to be reviewing the realism of your level of ‘assumed knowledge’.

Far from being coldly rational, as we commonly assume, people’s interpretation of statistical facts is heavily influenced by instinctive and emotional reactions. I think it was Gigerenzer who conducted experiments with many groups which found that people would much prefer a medical procedure with a 90 per cent rate success to one with a 10 per cent failure rate. It reminds me of the man who invented death insurance, but had trouble selling many policies until he renamed it life insurance. Lest you think all this is about terribly simple souls, the experiments found that even doctors much prefer a 90 per cent success rate. Doctors are also suckers for the base effect (as are many journalists). They’re always saying that doing some naughty thing doubles your chance of getting some terrible disease. But they recoil in puzzled silence when you reply: doubled from what to what?

This is saying all of us react differently to a piece of information - including statistical information - depending on the way it is spun (if it comes from a politician) or packaged or, as the psychologists say, ‘framed’. The psychologists remind us it simply isn’t possible to present information meaningfully without framing it in some way. All data is communicated in a context, and changing that context will change the way people interpret the data. Those who design survey questions understand this full well. But all statisticians need to understand it because it means they need to put a lot of effort into trying to make their framing as neutral as is possible.

Finally, and in the light of all this, I’m sure that, for many people, the effective communication of statistical information is greatly aided by data visualisation. The media - including my newspapers - are putting more effort into creating our own data visualisation graphics. In this endeavour we’re greatly aided when statistical agencies and other official data providers (such as treasuries) present the original data in ways we can easily ‘scrap’ from websites or in Excel spreadsheet files we can quickly and easily copy electronically. But I need to remind you that journalists are reporters, not researchers. We do little processing of statistics of our own volition. But if statistical agencies start producing their own whiz-bang data visualisation graphics, you can be sure we’ll be happy to retail them to our customers.

While on my feet giving the talk at NatStats last week I had a flash of insight that wasn't in the talk itself:

Econocrats are always dinning it into journalists not to base judgements about the state of the economy on anecdotal evidence rather than economy-wide statistical indicators. But the media are largely devoted to the provision of anecdotal evidence because anecdotes are just stories about people and stories about the experience of people (including themselves) are what our readers understand, identify with and are motivated by and use to understand their world. Good economic journalists try to do it the other way ie ascertaining what the macro indicators are telling us about the state of the economy and then finding stories about individuals which illustrate the stats.

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'Wealth creators' push materialism over social side

There is a contradiction at the heart of the way we organise our lives, the way governments regulate society and even the way the Bureau of Statistics decides what it needs to measure and what it doesn't. Ask people what's the most important thing in their lives and very few will answer making money and getting rich. Almost everyone will tell you it's their human relationships that matter most.

And yet much of the time that's not the way we behave. Too many of us spend too much time working and making money, and too little time enjoying the company of family and friends.

We live in an era of heightened materialism, where getting and spending crowds out the social and the spiritual. That's the way most of us order our lives and it's the way governments order our society. They worry about the economy above all else.

Indeed, the parties' chief area of competition is over their ability to manage the economy. The opposition's latest criticism is that under Labor we're losing our "enterprise culture". What's an enterprise culture? One where all the focus is on "creating wealth" - making money, to you and me - and none is on how that wealth should be distributed between households or what it should be spent on.

It's one where the demands of the "wealth creators" (read business people) should receive priority over the selfish concerns of the wealth recipients and dissipaters (read you and me). But above all, it's one where the chief responsibility of governments is to hasten the growth of gross domestic product.

On the face of it, Julia Gillard seems to fit the opposition's criticism. This week she's hoping to make progress in putting her long-cherished national disability insurance scheme into law. Last week she was in the western suburbs of Sydney celebrating international women's day and offering "a pledge to all women and girls" that "Australia is promoting a world where women and girls can thrive and where their safety is guaranteed".

And Gillard used the occasion of her visit to the west to demonstrate her practical concern about growing traffic congestion and to announce a "national plan to tackle gangs, organised crime and the illegal firearms market".

At one level, all this is true, none of it's made up. At another level, however, it's carefully crafted image building, intended to highlight the difference between Gillard and her opponent and emphasise those differences considered most likely to appeal to traditional Labor voters who show every intention of changing sides.

The deeper truth is that, like most politicians, Gillard is working both sides of the street. Ask her and she'll assure you her government is just as good at managing the economy - and "creating wealth" - as her opponents, if not better.

Unsurprisingly, this other, harsher side of Labor was revealed at the weekend by the Treasurer. Wayne Swan opened his weekly economic note thus: "Putting a budget together is always about priorities. For the Gillard government, our No. 1 priority will always be putting in place the right strategies to support jobs and growth to keep our economy one of the best performing in the developed world."

Ah, yes. Labor professes to be just as devoted to the great god GDP as its evil, uncaring opponents. As part of this, it's been struggling - unsuccessfully so far - to get its budget back to surplus. And as part of this struggle it has required all government agencies to economise in their use of resources.

The Bureau of Statistics has been required to find savings of between $1.1 million and $1.4 million a year - hardly a huge sum in a government budget of $387 billion. But the bureau has found a way to solve its problem for the coming financial year pretty much in one go. It's decided to cancel the "work, life and family survey" long scheduled for this year.

This is mainly a survey of how people use their time, requiring a random sample of households to keep diaries of the way their time was spent for a short period. GDP measures only the value of work that's been paid for in the marketplace. It ignores all the unpaid work performed in the home, including caring for kids, and the work of volunteers.

Time-use surveys fill that gap. How much time are women spending in paid and unpaid work? How is women's participation in the paid workforce changing over time as they become better educated? How much paid work is being done by people of retirement age? To what extent is paid work encroaching on our weekends? How is the burden of housework being shared between husbands and wives in two-income families?

It had been hoped that this year's survey would shed more light on changes in the time devoted to caring for invalids and the frail aged as governments try to save money by keeping people out of institutional care. And while we're at it, what has growing traffic congestion done to the time we spend commuting?

One of the most popular maxims of the wealth creators is: you can't manage what you don't measure. Directly or indirectly, most of the Bureau of Statistics' efforts are directed at measuring GDP. It's so important it's measured four times a year. Our time use hasn't been measured since 2006. The cancellation of this year's survey means it won't be measured again until 2019.

How do we keep on our present, hyper-materialist path? One of the ways is by failing to measure its consequences.

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Productivity improves, but no one notices

You could call it the mystery of the disappearing productivity crisis. Last week's national accounts for the December quarter confirmed that, if we ever really had an underlying problem with weak productivity improvement, we don't have one now. By now, that's not such a mystery. No, the puzzle is why the people who made so much noise about the supposed productivity crisis show little sign of having noticed its evaporation.

For months we had big business arguing the seemingly weak rate of improvement in the productivity of labour during the noughties needed to be corrected by restoring the Howard government's WorkChoices biasing of industrial relations law in favour of employers. Some even went so far as to claim it was Labor's Fair Work changes that caused the weak productivity improvement.

Another line we kept hearing was that a big cut in the rate of company tax was needed to get productivity up. No one prosecuted this campaign more enthusiastically than the national dailies; they were always fretting about productivity. Yet in their extensive reporting of the national accounts, neither found space to note what those accounts told us about such a crucial issue. Even the media's exaggerated preference for bad news over good isn't sufficient to explain that omission.

Call me cynical, but it makes me suspect all the tears shed over productivity were little more than cover for an exercise in big-business rent-seeking. Shift the rules in my favour and it'll do wonders for the economy.

In case you're wondering, the national accounts showed that, on the simplest measure - gross domestic product per hour worked - the productivity of labour improved by a roaring 3.5 per cent over the year to December.

But I think the best way to see what's been happening is this: using the trend (smoothed seasonally adjusted) figures for labour productivity in the market sector, it's been improving at the rate of 0.5 per cent or better for seven quarters in a row.

Obviously, 0.5 per cent a quarter represents an annualised rate of 2 per cent, which compares with the average rate of 1.8 per cent a year achieved over the past 40 years (and the 1.6 per cent Treasury is projecting for the next 40).

To be sure, the Bureau of Statistics warns against taking short-term movements in productivity too literally, preferring to do its measurement in completed "productivity cycles" that run for four or five years.

But the improvement we've seen over the past year or two isn't hard to credit. After all, the volume of production (real GDP) grew by 3.1 per cent over the year to December, whereas total employment grew by only 1.1 per cent and average monthly hours worked grew by just 0.2 per cent.

Nor is it hard to see how the few industries whose special circumstances did so much to make the economy-wide productivity figures look so bad are moving on from those circumstances. The mining investment boom shot the mining industry's productivity figures to pieces by adding inputs without yet adding much to outputs.

But the strong growth in the volume of coal and iron ore exports in the December quarter tells us the expanded production capacity is at last starting to come online. And we know the water utilities haven't undertaken a second round of building, then mothballing, desalination plants.

Big business is wedded to the happy notion that productivity improves when governments do things to make business's life easier. If these guys were a bit better versed in economics [as opposed to rent-seeking] they'd know the truth is roughly the opposite: productivity improves when governments either do things, or allow things to happen, that make life tougher for business.

What the Gillard government did was do nothing to lower the high dollar - not that there was anything sensible or effective it could have done - and limit the budgetary handouts to only part of manufacturing industry.

The result was a lot of pressure on export-and import-competing industries to raise their efficiency (or, at the very least, cut costs) or go under. As well, a lot of other industries, including retailers and much of the media, have been subject to pressure on sales and profits coming from the digital revolution and structural change.

These are just the tough times you'd expect would oblige firms to lift their game. As Reserve Bank governor Glenn Stevens said recently: "In several sectors of the economy a combination of factors is putting pressure on business models, and firms have been responding with an emphasis on lifting productivity and paring back costs. This process, while unavoidable, feeds into measures of sentiment ..."

As we go through a period of transition from mining-led growth to stronger growth in the rest of the economy, he said, "the pressures to adapt business models, contain costs, increase productivity and innovate will remain. But such adjustments are actually positive for longer-run economic performance."

Moral: Don't get your economics from overpaid chief executives - or crusading newspapers.

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Underneath, the economy is slowing

THE world is a complicated place - and the Bureau of Statistics' national accounts are more so. Sometimes they're better than they look, but the figures we got this week aren't as good as they look. On their face, they say real gross domestic product grew by 3.1 per cent over the year to December.

Since the economy's trend (medium-term average) rate of growth is about 3.25 per cent a year, that doesn't look too bad. The worry is, a lot more than half that growth occurred in the first half of the year, with growth in the last quarter of just 0.6 per cent - suggesting the economy is slowing.

The figures are unlikely to prompt the Reserve Bank to make much change to its forecasts last month of growth of just 2.5 per cent over the year to June, and probably not much better by the end of this year.

Looking into the detail, although consumer spending has generally held up better in recent years than many people suppose, it grew by a weak 0.2 per cent in the December quarter, and no better the quarter before.

Just why consumption has been so weak of late is a puzzle. The problem hasn't been weak growth in household incomes, nor a rise in the rate of household saving, which has been roughly steady at 10 per cent of household disposable income. It's the "disposable" bit that has been the problem: an unexplained increase in tax payments.

There was strong growth in the quarter in purchases of food and motor vehicles (for the year, up a remarkable 23 per cent), but a fall in spending at hotels, cafes and restaurants.

Probably the best news is that home building activity increased 2.1 per cent in the quarter, its best growth since early 2011, following a pick-up in the September quarter.

This suggests housing is finally starting to grow again, stimulated by lower interest rates and slowly rising house prices. But no one's expecting the recovery to be strong.

On the face of it, business investment spending contracted in the quarter, whereas public sector spending grew surprisingly strongly. But both results were distorted by the sale of an existing asset from the private sector to a state public corporation. Kieran Davies, of Barclays Bank, believes this is the Victorian government's purchase of a desalination plant for up to $4 billion.

As best he can untangle the figures, business investment rose 1 per cent during the quarter, while public sector spending was pretty flat. The latter's not surprising since governments at all levels are struggling to get their budgets back to surplus.

Within the overall growth in business investment, spending by the mining industries continued very strong, whereas spending by all other industries was weak.

According to the latest estimate by the Bureau of Resources and Energy Economics, the pipeline of committed resource projects is a record $268 billion. This suggests the peak in mining investment remains some quarters off and that, even when it arrives, it may be more of a plateau than the start of a dive.

While we're on the resources boom, the next notable feature of the accounts was that the volume (quantity) of exports grew 3.3 per cent during the quarter, whereas import volumes grew just 0.7 per cent. This means "net exports" (exports minus imports) made a contribution to overall GDP growth of 0.6 percentage points. By far the strongest growth came from coal and iron ore exports.

But a slowing in the rate of inventory accumulation made a negative contribution of 0.4 percentage points and, as Dr Chris Caton of BT Financial Group has calculated, almost all of this came from a sharp decline in mining inventories. It thus makes sense to say mining exports made a net contribution to growth of 0.2 or 0.3 percentage points.

So it's a mistake to say, as some have, that mining accounted for all the growth in the quarter. Small contributions came from consumer spending and housing. And it's good to see signs of the third phase of the resources boom getting started: there's a lot more growth in the volume of our mineral exports to come.

This is the time to be clear on the distinction between export volumes and export prices. Even as export volumes are growing, export prices are falling. Indeed, prices are falling mainly because volumes are growing. That is, prices are falling as supply catches up with demand.

The fall in export prices relative to import prices caused our "terms of trade" to deteriorate by 2.7 per cent during the quarter (and by 12.9 per cent during the year). This explains why, though real gross domestic production grew 3.1 per cent over the year, real gross domestic income rose by just 0.2 per cent.

This weaker growth in national income feeds through to business profits and household incomes, thus acting as a dampener on spending. And this, plus the coming peak in mining investment (and despite the income we'll get from growing mining export volumes) explains why what we need to see now is a transition from mining-led growth to growth in the rest of the economy: consumption, housing and non-mining business investment spending.

That's what's disappointing about this week's seemingly OK national accounts: as yet, not much evidence the transition is occurring. It's being spurred on by the fall in interest rates over the past year or more, but held back by the continuing high dollar.

Even so, Wayne Swan is right to remind us that, whatever our troubles, they pale into insignificance compared with the troubles of most of the rest of the developed economies.

Our growth of 3.1 per cent is faster than almost all the other countries in the Organisation for Economic Co-operation and Development and more than four times the average. Of the 27 advanced economies, 15 actually contracted in the December quarter.

Our real GDP has grown by 13 per cent in the five years since December 2007. Among the seven biggest advanced economies, only Germany, the US and Canada can claim to have grown in that time. And the best of them - Canada - has grown much less than half as much as we have.

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Labor first out of blocks in race to mislead

I guess you've heard the news: the Gillard government has obtained new analysis of data from the Bureau of Statistics showing that Tony Abbott's election commitments inflict brutal damage on working families, particularly those in western Sydney, increasing taxes and cutting support to families.

According to Treasurer Wayne Swan, Abbott's commitments include scrapping the tripling of the tax-free threshold, axing the new schoolkids' bonus and abolishing family payments from the household assistance package introduced in June last year.

The government tripled the tax-free threshold from $6000 to $18,200 a year from July last year, we're told, delivering tax cuts to all taxpayers earning up to $80,000 a year. Most of these people received savings of at least $300 a year, with many part-time workers receiving up to $600.

The schoolkids' bonus is worth $410 a year for primary school students and $820 a year for secondary school students to families who receive family tax benefit part A.

The household assistance package increased payments to families who receive benefit part A by up to $110 per child and by $70 per family for those receiving benefit part B. The median family income in Fairfield is $106,000. This family, with two children both in primary school, father working full-time on $86,000 a year and mother working part-time on $20,000 will be almost $1500 a year worse off, we're told. The mother will pay $600 more in tax and they will lose $820 in schoolkids' bonus and $72 in other benefits.

The median family income in Penrith is $118,000. This family, with two primary and one high school student, the father earning $70,000 and the mother on $48,000, will be $2300 a year worse off, we're told. The father will pay $250 more in tax, the mother will pay $300 more, and they'll lose $1640 in schoolkids' bonus and $108 in other benefits.

Terrible, eh? There's just one small problem. This stuff is so misleading as to be quite dishonest.

For a start, this is just politically inspired figuring, which doesn't deserve the aura of authority the government has sought to give it by having it released by the Treasurer with a reference to "new analysis of Bureau of Statistics data" and allowing the media to refer to it as "modelling".

It's true you'd have to look up the bureau's census figures to get the details of the median family in a particular suburb, but after that the "modelling" could be done on the back of an envelope.

There's a key omission from Labor's description of its wonderfully generous household assistance package: why it was necessary. Its purpose was to compensate low and middle-income families for the cost of the carbon tax. Since the Coalition promises to abolish the carbon tax, Abbott has said that all the compensation for the tax will also go. (Strictly speaking, the schoolkids' bonus is linked to the mining tax, but the Coalition is also promising to abolish this tax, and Abbott has said the bonus, too, will go.)

The trick is that Abbott has yet to give any details of how or when these concessions would go and what they'd be replaced with. But this hasn't inhibited Labor. It has happily assumed what the Coalition intends and is presenting its assumptions as hard facts.

The most glaring omission from Labor's calculation of the hip-pocket effect of all this is its failure to acknowledge the saving households would make from the abolition of the carbon tax.

Based on Treasury's original calculations, this should be worth about $515 a year per household, including $172 a year from lower electricity prices and $78 a year from lower gas prices.

Some Labor supporters argue that even if the carbon tax is abolished, prices won't fall. This is highly unlikely. The state government tribunals that regulate electricity and gas prices would insist on it. And a Coalition government would no doubt instruct the Australian Competition and Consumer Commission to police the wider price decrease.

Labor's repeated claim to have tripled the tax-free threshold from $6000 to $18,200 a year has always been literally true, but highly misleading. That's because it conveniently ignores the complex operation of the low-income tax offset.

When you allow for this offset, which Labor has reduced and changed without removing, the effective tax-free threshold has increased by a much smaller $4500-odd from $16,000 to $20,542. This explains why the tax cut arising from the seemingly huge increase in the threshold is so modest (for many, $5.80 a week) and also why the move yields no saving to anyone earning more than $80,000 a year. For them, the threshold increase has been "clawed back".

The idea of a Coalition government bringing about an actual increase in income tax is hard to imagine. Labor omits to mention Abbott has promised a modest tax cut, though he hasn't said when it would happen.

Labor also omits to mention that the generous schoolkids' bonus replaced its earlier 50 per cent education tax refund, which offered savings of up to almost $400 a year on the eligible expenses of primary school students and up to almost $800 for secondary students.

Labor has assumed that Abbott would merely abolish the schoolkids' bonus without reinstating the education tax refund. Maybe he would; maybe he wouldn't - he hasn't yet said. But only a one-eyed Labor supporter would trust Labor to read Abbott's mind.

It didn't take the announcement of an election date to ensure the informal election campaign would begin as soon as we were back at work in January. It's a daunting thought.

But at least it gives people like me plenty of time to demonstrate the dishonesty of the claims being made.

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Hockey would be no soft touch as treasurer

If the Liberals take over the management of the economy in September - as seems likely - one advantage should be that big business becomes more realistic about the extent to which it imagines the government can solve its problems. And just to make sure, Joe Hockey, the opposition's treasury spokesman, gave business his first pep talk along those lines last week.

Hockey is much underestimated. If you've been watching you've seen him progressively donning the onerous responsibilities of the treasurership, the greatest of which is making it all add up.

He has used his - now less considerable - weight to avoid raising unrealistic expectations and to tone down overly generous promises. You can see him thinking: "I'm the guy who'll have to find a way to pay for all these commitments. We've made a huge fuss about the need to get the budget back to surplus and it'll be down to me to ensure it happens."

In opposition the temptation is to espouse populist solutions that sound good but don't work. As a former cabinet minister, Hockey knows it's hard for governments to get away with such wishful thinking. If you've been listening carefully you'll have noticed Hockey quietly taking an economic rationalist approach while others demonstrated their lack of economic nous.

Those who doubt the strength of Tony Abbott's economics team should note that Hockey would be backed by Senator Arthur Sinodinos, a former senior Treasury officer. I believe Sinodinos played a key part in formulating the "medium-term fiscal strategy" - "to maintain budget balance, on average, over the course of the economic cycle" - which the Libs developed when last in opposition.

If so, Sinodinos deserves induction to the fiscal hall of fame. There have been few more important or wiser contributions to good macro-management of our economy.

One of the greatest failings of the Rudd-Gillard government was the way, in an attempt to keep in with big business, it yielded to the temptation to modify its policies in response to lobbying from particular industries. The consequence was to annoy other industries and incite them to get in for their cut. But the more concessions business extracted from Labor, the more business lost respect for its judgment and self-discipline.

This generation of Labor doesn't seem to have learnt from its Hawke-Keating predecessor which, with some lapses, stuck to the line that the days of industry rent-seeking were over and that, in a well-functioning market economy, the main responsibility for solving an industry's problems rests with the industry.

Judging by his speech to a business audience last week, I suspect Hockey has learnt the lesson. He outlined the many ways in which he believed the Coalition's policies would be better for business than Labor's, but stopped well short of promising business everything its heart desired.

For instance, he discussed the case of "a significant manufacturer with similar operations in Australia and the United States", who complained that labour costs were much higher in Australia.

"Australian labour is expensive," Hockey said. "Is that a bad thing? No, not at all. We can compete with higher wages provided our output per worker is globally competitive.

"Higher household income means that our people have higher spending power. That provides a high standard of living and facilitates strong household consumption. And it benefits businesses because it provides a strong and expanding domestic market."

Australia's standard of living must not go backwards, he said. There was no national benefit in cutting wages. "What we do need to do is to ensure that our workers have the skills and knowledge that our industry needs. Education, training and retraining is a key step to unlock labour productivity gains. And we need to ensure that employment conditions can meet the varied and changing requirements of Australian workers and Australian businesses."

This was why, within the framework of the Fair Work Act, a Coalition government would look at "cautious, careful and responsible improvements to labour market regulation".

Hockey noted that part of the reason Australian wages seemed high relative to US wages was our high dollar, which "is impeding the competitiveness of Australian exporters and making life difficult for Australian producers.

"But on the other side of the coin," he said, "the high Australian dollar brings benefits for businesses which rely on imported goods, and for consumers who purchase cheaper imported products. So what could or should be done?"

He made two points in reply. First, there's no "correct" value for the dollar. Second, all movements in the currency create losers as well as winners. "Those who argue for a lower dollar are effectively arguing in favour of higher prices for consumers," he said.

A Coalition government "would need to be extremely cautious in tinkering with such a successful policy measure" as the freely floating dollar. "We would encourage businesses to view the high dollar as an opportunity. A high dollar means imports are cheap. Business should be utilising this period to import cutting-edge equipment and world-class technology."

Hockey is already sounding like a more forthright treasurer than the incumbent.

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How Reserve Bank retains control of interest rates

When the banks began moving their mortgage and other lending rates at variance with the Reserve Bank's changes in its official interest rate, many people took this as a sign the Reserve had lost its ability to control market interest rates, making its monetary policy ineffective.

Fortunately for all of us, this impression was wrong. That so many people came to this conclusion showed their grasp on the mechanics of monetary policy (the central bank's manipulation of interest rates to influence the strength of demand in the economy) was shaky.

But this week one of the Reserve's assistant governors, Dr Guy Debelle, gave us all a little tutorial in a speech to a business school breakfast.

On Tuesday (and on the first Tuesday of every month bar January), the board of the Reserve meets to determine the appropriate "stance" (setting) of monetary policy. The decision takes the form of a target for the official rate (known in the trade as the "cash" rate). Sometimes the target is moved down a little, sometimes up a little, but mainly it's left where it is.

How does the Reserve unfailingly achieve the target? Settle back. The cash rate is the interest rate the banks charge each other to borrow and lend funds overnight.

Every bank has an account with the Reserve called its "exchange settlement account". Just about every monetary transaction in the economy goes through these accounts. As Debelle explains, when you pay your electricity bill by direct debit, the funds are effectively transferred from your bank account, across the exchange settlement account of your bank to that of your electricity company's bank and into the electricity company's account.

All these transactions mean the balance in each bank's exchange settlement account goes up and down throughout the day. But the Reserve requires each bank to ensure its account always has a positive balance. Banks that leave funds in their account overnight are paid interest at a rate 0.25 percentage points below the cash rate, whereas banks that look like having a negative balance may borrow the difference from the Reserve overnight at a rate 0.25 percentage points above the cash rate.

Get it? These penalties are designed to encourage the banks to borrow and lend to each other overnight at the (more attractive) cash rate.

The Reserve's ability to control the cash rate arises because it has complete control over the supply of funds in this market. It ensures there is just sufficient supply to meet the demand for funds at the interest rate it is targeting.

Where an increase in demand threatens to push the interest rate up, it will use its "open market operations" to increase the supply of funds just sufficiently to keep the rate where it wants it. Where a fall in demand for funds threatens to push the rate down, the Reserve will reduce the supply to ensure the rate doesn't change.

Historically, the Reserve would increase the supply of cash by buying second-hand government bonds from the banks and paying for them with cash. (Note that in this context, "cash" doesn't mean notes and coins, it's a nickname for the funds in exchange settlement accounts.)

Conversely, it would reduce the supply of funds by selling bonds to the banks, which they had to pay for from their exchange settlement accounts. These days, however, the Reserve achieves the same effect using repurchase agreements ("repos").

The main reason for fluctuations in the overall daily demand for exchange settlement funds is transactions involving the Reserve's one big banking customer, the federal government. Demand will rise on days when the government's receipts from taxation exceed its payments of pensions and all the rest. Demand for cash will fall on days when the government's payments exceed its receipts.

All this ensures the Reserve has a vicelike grip on the cash rate. And this gives it the ability to influence all the other interest rates in the economy. Why? Because the cash rate is, in effect, the anchor point for all other rates.

Banks fund only a very small part of their operations in the cash market, Debelle explains, but all their funding could be done from that market if they wanted to. The rate at which they're prepared to borrow for periods longer than overnight is the averaged expected path of the cash rate over the life of the loan plus various margins for risk.

If this were not the case, a bank would be better off borrowing all the funds it needed in the overnight cash market and rolling them over every day.

The reason banks borrow and lend at rates higher or lower than the average expected cash rate over the life of the loan is the need to allow for the various risks involved (the risk of not being repaid, the risk in agreeing to lend your money for a longer time, and so forth) and, of course, profit margins along the way.

For several years leading up to the global financial crisis, these various margins (known as "spreads" or "premia") didn't change much, meaning a change in the cash rate brought about an identical change in mortgage and other bank lending rates.

Since the crisis, however, margins have been changing a lot, as a result of people realising they weren't charging enough to cover the risks they were running, and our banks realising they needed more domestic, retail and longer-term funding to protect them against future crises, leading to intense competition between them to attract term deposits.

The net effect has been that the banks' borrowing costs have risen more (or fallen less) than the cash rate has, causing changes in, say, the mortgage rate, to be less generous than changes in the cash rate and thus widening the margin between the cash rate and the mortgage rate.

The Reserve has allowed for this shift in margins, cutting the cash rate by more than it would have so as to ensure market interest rates - the rates people actually pay - are where it wants them to be.

Its influence over market rates thus remains undiminished. And that's because the cash rate remains by far the most powerful influence over other interest rates - though, as we've seen, not the only influence.

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