MACRO MANAGEMENT AND THE SUPPLY SIDE

Management of the macro economy has moved to a more sophisticated and thus more medium-term approach, which has increased the focus on the supply side. I want to discuss some less familiar technical terms that have become part of the debate: ‘trend’ growth, the ‘potential’ growth rate, the ‘output gap’ and how macro policy and micro policy fit together.

The meaning of ‘trend’ growth

It has become common to hear the RBA or the treasurer saying the economy (or private consumption or some other key macro variable) is growing at, below or above ‘trend’ - and expecting people to know what this means.

It can be a bit confusing because the Bureau of Statistics uses the word ‘trend’ to mean something quite different. So let’s get that out of the way first. The bureau presents its estimates of key indicators on three bases: original, seasonally adjusted (which allows valid comparisons to be made between adjacent months or quarters) and ‘trend’, which would be better described as ‘smoothed seasonally adjusted’. To remove some of the ‘noise’ in the seasonally adjusted figures - and thus make their underlying direction more readily apparent - you subject the series of observations to an averaging process called a 5-term (for quarterly data) or 13-term (for monthly data) centred ‘Henderson’ moving average. The advantage of this statistical technique is that it makes the direction in which the variable is moving very clear without moving any turning-points. The disadvantage is that you don’t know the final value of an observation until two further quarters (or six further months) have passed. Until then, the estimate is subject to regular revision.

But as the term is used by macro economists (as opposed to the statisticians), ‘trend’ means an indicator’s medium-term to long-term average, with ‘medium-term’ meaning a period of more than two or three years, and long-term meaning maybe 10 or 20 years. For instance, the Rudd government’s economic statement before the 2013 election campaign showed the 30-year average growth rate for real GDP is 3.25 per cent a year.

But here’s where it gets a bit tricky. As well as using ‘trend’ to refer to this backward-looking historical average growth rate, the macro managers also use it to refer to the forward-looking average rate of growth over the future medium term. This forward-looking ‘trend’ is the same as the economy’s ‘potential’ rate of growth.

The meaning of the ‘potential’ growth rate

The potential rate of growth in production (output or real GDP) is the maximum average rate at which it can grow over the medium to longer term without worsening inflation. It thus has similarities to the non-accelerating-inflation rate of unemployment (NAIRU), which is the lowest rate to which unemployment can fall without worsening inflation. Both are measures of full employment or full capacity or the ‘sustainable’ rate of growth.

The three Ps of economic growth

A common way to examine economic growth is to decompose it into ‘the three Ps’: population, participation and the productivity of labour. It is, in fact, a labour-market oriented way of thinking about economic growth. Over the medium to longer term, the economy’s rate of growth can be seen as determined by the rate of growth in the population (in particular, the population of working age), any change in people’s participation in the workforce, and the rate at which the productivity of labour is growing.

Now, when economists treat the backward-looking medium-term ‘trend’ rate of growth as essentially the same as the forward-looking ‘potential’ growth rate they’re implicitly assuming there’s no reason to expect any of the three Ps to change in the coming decade or so from what they’ve been over the past few decades.

But that’s not a reasonable assumption, particularly at present. And this is why Treasury’s more forward-looking, potential-oriented approach to trend has led it to keep revising down its estimate for trend. We can make whatever guesses we like about whether the medium-term rate of improvement in labour productivity will be faster, slower or about the same as it’s been in the past. But the two other Ps - population of working age and the rate of participation - being demographic variables, can be projected with more confidence. And one thing that leaps out from the demography and the ageing of the population is that the great population bulge which is the baby-boomers (those born between 1946 and 1961) is rapidly entering an age cohort with a significantly lower rate of participation than the cohort they are leaving. (This remains true even if it’s also true that many baby-boomers are retiring later than had been expected). If you’ve noticed that Treasury has been revising down its estimate of trend growth, this is the main reason for it. Actually, this process has been occurring for some time. According to Treasury’s PEFO issued early in the 2013 election campaign, forward-looking trend growth was taken to be 3.5 per cent from 1998, then lowered to 3.25 per cent in 2005 and to 3 per cent in 2006. These downward revisions also reflected ‘lower projected productivity growth’. The trend rate is expected to be lowered further to 2.75 per cent some time ‘early next decade’.

The way to determine what Treasury’s estimates are for trend rates of growth in other key macro variables is to look at its annual mechanical ‘projections’ used for the last two years of the budget’s ‘forward estimates’. Trend growth in real GDP of 3 per cent is consistent with annual growth in total employment of 1.5 per cent and an unemployment rate steady at 5 per cent. This implies Treasury’s estimate of the NAIRU - full employment or unemployment’s ‘long-term sustainable level’ - is also 5 per cent. It further implies that, on average, employment needs to grow by 1.5 per cent just to hold the rate of unemployment steady. These estimates, in turn, fit with a CPI inflation rate of 2.5 per cent (ie the mid-point of the RBA’s medium-term target range) and annual growth in nominal GDP of 5.25 per cent (implying inflation as measured by the GDP deflator averages a fraction less than as measured by the CPI because, in the present environment, the terms of trade are assumed to trend down, which reduces growth in the GDP deflator but not the CPI).

While we’re on the three Ps, the charter of budget honesty requires Treasury to produce an ‘intergenerational report’ every five years. We’ve already seen three such reports. Treasury prepares projections of the major classes of government spending for the following 40 years (which always suggest massive growth in federal spending on health care), and estimates the size of the ‘fiscal gap’ if the growth in tax collections is to be capped as a percentage of GDP. But just as interesting are Treasury’s underlying estimates of the three Ps, past and future. In the 2010 IGR, the average annual rate of growth in real GDP over the past 40 years was 3.3 per cent, with growth in the population of working age contributing 1.7 percentage points, change in participation (broadly defined - see below) contributing minus 0.2 points and productivity improvement 1.8 points. Treasury projected that, over the coming 40 years, real GDP will grow at a slower average rate of 2.7 per cent a year, with growth in the working-age population contributing 1.3 percentage points, change in participation contributing minus 0.2 points and productivity improvement contributing 1.6 points. So most of the slowing in growth is explained by slower population growth and the rest by slower productivity growth. Of course, the reason we want to see the economy growing strongly is to increase our material standard of living, which is simply measured as growth in real GDP per person. Treasury estimates that the growth in GDP per person will slow by a smaller gap: 1.9 per cent over the past 40 years versus 1.5 per cent over the coming 40. In this case, the gap is explained equally by slower growth in the population of working age and slower growth in productivity.

Note that the expected slowdown in productivity improvement is no more than Treasury’s best guess. In both 40-year periods the working-age population grew a fraction faster than the population over all, but the difference between working-age and overall growth is expected to change sign in the coming 40 years because of the ageing of the population. It shouldn’t surprise you that participation is expected to fall and thus make a negative contribution to growth in the coming 40 years. But it may surprise you that participation also made a negative contribution in the past 40 years, at a time when we know the participation of women grew strongly. The explanation is that this improvement was more than offset by the higher rate of unemployment during the period and by a decline in average hours worked per worker as the proportion of part-time workers increased.

Speed limits and the ‘output gap’

One term you may be more familiar with is the ‘output gap’. This is the difference between the actual level (not the growth rate) of GDP and the level of potential GDP. In any particular year, actual growth is determined by the strength of aggregate demand, whereas the potential growth rate is the maximum sustainable rate of growth over the medium-term, set by the growth in aggregate supply.

So if in any particular year actual growth exceeds the trend (potential) growth rate this could be taken to mean that aggregate demand is growing faster than aggregate supply, and so is known as an ‘inflationary gap’. But it’s not that simple. Whether or not growth in excess of trend is inflationary depends on whether the economy is already operating at full employment (of all resources, not just labour) or full capacity. If it is then, yes, such growth will be inflationary (and will involve attempting to drive the unemployment rate below the NAIRU). If, however, the economy is operating well below full capacity (with factories and workers not fully employed) then short-term growth in excess of trend will not be inflationary. Indeed, the usual pattern in the first few years after a recession - in which, of course, actually capacity falls to levels way below full capacity - is for growth to far exceed trend. This is not a problem, it’s desirable.

So trend should be thought of as setting a ‘speed limit’ for the rate at which the economy should be growing only after the economy has returned to full capacity. Remember, too, that full capacity is not a fixed point. It grows every year. By how much? On average, by the trend rate of growth - this is what trend measures: the average rate at which the economy’s capacity to produce goods and services expands every year.

Factors leading to growth in the economy’s productive capacity

What factors cause the economy’s supply side - its capacity to produce goods and services - to grow each year? That’s easy: growth in the three Ps. Aggregate supply grows in line with the growth in the labour force, new business investment and public infrastructure, gains in the human capital of the workforce (education and training) and productivity gains arising from economies of scale and advances in technology.

Governments can exert some influence over the growth in the labour force by their policy on immigration and by reforming policies that have the effect of discouraging participation in the labour force. Government policies can also have an influence on the NAIRU. As well, governments can exert some influence over productivity improvement by the incentives and disincentives they create affecting primary research, research and development, and the tax and transfer system generally. They also exert influence by the size and effectiveness of their spending on education and training, as well as on economic infrastructure.

The Gillard government’s budget of May 2011 provided an interesting example of a government using its budget not just to influence aggregate demand but also to influence aggregate supply. It sought to add to supply, especially the supply of labour, particularly skilled labour. It involved a modest expansion of the immigration of skilled workers, the reform and expansion of vocational education and training (TAFE), and the use of sticks and carrots to encourage greater participation in the labour force by disadvantage workers (the long-term unemployed, sole parents and the disabled) and by wives in single-income couples who were under 40 and had no children to look after.

How macro and micro policy fit together

On the surface, the traditional instruments of macroeconomic management - monetary policy and fiscal policy - are very different to the relatively new idea of ‘microeconomic policy’. The traditional instruments are aimed at demand, whereas micro reform is aimed at supply; they work in the short term, whereas micro policies generally effect change only over the medium term. But despite appearances, microeconomic policy is actual an instrument of macro management.

Historically, the macro managers focused solely on managing demand, trying to get it up to the potential growth rate in the recovery phase after recessions, and trying to hold it down to the potential growth rate during booms. The era of micro-economic reform, however, represents the realisation by the economic managers that they can increase the economy’s rate of growth (rather than just keeping it as stable as possible) by improving the flexibility and efficiency of the supply side and also by actually increasing supply.

So the traditional macro instruments are aimed at achieving a stable rate of growth whereas micro policy aims at achieving a higher rate of growth over the medium term, at raising trend. Another way to think of it is this: if avoiding inflation means keeping demand and supply growing at the same rate, one solution (the traditional solution) is to ensure demand doesn’t grow too fast. But another, more creative solution is to do what you can to hasten the growth of supply. To the extent you can do this, you can get faster growth without inflation problems.

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A lot of politics is unconscious pre-judgment

At last. God's in his heaven and all's right with the world. The rightful rulers of this country are back in charge, so now things can only get better. You think I'm joking? I'm not.

There's an American psychological test called the implicit association test which asks people to divide nice words and nasty words, black faces and white faces, into two categories and do it as fast as they can.

When journalist Malcolm Gladwell, author of Blink, tried the test he was so dissatisfied with his score he did it over and over, trying to improve his results. Why? Because he's half Jamaican - with a fabulous afro haircut - but the test revealed him to be unconsciously prejudiced against black people.

It turns out more than 80 per cent of all those who have taken the test were found to have "pro-white associations".

Gladwell explains our attitudes towards race and gender operate on two levels. We have conscious attitudes, things we choose to believe, which we use to direct our behaviour consciously. But the test measures our unconscious attitudes, "the immediate, automatic associations that tumble out before we've even had time to think". Such unconscious attitudes affect our behaviour without us realising it.

I believe something similar operates in our unconscious attitudes towards the two main political parties. We see the Liberals - the party of the bosses - as the party best suited to run the country.

Sometimes enough of us feel sufficiently rebellious to install Labor - the party of the workers - but this leaves many of us uncomfortable and yearning for the return of the masters. And when, sooner or later, it becomes clear Labor isn't doing well, no one is terribly surprised and we rush back to the security of our pater familias.

You don't understand anything about the underlying forces of Australian politics until you understand that.

It applies particularly to the economy. For decades pollsters have asked people which side of politics is better suited at managing the economy. And for decades the almost invariable answer is the Coalition.

There was a time during the term of the Hawke-Keating government when the economy was doing well and Labor was ahead on this question. But such times are the exception. Normally, Labor judges its success just by the extent to which it has narrowed the gap with the Libs.

It follows that the more the economy is seen as the dominant issue of federal politics - as it has been since Gough Whitlam's day - the more the Libs are seen as the natural party of government.

No one believes this more fervently than business people, of course. Business is always uncomfortable with a Labor government, but the Rudd-Gillard-Rudd government proved much less adept at maintaining good relations with business than the Hawke-Keating government.

So much so that the economist Saul Eslake has noted "the extent and depth of antipathy among the business community towards the present [Labor] government - which goes way beyond the normal inclination of most business executives or owners towards centre-right governments".

A big part of the problem was Labor's resort to the language of class conflict, starting with its decision to rename the original mining resources rent tax as the resource "super profits" tax.

New governments always enjoy a honeymoon with the electorate and a lift in business and consumer confidence. But this time it's hoped the turnaround in business confidence will be big enough to lead to a recovery in non-mining business investment, which has been weak for several years.

The resources boom and its high dollar, the end of the housing credit boom and the return of the more prudent consumer, and the continuing digital revolution mean that, although the economy has been travelling well enough overall, various industries have been hard hit by "structural change".

Most of these structural pressures are beyond the influence of government policy. That's particularly true of retailing, which includes a lot of small businesses and has been doing it especially tough.

The temptation for hard-pressed business people to blame their troubles on a Labor government has been irresistible. The change of government will make them a lot happier. And the more confident business is about the future, the better it's likely to do. The test will come when businesses realise their underlying problems haven't gone away.

Business people are usually highly critical of anyone seen to be "talking down the economy". But, we've learnt, this ethic applies only when the Coalition is in government. Tony Abbott and Joe Hockey were talking the economy down for at least three years, and many business people were publicly agreeing with them.

Of course, the assumption that Liberal governments always manage the economy well - that, in Abbott's revealing phrase, it's in their DNA - is wrong, just as the assumption that Labor governments are always bad at it is wrong.

The hope that all our problems will evaporate now the good guys are back in charge is wishful thinking.

But that doesn't stop our deeply held assumption to the contrary - an assumption shared by both Liberal and Labor politicians - from having real effects on our behaviour. One of the surprising truths of economics is that, to some extent, our expectations are self-fulfilling.

And already the budget and boat-people crises are over.

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Big change in party, little in policy

Coalition supporters rejoice! The evil incompetents have been banished and the good guys are back in charge. But don't get too excited because by the time we reached polling day many illusions about the difference a change of government would make had been shattered.

A standard delusion of election campaigns is that the Coalition portrays itself as standing for lower taxes, higher spending and lower budget deficits.

And Tony Abbott seemed to be cutting taxes big time, abolishing the carbon tax and the mining tax and cutting the company tax rate to 28.5 per cent.

But now we finally have the Coalition's full costings we see how far the reality falls short of the headline.

Its tax cuts will cost about $20 billion over four years (in cash terms), but its offsetting levy on big companies and reversal of Labor tax breaks - mainly on superannuation and small business - will claw back about $14 billion over four years.

And that's before you count the unlegislated Labor tax increases Abbott will put into law - including the increases in the Medicare levy and cigarette duty, and the new tax on bank accounts - worth about $28 million over four years.

Don't sound like lower taxes to me.

But surely the most disillusioning thing for Liberal true believers is the way five years of railing against Labor's utterly wasteful spending, never-ending budget deficits and soaring debt levels was simply cast aside over the course of a five-week campaign.

When, just before the campaign began, Labor was forced to reveal the deficit would be worse before we returned to surplus in another four years' time, the Libs proclaimed this a ''budget emergency''.

But then, just two days before polling day, they revealed their response to this emergency, which turned out to involve a net reduction in the cash deficit of just $6 billion over four years. On Treasury's projections, cumulative future deficits of a further $55 billion will now be a mere $49 billion and the return to surplus not a day earlier. Yippee.

Let me be clear: I wholeheartedly agree with the Liberals' last minute pull-back from resort to fiscal austerity. But then I was never taken in by their five years of frightening the fiscally illiterate.

What's supposed to be next on the agenda of a new government is a first look at the books, the amazed discovery it's all much worse than their predecessors let on, and the regretful announcement that this fiscal crisis necessitates a huge round of cost-cutting and the breaking of ''non-core'' promises.

Sorry, this ain't gunna happen, either. Why not? Mainly because Peter Costello's charter of budget honesty and, in particular, his instigation of the econocrats' pre-election economic and fiscal outlook statement was specifically designed to ensure he was the last treasurer able to pull that stunt.

If you've read the PEFO you've already seen the books.

But Abbott is further locked in by his repeated resolutions not to break his promises. He's even promised to let the deficit blow out rather than break a spending promise.

Labor claimed the planned ''commission of audit'' will be used as the vehicle for big spending cuts, but this was just its retaliatory scare campaign.

All past Coalition audits have been performed by purist economic rationalists who make radical recommendations no government would dream of accepting.

These and other promised inquiries (44 in Abbott's case) are just a device to get party hard-liners off a Coalition leader's back before elections.

There are just three main respects in which Abbott's policies are significantly different to Labor's.

First, the redistribution of the burden of taxation and the benefit of government spending against the Labor (and, for that matter, National Party) heartland and in favour of the Liberal heartland.

Second, the move from a market-based response to climate change to a pretend response. The campaign revealed a cap on ''direct action'' spending that means Abbott's professed bipartisan commitment to a 5 per cent reduction in emissions by 2020 is a sham.

Third, a marked improvement in business confidence now the socialist hordes have been vanquished.

This is the one delusion that remains from the rubble of an election campaign by the Liberals' most populist and least rationalist leader in a generation.

Fortunately, its delusory nature shouldn't stop it giving the economy a genuine boost as business ends its three-year-long dummy spit.

Today's return to real life will end one more illusion that accompanies every campaign: that it's governments who do most to manage the economy not the unchanging econocrats of the Reserve Bank.

There could be no more powerful reason why the change of government will change surprisingly little.

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Little progress in economy's transition

With the election campaign supposedly fought mainly on economic management, it's surprising this week's figures for growth in the June quarter got so little attention. So what shape is the economy in as it looks like being handed over to a new government?


According to the Bureau of Statistics' national accounts, it's not doing well, but nor is it doing particularly badly. Real gross domestic product grew just 0.6 per cent in the quarter and 2.6 per cent over the year to June.

This is a touch better than many economists were expecting, but it's well short of our ''trend'' growth rate of 3 per cent a year. According to the figuring of Paul Bloxham, of the HSBC bank, we've slowed from an annualised rate of 3 per cent in the second half of last year to an annualised 2.3 per cent in the first half of this year.

This is too slow to generate sufficient additional jobs to employ the growing labour force and prevent unemployment from rising. Unemployment's gone from 5.4 per cent to 5.7 per cent of the labour force over the seven months to July.

The problem - as everyone must know by now - is that we're engaged in a difficult shift from growth led by mining to growth led by the rest of the economy as the resources boom goes through a ''phase shift''.

And, as Reserve Bank governor Glenn Stevens has reminded us, the transition is being made more difficult by the end of the long-running housing credit boom, which has prompted households to return to their relatively high rate of saving and therefore allow their consumption spending to grow no faster than their incomes.

This week's accounts show little sign we've got far with the transition, making it fortunate we're still getting some support from the resources boom as it moves from its investment phase to its production and export phase.

Investment spending by the mining sector looks to have fallen about 3 per cent in the quarter, but increased mineral exports do most to account for the 1.3 per cent growth in the volume of exports in the quarter.

With reducing mining investment also meaning fewer imports of mining equipment, this was sufficient to mean ''net exports'' (exports minus imports) had no net effect on growth during the quarter. (Over the financial year, export volume growth of 6.4 per cent and a fall of 1.8 per cent in import volumes meant net exports contributed a huge 1 percentage point to the overall growth of 2.6 per cent.)

Note that increased stockpiles of minerals did most to account for a rise in the levels of business inventories, which contributed 0.2 percentage points to growth during the quarter.

Note, too, that our terms of trade were steady in the quarter, implying no further fall in mining export prices.

The story on growth in the non-mining economy isn't as good. Consumer spending grew by 0.4 per cent for the quarter, which contributed 0.2 percentage points to overall growth. (Over the financial year, consumer spending grew 1.8 per cent, contributing 1 percentage point to overall growth.)

This growth is better than implied by the very weak monthly figures for retail sales (which account for only about a third of total consumer spending), mainly because of strong growth in purchases of services and, particularly, new cars.

Even so, its growth is well below trend consumption growth, which should be about 3 per cent a year.

With the household saving ratio roughly stable at a little more than 10 per cent of household disposable income, this tells us disposable income must also be growing at well below trend.

Why? Because its growth is not being bolstered by a lot more people getting jobs and because wage increases aren't as high as they were.

Is slower wage growth a bad thing? It may not sound wonderful, but it is giving the Reserve Bank confidence inflation will stay low notwithstanding the likely rise in import prices following the fall in the dollar. So it has permitted the Reserve to cut interest rates further.

Turning to the other main components of non-mining growth, home building and alterations fell by a surprising 0.6 per cent in the quarter.

But though the housing market is hardly rip-roaring in response to the present very low interest rates (another consequence of the prudence that's followed the end of the credit boom), it is recovering, and home building grew by a reasonably healthy 4 per cent over the year to June.

Non-mining business investment seems to have shown no growth during the quarter, which is a disappointment. We must hope the expected change of government will give business a bit more confidence to take advantage of low interest rates and the still-low cost of imported capital equipment.

Despite all the talk of cuts, Kieran Davies, of Barclays bank, calculates the public sector grew by 1.2 per cent in the quarter.

Though GDP per hour worked improved by just 0.2 per cent in the quarter, it's up by 1.8 per cent over the year. That's pretty much in line with trend - a far cry from the earlier talk of a productivity crisis.

Since much of the earlier apparent weakness was explained by the investment phase of the mining boom (many workers employed building new mines and facilities from which nothing was being produced), the more recent improvement is no doubt partly explained by more of the mines coming on line.

The trade-exposed sector's difficulty coping with the high dollar - which does much to explain the weak growth of the non-mining economy - probably helps explain a bit more of the improvement.

People have trouble understanding that productivity gains tend to come from pain rather than pleasure.

But let's not worry about that. Provided government changes hands this weekend, all our economic problems will evaporate within days.

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Why Abbott wouldn't be a great cost cutter

If Tony Abbott wins the election would he "cut, cut, cut" to fill the "$70 billion black hole" needed to cover the cost of his election promises, as Labor repeatedly claims? Would he follow the Europeans in adopting austerity policies, as others claim?

No. Why not? Because the man who'd be his treasurer, Joe Hockey, isn't that stupid and Abbott isn't that committed.

Let me make a fearless prediction: should the Coalition win the election, we'll hear precious little more about the evils of "debt and deficit".

While Labor was in power, Abbott and his colleagues exaggerated the significance of the size of the budget deficit and the level of the public debt because this was the only way to disparage the economic record of a government that had - with much help from the Reserve Bank - done surprisingly well.

But once the Coalition was back in power its need for fear-mongering about debt and deficit would disappear and it would face the same struggle to get the budget back to surplus that Labor faced.

Whenever it was challenged about its slow progress it would blame Labor but, apart from that, it would prefer to talk of other things.

How can I be sure? Mainly because Abbott's been backing off already. He used to say he'd get the budget back to surplus in "year one". Now his promise is merely that "by the end of a Coalition government's first term, the budget will be on track to a believable surplus" and "within a decade" the budget surplus will be 1 per cent of gross domestic product.

Only "on track" after three years? And "within a decade"? That's three elections away.

But also because the Libs have form on this sort of scare campaign. While John Howard and Peter Costello were in opposition in 1996, they drove a "debt truck" around Australia to ensure every "man, woman and child" knew how much they owed as their share of the nation's foreign debt. In government, however, they never mentioned the foreign debt again.

But can they get away with going cold after having made so much fuss? Well, the Republicans in America have been doing it for years. Their attitude is simple: budget deficits aren't a worry when they're being incurred by Ronald Reagan or the George Bushes, but they're a terrible worry when they're being racked up by Democrats like Barack Obama.

My guess is that, for the most part, those who've been most concerned about our supposedly soaring debt are those who'd naturally vote Liberal. They're really saying: "I'd feel a lot more comfortable about the budget if only the Libs were in charge of it."

Well, if Abbott wins, they would be. And that would be a signal to many people to stop worrying and leave everything to that nice Mr Hockey.

Hockey, by the way, has said several times that they wouldn't risk worsening unemployment at a time when the economy is fragile by pursuing policies of austerity - that is, by cutting spending or raising taxes by a lot more than is needed to cover the cost of their promises, in an attempt to reduce the budget deficit faster than would happen automatically as the economy strengthens.

As the Europeans have demonstrated, trying to force the pace while the economy is weak is counterproductive. It pushes the economy back into recession, actually making the deficit worse rather than better. So I don't have any trouble believing Hockey when he says he wouldn't be so foolish as to try it here.

Labor's claim that Abbott's election promises have created a $70 billion black hole he will need to fill with spending cuts is a wild exaggeration. It's been debunked by several fact-checking outfits.

But Kevin Rudd, Penny Wong and Chris Bowen haven't skipped a beat in repeating this false claim.

So don't for a minute imagine all the scare campaigns, dishonesty and dissembling is limited to one side. If you're tempted by such thoughts you've allowed partisanship to cloud your thinking.

The fact remains, however, that the Coalition is delaying until almost the last moment before revealing the full list of spending cuts needed to pay for its promises.

What's it got to hide? Well, maybe it has a few nasties it's hoping won't get too much attention before the poll, but it's just as likely it's worried about making some mistake in its figuring - in this area oppositions are at a huge disadvantage relative to governments - that Labor could use to damage its credibility.

An Abbott government would be looking for budget savings - just as Labor has been for several years - and would probably be more inclined to cut spending than end tax breaks.

Its first budget, in particular, would be a tough one, including various unpleasant measures that weren't contrary to its promises but many people weren't expecting. Its primary purpose would be to replace Labor's pet programs with the Coalition's pet programs.

But Abbott has made so much fuss about restoring our trust in politicians that I don't expect he'd follow Howard in using his first budget to break a lot of "non-core" promises.

He'd end up breaking many promises, of course - because "no surprises, no excuses" is a promise no honest politician would make - but not at first. And, like Howard, he doesn't have the stomach for genuinely smaller government.

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Why taxes would rise under Abbott

Election campaigns have become works of fantasy where, to enter the spirit of things, you have to suspend disbelief. And the greatest unreality this time is Tony Abbott's claim the budget can be returned to surplus in the coming decade while taxes go down, not up.

To most people the idea of permanently paying less tax is hugely attractive. And Abbott is promising to abolish the carbon tax and the mining tax, cut the company tax rate by 1.5 percentage points and abandon Labor's plan to end tax concessions for company cars. All this would cost about $28 billion over four years.

So what reason is there to doubt he would deliver a lasting reduction in taxes? Simply his promise to get the budget back to surplus - plus the knowledge government spending is set to grow strongly in the next decade.

To return to surplus and to do it while avoiding growth in tax collections would require a literally unbelievable degree of spending restraint.

Remember, though it gets little notice, Abbott is also promising to impose new taxes, increase taxes and eliminate tax breaks. These are partly to help cover the cost of the taxes he's getting rid of and partly to help pay for his new spending promises.

He's proposing a 1.5 per cent levy on big companies to cover the net additional cost of his paid parental leave scheme and a 0.5 percentage-point increase in all rates of income tax (aka the Medicare levy) to help cover the cost of the national disability insurance scheme (both raising $16 billion over four years).

To help cover the cost of abolishing the mining tax he's proposing to save $4.7 billion over four years by cutting business tax breaks: ending the instant asset write-off, removing accelerated depreciation for motor vehicles, ending the phase-down of interest withholding tax on financial institutions and ending the "tax loss carry-back".

Also to help cover the cost of abolishing the mining tax he proposes to save $3.7 billion in four years by effectively increasing the superannuation contributions tax for those earning up to $37,000 a year, and save $1.6 billion in four years on no-longer-forgone super tax breaks by delaying for two years phase-up in compulsory employer contributions.

And all this is before we get to Labor's as-yet-unlegislated tax rises, which Abbott has quietly indicated he would proceed with: extra revenue of almost $10 billion over four years from measures to "protect the corporate tax base", cut research tax breaks, increase cigarette tax and impose a levy on savings accounts.

When you see the list of tax hikes that accompany Abbott's grand tax-cutting gesture, it doesn't exactly inspire confidence he could keep taxes down in a way none of his predecessors has managed to.

And when you realise that - according to the earlier reckoning of Saul Eslake, of Bank of America Merrill Lynch - his election promises involve extra government spending of almost $15 billion over four years, it doesn't inspire confidence he could achieve the herculean spending restraint needed to get the budget back to surplus as well as keep taxes down.

The medium-term projections in Treasury's pre-election economic and fiscal outlook, about which I suspect we'll be hearing a lot more after the election, demonstrate how challenging the budget task will be in the coming decade.

According to the projections, if the government elected this Saturday sticks to Labor's strategy of limiting average real growth in spending to 2 per cent a year and not allowing tax collections to exceed 23.7 per cent of gross domestic product, the budget surplus will recover to 1 per cent of GDP by 2020-21.

But, since spending is projected to grow at an underlying real rate of 3.5 per cent a year, this would require an unprecedented restraint. And, even so, it would still require tax collections to grow 1.5 percentage points faster than the economy - equivalent to an ultimate $26 billion a year in today's dollars - over the decade.

Alternatively, were spending allowed to grow at its underlying rate, this could still leave us with a growing surplus, provided unrestrained bracket creep was allowed to cause tax collections to grow 3.3 percentage points (an ultimate $56 billion a year) faster than the economy.

And, get this. Were you to let spending grow at its "natural" rate, but limit growth in tax collections to a ceiling of 23.7 per cent of GDP - the level in the Howard government’s last year - the rest of the coming decade beyond 2018-19 would see an ever-rising budget deficit.

Whoever wins this election, I'll be amazed if taxes do anything but keep rising.

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Forest logging propped up by conservationists

Everyone knows the environment and the economy are in conflict; that any effort we make to protect the environment comes at the expense of profit and jobs.

So, for instance, everyone knows that if the community wants to see restrictions on the logging of native forests in Tasmania, it's only reasonable for the government to compensate the industry and its workers for their loss of livelihood.

And this is precisely what the federal government has been doing for years. As long ago as 1989, the Tasmanian forestry sector received $42 million under the Helsham agreement. Under the Tasmanian regional forestry agreement of 1997, it got $110 million and under the Tasmanian community forest agreement of 2005, it got $203 million.

Under the Tasmanian forestry agreement - negotiated by the industry, unions and conservation groups, and finalised earlier this year - it will get another $300 million. Two weeks ago, as the battle for Tasmanian votes hotted up, Labor announced that the release of some of this money would no longer be conditional on the preservation of certain forests.

The national native forest industry has been doing it tough in recent years. Over the period from 2009 to 2011, removals of "roundwood" (logs) were 30 per cent below the average of the previous 18 years. And woodchip exports fell by a third between 2008 and last year.

The fall in production and exports has bankrupted the native hardwood industry's largest producer, Gunns Limited, and led to the closure of numerous processing facilities around the country.

State forest authorities have also recorded substantial losses. Forestry Tasmania recorded a net loss before tax and other items of $64 million over the four years to last year, an average of $16 million a year. The Forests Corporation of NSW recorded a total loss of $85 million over the same period, an average of $21 million a year.

The way the industry likes to tell it, it was hit by the banning of logging in certain forest areas and the tightening up of forest management practices. But while it was recovering from this blow, it was hit first by the global financial crisis and then by the high dollar (which has reduced earnings from exports and reduced the price of the imported forest products it competes against).

Talk about bad luck. Clearly, the industry just needs a bit of government help to keep it on track until things get back to normal.

And, indeed, all of the parties to the latest Tasmanian forestry agreement believe it will deliver "an ongoing, vibrant forestry industry in Tasmania based on native forests and, increasingly in the future, plantation".

There's just one problem: this is wishful thinking. The industry's story uses the environment as a convenient whipping-boy to draw attention away from its long-term structural decline - and probably demise.

The chequered story of the native forest industry and the way it has sucked ever-growing subsidies from governments can be deduced (as I have done) from a report prepared earlier this year by Andrew Macintosh, of the Australian National University, for the Australia Institute, The Australian Native Forest Sector: Causes of the decline and prospects for the future.

It's true the industry has been adversely affected by conservation measures, the global financial crisis and the high dollar. But they're secondary to its underlying problem of declining demand for its products and increasing competition both from other products and other, overseas producers of its products.

When you look at it, you see that the logging of hardwood native forests is under pressure from every direction.

To the extent that people still want hardwood, they increasingly prefer it from plantations, not native forests. But demand for hardwood itself is declining in favour of softwood, most of which comes from plantations.

Demand for wood is being reduced by demand for other products such as steel, by engineered wood (where thin bits of wood are glued together in different ways) and by wood-saving innovations.

And all that's before you get to increased competition from wood producers in other countries - competing in our domestic market and competing in our export markets.

The supply and future supply of plantation wood has been greatly expanded by another government subsidy, managed investment schemes, in which misguided punters overinvested in crazy pursuit of tax breaks.

Where the native forest sector can't sell its logs for use in building construction - as increasingly it can't - it sells them to be chopped into woodchips for papermaking. Naturally, woodchips are worth less. But even the native forest woodchip market is facing reduced demand and increased competition.

Macintosh concludes that "with sluggish demand in many key markets, strong competition from Asian, South American and African producers, and a distinct market preference for plantation-sourced products" and "in the absence of additional government assistance, the sector is likely to continue to decline and, in some areas, it could collapse entirely".

See what's happening? Our perception that protecting the environment is always in conflict with the economy and jobs is being used by the industry, its unions and the politicians as a cover for continued handouts to the industry, handouts that will do nothing but delay the inevitable.

And the conservation groups, having been convinced the industry's problems are all their fault, are running cover for an industry that doesn't want to face the truth and politicians trying to buy Tasmanian votes.

The result is that taxpayers are paying to allow an industry that probably would have collapsed to continue doing damage to native forests. It's getting help other industries wouldn't get, partly because it's doing something most other industries don't do: destroying the environment.

This makes sense?

If the conservationists had more sense they'd joint the economic rationalists in urging governments to stop giving subsidies - explicit and hidden - to an industry trying to defy market realities.

Environmentalists would do more good if more of them knew a bit of economics.

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Parties' sameness hides a big difference

You could be forgiven for concluding there's little to pick from in this election; the age of ideology is long gone and the true difference between the parties is minor. The two sides have assiduously eliminated their differences to the point where we're asked to choose between the red management team and the blue management team.

You could be forgiven for thinking all this because there's much truth to it. The more "scientific" and calculated politics has become the further the sides have moved towards the centre.

But it's not the whole truth. The parties may not be terribly ideological and - with the notable exceptions of Julia Gillard and Wayne Swan - they may assiduously avoid the language of class conflict, but they do play favourites in the policies they espouse.

If you think the class war is over, you're not paying enough attention. The reason the well-off come down so hard on those who use class rhetoric is that they don't want anyone drawing attention to how the war's going.

All of them except Warren Buffett, the mega-rich American investor. "There's class warfare, all right," he once said, "but it's my class, the rich class, that's making war, and we're winning."

The reason the wiser heads in Labor don't want to talk about class conflict, either, is they know it gets them nowhere. It alienates people at the top without attracting many at the bottom.

This, of course, is why the well-off like me are winning. The workers are too busy watching telly to notice the ways they're being got at. It requires attention to boring things like superannuation when you could be up the club playing the pokies.

The significant thing about the looming change of government is not that the economy will be much better managed - it won't be; these days most of the key decisions are made by the econocrats - but that the Coalition will bring to its decisions about taxing and spending a different bias to Labor's.

How can I say that? By looking at Tony Abbott's promises. If you do pay attention it's as plain as a hundred dollar bill.

Let's start with that boring question of the concessional tax treatment of superannuation. It's by far the most expensive example of (upper) middle-class welfare.

Super has always been a scheme heavily favouring those on the highest rates of income tax, who also happen to be those most able to afford to save.

But towards the end of his time as treasurer, Peter Costello introduced "reforms" that made it far more favourable to the well-off by making super payouts tax free and opening the scheme wide to "salary sacrifice" by those able to afford it.

At the time, many economists said what they're saying now about Abbott's paid parental leave scheme, that it was so generous as to be fiscally unsustainable.

And so it has proved. In its unending search for budget savings the Labor government has chipped away at that generosity in almost every budget (as I know to my cost).

And as part of its mining tax package, Labor finally acted to remove one of the most iniquitous features of the scheme.

It introduced the "low-income super contribution rebate" to end a situation where everyone earning less than $37,000 a year gained nothing from the concessional treatment of super contributions (while people like me saved tax of 31.5? in the dollar).

Earlier this year, when Labor was making noises about doing more to make super less inequitable - and the big banks and insurance companies were putting up their usual furious fight - Abbott promised to avoid any further changes for three years. Labor later topped this by promising no further changes for five years. Who benefits most from this moratorium - aspirational families in the western suburbs?

And get this: to help pay for its promise to abolish the mining tax - paid on their super-profits by three of the biggest mining companies in the world - an Abbott government would abolish the low-income super contribution rebate.

Who would benefit most from Abbott's opposition to Labor's plan to remove the concessional tax treatment of company cars?

Abbott's paid parental leave scheme would introduce a major new example of middle-class welfare. Since even most on his own side disapprove of it, it's guaranteed to be chopped back in future.

Then there's his pledge to remove the means-testing from the private health insurance rebate.

To its unforgivable shame, Labor has repeatedly refused to increase the poverty-level rate of the dole. In March, however, it began paying dole recipients a twice-yearly supplement of up to $105. No doubt as part of its campaign against waste and extravagance, an Abbott government would abolish this supplement.

Early in its term, the Howard government rejigged its grants to schools so as to favour private schools. After doing nothing for six years, the Labor government accepted the Gonski report's plan to bias school funding in favour of disadvantaged students, most of whom are in public schools.

After roundly condemning the Gonski proposals, Abbott affected a deathbed conversion to them as the election loomed. Read his fine print, however, and the parents of children at private schools can rest easy. The disadvantaged will soon be back at the back of the queue where they belong.

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Checkmate election spells fiscal indiscipline

It's truly ironic that after spending five years banging on about debt and deficit, and then proclaiming us to be in a budget emergency, the side most likely to form the next government has made one fiscally irresponsible commitment after another.

It's all part of the way the two sides' long-running battle of the scare campaigns has morphed into a checkmate election campaign in which most effort has gone into eliminating the differences between the parties, leaving them with little to debate and voters with little choice other than which side to "trust". What if you don't trust either lot?

It's just bad luck for those of us who believe fiscal sustainability is something to be achieved, not just talked about when it's convenient. Perhaps the most irresponsible act arising from the checkmate game is Tony Abbott's commitment - without time limit - never to change the goods and services tax.

This puts paid to big business's dream of increasing the rate or broadening the base of the GST (or both) to finance a cut in the company tax rate. But lots of people have their eyes on the GST as a solution to their problems and I think the premiers have first go.

They were promised a growth tax, but the return of the prudent household (whose consumption spending grows no faster than its income) and the faster-growing exclusions from the GST's base (most notably, private spending on health and education) mean collections from the GST aren't keeping pace with the public's demand for increased spending on most areas of state responsibility, but particularly hospitals.

When Labor keeps accusing its opponents of planning to cut spending on health and education, the Coalition vigorously denies it. But any federal party that refuses to increase collections from the GST will inevitably be squeezing state spending on health and education. (Meaning a re-elected Labor government would too.)

Rivalling the irresponsibility of refusing to change the GST is the Coalition's promise to make no further changes to the concessional tax treatment of superannuation, which Labor matched with a promise to make no changes for five years.

Super is the most egregious example of middle-class welfare - the less help you need, the more you get. So the side that needs to pay for about $28 billion worth of promised tax breaks over four years before it finds ways to cover government spending growing at an underlying real rate of 3.5 per cent a year swears not to touch the biggest rort going.

And the other side, which still doesn't know how it would cover the ever-growing later-year costs of the disability scheme and the Gonski education funding - on top of the inescapable strong real growth in healthcare costs - makes the same undertaking.

One thing you can be certain of is that the Coalition's pledge to avoid further reform of super means its two-year postponement of the phase-up of compulsory employer contributions to 12 per cent of salary will end up being permanent. No bad thing.

Next, note that in one of the few cases where one side outbid the other rather than merely matching it - the Coalition's far more generous paid parental leave scheme - the conservatives have opened up a brand new source of middle-class welfare, a lucrative new entitlement program, one that as well as being expensive and unfair will do little to increase labour force participation.

It's true, however, that there are two big examples of checkmate politics where the Coalition hasn't been as fiscally irresponsible as it would like voters to believe. The first is its me-too on Labor's disability scheme.

As Saul Eslake, of Bank of America Merrill Lynch, has pointed out, the little-remarked 0.5 percentage-point increase in all rates of income tax the Coalition has accepted as part of the package will start four years before the full scheme starts. I'm sure the extra revenue will come in handy.

The second checkmate that won't be as costly as it seems is Abbott's supposed about-face in accepting the Gonski education funding reforms. The first trick is that he's agreed only to match the first four years of spending. Most of the increase is in the following two years. And when he says he'd remove the strings Labor has attached to its scheme he means he will neither make the states contribute towards the cost of Gonski's reforms nor check to ensure they don't use the fed's new Gonski money to cut back their existing spending.

So Abbott's deathbed conversion to more equitable sharing of federal grants to public and private schools turns out to be no conversion at all, just an old private school boy's three-card trick.

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Resurces boom now a growth negative but still going

Kevin Rudd keeps saying the China resources boom has ended, but Reserve Bank governor Glenn Stevens said recently the boom was merely "changing gear" and going through a "phase shift". So who should we believe?

The econocrat, of course. The politician is exaggerating. It's true, however, that we have reached a highly significant point in the boom: though it's far from ending, we've reached the point where it's gone from making a positive contribution to economic growth (real gross domestic product) to making a net negative contribution.

The resources boom we're living through is one of the most significant things ever to happen in the history of our economy. So it's worth getting a clear picture of it in your mind. It's not a simple story.

The boom began in 2003 and was divided into two parts by the global financial crisis of 2008-09. For a few months it looked as though it was over, but then it started up again to be bigger and better than before.

But here's the tricky bit: you can divide the life of the boom into three phases - hence Stevens' talk of a "phase shift".

The first phase was an almost unbelievable increase in the prices we received for our exports of coal and iron ore, prompted particularly by the rapid industrialisation and urbanisation of China and other developing countries. This greatly increased our export income and lifted our terms of trade - export prices received relative to import prices paid - to their most advantageous in about 150 years.

But minerals prices stopped rising and started falling a long time ago - the middle of 2011 - and since then our terms of trade have deteriorated by about 18 per cent.

It's clear prices have further to fall, but how far and how fast they fall we can only guess. Right now, our terms of trade are still very much better than they were in the decades before the boom.

And the econocrats are confident that, even when prices have fallen as far they're going to, our terms of trade will remain a lot better than they were. If so, this will be a lasting consequence - and benefit - of the boom.

The second phase of the boom followed from the higher prices: resource producers responded to the increased demand by greatly increasing their investment in new mines and facilities. That was particularly true for iron ore and natural gas, and to a lesser extent coal.

Stevens says annual new investment spending by the resources sector rose from an average of about 2 per cent of GDP, where it had spent most of the previous 50 years, to peak at about 8 per cent.

That's a phenomenal increase. And all that mining construction activity has been the main factor driving the growth in the economy for the past few years while the manufacturers and tourist operators have been hit by the high dollar, and home building and retailing have been hit by the end of the long credit boom and other problems.

But the construction phase seems now to have gone over the hill. Treasury observed in the economic statement that "with investment in iron ore and coal projects likely to have already peaked, future resources investment will be underpinned by liquefied natural gas projects already under construction".

So the big development is that the amount of mining investment spending seems to have stopped getting bigger from quarter to quarter - and thus contributing to the quarterly growth in real GDP - and will now get smaller each quarter, meaning it will now subtract from quarterly growth.

Note, however, that though the amount of construction activity will get smaller each quarter, more investment will still be happening each quarter. That is, the second, construction phase of the boom isn't over, it's just passed its peak.

Come back in five years time and we'll have a lot more mines and natural gas facilities than we have today. Don't let the economists' obsession with quarter-to-quarter growth mislead you.

The next thing to remember is that maybe 40 per cent of our total mining investment spending goes on the purchase of imported capital equipment.

And, obviously, money we spend on imports is a minus in the sum that gives us GDP, the value of domestic (local) production of goods and services. So a reduction in a minus helps with growth. Allow for the decline in imports and the reduction in mining investment spending doesn't subtract as much from the bottom line as first appears.

Which brings us to the boom's third phase, production and export, which is just getting going. As all the newly built mines and gas facilities come on line, we experience very strong growth in the volume (quantity) of mining production and exports of minerals and energy.

This, of course, makes a positive contribution to the growth of GDP - and it's the main reason for saying the boom is far from over. Stevens says volumes of iron ore are rising by about 15 per cent a year. Shipments of natural gas won't start increasing strongly until 2015, and will probably have several years of very strong growth then remain high for a few decades.

Treasury says the record surge in investment has more than doubled the resource capital stock (production capacity) over the past decade, and this will support strong growth in mining commodity exports for years to come.

Even so, when you put all the bits together - a negative contribution from slow mining investment spending, a positive contribution from fewer capital imports and a positive contribution from increased production of exports - you're still left with a net negative contribution to growth from here on.

Finally, don't forget this: we started with a mining sector that accounted for about 4 per cent of total national production. Now it's 10 per cent and counting - a lasting consequence of the boom.

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ECONOMICS FAQ

Talk to VCTA Teachers Day, Melbourne, Friday, August 23, 2013

Often when I talk to economics teachers I focus on helping them keep up to date with the latest thinking on some topic, believing they need to know a lot more background information than their students do and leaving it for them to decide how much of what I’ve said they need to pass on to their kids. But this time I’m going straight to the classroom to give you answers to what I imagine are frequently asked questions by your students - and maybe even by you. The full version of my speech is a lot longer than I’ll have time to talk to today, so make sure you get a copy. Even so, I’m sure there are many more FAQs than I’ve had time to write about - or even think of. So if you’ve got questions I didn’t answer, I’d be grateful if you’d write them down and give them to me - or send me, if you think of them later - and I’ll use them for another talk or bear them in mind for my Saturday column, which has high school economics students as primary target audience.

Can we trust the official unemployment figures?

Short answer: yes and no. Yes we can trust the figures in the sense that, contrary to a widely believed urban myth, there was no time in the past when some government - Labor or Liberal - doctored the figures to make them look better. The figures are calculated by the Bureau of Statistics, which is not a government department but, like the ABC, has a high degree of independence of the elected government and doesn’t let politicians tell it how to measure things. The bureau, which is regarded as one of the best statistical agencies in the world, sticks closely to the statistical conventions laid down by the UN Statistical Commission, the IMF and, in the case of the labour force survey, the ILO. The definitions it uses to decide who is employed, unemployed or ‘not in the labour force’ haven’t changed significantly for many decades.

Remember that the labour force figures come from a sample survey conducted every month by the bureau, using a sample of 26,000 households - up to 20 times those used in media opinion polls. Even so, this does mean it is subject to sampling error, and the results jump around from month to month, meaning it’s best to look at the ‘trend’ (smoothed seasonally adjusted) figures.

Many people assume that the number of people said to be unemployed by the bureau is the same as the number on the dole. This isn’t true. You can be on the dole but not counted as unemployed in the survey (say, because you picked up a few hours of casual work during the week) or you can be counted as unemployed by the survey but not on the dole (say, because your spouse’s job gives you too much income to be eligible). Some old people have ideas in their heads that are a hangover from the time before 1978, when the Fraser government paid to have the labour force survey moved from quarterly to monthly, so that it replaced the old method of measuring unemployment as the number of people registered with the Commonwealth Employment Service.

I suspect some people’s false memories of the government fiddling with the figures stem from their memory of controversies over governments changing rules about how much work you can do and still be eligible for disability benefits or the dole. It’s sometimes claimed that a government has tried to hide some of the unemployed by putting them on training schemes. But people have been making such claims for years and the claim implies the training schemes are phoney, that they’d be of little value to the job seeker and are motivated only by a desire to fudge the figures. Whether a person is classed as unemployed depends not on how they’re classified by a government department, but on what answers they give to the bureau’s interviewers.

So, yes, we can trust the official figures in the sense that they haven’t been fiddled. But, no, we can’t trust them in the sense that they don’t give an accurate picture of the extent of unemployment. It is true - and has been for decades - that, under the international convention, someone who’s done as little as an hour’s work in the previous week is classed as employed, not unemployed. This means the official definition of unemployment is too narrow, making it too hard to qualify as unemployed and thus understating the full extent of joblessness. Note that very few people actually work only a few hours a week. It’s also true that the majority of people working part time (ie less than 35 hours a week) are happy with the number of hours they’re working. Many full-time students, young mothers and semi-retired people don’t want to work full-time.

Even so, a significant number of part-timers do wish they could get more hours, so we have a significant problem with under-employment. I suspect this measurement problem has arisen because the decision to call someone employed if they worked for only a few hours was made long ago when part-time and casual employment was quite rare. As it has become increasingly more common, the original definition of unemployment has become increasingly misleading.

The bureau has tacitly acknowledged this by calculating the rate of underemployment and adding this to the official unemployment rate to get the rate of ‘labour force underutilisation’. This broader measure of unemployment is calculated every quarter and published with the monthly labour force survey. From July 2014 the bureau plans to calculate and publish the broader measure monthly. Let’s hope this will prompt economists and the media to give it more attention.

In May 2013 the trend unemployment rate was 5.5 pc, while the underemployment rate was 7.3 pc, giving an underutilisation rate of 12.8 pc. Note that the measure counts as underemployed not just people working part-time who’d prefer to be full-time, but also those part-timers who’d like only a few more hours. So to that extent its definition of unemployment is probably a little too broad.

For many years I’ve used the rough rule of thumb that the easy way to correct the official unemployment rate is to double it. If you’re making comparisons with the past, however, you have to remember to double both the starting point and the end point. And remember that even if the level of the official rate is too low, it should still give a reasonably reliable indication of whether unemployment is rising, falling or staying the same.

Does the RBA still control interest rates when the banks can do as they please?

Short answer: yes it does. The RBA uses market operations to keep the overnight cash rate under very tight control. The cash rate has acted - and still acts - as the anchor for all other short-term and variable interest rates. Of course, all the other interest rates - from bank bill rates to mortgage interest rates - are a margin (or ‘spread’) above the cash rate because they involve riskier lending, but for several years before the global financial crisis world financial markets were very steady and those margins changed little. This gave people the impression mortgage interest rates always move in lock-step with the cash rate. After the turmoil of the crisis, however, many of the margins widened. The banks passed this increase in their cost of funds on to their borrowing customers. In the case of people with home loans, the banks did this by increasing their mortgage interest rates by more than any increase in the cash rate, or by failing to pass on the whole of any cuts in the case rate. Note that the banks increased the rates they charge their business borrowers by a lot more than they increased the politically sensitive mortgage rates.

For a brief period during the GFC the overseas financial markets in which our banks borrowed a high proportion of the money they lent to their customers ceased to operate. When trading resumed their margins were a lot higher. Realising the extent of our banks’ over-dependence on overseas ‘wholesale’ markets, the share market, the credit rating agencies and the official regulators put pressure on our banks to borrow more of the funds they needed from domestic depositors, whose deposits tended to be ‘sticky’ (slow to move away in search of higher returns) and thus more dependable. The resulting sudden surge in all the banks’ demand for deposits forced up the interest rates they paid on deposits, particularly term deposits, raising them from below the cash rate to above it. This, of course, was a great benefit to Australian savers, but the banks passed this higher cost on to their borrowers.

Could the banks have absorbed these higher borrowing costs? They could have - their profitability (not just the absolute size of their profits, but the rate of their profits relative to the value of their total assets or their shareholders’ capital) is very high by world standards or by the standards of other Australian industries - but they chose not to. And the limited degree of competition between the members of the big-four banking oligopoly gave them the pricing power to pass their higher costs on to borrowers and preserve their rate of profitability.

But don’t confuse the rights and wrongs of the banks’ actions with the quite separate question of whether their behaviour has robbed monetary policy of its effectiveness. It hasn’t. Why not? Because although the RBA uses the cash rate as its instrument, what does the real work of monetary policy are the market interest rates actually paid by businesses and households, so the RBA focuses on getting market rates where it wants them to be. If the independent actions of the banks cause market rates to be higher than where the RBA wants them, it simply cuts the cash rate by more to achieve its desired result. In other words, the fact that the banks’ margin above the cash rate is now wider than it was before the GFC simply means the RBA has had to cut the cash rate by more than it otherwise would have to get markets rates to where it wants them.

Does monetary policy still work?

Short answer: yes. When the share and property markets were booming in the late 1980s, the RBA spent several years raising interest rates to get the boom under control. The rise in rates didn’t seem to be working, and it became fashionable to say that monetary policy had become ineffective. I was still wondering whether this could be true when the economy started the slide that became the recession of the early 90s, the worst recession since the Depression, in which unemployment got close to 11 pc. Then all the smarties started saying interest rates had been held ‘too high for too long’.

There could be no better experience to cure me of ever doubting that monetary policy was effective. And yet we hear such claims whenever people observe a delay between the RBA starting to move the cash rate and making clear its desire to speed up or slow down demand but nothing seems to be happening. When the RBA cuts the rate but there’s a delay before demand picks up, people use an old Keynesian phrase that using interest rates to try to stimulate demand is like ‘pushing on a string’. But that analogy is appropriate only when the economy is in a liquidity trap - which the North Atlantic economies may be in at present, but we certainly aren’t.

In 40 years of watching the management of the Australian economy I can’t recall any time when monetary policy has failed to move demand in the desired direction. The problem is just that, as you well know, monetary policy operates with a lag that’s ‘long and variable’. Another thing that makes the process slow and adds to people’s impatience is that the RBA almost invariably moves in baby steps of 0.25 percentage points. Clearly, a single 25 basis point change isn’t likely to have a big effect on decisions about borrowing and spending. It’s probably true, too, that the response to a monetary tightening or loosening episode isn’t proportional or linear. That is, you may adjust rates several times without getting much effect, but then anther click finally has a big impact. The RBA uses the rule of thumb that most of the effect of a monetary policy on demand occurs within two years, with maybe two-thirds of the full effect occurring in the first year. The effect on inflation - which, of course, runs via the effect on demand - is longer again.

Would a big cut in the cash rate produce a fall in the dollar?

Short answer: no. This question has been asked a lot in recent times as trade-exposed industries such as manufacturing have be hard hit by the high dollar associated with the resources boom.

The first point to understand is that, in practice, economists don’t have a good handle on what factors determine movements in the exchange rate over short periods of less than a year of so. There are rival theories, but no particular theory always gives a convincing explanation of why the exchange rate has moved - or not moved - as it has in recent weeks. Instead, one theory tends explain recent events better than another does at a particular time, so economic practitioners tend to switch between the rival theories depending on which one seems to be working better at the time. I think the reason no theory seems to work well at all times is that the global foreign exchange market isn’t nearly as rational as the perfect market hypothesis assumes.

In the old days, a common theory was that the currency of a country with an excessive current account deficit would tend to depreciate, so as to help bring it back to equilibrium and, similarly, the currency of a country with an excessive current account surplus would tend to appreciate. These days, you rarely hear this theory relied on because there’s little if any empirical support for it. I think it was a hangover from the days of fixed exchange rates, when it was clear the authorities’ decisions on whether to devalue or revalue the currency were determined by pressures on their current accounts. In these days of floating currencies and the removal for foreign exchange controls, it’s clear the ‘driver’ of floating exchange rates has switched from the current account to the capital account - that is, from trade flows to capital flows.

These days, and particularly from an Australian perspective, there are three main, rival theories to explain exchange rate movements. The first is that the biggest influence over our exchange rate is our terms of trade, and particularly world primary commodity prices. There is much empirical support for this view if you look at a graph of the two over the years, though you can see the correlation breaking down over some shorter periods. The second theory is that the biggest influence over our exchange rate is our ‘interest-rate differential’ - the size of the difference between our official interest rate (or short-term commercial rates) and those of the major developed economies, particularly the United States. The higher our rates are relative to the others, the more our exchange rate is likely to be high and rising, and vice versa. Note that this is very much a capital-flows driven theory. The third theory is a kind of combination of the first two: countries with strong economic prospects relative to the major developed countries should have strong currency, whereas countries with weak prospects relative to the majors should have a weak currency. This theory makes a lot of sense and often seems to be pretty true, but there are times when it’s far from true.

Australia’s very strong exchange rate over most of the past decade is commonly explained by the resources boom and our exceptionally favourable terms of trade as a result of record high prices for coal and iron ore. Its rise can not be explained by any increase in our interest rates relative to the major economies, even though their rates have been at rock bottom since the global financial crisis. But this has not discouraged people adversely affected by the high dollar from convincing themselves the high rate is the product of currency market speculation or our relatively high rates since the GFC, and then arguing the RBA should make a big cut in our cash rate with the express purpose of engineering a big fall in the dollar.

Our terms of trade began falling in about September 2011, but the dollar didn’t start to fall until April 2013. This delay probably encouraged people to switch to a different theory. They may have thought the RBA was being too cautious in the speed at which it was bringing rates down.

Although no one can be too dogmatic about these things, the RBA does not believe the interest rate differential has very much effect our exchange rate. And this is despite the signs we see that expectations about whether the RBA will or won’t move rates haves an immediate effect on the bill rate. These effects are very temporary. During the period in which the RBA was lowering rates and openly expressing its hope that the dollar would fall to a more appropriate level, many people concluded it was cutting rates in the hope this would lower the exchange rate. It wasn’t. Rather, it was loosening monetary policy because the exchange rate wasn’t coming down. That is, it was trying to ease pressure on the tradeables sector as a substitute for a lower dollar.

Although the Aussie stayed high for about 18 months after commodity prices had fallen sharply, it has fallen by about 10 per cent since April 2013. Some people may attribute this to steady easing in policy over most of that time, but the BRA doesn’t agree with them. A much more likely explanation is that the Aussie finally began falling when Wall Street began worrying that the long-awaited pickup in the US economy would prompt the Fed to start ‘tapering’ the size of its quantitative easing. QE - the central bank’s purchase of bonds and other securities which are paid for merely with bank credits - puts downward pressure on a country’s exchange rate.

The point to note is that the exchange rate is a relative price - the value of my currency relative to the value of yours. So it shouldn’t be so surprising that changes in the level of our exchange rate need to be explained in terms of changed conditions in the US as well as changes in Australia.

Why are our interest rates always higher than other people’s?

Short answer: because we’re riskier. It’s true our interest rates are almost invariably higher than those in the major economies. This has been true for many years. It wasn’t hard to understand before the mid-1990s - when our inflation rate was still well above everyone else’s - but it remains true even when you compare real interest rates.

The explanation seems to be that, as a nation of perpetual net borrowers from the rest of the world (we run a persistent current account deficit), we are required to pay our foreign lenders a significant risk premium on top of the going international rate to compensate them for the extra risks they run in lending to a country that already has a very large net foreign debt and that, being a relatively small economy, is perceived to be more volatile (even though that’s not always true).

Another way of putting it is that Australia always has higher interest rates because we’re a country with an abundance of potentially profitable investment projects relative to the major economies. Our projects have to be relatively profitable or we wouldn’t be able to continue borrowing despite the high risk premium foreign lenders require us to pay.

Does a budget deficit mean fiscal policy is expansionary and a surplus mean it’s contractionary?

Short answer: no they don’t. Life would be very simple for students of macroeconomics if they did, but unfortunately they don’t. Why not? Because what macro economists focus on is not the level of economic activity, but the change in the level - that is, whether the economy has been/will be expanding or contracting. That means they’re interested in determining whether the budget - fiscal policy - is making a positive or negative contribution to economic growth. So it’s the change in the budget balance - and the direction of the change - that matters when assessing whether a particular budget is expansionary or contractionary.

These days the RBA and most market economists assess the stance of policy adopted in a particular budget simply by looking and the direction - and size - of the expected change in the budget balance between the previous year and the budget year. An expected reduction in a deficit or increase in a surplus is regarded as contractionary; any expected increase in a deficit or decrease in a surplus is regarded is expansionary. As a guide, the change needs to be equivalent to at least 0.5 pc of GDP to be significant. A change of 1 pc or more is extremely significant.

Strict Keynesians, however, define the stance of fiscal policy differently, distinguishing between changes in the cyclical component of the budget balance (caused by operation of the budget’s automatic stabilisers as the economy moves through the business cycle) and changes in the structural component (caused by governments’ explicit changes to taxes and spending programs). So they define the stance of policy adopted in a budget according to the direction of the expected change in the structural component arising from the net effect of the spending and taxing changes announced in the budget. They ignore the change in the budget balance caused by the economy’s effect on the budget, focusing on the change caused by the budget’s effect on the economy.

Note, changes in the stance of fiscal policy will be only one of the factors contributing to whether the economy is expanding or contracting. Other factors include: the stance of monetary policy, movements in the exchange rate, changes in the world economy and in confidence.

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Why election campaigns have become so vacuous

For many of us, the big question isn't who should win the election - or who will - but why election campaigns have become so vacuous. Why so much politics but so little policy? So much argument but so little debate? So much sound and fury signifying not very much?

No doubt there are many reasons but I suspect an important one is that campaigning has become more professional, more scientific. The consultants and others who advise politicians have caused them to think more deeply about what they do and why they do it, what works and what doesn't.

The result is a more pragmatic, even ruthless attitude. It's not their job to foster debate, or ensure voters are fully informed on the choices available to them. And being open and accountable is more likely to lose you votes than win them.

If it's just about attracting enough votes to win, and that's not easy, better not to waste time on anything that doesn't do much to help. Why waste your energy trying to win the votes of people who long ago decided not to vote for you or those who are always going to vote for you?

So these days campaigns are directed at people who haven't made up their minds. It would be nice if these were people who were so deep into the policy choices they needed some extra convincing.

Sadly, politics doesn't work that way. The people whose votes are up for grabs tend to be those who don't have strong opinions, aren't ideological and don't take much interest in politics until the election is upon them.

I'm breaking it to you gently that modern election campaigns aren't aimed at anyone smart enough to read a paper like this one. They're for the people who don't think, not the people who do. So campaigns have become less cerebral and more emotional.

Politicians care more about the ads they run on telly than their televised debates. They find simple slogans and pithy sound bites more effective than complex arguments. They find scare campaigns - on the carbon tax, WorkChoices, the mining tax, debt and deficit, and the goods and services tax - very effective with people who are guided more by feelings than thought.

The way politicians look and sound has become as important as what they say. Perceptions matter more than reality.

Few of us have face-to-face contact with politicians during campaigns, so almost all we know comes to us via the media. So campaigns are a product of the symbiotic relationship between politicians and the media.

But the news media have long been in competition with the ever-growing range of other ways for people to entertain themselves in their spare time. So the news media have had to step up the entertainment content of their news, treating politics as a form of football - who's winning in the polls, who won the week, who's got a problem with their hammies - bringing us endless colour and movement on the campaign trail and eternally searching for laughable "gaffes".

The more the media try to keep news entertaining, the more they keep searching for novelty and changing the subject. They see themselves as catering to their audience's ever-shortening attention span, little realising that by changing the subject so often they're helping to shorten that span even further.

The opposition could have released all its policies weeks ago but it didn't because it needed to "maintain momentum" by releasing individual policies every few days during the five-week campaign. Because of this, we're told, it's unable to tell us how its promises will be paid for until the last week.

But this preoccupation with changing the subject combines badly with each side's strategy of focusing attention on a few issues it knows from its focus groups are its strengths, while shifting attention away from those issues it knows are points of vulnerability.

The amazing result is the large number of important policy changes in this campaign that have been announced but never referred to again as the campaign rushes on to something new. Sometimes both sides are in tacit agreement to slip through a tax increase without it being noticed. More often, one side checkmates the other on an issue, so there's nothing left to talk about.

Thus are we robbed of real choice by two sides who've done nothing but argue furiously throughout the three years of minority government.

Under the heading of looming tax increases it suits neither side to talk about (and so go unexamined by the media) the 0.5 percentage point increase in the Medicare levy, an effective doubling of the tax on cigarettes and a new tax on bank deposits likely to be borne by people with home loans.

Under the checkmate heading are the bipartisan promises to not make further changes to superannuation tax concessions (the biggest middle-class welfare rort of them all), to implement the Gonski school funding reforms (provided you don't read Tony Abbott's fine print), to implement the national disability insurance scheme (and worry about the full cost later), to leave the GST unchanged (and thus keep state spending on health and education under an unrelenting squeeze) and to waste yet more taxpayers' money chasing the pipedream of Northern Development.

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Mixed motives for Hockey’s budget intransigence

Joe Hockey has many reasons - worthy and unworthy - for avoiding making any firm commitment on when an Abbott government would get the budget back to surplus.

Starting with the worthy ones, Hockey is perfectly justified in saying the outlook for the economy as it makes the transition to more normal sources of growth is far too uncertain, and the consequent forecasts and projections for the budget balance shown in Treasury's pre-election economic and fiscal outlook far too unreliable, to provide any sensible basis for such a commitment.

Everything Treasury said in the outlook about its uncertainty and the fallibility of its forecasts confirms the foolishness of treating the latest estimates as offering anything but the roughest of rough ideas of what the future holds.

What Hockey is not justified in doing is impugning the professional competence of Treasury - when it comes to guessing the future, the econocrats are at least as good as the rest - or implying it had been got at by its political masters. Nor is he justified in telling the punters that wrong forecasts equal economic mismanagement and profligate spending by Labor.

The second worthy reason for the Coalition parties to make no firmer commitment than their uncheckable promise to always do better than Labor is that, despite their fear campaign on the evils of deficit and debt, sensible fiscal policy tells us there's no urgency about getting the budget back to surplus.

When the Rudd government laid out its "deficit exit strategy" in its second big fiscal stimulus package in February 2009, it specified that the strictures it would impose on itself - to avoid more tax cuts and limit the real growth in government spending to 2 per cent a year - wouldn't take effect until the economy had turned up and was back to growing at its medium-term "trend" rate (3 per cent a year).

For as long as it seemed the economy had returned to growth at or near trend, it was reasonable to stick to those strictures and thereby do nothing to hinder the budget's automatic stabilisers in their role of returning the budget to surplus as the expansion proceeded.

With hindsight, however, it is clear growth has reached or exceeded 3 per cent only in one year - 2011-12 - since the global financial crisis hit in 2008-09. It was well below trend in the first three years. For the past financial year growth is now expected to be 2.75 per cent, falling to 2.5 per cent in 2013-14.

This below-par performance was concealed by Treasury's persistent over-forecasting of real growth. And that's before you get to its recent over-forecasting of the growth in nominal gross domestic product - and thus tax collections - because it underestimated the fall in export prices.

The point is that the bipartisan "medium-term fiscal strategy" simply requires governments to let the automatic stabilisers do their job of returning the budget to surplus without hindrance by explicit policy decisions.

You don't make the deficit worse - after any initial temporary stimulus - but nor are you required to hurry things along except to the extent that you're acting to reduce any structural - that is, longer-term - component of the deficit once strong growth has resumed, and such efforts won't be counterproductive ("pro-cyclical") as they've proved to be in Europe.

Of course, none of this absolves the Coalition from its obligation to show how it will pay for its election promises, with costings done by the Parliamentary Budget Office and consistent with Treasury's costing conventions - as applied to their Labor opponents - not fudged-up costings supposedly audited by some underqualified, little-known firm of accountants, as in the last election, nor some panel of retired worthies with no access to the multitude of data needed to cost programs with any accuracy.

And the unworthy reasons for avoiding any firm commitment on when an Abbott government would get the budget back to surplus? I can think of three. Because it's a safe bet the Coalition parties intend to put their debt-and-deficit rhetoric on the back burner as soon as they're back in power and the fear campaign has served its purpose.

Because, even in government, Tony Abbott is likely to prove an incorrigible populist with little interest in or sympathy for the precepts of rational economics. As is clear from the way he keeps departing from the agreed line in this campaign, Hockey, Arthur Sinodinos and Malcolm Turnbull would have an unending struggle trying to keep the boss up to the mark. He could easily prove worse than Kevin Rudd in fiscal indiscipline.

And, finally, because an Abbott government would have handicapped itself so badly on the tax side of the budget that fiscal responsibility would require a degree of continuing restraint on the spending side of which no flesh-and-blood government is capable.

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Budget forecasts for adults only

When Treasury and the Department of Finance issued their pre-election economic and fiscal outlook statement this week it had something written on the cover in invisible ink: Why don't you all grow up!

Although the figures in the PEFO ("pee-fo") for the forecast and projected growth in the economy and the change in the budget balance over the four years to 2016-17 were virtually identical to those in the Labor government's economic statement 11 days earlier - no surprise to anyone except conspiracy theorists - the words were quite different.

What Treasury issued was a kind of adults only version of the government's document, a rebuke to people who think knowing what the future holds is easy peasy and anyone who gets their forecasts wrong must be either incompetent or corrupt.

The Labor government was so unsophisticated in its understanding of the limitations of forecasting it took a Treasury projection of the budget balance in four years' time and raised it to the status of a solemn promise. No one working in Parliament House thought this a foolish thing to do.

The first thing Treasury does in the PEFO is stress that, while all forecasts are uncertain, the economy's transition to new sources of growth make these forecasts particularly so. It said the transition "may not occur as smoothly as forecast" twice on the first page.

Cop this for a product warning: "This uncertainty surrounding global growth prospects poses a risk to the terms of trade and nominal gross domestic product forecasts. There is also a risk that the anticipated fall in resources investment following its peak could be sharper than expected, especially around the middle of the decade. In addition, the transition to new sources of growth may not occur as smoothly as anticipated. Unexpected global or domestic developments could also generate further sharp movements in the exchange rate."

It's long been the convention to express forecasts as a "point estimate" - a single figure rather than a range. But quoting single figures gives the forecasting exercise an air of false precision which can mislead the uninitiated.

So Treasury has joined the Reserve Bank in showing the "confidence interval" surrounding its key point-estimate forecasts. It has examined the (lack of) accuracy of its forecasts over the past 13 years and used this to show its latest forecasts over a symmetrical range, with its point estimate the central forecast within that range.

Its central forecast is that real GDP will grow at an average annual rate of 2.75 per cent over the two years to 2013-14. So if you assume its forecast errors are similar to those in the past, and also assume its forecasts are just as likely to prove too high as too low, there is a 70 per cent probability that actual real growth will average somewhere between 2 per cent and 3.5 per cent (that is, the central forecast plus or minus 0.75 percentage points).

Its central forecast is that nominal GDP will grow at an average annual rate of 3.125 per cent over the two years. So there's a 70 per cent chance the actual rate of growth will average between 1.75 per cent and 4.5 per cent (central forecast plus or minus 1.375 percentage points).

Why is the confidence interval for nominal GDP so much wider than for real GDP? Because, to get to nominal, you also have to forecast the GDP inflation rate (strictly, the GDP deflator) and it's much more uncertain because it's heavily affected by the change in the terms of trade (export prices divided by import prices) and thus the prospects for world commodity prices.

Why is the GDP inflation rate forecast to be so small, just an average rate of 0.375 a year? Mainly because export prices are expected to fall a fair bit further.

Why does the growth in nominal GDP matter much? Because, as Wayne Swan never tired of pointing out, we live in - and pay tax in - the nominal economy; the real economy is just a (useful) concept.

It was because Treasury kept under-forecasting the rise in export prices that it kept underestimating the improvement in the budget balance in the early years of the resources boom. It's because it's been under-forecasting the fall in export prices that it's been overestimating the improvement in the budget balance in recent years.

Another aspect of the politicians' and media's incomprehension of the budget figuring is their failure to understand the difference between forecasts and projections. By government decision, the figures for the budget year and the first year of the forward estimates are forecasts - that is, Treasury's best guess on what will happen. But the last two years of the forward estimates are merely projections - that is, you assume it will be an average year and mechanically plug in the figures accordingly.

You assume "trend" real growth of 3 per cent, trend employment growth of 1.5 per cent, inflation at the middle of the Reserve Bank's target range - 2.5 per cent - and unemployment at what the econocrats consider to be its lowest sustainable rate (aka full employment), 5 per cent.

This makes it all the more foolish for the government to turn a mere projection of the budget balance in four years' time into a solemn promise, and for the rest of us to take it seriously.

It also means you can get some literally incredible jumps between the last forecast year and the first projection year.

For instance, between 2014-15 and 2015-16, the unemployment rate is supposed to drop from 6.25 per cent to 5 per cent, even though real growth stays unchanged at just 3 per cent.

Treasury uses the PEFO to show what it would have forecast for the last two years of the forward estimates had it not been required to use projections, and drops a big hint it will ask the "future government" to change the rules to four years of forecasts.

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City and country problems all demand higher taxes

At last we've settled on an election issue of substance: did Kevin Rudd use notes in the TV debate and was this against the rules? And that's not all: did he rustle his notes and, if so, was this deliberate or just a nervous mannerism?

The two leaders' aim in the debate was the same as their aim in this campaign: to make it to election day while giving as few commitments as possible about what they'll do in the next three years.

I wouldn't mind so much if they were trying to stay unencumbered, able to respond to any eventuality. But actually they're trying to create the illusion that everything they have planned will solve our problems without any price to be paid.

Tony Abbott keeps telling us about all the taxes he plans to abolish but not how he'll cover the loss of revenue, except to say he'll get rid of government waste. Sure.

In response to Rudd's embarrassing "cheap scare campaign" on the goods and services tax he assured us that "the GST is not going to change", but avoided answering a question on how long that guarantee would last.

By the end of the next day, however, the pressure had become irresistible and he ruled out changing the GST for as long as an Abbott government lasts. In modern campaigning, tough issues aren't debated, they're closed off.

And on when Sydney will get a second airport, both men are evasive. In the 40 years since Gough Whitlam asserted "you're getting Galston", successive governments have pushed the decision aside.

These guys touch on matters of concern to ordinary people's ordinary lives but they rarely get to grips with them. Consider the findings of the latest Ipsos Mind and Mood report on differences between the city and the country, Life in Two Australias. A series of 16 group discussions in Sydney, Melbourne, Tamworth, Townsville and Bunbury finds that, whatever their complaints, country people prefer the country and city people prefer the city, though country people do seem more effusive.

They see their lives as low-stress, with friendly faces, open spaces and manageable mortgages. It's a cleaner environment where their kids can get dirty. Parents feel their kids get great formal education but are also more rounded and grounded in their social and communication skills.

"Skinny-dipping, fishing, four-wheel driving, open fires and bartering were cherished aspects of a free-range, unconstrained regional lifestyle," the researchers, led by Dr Rebecca Huntley, report.

And the big drawback? "It is healthier to live in the country unless you're sick." Poorer access to good quality health services was a key disadvantage of regional centres, sending the sick onto long local waiting lists or down the highway in search of help in the city.

Although country participants felt they had a monopoly on community spirit, city people valued social inclusion and connection with their neighbourhoods. And though their green spaces and open places may be smaller, they're valued.

The high cost of housing and rising living costs were key motivations for considering a move to the regions. Country life looks attractive to stressed-out city residents, young families and retirees.

But could they leave family and friends? What about the horror stories of inadequate country health services? Would there be enough shops and enough entertainments to keep them amused? And would they be welcomed? "Rumours of gossip-laden, judgmental, close-knit social networks that could be hard to break into fed fears of potential social isolation," the researchers find.

How does this discussion of ordinary life fit with the preoccupations of the election campaign? Well, it's clear adequate healthcare and access to doctors is a major concern for country people.

But health is one of the issues being closed off. There's a lot more needing to be spent. But Labor is being pilloried for its increased spending (on health as much as anything) and the focus is on criticising tax increases, cutting company tax, abolishing new taxes and swearing never to increase old ones.

For city-siders, however, the big issue is roads and public transport. "The lengthy commute in bumper-to-bumper traffic is literally driving people out of our capital cities to regional Australia in hope of recovering wasted hours spent in the car each day," the researchers say. City drivers feel forced to take to their cars because of inadequate public transport, while country people envy their trains, trams, buses and taxis.

Ah, here we may have found a match. Although Rudd hasn't had much to say about roads and transport, Abbott says he hopes he'll become known as an infrastructure prime minister and reels off a list of city road projects he wants to fund.

Sorry, but I'm not convinced. The Coalition doesn't seem to have learnt what I thought everyone realised by now: building more expressways solves congestion only for long as it takes more people to switch to driving their cars.

The problem is reduced only by improved public transport. But Abbott would revert to the view that the feds don't finance urban public transport projects.

So leave it to the states. But they've just had their finances crimped by his promise never to repair the premiers' biggest but ailing source of revenue, the GST.

And both sides' belief that government debt is evil condemns us to a life of inadequate public infrastructure.

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How controversial change can still be achieved

As you see from Tony Abbott's unceasing attack on new taxes and both sides' wariness on calls for an increase in the goods and services tax, the politicians on both sides are certain voters are united in not wanting to pay a cent more in taxes.

This certainty is unshaken by much opinion polling seeming to suggest the contrary.

Which makes it remarkable that, with a minimum of fuss a few days before this year's budget, both sides agreed to raise all rates of income tax by half a percentage point from next July, and that this decision prompted hardly a peep from the public.

It's even more remarkable that this remarkable event has passed almost completely unremarked. The nation's usually unshut-upable media commentariat forgot to comment. Why? Because this highly unusual event happened so quickly and without controversy.

If you're not sure what I'm talking about, it's the decision to partially fund the national disability insurance scheme by increasing the Medicare levy from 1.5 per cent to 2 per cent. But why did this potentially unpopular event cause no controversy?

First, because the tax rise was directly linked to a popular new government spending program. The economic rationalists' long-standing disapproval of "hypothecation" is too rational by half. It fails to understand that accepting the need for higher taxes is an emotional judgment, that government and its budgets have become so huge and complex people can't see the connections any more and have become alienated from the process.

People are reluctant to give governments an open cheque: "How do I know what you'll use it for?" It amazes me economists can't see that people are attracted by the logic of a normal consumer transaction: if you want some item you have to pay for it; if you pay out money you expect to get something back in return.

But the second reason the decision to raise income-tax rates aroused little public opposition is because it became bipartisan. When oppositions oppose government reform proposals, the media seize on the controversy and give it much publicity.

All those who fear they may be adversely affected have a flag to rally around. And it's not just that. Many people take their attitude to a policy proposal from the stance adopted by the party they habitually support.

But when the potential opponents of a measure have no champion to rally around or see little sign of public sympathy for their objections, they tend to shut up and go along with the herd.

It surprises me that the advocates of controversial economic reform keep banging on about the need for our politicians to "show leadership" - that is, risk being tossed out of their jobs - when the clear lesson of history is that the Hawke-Keating government showed so much leadership in initiating micro-economic reform as it knew John Howard and John Hewson wouldn't seek partisan advantage by opposing reforms they, too, believed in.

Look at the way Labor toyed with a broad-based consumption tax while in government, but bitterly opposed it when the Howard government proposed it. And then, once in government, never for a moment considered modifying the supposedly evil tax.

Look at the way the Coalition took a carbon emissions trading scheme to the 2007 election to match Labor but then, when relegated to opposition, vociferously condemned essentially the same scheme. Previously silent climate-change deniers were let out of the closet.

And now look at the way Abbott opposes Labor's overt subsidies to the moribund motor vehicle industry but then opposes its reform of the fringe benefits tax on company cars because it would remove a hidden subsidy to the industry.

Or look at the way he criticises so many of the more recent tax increases and other measures Labor has used to try to plug the budget deficit, while carefully avoiding promising to reverse them in government.

The conclusion is clear: these days there's little ideology or principle in the opposing positions the parties adopt, just opportunism. You would implement much the same policy if you were in government but, since you're in opposition, you seek to gather the support of whoever is disaffected with the policy.

Our rival management teams are always seeking advancement by concocting difference where little exists. So the key to getting controversial reforms implemented is not to urge governments to be brave but to persuade their opponents to exempt this particular measure from their efforts to differentiate themselves, foster discontent and collect the support of disaffected minorities.

Obviously, two-party democracies work on oppositions opposing. But that doesn't require them to oppose absolutely everything.

This approach isn't likely to work, however, if the term "reform" is merely being used to disguise business rent-seeking. You do need genuine national interest.

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