How six states became one economy

It's been a year of anniversaries: 50 years since The Australian Financial Review became a daily, 30 years since the floating of the dollar, 21 years since the Council of Australian Governments replaced the special premiers' conference and 15 years since the start of the national electricity market.

In the Fin Review's self-congratulatory anniversary edition - apparently, the paper brought about micro-economic reform single-handedly - one of my old bosses, Vic Carroll, made a point most of us have forgotten, if we ever knew.

Before Paul Keating began opening Australia to the world in the 1980s, we first needed to break down the barriers between the six states to get one national market. In theory we've had a common market since Federation; in practice it didn't start until the 1960s.

We had separate stock exchanges and even big companies tended to stick to their own state. Coles and Woolworths didn't start to invade each other's home states until the 1960s. The big banks were concentrated in their home states until eight merged to become four in the early 1980s.

For many years the brewers defined much of the Riverina as part of Victoria and thus out of bounds to Sydney-based Tooth and Co. It took the Trade Practices Act of 1974 to make agreements on competition-reducing territorial carve-ups illegal.

A main role of COAG has been to gain agreement between the states to align their regulation of markets and in other ways facilitate cross-border trade. Progress has been painfully slow and at Friday's meeting it gave up trying to introduce a national occupational licensing scheme.

But that makes COAG's initiative of establishing a national electricity market (covering all states bar WA) in 1998 the more remarkable. Before then, we had six separate, state-owned vertically integrated monopolies.

The Australian Energy Market Commission has celebrated the national market's 15th anniversary by commissioning KPMG consultants to prepare "a case study in successful micro-economic reform". The idea was to record the insights of key players before they were carted off to retirement homes.

It took eight years of preparation before the market began. Step one was for each state to break its monopoly electricity commission into separately owned power generators and separately owned electricity retailers, leaving the transmission and distribution network ("poles and wires") as the irreducible natural monopoly.

The generators could be made to compete with each other (and probably privatised) and the retailers made to compete with each other (and privatised) by giving them equal access to the network.

The hard part was setting up the continuously trading wholesale auction market in which competing generators supply power to competing retailers. Once the state networks had been physically connected to a single grid, this was made possible by the "fungibility" of electricity. If one unit of power is identical to any other, I don't have to actually generate the power I end up selling you.

That's handy, but it makes the market, with all its derivative contracts, horrendously complex. Its smooth operation is a notable tribute to the economist's art: it's a quite artificial, geek-designed, government initiated and regulated market. T. Abbott and other sceptics please note.

The case study should prove a useful guide to would-be reformers. One tip is that this radical change was achieved through many small steps. Each state set up its own market before they merged into one after many trial simulations.

Though the federal government had no responsibility for electricity, it was deeply committed to micro reform and, since it would benefit from higher tax collections, transferred these to the states as incentive payments for reforms achieved.

No business people or economists need telling that many people find money highly motivating. Premiers more than most. But the study warns "there are risks that the incentive becomes payment maximisation rather than policy optimisation".

Likewise, establishing a competitive industry structure must take precedence over doing things to maximise the proceeds from privatisation. "Incentive payments are not a substitute for mutual commitment to policy outcomes," we're told.

Careful planning, widespread consultation and good processes are all necessary, but the study emphasises the key role of committed leaders. At the political level, reform was pushed by Bob Hawke and Nick Greiner, by Paul Keating and Jeff Kennett, then by John Howard.

But the person who deserves greatest approbation was the chairman of the National Grid Management Council, John Landels, formerly of Caltex. His strengths were he was beholden to no one, kept the board focused while letting the technocrats get on with the details, and he had pull with prime ministers and premiers. And I doubt he was doing it for the money.

Read more >>

Holden's fate will have little effect on economy

Contrary to appearances, the economy is not falling apart nor has the Abbott government taken leave of its senses.

The threat to the economy from Holden's decision to cease making cars has been greatly exaggerated by those with axes to grind - the opposition, the motor vehicle union and other industry apologists, plus the overexcited media.

The greatest threat comes not from what happens to the car industry - nor from Qantas' plan to lay off 1000 workers - but from the risk that all the talk of job losses could leave people in industries far removed from the troubled sector with an exaggerated impression of their chances of losing their own jobs, prompting them to become more cautious in their spending and housing decisions.

There is no denying the Abbott government is off to a rocky start, with its backing and filling over the Gonski education reforms, its ruminations over continued Australian ownership of Qantas, and its refusal to permit the foreign takeover of GrainCorp casting doubt over Tony Abbott's election-night claim that Australia is now ''open for business''.

What we have had from Abbott is clunkiness. It's been hard to detect the hand of a government that knows what it is doing and where it is heading, let alone one that can articulate its destination and reasons for wanting to take us there.

But its most controversial decision so far - to decline to keep paying the protection money demanded to defer General Motors' departure from production in Australia - offers hope that this is a government with the courage to give genuine leadership, to make the unpopular decisions needed to secure our economic future.

If we want the economy to return to a healthier rate of growth, with rising job opportunities, the answer is for our businesses to find new and better ways to make profits, not for them to become ever more reliant on government subsidies.

It is for us to face up to, and adapt to, a rapidly changing world economy, not use taxpayers' money to try to prevent change, eventually turning our economy into an industrial museum.

If we want the federal budget to be returned to balance without huge hikes in taxation, part of the answer is to stop providing welfare to industries as well as people.

It is understandable for older Australians to be sentimental about the end of car making by our first car maker - even though most of us stopped buying locally made Holdens many moons ago, just as most of us have stopped using Qantas to fly overseas.

How much tax are you prepared to pay for sentimental reasons?

It is also understandable for older Australians to worry about the decline of manufacturing. If we stop making things, where will the jobs come from?

Employment in manufacturing has been falling since the early 1970s, during which time the workforce has doubled. Manufacturing now accounts for only about 8 per cent of total employment.

Do you really believe the remaining 92 per cent of us have phoney, inconsequential jobs? The big jobs growth has been in education, health, community and business services. Where will the jobs come from? That's where. The same thing is happening in all the rich countries.

The prospect is for the rate of unemployment to keep creeping up next year until the effect of record low interest rates causes spending on consumption, home building and business investment to recover and take the place of the now-declining investment in new mines.

What happens in car-making will have a negligible effect on what happens to unemployment everywhere except Adelaide. For a start, few jobs will be lost until the plants close in 2016 and 2017.

It's planned that 2900 jobs will go from Holden, with a greater flow-on to the parts-makers. But car and component manufacturing account for only about 0.4 per cent of total employment.

Even the end of local car-making wouldn't mean the end of cars. Saul Eslake of Bank of America Merrill Lynch reminds us there are five times as many people employed in the wholesaling, retailing and maintenance of cars as are employed building them.

Car-making ended in Sydney in the 1980s. Steel-making ended in Newcastle in 1999. Since then, both cities have not only survived, but prospered.

Read more >>

Multi-factor productivity not what it's cracked up to be

Figures for the economy's productivity performance haven't looked good for the past decade, causing consternation among economists and business people. But a careful study by the Productivity Commission has failed to find any particular problem, nor anything we could do to make the figures look better.

Productivity is a measure of the efficiency with which the economy turns inputs of labour and capital into outputs of goods and services. Thus productivity is measured as output per unit of input.

The more we can improve productivity the better off we are. We have in fact being increasing it a little almost every year since the Industrial Revolution, and this is what has made us so much more prosperous. So if you believe the goal of economic management should be to increase our material standard of living (which I don't), nothing is more important than ever-improving productivity.

The simplest (and probably least inaccurate) way to measure productivity is to take the quantity of goods and services produced during a period (real gross domestic product) and divide it by the number of hours of labour required to achieve that production.

Doing this each year shows that our "productivity of labour" improved unusually rapidly in the second half of the 1990s, but then showed little further improvement during most of the noughties. Over the past two or three years, however, it has returned to a reasonably healthy rate of improvement.

But you can improve the productivity of labour simply by giving workers more machines to work with. And this tells us nothing about the efficiency with which the economy's physical capital is being used. So in recent years it has become fashionable to focus on a more sophisticated measure called "multi-factor productivity".

This is the growth in real GDP (output) that can't be explained by any increase in inputs of both labour and physical capital. So, in principle, multi-factor productivity represents "technological progress" - the invention of better physical technology and the discovery of better ways to organise the production of goods and services. It's technological advance that does most to raise material living standards.

When you look at our performance over the past few years you find that, though the productivity of labour has been improving at a reasonable rate, multi-factor productivity hasn't improved. It was this that staff at the aptly named Productivity Commission set out to investigate in a study published last week.

They found that the flat performance of multi-factor productivity in the market economy was explained mainly by an actual decline in the multi-factor performance of manufacturing. So they focused their investigation on manufacturing.

Estimates by the Bureau of Statistics show that between 1998-99 and 2003-04 multi-factor productivity in manufacturing improved at a rate of 1.3 per cent a year. But between 2003-04 and 2007-08 it fell by 1.4 per cent a year. Since then (up to 2010-11) it has deteriorated at the slower rate of 0.8 per cent.

Delving further, the researchers found that two-thirds of the deterioration between the first two periods could be explained by just three of manufacturing's eight sub-sectors. From worst to least worse: petrol and chemicals, food and beverages, and metal products.

Trouble is, they could find "no overarching systemic reason for the decline". That is, no problem or problems you could tell the government it needed to fix.

What they found were several factors that made the figures look bad but weren't actually bad themselves, plus one factor we all know about, can't do much about, but have reason to hope will improve soon: the high dollar.

The metal products industry's poor performance was explained mainly by a big expansion in alumina refining capacity which had yet to come on line. Obviously a temporary problem.

The petroleum and chemicals industry's poor performance was explained to a significant extent by increased investment by petroleum refineries to meet new environmental standards. That is, there was an improvement in the quality of their output which the figures didn't pick up.

The food and beverages industry's poor performance was partly explained by a change in consumer preferences in favour of products made in smaller-scale, more labour-intensive bakeries. No probs if that's what the punters want.

In both petroleum and chemicals and food and beverages the poor performance was explained also by reduced use of production capacity, caused largely by the effect of the high dollar in reducing exports and increasing competition from imports.

But now I must give you the product warning economists keep forgetting. Like so many other concepts in economics, multi-factor productivity is simple in principle but as ropey as hell in practice. Putting a number on the concept requires you to make a lot of unrealistic assumptions (perfect competition, equilibrium, for instance) and use statistics that don't accurately measure what they're supposed to measure.

As the researchers acknowledge, multi-factor productivity is measured as a residual: after you estimate the amount of production you subtract an estimate of the amount of labour used and an estimate of the amount of capital used (particularly dodgy) and what's left is multi-factor productivity.

It's what a modeller would call an "error term" - the net result of all the mismeasurement of output, labour input and capital input. So, as the researchers acknowledge, the figures they have used can't be taken as a reliable measure of technological progress.

My word for it is ragbag: technological progress may be in there somewhere, but so will be a lot of other things, real and non-existent.

You can work out the figures for multi-factor productivity, but if they look good you don't know whether they really are, nor why they are. If they look bad it's the same.

What the Productivity Commission's study tells me is that even with figures that look really bad, it can find nothing amiss. Worrying about measures of multi-factor productivity is jumping at shadows.

Read more >>

AN ECONOMIC RESPONSE TO THE LIMITS TO GROWTH

Mathematics of Planet Earth, Limits to Growth symposium, Parade Theatre, University of NSW, Wednesday, December 11, 2013

Virtually all our business people, economists and politicians have long rejected the contention there are ‘limits to growth’. They are able to do this primarily because their way of thinking about the economy is based on a model of the economy that excludes a role for the natural environment except as a passive supplier of natural resources. This model was developed in the late 19th century at a time when economic activity wasn’t doing much obvious damage to the natural environment and ecosystem services could be regarded as ‘free goods’. More recently, economists have refused to accept that there are limits to growth on the grounds of ‘technological optimism’: should any shortages of particular natural resources emerge, market forces - in the form of very high prices - would call forth technological solutions to the problem.

There is, however, a large element of denial in their reaction because they are so conscious of the material benefits that flow from economic growth. When the economy’s generation of income - and its production of goods and services, which is the same thing, and is conventionally measured by the growth in real gross domestic product - grows faster than the population is growing, income per person is rising, meaning that, on average, our material standard of living is rising. Doesn’t that sound good to you?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

An economic response that accepts there are indeed limits to growth in the throughput of natural resources says, don’t worry, we could rejig economic incentives in a way that discouraged further growth in natural resource use while minimising the economic disruption and loss of livelihood. And this would be vastly preferable to waiting for the economic destruction that would occur if we blindly sought to exceed those limits.

Read more >>

Trans-Pacific Partnership: we pay more for longer

According to someone called Oscar Ameringer, politics is the gentle art of getting votes from the poor and campaign funds from the rich, by promising to protect each from the other. However, when Tony Abbott spoke at the Business Council's 30th anniversary dinner last week, he was very much in protecting-big-business mode.

"On election night, not quite three months ago, I declared that Australia is under new management and once more open for business," he told the captains of industry. "My business - the business of government - should be making it easier for you to do your business because government doesn't create prosperity, business does.

"Governments' job is to make it easier for good businesses to do their best ... that's why almost everything we've done over the past three months has been to make it easier for Australians to do business."

It's possible, of course, that Abbott didn't really mean all that. Perhaps he was just greasing up business people because they were who he happened to be speaking to. Maybe next week he'll tell a bunch of consumers he's doing it all for them.

It's too early to tell just whose interests the Abbott government is seeking to advance. Maybe it doesn't yet know itself.

But I get a bit twitchy when I hear politicians running the line that what's good for General Motors is good for America.

I worry when I hear allegations that Australia bugged the cabinet room of a friendly nation not in the national interest but in the interest of a particular Australian company. Then that one of the politicians at the time has since become an adviser to the company.

I confess to being concerned about what deal Trade Minister Andrew Robb is doing in our name at the Trans-Pacific Partnership negotiations in Singapore this week.

The partnership is a trade treaty the US wants with 11 other Pacific rim countries: Canada and Mexico, Chile and Peru, Australia and New Zealand, Japan and Malaysia, Singapore, Brunei and Vietnam.

The US has been negotiating the treaty since 2006 in what it has insisted be complete secrecy. Although it has no doubt been consulting with its own big companies, and it's a safe bet our business lobby groups have been briefed about the contents of the treaty and have advised our government on their views and goals, the rest of us aren't meant to know what's going on.

Parliament will have to be told the content of the done deal before it votes to ratify any treaty the government has agreed to, but that's all. It's "need to know" and you, dear voter, don't need to know. Leave it to the adults.

Well, not quite. Last month one of the draft treaty's 29 chapters, on intellectual property, was published by WikiLeaks.

This week one country's detailed description of the state of negotiations was leaked. So we know a fair bit about what we're not supposed to know. And what we know isn't terribly reassuring.

What I know about the US government's approach to trade agreements - which doesn't seem to have changed since the deceptively named free-trade agreement we made with it in 2004 - is that its primary objective is to make the world a kinder, safer place for America's chief export, intellectual property: patents, copyright and trademarks - in the form of pharmaceuticals, films, books, software, music and much else.

To this end, the length of copyright would be extended beyond the 70 years to which it has already been extended, and copyright infringement would be made a criminal offence. It would be made easier for pharmaceutical companies to artificially extend the life of their patents and frustrate the activities of others wishing to produce generic versions.

It is clear this would greatly benefit America's big entertainment, software and drug companies.
What's equally clear is that it has no economic justification, being simple "rent-seeking"; government intervention in markets to enhance the profits of particular companies.Rupert Murdoch's 21st Century Fox would be a prime beneficiary.

Since Australia is a net importer of intellectual property, our government ought to be in no doubt the Americans' demands are contrary to our economic interests.

The leaks reveal many dubious demands by the US, but none more so than its promotion of "investor-state dispute settlement" provisions, which would allow foreign companies to pursue legal actions against our government in foreign tribunals if, for example, it were to introduce policies they considered contrary to their interests.

This would give foreign companies an advantage local companies didn't have. The Productivity Commission found such provisions offered few benefits, but considerable policy and financials risks. The former Labor government had a blanket ban on agreeing to such clauses, but Robb's approach is more flexible.

Why would any country agree to such unreasonable demands? Because, in exchange, the Americans are holding out the promise of greatly enhanced access to their markets - in our case, for sugar and beef.

So what we're not supposed to know is that, if the rest of us get sold out, it will all be in aid of Australian farmers. The trouble with running the economy to benefit business is you end up harming some to help others.

But not to worry. The leaks suggest agreement on the treaty is a long way off.

Read more >>

Keating gives Abbott a masterclass

With our neophyte Prime Minister and his Treasurer struggling to find their feet - and a direction to travel in - let's hope they've been watching the ABC's interviews with Paul Keating. If not, they're out on DVD this week.

For those of us who lived through the Hawke-Keating government's extraordinary 13 years - and those who didn't - Kerry O'Brien's four interviews are a reminder of Keating's indisputable claim to be our greatest, most reforming, treasurer.

If you're tempted to doubt that, consider Business Council president Tony Shepherd's description of our economy in the early 1980s. Keating had described it as a "moribund, inward-looking industrial graveyard" and he'd been right, Shepherd said.

"We had a fixed exchange rate, tariffs [on imports] were still high, we were frightened of Japanese investment ... our financial system was tightly regulated, our industrial relations system was centralised, complex and unproductive, and just about every service was provided by the public sector. State ownership extended to banks, insurance, telecommunications, airlines, ports, shipping, dockyards, electricity, gas etc," Shepherd said.

Keating was the instigator of virtually all those reforms. And though many of them weren't opposed by the Coalition opposition, they were radical reforms - brave steps into the unknown - controversial in the community, including among many Labor voters.

O'Brien's interviews reveal Keating in all his strengths and weaknesses. His self-congratulation ("there's nothing there to be humble about"), bravado ("what I love about the Road Runner is he runs that fast he burns up the road behind him; there's no road left for the others"), colourful language ("a pimple on the backside of progress"), disposal of people who got in his way (Bob Hawke, for instance) and revenge against supposed enemies ("don't get mad, get even" - including with Fairfax).

But no leader of this country since John Curtin has more cause for self-congratulation than Keating. No leader is without character failings and Keating's were outweighed by his contribution.

If Tony Abbott and Joe Hockey want their chapter in Australia's economic history to be half as glorious as Keating's there's much they could learn from him, starting with his clear sense of purpose. "I had to make sure this slothful, locked-up place finally became an open, competitive economy."

His vision was of "an efficient, competitive, open, cosmopolitan republic, integrating itself with the Asian region".

"To do what's right and good gives you the surge. Without the surge, what are you? You're just mucking around with tricky press statements, appearances and 'doorstops'." - "You make the political strategy around good policy rather than around trickery."

Keating was a man of courage. "I always believed in burning up the government's political capital, not being Mr Safe Guy." - "You're nobody until you attract a good set of enemies." - "If you run hard enough and fast enough for a great change you'll get it." - "Statecraft and nation building are about taking the risks and moving the country on."

And a man of toughness. "Nations get made the hard way; nation building is a hard caper." - "You've got to elbow your way through." - "In the end, if you want to get the changes through you've got to hold your nerve and squeeze the system."

Does that sound like any present politician? Last week Hockey said he had an "economic plan" focused on building economic growth. Great. At last. What is it?

"It is focused on getting rid of inhibitive taxes and inhibitive regulation that undermines our capacity to be at our best. We need to speed up the Australian economy and ... if we repeal the carbon tax, it will add to economic growth ... when we get rid of the mining tax it sends a clear message to the world that we need mining investment."

Really? That's the best you've got - to undo the reforms of the previous government? To move to a less economically efficient instrument against climate change and undercharge mainly foreign-owned mining companies for their appropriation of our non-renewable resources? That will balance the budget? That's what will lift productivity? Seriously?

According to Abbott last week, "the challenge is always the same: to build the strongest possible economy with lower taxes and less red tape leading to higher productivity and stronger economic growth ... my business - the business of government - should be making it easier for you to do your business".

Really? Easy as that, eh? No need for courage or toughness. No need to do anything that won't win a vote of thanks from the Business Council.

Read more >>

Mining still driving economy - slowly

The economy performed poorly in the September quarter, but that's OK. It was all Labor's fault, but now Labor is out. From here on it will be the Coalition's watch and everything will be much better. Or not. At least from here on Joe Hockey will be talking the economy up - as a treasurer should - not talking it down.

The national accounts we got this week show the economy grew by only 0.6 per cent in the quarter and by 2.3 per cent over the year to September. According to Hockey this shows "an economy that is growing below trend, with a soft labour market, cautious consumers and plateauing business investment".

That's the frankest assessment we're ever likely to get from the man. Although no one can say with confidence what the future holds, the best guess is that, this time next year, the economy won't be growing much faster than it is now. The non-mining economy should have picked up a bit by then, but this may be offset by big falls in mining investment spending.

As it is now, the national accounts show little strength in the rest of the economy, leaving mining accounting for what growth we did get. Starting with consumer spending, it grew by just 0.4 per cent in the quarter and by 1.8 per cent over the year to September.

That's well below its trend rate of about 3 per cent and is explained mainly by weak growth in employment (a smaller increase in the members of households earning incomes) and slower growth in wage rates. Households saved 11 per cent of their disposable income, roughly what they've been saving for three years.

Overall, home building activity fell by 0.5 per cent in the quarter to grow by just 1.7 per cent over the year, but this was because another fall in spending on renovations outweighed weak growth in the building of new homes.

The fall in renovations is surprising: usually when the buying and selling of homes picks up - as it has - renovations pick up as sellers tidy up for a sale and new buyers undertake more extensive changes.
We've seen an increase in council building approvals that's yet to show up in actual building activity, so perhaps housing will make a bigger contribution to growth in the coming year.

Overall, business investment spending increased by 1.1 per cent, but fell by 2.5 per cent over the year. Within this, mining investment rebounded in the quarter, but still looks like it reached its peak last year. Kieran Davies, of Barclays bank, says he expects mining investment to make a major subtraction from growth as it returns to a more normal level over the next few years.

Non-mining investment spending was broadly unchanged during the quarter and down about 4 per cent over the year. Davies says business confidence has picked up sharply, and this normally leads to increased investment, but the delay varies and at this stage he's not expecting much of a pick-up until later next year.
"This is because relatively low levels of capacity utilisation suggest companies are in no rush to expand, even though they can borrow at record low interest rates and many firms are cashed up," he says.

Public demand - spending by governments and their authorities - was broadly unchanged in the quarter, after rising by 0.7 per cent the previous quarter. Within the lack of change overall, however, a 5.5 per cent fall in public investment spending was negated by a 1.1 per cent rise in public consumption spending (mainly public service wages).

Davies says the fall in investment was driven by lower state capital works spending, but this "could turn around later next year and into 2015" because Hockey is encouraging the states to spend more on infrastructure and may introduce some new arrangements to help the states fund this investment.

The volume of exports grew by 0.3 per cent during the quarter and by 6.1 per cent over the year, while the volume of imports fell by 3.3 per cent during the quarter and 3.7 per cent over the year.

Most of this is explained by mining. Bulk commodity exports are up about 15 per cent over the year, while the fall in mining investment - which is "import-intensive" - accounts for the fall in import volumes.

This means "net exports" (exports minus imports) account for more than all the growth in the quarter, and contributed 2.1 percentage points of the 2.3 per cent growth in real gross domestic product over the year.

Who said the resources boom was over? Developments in the mining industry will go on having big effects on the economy for a long time yet. It won't be long, however, before the negatives exceed the positives. That is, before the decline in mining investment spending (even net of the helpful decline in imports of capital equipment) exceeds the gain from increasing exports of minerals and energy as the new mines and natural gas facilities come on line.

And don't forget the quarter saw a further, mining-driven deterioration in our terms of trade - export prices relative to import prices - of 3.3 per cent, taking the total deterioration since the peak in 2011 to 17.7 per cent. This reduction in our real income contributes to the explanation of why consumer spending has been weak.

Hockey is right when he says other indicators - retail sales, building approvals, business and consumer confidence - have improved since September. And it's reasonable to hope this will lead to a modest improvement in consumption, home building, business investment and other aspects of the non-mining economy.

But we know there will be big falls in mining investment, which could offset most of the gain. There's not a lot Hockey can do about that between now and then. Even infrastructure spending takes a long time to get going.

Read more >>

How patients and taxpayers lose out to chemists

Sometimes the good news just doesn't get through. Did you know, for instance, that the prices of three widely used medicines fell from the start of this month, meaning more than 850,000 Australians will be paying less? As federal Health Minister Peter Dutton announced, this is happening because of a wise policy instituted by the Howard government in 2007.

The saving on the most frequently prescribed medication on the pharmaceutical benefits scheme - the anti-cholesterol drug atorvastatin (known as Lipitor before its patent expired) - will range between $5.58 and $12.51 a script, depending on which brand the chemist gives you.

For olanzapine - used for schizophrenia and bipolar disorder - the saving will be up to $6.69 a script. For venlafaxine - used for major depressive disorders - the saving will be $7.03 to $10.60 a script.

But Dutton is too modest. He didn't mention that the wholesale prices of four other drugs have also fallen, reducing the cost to the taxpayer but not the direct cost to patients.

The pharmaceutical scheme requires patients to make a co-payment of up to $36.10 a script (or up to $5.90 for people with concession cards), with the government paying any amount above the co-payment. So the more the price falls below $36.10, the greater the direct saving to patients.

There's just one problem with all this good news. As Dr Stephen Duckett points out in a report for the Grattan Institute, it's not nearly as good as it should be. The price cuts the government has extracted from the drug companies still leave Australian taxpayers and patients paying about 14 times more for those seven medicines than are paid in New Zealand, Britain and parts of Canada.

Duckett - a hugely experienced health economist - estimates that, had our government driven a deal as tough as other governments, patients would be paying less for all seven of them, not just three. The out-of-pocket saving would average about $21 a drug.

Take atorvastatin (a medicine close to my heart; as close as my blood vessels, in fact). The wholesale price of a box of 30, 40-milligram pills has fallen to $19.32 (the price from the chemist would be a bit higher). The equivalent price in Britain is $2.84 and across the Tasman it's $2.01.

If our price came down that far it wouldn't only be ordinary patients who made savings, pensioners and other concession card holders would too.

Remember, even with our subsidy scheme, plenty of people don't take the pills they should because they find it too expensive. (I'm on seven prescription pills; I can afford it, but plenty of people my age can't.)

There was a time when Australians paid less for medicine than most people in developed economies. Now we pay high prices because John Howard decided to go easy on the international drug companies. In its six years in office Labor did little to remove this rort. Why not? Keep reading.

The change came when a lot of widely used medicines came to the end of their patents. A patent gives its holder a monopoly over production of that drug. It can charge a very high price for the drug, one far above its cost of production.

Governments choose to grant patents and so allow overcharging to encourage companies to incur the high costs and risks of developing new medicines.

But when the patent expires, other companies start producing generic versions (all of them still required to meet standards set by the Therapeutic Goods Administration) at very much lower prices.

Governments in other countries determine the lowest price being charged and that is what they pay when buying for their pharmaceutical subsidy schemes. In Australia, however, we decided to go easy on the drug companies. When the drugs first came off patent, we cut the price by only about 30 per cent.

Then Howard introduced a complicated "price disclosure" system, which has the effect of lowering the prices of generic equivalent drugs very slowly. Presumably, if we wait long enough, prices will get down to where they already are in countries that do a better job of protecting their citizens. In the meantime, our government has required us - as taxpayers and patients - to pay far more for our medicines than we need to.

But why? Well, I don't believe it's because many of the drug companies had their headquarters in Howard's electorate. Nor are many of the pills manufactured in Australia. No, it's because the drug companies cut our chemists in on the deal.

Because so many of their patients trust them, chemists are politically powerful. If any government were to cut too far into the taxpayer subsidy our chemists have long enjoyed, the chemists would go on the war path against that government.

Duckett - who knows where the bodies are buried - estimates we are paying more than $1 billion a year too much for generic drugs, with most of that picked up by the taxpayer.

Soon we will get the midyear economic statement with its cuts in government spending. There will be more cuts in the budget in May. Some will affect you.

Joe Hockey will assure you he had no choice. What he will mean is that he's less afraid of you than your chemist.

Read more >>

What if growth slowed to a trickle and no one cared?

It is the professed belief of almost every economist, business person and politician that Australians require governments to achieve maximum improvement in their material standard of living. I'm not sure that's true - but we're about to find out.

Of late the econocrats have been warning that, unless we undertake major reform, national income will grow a lot more slowly in the coming decade than it did in the past one. According to Dr David Gruen, of Treasury, gross national income per person grew at an annual rate of 2.3 per cent over the past 13 years, but may grow by only about 0.9 per cent over the coming 10 years.

This projected slowdown is explained mainly by the switch from rising to falling prices for our mineral exports - that is, it focuses on income rather than production. It implies only a small slowdown in the underlying rate of growth in gross domestic product (GDP) per person, being based on the assumption that we maintain our long-run rate of improvement in the productivity of labour - an assumption some may question.

Reserve Bank deputy governor Philip Lowe says that, if we don't achieve a substantial improvement in productivity, "we will need to adjust to some combination of slower growth in real wages, slower growth in profits, smaller gains in asset prices and slower growth in government revenues and services".

So far, these supposedly dire warnings have met with a giant yawn from the public. And, assuming the slowdown comes to pass, I'm not convinced the public will notice it, let alone care. I doubt that we will retain the national resolve to implement the reforms economists say we need to keep incomes growing strongly, nor am I sure the economists' favourite prescription would work. As for myself, I think slower growth could be a good thing.

Would the punters notice? Maybe not. Despite a decade of above-average growth in real income per person, most people would swear that, whoever had been benefiting from the resources boom, not a cent of it had come their way.

For at least seven years, the popular perception has been that people are struggling to keep up with the cost of living - that is, living standards are slipping. And get this: politicians on both sides, who profess to believe that rising living standards are governments' raison d'etre, have fallen over themselves to agree - contrary to all the objective evidence - that times are tough.

Clearly, they believe failing to agree that times are tough is more likely to get them tossed out than falsely confessing to have failed in their supposedly sacred duty to keep living standards rising.

You may object that the punters' failure to perceive that their living standards have been rising may not stop them correctly perceiving that living standards are now rising only slowly. But consider the United States, where real median household income has been flat to down for the past 30 years because almost all the real income growth has been appropriated by the top few per cent.

Have decades of failure to enjoy rising material comfort caused the American electorate to rise up in revolt? Not a bit of it.

It's significant that the advocates of eternal growth never promote it in terms of rising affluence, but always in terms of the need to create jobs. Barring recession, there's no suggestion production won't be growing fast enough to hold unemployment at about 5 per cent over the decade.

Of course, a recession that led to rapidly rising joblessness would undoubtedly cause great voter disaffection, but that's not what we're talking about.

While it may be possible for the economic, business and political elite to agree their precious materialism has sprung a leak and that something must be done, that doesn't mean they could agree on major reform; it's more likely to lead to continued rent-seeking at the expense of other interest groups. If my share of the pie is bigger, what's the problem?

Economists have no evidence to support their fond belief that the burst of productivity improvement in the second half of the 1990s was caused by micro-economic reform. But even if you share their faith, it's a dismal record: if you undertake sweeping reform of almost every facet of the economy then, 10 to 15 years later, you get no more than five years of above-average improvement. What's more, all the big reform has already been done.

With the global ecosystem already malfunctioning under the weight of so much economic activity, it's time the age of hyper-materialism came to an end and we switched attention from quantity to quality.

Read more >>

Rise in living standard set to slow

It's a funny thing about the awful truth: people are much more inclined to talk about it after elections than before. And it seems as though, of late, our top economists have done little but tell us our economic future is a lot more "challenging" than was contemplated during the election campaign.

The first sobering message is that getting the budget back to balance won't be as easy as it suited both sides to pretend in the three-year campaign. Indeed, it could be a struggle that goes on for at least a decade - depending on how long it takes us to face up to some tough decisions.

The next soberer is that our material standard of living is likely to improve at a much slower rate in the coming decade than it did in the last one. We got that warning in a speech last week by Dr David Gruen, the top macro-economy manager in Treasury. And we got it again in a speech this week by Dr Philip Lowe, deputy governor of the Reserve Bank.

The simple way to see what's happening to our standard of living is just to take real gross national income and divide it by the population, to give real income per person.

According to Treasury's calculations, this grew at an average rate of about 2 per cent a year during the 1970s, '80s and '90s. Over the 13 years to this year, it grew by 2.3 per cent a year. But over the coming decade to 2023, Treasury's best guess is the rate of real improvement will slow to a bit less than 1 per cent a year.

That's more than a halving in our rate of material advance. What is it that's expected to cause this marked slowdown? Well, that's a long story. Settle back.

The greatest single factor causing our standard of living to rise almost continuously over the years is improvement in the productivity of labour - that is, increased output of goods and services per hour worked. Labour productivity improves when workers are given more machines to work with, when workers' skills improve because of education and training, when improvements in public infrastructure allow firms to operate more efficiently and, particularly, because of technological advance: the invention of new and improved products and production processes.

The next most important contributor to our material standard of living is "labour utilisation": the proportion of the population that's of the right age to be in the labour force (often taken as everyone aged 15 to 64), the proportion of people of working age who actually are in the labour force, the proportion of these who are employed rather than unemployed, and the average hours worked by people employed (many of whom will be only part-time).

The standard story from economists is that the nation's income increases when we produce more goods and services. But it's not quite that simple. It's not just how much we produce, it's also what that is worth when we sell it to foreigners so we can buy what we want from them.

About 10 years ago the world started paying us a lot more for our minerals and energy - we called it the resources boom - and this increased the income we derived from the stuff we were producing. As Lowe puts it, "over time we have been able to buy more and more flat-screen televisions for each tonne of iron ore that we have sold overseas".

Economists call this an improvement in our "terms of trade" - prices we receive for exports relative to the prices we pay for imports. And the main reason our standard of living rose by a high 2.3 per cent over the past 13 years is the big improvement in our terms of trade.

It contributed about 0.8 percentage points of that 2.3 per cent growth, more than making up for a weaker rate of improvement in the productivity of labour.

But, as we all know, the fabulous prices we were getting for our coal and iron ore started falling back a year or two ago, and Treasury expects them to fall a fair bit further. Indeed, it expects the deterioration in our terms of trade to subtract about 0.5 percentage points from the annual growth in real national income per person.

And there's a second factor we'll have going against us. Until recently, we've been enjoying a "demographic dividend" as the population of working age grew faster than the overall population (mainly because of the falling rate of fertility).

Over the 30 years to 2010, the proportion of the population aged 15 to 64 rose from a bit more than 64 per cent to a peak of about 67 per cent. But now, with the continuing retirement of the baby-boomers, it's projected to fall to about 62 per cent over the coming 30 years.

So whereas until now the demographic dividend has contributed to the rate of improvement in our standard of living, over the coming decade demography will subtract from that rate (we'll have fewer producers relative to consumers).

Now, there's nothing we can do to stop world minerals prices falling back and not a lot we can do to delay the retirement of the baby-boomers. So, ready for the commercial message from your friendly econocrats?

Lowe says that "over the next decade or so, if we are to achieve anything like the type of growth in real per capita income that we have become used to, then a substantial increase in productivity growth will be required.

"If this lift in productivity growth does not take place, then we will have to adjust to some combination of slower growth in real wages, slower growth in profits, smaller gains in asset prices and slower growth in government revenues and services."

Read more >>

Election well over, now for the truth

For three years Tony Abbott and company told us all our political problems were caused by Labor, and if only we elected the Coalition our problems would be no more. For three years Labor told us the budget would be back to ever-growing surpluses in next to no time.

And for six years - which coincided with our biggest boom since the Gold Rush - both sides of politics told us Australian families were having terrible trouble coping with the rising cost of living.

They encouraged us to feel sorry for ourselves, accepted the blame for the heavy burdens we were labouring under, and implied they could do more to help.

What they didn't tell us was the truth: that for most of us, wages and pensions were rising faster than the cost of living - meaning our standard of living has actually been improving - but that this was due partly to the resources boom, which couldn't last, and partly to the government doing more for us in the budget than it could afford to go on doing unless we were prepared to pay a lot more tax.

In the recent election campaign both sides promised a much enhanced scheme to help the disabled and significantly increased funding for schools. To these Abbott added more generous paid parental leave, abolition of the mining tax and abolition of the carbon tax.

What they didn't tell us was that, when you go out beyond the next four years, they had no way of paying for their promises on top of all their existing commitments, which will get ever-more expensive.

So the stories we're hearing now of the federal and state governments' longer-term budget problems must be coming as an unpleasant surprise to a lot of people.

First we had a Productivity Commission report reminding us that increased spending on age pensions, age care and healthcare (for everyone, not just the increasing proportion of old people) - not to mention the cost of superannuation tax concessions - would put growing pressure on the budget, and do so at a time when a smaller proportion of the population was working and paying income tax.

The commission recommended that the age pension age be phased up to 70 and that old people who own their homes be required to borrow against them to help cover the cost of their aged care.

Then we had a report from Melbourne's Grattan Institute estimating that the combined federal and state government budget deficit is likely to grow to $60 billion a year over the coming 10 years.

The institute provided a menu of tax increases for the politicians to pick from: broadening the goods and services tax to cover food and private spending on health and education, removing the tax-free threshold for payroll tax, getting rid of the health insurance tax rebate, restoring the indexation of petrol excise, making the family home subject to capital gains tax, eliminating the 50 per cent discount on the gains tax, or getting rid of negative gearing.

On the spending side, the pollies could cut spending on transport infrastructure, halve industry support, increase university HECS fees, greatly increase school class sizes, cut defence spending or make savings on healthcare.

But Grattan zeroed in on retirement income support. It's already planned to phase up the age pension age to 67 by 2023, but the institute proposes lifting it to 70 by 2025. It's already planned to lift the minimum age for access to superannuation from 55 to 60 in 2024, but the institute proposes lifting it to 70 by 2035. These two measures would save about $12 billion a year.

It suggests including the family home in the assets test for the age pension (saving about $7 billion a year) and reducing the tax concession on super contributions for higher income-earners (saving $6 billion).

This story that the budget will come under pressure is nothing new. We've already had it from three reports prepared by Treasury, from previous Productivity Commission reports and many others.

So let me ask you: What sort of conclusions and recommendations do you expect the Abbott government's commission of audit to come up with? My guess is, not very different to what we've been hearing - though, since it has been contracted out to the Business Council, it may go out of its way to direct the pain away from big business and the well-off.

Since we have to make a lot of tough choices if we're to avoid the North Atlantic economies' record of racking up ever-growing budget deficits and debt for decade after decade, I think pushing back the retirement age makes a lot of sense - more sense than many of the other items on the list.

The already retired and all those not far off retirement wouldn't be affected. But the notion that, despite ever-greater longevity, better health and less physical work, we should remain free in perpetuity to live in taxpayer-funded retirement for 30 years or more is insupportable.

For at least the past six years self-centredness has reigned supreme, with everyone - from big business to alleged battlers - demanding the government do more for them, but insisting others pay for any improvements.

It can't go on. Let's hope Tony's got the ticker to turn things around - and do it fairly.

Read more >>

Budget will test Abbott's mettle

Will the Abbott government ultimately be judged a great reforming government or the worst money manager since Whitlam? In a delicious irony considering all the phoney outrage Abbott & Co expressed on the subject in opposition, this judgment will turn on how they respond to the budget's deep structural problems.

That conclusion leaps out from John Daley's latest budget report for the Grattan Institute. Normally, governments muddle through, taking some tough measures but not enough. In this case, however, Tony Abbott will need to take a lot of tough decisions or be judged a failure who ran a permanent budget deficit and incurred ever-mounting public debt because he lacked the guts to make us pay our way.

Daley finds that, on existing policies, federal and state governments face a decade of structural (operating) budget deficits, which by 2023 could reach 4 per cent of gross domestic product, or $60 billion a year in today's dollars.

About a quarter of this $60 billion arises from the Coalition's election promises. Some of these - the disability scheme and increased education spending - were common with Labor, but not the replacement of the carbon tax with "direct action" (which adds $5 billion a year), nor the more generous paid parental leave scheme.

Three-eighths of the $60 billion arises from the projected increase in spending on healthcare. This comes not so much from ageing as from the unceasing increase in both the supply of and the demand for ever-more-effective, but ever-more-expensive health technology.

One-eighth of the $60 billion arises from "welfare" - mainly, the sad fact that we won't be able to keep widening the income gap between sole parents and people on the dole, and the rest of us, including even people on the pension.

That leaves about a quarter of the $60 billion explained by the likelihood that our return to normal cyclical conditions will involve significantly lower prices for mineral exports and thus lower tax collections.

We can't grow our way out of this deficit. Being "structural", it already assumes the economy is back to growing normally. And above-average growth has much the same effect on both sides of the budget.

With one exception, the only way a structural deficit can be reduced is to make explicit decisions to cut spending or increase taxes. Worse, you have to resist the temptation to make any further unfunded spending or tax-cut decisions just to stop the structural deficit getting bigger.

The exception is bracket creep, which Daley estimates could contribute about $16 billion a year to closing the $60 billion gap. No doubt we'll get a lot of creep, though you can't avoid income-tax cuts for a decade.

Daley's report explodes some budget myths. One dear to the Coalition's heart is that the problem can largely be fixed by eliminating "waste and extravagance", including a bloated public service and (narrowly defined) middle-class welfare.

Sorry, there just aren't enough savings in anything you could do that is remotely feasible. You're talking chickenfeed.

Then there's business' dream that the solution is simple, if a little difficult politically: just cut government spending to fit (and cut company tax while you're at it). When last week's report card from the International Monetary Fund appeared to advocate "sizeable cuts in projected spending", the usual suspects raised a rousing cheer.

Sorry, leaving aside changes to the age pension, the best Daley can come up with on the spending side would produce savings of just $25 billion a year.

These would require reducing spending on infrastructure by a third, halving federal and state industry support, increasing university HECS fees, greatly increasing school class sizes and getting rid of the industry subsidies hidden in the pharmaceutical benefits scheme and defence spending (think subs).

The truth no one wants to know is that we won't get the budget back to structural balance without explicit tax increases. Daley shows, however, we could go a long way by getting rid of some inefficient and unfair tax expenditures, such as the capital gains tax exemption for the family home, the 50 per cent gains-tax discount and negative gearing (worth $22 billion a year in total).

But Daley's big one is retirement income support. Phase up eligibility for the pension or access to super to 70 and save $12 billion a year. Include the family home in the age pension assets test and save $7 billion. Make the super contributions tax fairer and save $6 billion a year.

What's that? You don't see Abbott and Joe Hockey doing anything much on that list? Well, stand by for endless budget deficits and ever-mounting government debt. No guts, no avoiding disgrace.

Read more >>

Outlook for us and the world is sombre

Australia and the world are experiencing a Micawber moment. The economic prospects aren't reassuring, but there's not a lot we can do except hope something will turn up. Wherever you turn, the outlook is for continuing sub-par growth.

According to Dr Min Zhu, a deputy managing director of the International Monetary Fund, in Australia this week, the post-global crisis growth cycle may be coming to an end. At the peak of the crisis in late 2008, most countries gave their economies enormous injections of fiscal (budgetary) and monetary (interest rate and liquidity) stimulus to get them moving.

It worked. After an unprecedented contraction of 0.4 per cent in 2009, gross world product grew by 5.2 per cent the follow year, by 3.9 per cent the year after, then 3.2 per cent last year. Notice it running out of steam? At this late stage it's expected to slow further to 2.9 per cent this year.

If 2.9 per cent doesn't sound too bad, remember the world economy's long-term average rate of grow is 3.5 per cent a year.

In last month's world economic outlook document, the fund warns that "the major economies must urgently adopt policies that improve their prospects; otherwise the global economy may well settle into a subdued medium-term growth trajectory".

Trouble is, Zhu says most countries - rich and poor - have little "space" left for further fiscal or monetary stimulus. Indeed, the policy action the fund is calling for is more structural than cyclical: "strong plans with concrete measures for medium-term fiscal adjustment and entitlement reform" in the case of the United States and Japan, while the euro area "must develop a stronger currency union and clean up its financial systems".

As for the emerging market economies, many of them "need a new round of structural reforms". China, for instance, "should provide a permanent boost to private consumption to rebalance the growth of demand away from exports and investment".

Well that's fine and dandy. But though structural reforms that improve the functioning of the economy may ultimately have a big payoff, it usually takes ages to come through. And often there are costs up-front.

In the meantime the world's left, like Mr Micawber, hoping we turn out to be luckier than the forecasters expect. And the outlook for our economy isn't all that different.

Reading from a graph in the presentation to the Australian Business Economists' annual conference this week by Dr David Gruen, at the time of the pre-election economic update Treasury was expecting growth of 2.6 per cent this year, improving to 2.7 per cent next year.

That compares with the economy's "potential" growth rate of about 3 per cent - the rate needed to hold unemployment steady. So we can expect a continuing rise in joblessness. And the boss of Treasury, Dr Martin Parkinson, said this week that the prospects for the economy had deteriorated a little since the election.

The pundits seem agreed that the economy could return 3 per cent growth in 2016. But that's just the nice way of saying we look like having to endure three years of sub-par growth. Beaudy.

In theory, we do retain "space" to further stimulate demand with either lower interest rates or increased government spending. But rates have already been cut a long way, and the Reserve Bank seems likely to avoid another cut while we see what difference those earlier cuts make.

As for the budget, it has been in deficit for four years already, so no one is keen to go any deeper. At this stage the Abbott government is following the Labor government's policy of avoiding taking measures to hasten the budget's return to surplus - which would, in any case, be counterproductive to some extent at a time when the economy's weak.

But some of the noises Joe Hockey has been making suggest he's preparing to step in with big spending on infrastructure should the end of the mining investment boom cause a much bigger hole in overall demand than we're expecting. Replacing heavy investment in mining with heavy investment in infrastructure would make a lot of sense.

The main thing we are hoping will "turn up" is a turn down in the dollar. Even the fund said this week it believed the dollar was overvalued by about 10 per cent. An exchange rate with the US dollar in the mid-80s would do a lot to stimulate our trade-exposed industries.

Gruen reminds us that, whereas through most of the noughties exports of resources made a contribution to annual growth in real gross domestic product of about 0.4 percentage points, over this year and the next two or three they will contribute well over 1 percentage point.

The decline in mining investment - which itself will make a big subtraction from growth - will also lead to a decline in imports, since mining investment involves a lot of spending on imported capital equipment. That's a saver.

And for those who worry we may be blowing up a housing bubble, Gruen advises that the median capital-city house price has been roughly steady at four times average household disposable income for the past decade and at present is a fraction below four.

If you look at the graph you don't find the ratio has been steadily climbing over the years. Rather, it was a bit less than three times during the 1990s, but then jumped to four times in the early noughties and has stabilised there.

What happened in the early noughties to bring about this change? The return to low inflation and, with it, low nominal interest rates for home loans. This fall greatly increased the amount banks were prepared to lend people on an unchanged income. Australians used this increase in borrowing power to bid up the prices of our housing.

Read more >>

How we lost our way on climate change - sorry, kids

I don't have grandchildren but I'm hoping for some, someday, so this column is for them. I want you to know that although, in the mid-teens of this century, Australians elected a government that wasn't genuine in its commitment to combating the effects of climate change, and that even abolished the main instrument economists invented for that purpose, I never accepted this complacency.

Partly because that government's predecessors had done such a poor job of introducing effective measures - and even a party known as the Greens played its cards all wrong - the nation lost its resolve and allowed its original bipartisan commitment to decisive action to be lost.

The minority of people who doubted the scientists' advice that the globe was warming combined with libertarians - who, as a matter of principle, oppose almost all arguments for intervention by government - to persuade the Liberals to break with bipartisanship.

If the Liberals under their new leader, Tony Abbott, had opposed action against climate change outright, Liberal voters who accepted the need for action would have been forced to choose between the party and their beliefs.

Instead, Abbott focused his opposition on the Labor government's main instrument for gradually bringing about a reduction in emissions of carbon dioxide and other greenhouse gasses, an emissions trading scheme whose price would be fixed by the government for the first year or two.

Abbott insisted the Coalition remained committed to Australia's international undertaking to reduce emissions by at least 5 per cent below 2000 levels by 2020, and by 15 per cent or 25 per cent provided other countries were taking comparable action.

The big difference was that, rather than using Labor's "carbon tax" to achieve the target, the Coalition would rely on "direct action", such as offering monetary incentives to farmers and others to reduce emissions.
This left Abbott free to run an almighty scare campaign about how Labor's "great big new tax on everything" would greatly increase the cost of living for ordinary Australian families and impose big costs on Australian businesses, which would impair their ability to compete.

Abbott associated with outright climate-change deniers and said things that seemed to brand him as one of them, while always adding, sotto voce, that he accepted human-caused climate change and the need to do something about it.

Apart from attracting voters away from Labor and its frightening carbon tax, the result of making climate change an issue of party dispute was to give Liberal supporters a licence to stop worrying about climate change - if the leaders of my party aren't worrying, why should I? - while providing a fig leaf for those Liberals who retained their concern.

The business lobby groups' initial position had been: if it's inevitable we do something, let's get on with it and make future arrangements as certain as possible. But with their side of politics inviting them to put their short-term interests ahead of the economy's long-term health, most business people found it too tempting to resist.

To be fair, some businesses stuck with their schemes to reduce their own emissions and some pressed on with repositioning their business for a world where the use of fossil fuels had become prohibitively expensive as well as socially disapproved of.

You will find this hard to believe, but in the mid-teens, it was still common to think about "the economy" in isolation from the natural environment which sustained it. Economists, business people and politicians had gone for two centuries largely ignoring the damage economic activity did to the environment.

The idea that, eventually, the environment would hit back and do great damage to the economy was one most people preferred not to think about. At the time, it was fashionable to bewail the lack of action to increase the economy's productivity. Few people joined dots to realise the climate was in the process of dealing a blow to our productivity, one that would significantly reduce the next generation's living standards.

At the time, we rationalised our selfishness - our willingness to avoid a tiny drop in our standard of living at the expense of a big drop in our offspring's - by telling ourselves half-truths and untruths about the global nature of climate change.

We told ourselves there was nothing Australia could do by itself to affect climate change (true), that at the Copenhagen conference in 2009, countries had failed to reach a binding agreement on action to reduce emissions (true) and that the world's two biggest polluters, China and the US, were doing nothing much to reduce their emissions.

We had no excuse for not knowing this was untrue because successive government reports told us the contrary. One we got just before the carbon tax was abolished, from the Climate Change Authority, said the two superpowers were stepping up their actions to reduce emissions. "These measures could have a significant impact on global emissions reductions," it concluded.

I recount this history to explain how my generation's dereliction occurred, not to defend or justify it. We knew what we should have done; we chose not to do it. I never fell for any of these spurious arguments.
Did I ever doubt that climate change represented by far the greatest threat to Australia's future economic prosperity? Never. Should I have said this more often, rather than chasing a thousand economic will-o'-the-wisps? Yes.

Read more >>