Big cities have become the engine of the economy

Old notions die hard. If you took all the production of goods and services in Australia and plotted on a map where that production took place, what would it look like?

Any farmer could tell you most of the value is created in the bush. A miner, however, would tell you - a bunch of ads have told you - these days most of the wealth is generated in areas such as the Pilbara in Western Australia and the Bowen Basin in Queensland.

Then, of course, there are the great manufacturing states of Victoria and South Australia - with most work done in the suburbs of Melbourne and Adelaide, but also regional cities such as Geelong.

That make any sense to you? It's completely off beam.

A report issued this week by the Grattan Institute finds that, these days, 80 per cent of the dollar value of all goods and services in Australia is produced on just 0.2 per cent of the nation's land mass. Just about all of that is in our big cities, as close in as possible.

The report, by Jane-Frances Kelly and Paul Donegan, finds that big cities are now the engines of our prosperity. If you take just the central business districts of Sydney and Melbourne - covering a mere 7.1 square kilometres - you have accounted for almost 10 per of Australia's gross domestic product.

What do workers do in all those city offices? Nothing you can touch. That's how much the economy's changed.

To find the economy as many people still imagine it to be, you have to go back 50, even 100 years. About 100 years ago, almost half Australia's population of 4 million lived on rural properties or in small towns of fewer than 3000 people.

Many of these would have been market towns serving the agricultural economy. Agriculture and mining accounted for a third of the workforce. And only about one in three Australians lived in a city of at least 100,000 people.

These days, agriculture employs only 3 per cent of workers and contributes only 2 per cent of GDP. Our two biggest CBDs contribute at least four times that much.

By the end of World War II, manufacturing had become Australia's dominant industry. At its height in 1960, the report reminds us, manufacturing employed more than a quarter of the workforce and accounted for almost 30 per cent of GDP.

The rise of manufacturing shifted much of our economic activity - our prosperity - to the big cities, but mainly to the suburbs. Suburbs away from city centres had lower rents and less congestion.

Postwar growth in car ownership made possible the shift to a manufacturing economy with a strong suburban presence. It also led to the demise of many small towns and the rise of regional centres.

Today, however, manufacturing employs only 9 per cent of the workforce and accounts for just 7 per cent of GDP. The thing to note is that this seeming decline in manufacturing has involved only a small and quite recent fall in the quantity of things we manufacture in Oz.

Similarly, the decline in agriculture's share of employment and GDP has occurred even though the quantity of rural production is higher than ever. The trick is that these industries didn't contract so much as other parts of the economy grew a lot faster, shrinking their share of the total.

One of those other parts is mining, of course. But get this: "While Australia's natural resource deposits are typically in remote areas, workers in cities make a critical contribution to the industry's success," the report says.

"For instance, in Western Australia, where the most productive mining regions are located, more than one third of people employed in mining work in Perth."

That's partly because of fly-in fly-out, but mainly because many of these workers are highly skilled engineers, scientists, production managers, accountants and administrators.

So what explains the greater and still-growing economic significance of big cities, so that Sydney, Melbourne, Brisbane and Perth now contribute 61 per cent of GDP? The rise of the knowledge economy.

Increasingly, our prosperity rests not on growing, digging up or making things, but on knowing things. Our workforce is more highly educated than ever, and this is the result.

"Knowledge-intensive jobs are vital to the modern economy. They drive innovation and productivity, and are a critical source of employment growth. In the last 15 years there has been much higher growth in high-skilled, compared to low-skilled, employment," the report says.

Knowledge-intensive activities aren't confined to jobs in the services sector, but are also increasing in mining and manufacturing. They often involve coming up with new ideas, solving complex problems or finding better ways of doing things.

But here's the trick: it suits many of the knowledge workers, and the businesses that employ them, for those workers to be crowded into big cities, as close in as possible. When you're all packed in together, there's more scope for the transfers of expertise, new ideas and process improvements known as "knowledge spillovers".

Such spillovers come particularly through face-to-face contact. Large cities offer employers knowledge spillovers and a large skilled workforce. They also offer people greater opportunities to get a job, move to a better job, build skills and bounce back if they lose their job.

Read more >>

Mining boom our gift to rich foreigners

The mining tax - whose last-minute reprieve may well prove temporary - is the greatest weakness in the argument that we gained a lot from the resources boom. The blame for this failure should be spread widely, with economists taking a fair share.

Late last week a majority of senators passed the bill repealing the minerals resource rent tax, but not before knocking out its provisions cancelling various programs the tax was supposed to be paying for.

The government is refusing to accept the amended version of the bill, arguing that "by voting to keep many of the associated spending measures [naughty - most are actually tax expenditures], senators have effectively voted to keep the mining tax".

We'll see how long that lasts. But if you're thinking the tax raises so little it hardly matters whether it stays or goes, you're forgetting something. When Labor allowed BHP Billiton's Marius Kloppers and his mates from Rio Tinto and Xstrata (now Glencore) to redesign the tax, they predictably opted to take their depreciation deductions upfront. Once they're used up, however, receipts from the tax will be a lot healthier - provided it survives that long.

You can blame Kevin Rudd, Wayne Swan and Julia Gillard for their hopeless handling of the tax. But don't forget to copy in Tony Abbott who, faced with a choice between the interests of Australian taxpayers and the interests of three foreign mining giants, sided with the latter in the hope they'd fund his 2010 election campaign.

You can also blame Treasury for originally proposing an incomprehensible, textbook-pure version of the tax which couldn't survive, and so getting us lumbered with a fourth-best version. It also did a bad job of quietly test-marketing the tax with its banking contacts and of estimating the likely receipts.

But where were all the economists - including academics - explaining to the public why the tax wouldn't discourage mining activity or otherwise damage the economy, as it suited the big miners to claim?

Where were the economists explaining the special need for a resources rent tax in the case of the exploitation of mineral deposits, particularly when the miners were so largely foreign-owned?

As usual, they were keeping their mouths shut. Contribute their expertise to the public debate? Why? Better just to criticise from the sidelines.

Part of the problem is an ethic among economists that regards it as bad form to distinguish between local and foreign investors for fear of inciting "economic nationalism" - a form of xenophobia. If an investment generates jobs and income, why does it matter whether the firms involved are local or foreign?

It's no doubt thanks to this ethic that we do such a bad job of measuring foreign ownership (and so deny ourselves the ability to use hard facts to fight xenophobic impressions that foreigners now own everything). But the best guess is that mining is about 80 per cent foreign-owned.

Trouble is, mining is an obvious exception to this generally sensible aversion to economic nationalism, for two reasons: because our abundant natural endowment makes minerals and energy such a huge source of economic rent and because mining is so extraordinarily capital-intensive.

Added to that, as Dr Stephen Grenville (a former senior econocrat who does make a useful contribution to the public debate, via the Lowy Institute) has written, "mining royalties, a state government domain, fall victim to special relationships and inter-state competition to attract projects".

Put all that together and you see why having an effective resource rent tax is so essential to ensuring Australians get a fair reward for the exploitation of their birthright. High economic rents, few jobs created and the lion's share of profits going to foreigners mean unless especially high rates of profitability are adequately taxed we don't have a lot to show for the resources boom.

Saying that isn't anti-foreigner, it's simple self-interest, the driving force of market economies. Foreigners are welcome, provided we get a fair share of the benefits. Foreign investment isn't meant to be a form of aid to rich foreigners.

It's true our rate of national saving increased during the boom. But a lot of this was foreign-owned mining firms reinvesting their profits in local expansion rather than repatriating them, thereby increasing their share of our productive assets.

Now the construction phase is ending, more of the (undertaxed) profits will be sent back home. And the capital-intensive production and export phase will mean each $1 billion of growth in GDP now creates fewer jobs than it used to. Thank you Labor, thank you Coalition, thank you economists.

Read more >>

How to reform industrial relations

Tony Abbott's strategy for getting back into government was to make himself a small target by adopting few controversial policies. He mollified his big business backers by promising to hold many inquiries and take any proposals for controversial reform to the 2016 election.

But once in government Abbott couldn't avoid announcing many unpopular measures to get the budget back on track. These have hit his standing in the polls, while causing difficulty and delay in getting budget measures through the Senate.

It's likely a lot of them won't pass, implying the government will have to put a lot of effort into finding more palatable savings. Even then, some of this year's unpopular measures - particularly the age-pension changes - will have to be defended at the election.

Meanwhile, most of a year has passed without the government getting on with its promised inquiries into controversial issues such as industrial relations, tax reform and federal-state relations (think three letters: GST).

Not a lot of time is left for the various inquiry processes to report, for the government to consider the reports, decide what reforms it proposes and then explain and justify them to voters before the election.

Does Abbott's unexpected radicalism on budget measures presage equally radical proposals in these other issues? If so, the next election campaign will be a lot more exciting than the last one.

Or does all the hostility he has aroused just with his budget measures make it more likely Abbott won't want to bite off a lot more trouble on other fronts?

On the question of industrial relations reform, Abbott and his minister, Eric Abetz - not to mention the Productivity Commission, which will be conducting the inquiry - would do well to ponder a recent speech by Geoff McGill, a long-experienced industrial practitioner and now a visiting scholar at Sydney University's Workplace Relations Centre.

McGill observes that the history of federal industrial relations legislation "has been punctuated by swings in the IR pendulum across the political cycle". First the Howard government's Work Choices swung the pendulum in favour of employers, then the Labor government's Fair Work swung it back towards the unions.

Now big business and its cheer squad in the national dailies want the restored Coalition government to give the IR pendulum another shove back in the direction to the employers. Isn't this the way the political game is played?

It is. But McGill questions whether continuing to play that way is the best way to get where we want to go. The advocates of yet another round of industrial relations "reform" justified it mainly by arguing the need for faster improvement in the productivity of labour.

That's something all sides can agree is a desirable objective. But McGill shoots down some wishful thinking on the topic. "Productivity growth is a complex process and usually described in simplistic terms," he says. "It can never be assumed and is only evident after the event.

"There is little evidence to support claims that particular changes in industrial relations legislation will boost national labour productivity."

It's the substance of the employment relationship, not its legal form, which determines whether people are engaged and productive, he says. Productive workplaces are not the outcome of legislation, but of the quality of leadership and culture at the workplace.

Surely there must be a law against someone speaking such obvious sense.

McGill brings to mind another point. Much of the thinking behind "the end of entitlement" and the unpopular budget measures is about saying governments can't solve all your problems for you (just the opposite of the message all politicians spread during election campaigns). It's not possible and, in any case, it's not healthy for people to be so dependent on the authorities.

True enough. But if that's what the government is telling everyone from the young unemployed to uni students to age pensioners, why is it allowing big business to imagine its industrial relations problems should - or even could - be solved by the government changing the law?

Actually, my guess is most of business isn't silly enough to think that. The push is probably coming from lobbyists trying to justify their fee, journos trying to sell newspapers and a relative handful of belligerent employers facing equally belligerent unions and hoping the government will give them some new stick to beat over the heads of their opponents.

Another point of McGill's: if we want better industrial relations leading to greater productivity improvement and the main way for employers to bring this about lies in the workplace, maybe a better way to encourage them to focus on the domestic challenge is to give them a period of legislative stability rather than more changes in the rules of the game.

Most successful managers understand that getting along with people - winning their regard, respect, support, trust, loyalty and co-operation - works better than getting heavy and legalistic. That's how you get better industrial relations - by, as McGill says, putting more emphasis on the relations and less on the industrial.

Managers like to be kept in the loop. Guess what? So do workers. Smart managers keep their staff well informed about the company's performance and the challenges it faces, and give early warnings - even to the union - about any need for nasties like redundancies. They never risk a breakdown in relations by telling workers things they subsequently discover to be untrue.

You engender co-operation by treating people well, consulting them, giving them a degree of autonomy, rewarding loyalty and sharing the business's proceeds fairly between shareholders, managers and staff. Workers accept a hierarchical pay structure, but you don't cause envy and disaffection by rewarding some equals more than others.

And if you don't like outside union officials coming into your workplace, you keep your workers so happy they never need to call them in.

Read more >>

Carbon tax not real reason for soaring power prices

Tony Abbott is right about one thing: the price of electricity has shot up and is now a lot higher than it should be. It's a scandal, in fact. Trouble is, the carbon tax has played only a small part in that, so getting rid of it won't fix the problem.

Until a rotten system is reformed, the price of electricity will keep rising excessively, so I doubt if many people will notice the blip caused by the removal of the carbon tax. (As for the price of gas, it will at least double within a year or two, as the domestic price rises to meet the international price, making the carbon tax removal almost invisible.)

So Abbott will be in bother if too many voters remember all the things he has said about how much the tax was responsible for the rising cost of living, how much damage the tax was doing to the economy and how much better everything would be once the tax was gone.

He would be wise to change the subject and join the push to reform the electricity pricing arrangements.

A new report by Tony Wood and Lucy Carter, of the Grattan Institute, Fair Pricing for Power, says that over the past five years the average Australian household's electricity bill has risen by 70 per cent to $1660 a year.

And this has been happening while the amount of electricity we use has been falling, not rising. Just why electricity demand has been falling is a story for another day.

The cost of actually generating the power accounts for 30 per cent of that total. The cost of delivering the power from the generator to your home via poles and wires - that is, the electricity transmission and distribution network - accounts for 43 per cent of the total.

That leaves the costs of the electricity retailer - the business you deal with - accounting for 13 per cent of the total bill, with the carbon tax making up 7 per cent and the various measures to encourage energy saving or use of renewables making up the last 7 per cent.

Of these various components, the one that does most to account for the rapid rise in overall bills is the cost of the physical distribution network. Whereas there's fierce competition between the now mainly privately owned power stations, the network businesses - still government-owned in NSW and Queensland, but privatised in Victoria and South Australia - are natural monopolies.

This means the prices the networks are allowed to charge - whether government or privately owned - are regulated by government authorities. And this is the source of the problem. Loopholes in the price regulation regime have made it easy for the network businesses to feather their nest at the expense of you and me.

Why would a government-owned network business want to overcharge? Because their profits are paid to the state Treasury, which needs all the cash it can get. So the NSW and Queensland governments gain by looking the other way while their voters are ripped off. The gouging hasn't been nearly as bad in privatised Victoria, where electricity prices are well below the national average.

An earlier report from the Grattan Institute identified four main faults in the system used to regulate the prices of network businesses: the pricing formula allows excessive rates of return, considering essential monopolies are low-risk; government ownership leads to excessive investment in infrastructure and reduced efficiency; reliability standards to prevent blackouts are wastefully high; the pricing formula rewards investment in facilities you don't really need.

The various combined state and federal regulatory bodies have belatedly begun attempting to fix these problems, but they could do a lot more if the politicians prodded them harder.

Meanwhile, the latest Grattan report proposes a solution to one aspect of the over-investment problem: coping with peak demand. The trouble with electricity networks is that, if you want to avoid blackouts, the network has to be powerful enough to cope with the periods when a lot of people are using a lot of electrical appliances at the same time, which these days is a hot afternoon.

Over the course of a year, these occasions are surprisingly few, so you end up having to build a lot of capacity, which is expensive, but then is rarely used. It would make far more sense to encourage people to avoid such extreme peaks in their demand.

The way the pricing system works at present, however, is that far from discouraging people from buying airconditioners and turning them on full blast on very hot afternoons, they're subsidised by those householders who don't.

The simple answer would be for the part of people's bills that relates to their share of network costs to be changed from charging for how much power they use to a capacity-based charge. That is, they pay according to the maximum load they put on the network in peak periods.

The result would be to remove the subsidy between high and low-capacity users, increasing or reducing their bills by up to $150 a year.

The greater benefit would be the price signal sent to high-capacity users to reduce their use of appliances during peak periods and save. As people responded to this incentive, the need to keep adding to the network's capacity would fall, thus reducing the need for higher electricity prices.

Read more >>

Bankers and wealth managers take ethics oath

As the misadventures of the can-do Commonwealth Bank remind us, even though our bankers didn't bring the house down in the global financial crisis as happened elsewhere, we still had too many victims of bad investment advice losing their savings.

So, what's the answer? Tighter regulation of banks and investment advisers, or a higher standard of ethical behaviour by individuals working in banking and wealth management? Try both.

I'm not so naive as to have much faith in self-regulation, but that's not to deny that some people's behaviour is more ethical than others', nor that more individuals behaving ethically would make a difference.

When you stop believing our personal behaviour matters, that we're all mere cogs in some uncontrollable machine, it's time to slit your throat.

My guess is most people like to think of themselves as reasonably ethical, which is not to say most of us actually are at all times (not even me). Trouble is, most people make their judgments about what is ethical and what's not from the behaviour of those around then.

Moral compasses are hard to find. But that's why I'd like to see a movement initiated by Dr Simon Longstaff, of the St James Ethics Centre, the "banking and finance oath", get more publicity and more signatories. The better known are the oath and those who've signed up, the better judgments others can make about how a particular action measures up.

The oath consists of nine principles: trust is the foundation of my profession; I will serve all interests in good faith; I will compete with honour; I will pursue my ends with ethical restraint; I will create a sustainable future; I will help create a more just society; I will speak out against wrongdoing and support others who do the same; I will accept responsibility for my actions; my word is my bond.

The names of the many signatories to this oath are listed on its website, thebfo.org. They include Glenn Stevens, Jillian Broadbent, Carolyn Hewson, Warren Hogan, Andrew Mohl and Elizabeth Proust.

Why doesn't someone ask the chief executives of the big four banks just what it is that makes them feel unable to sign up? It couldn't be a threat to their profitability, surely.



THESE days the world is positively awash with forecasts of what will happen to the economy. Treasury publishes its forecasts twice a year, the Reserve Bank publishes four times a year and a couple of dozen economists in the financial markets make their forecasts regularly and freely available.

But it wasn't always like that. Before the financial markets were deregulated in the early 1980s few economists worked in them, the Reserve kept its opinions to itself and Treasury's official forecasts in the budget papers were kept terribly vague. Billy Snedden's last budget advised that "economic growth is expected to quicken considerably in 1972-73".

When I became an economic reporter in 1974, one of the few unofficial forecasters was Melbourne University's Melbourne Institute, where the regular pronouncements of Dr Duncan Ironmonger drew rapt attention from the media.

And by then Philip Shrapnel's business selling his forecasts had been going for 10 years, meaning the economic analysis and forecasting firm BIS Shrapnel is celebrating its 50th anniversary this year.

Shrapnel, who trained at the Reserve, spent a few years working as a forecaster for pretty much the only notable management consulting firm in those days, WDScott, before going out on his own. He was a character, said to polish off a least half a bottle of scotch as he stayed up studying the documents on budget night.

A lot of the people who paid to attend his forecasting conferences - still held today - would have been there to get his forecasts and plug them into their company's annual budget. These days my guess is his company makes more of its money from its research reports on particular industries and its special focus on property and construction.

Whereas David Love's rival subscription newsletter, Syntec, made its name from its uncanny ability to read the mind of Treasury, Shrapnel was fiercely independent. Not for him the risk-averse strategy of clustering with everyone else around the official forecast.

His successors retain this approach of doing their own analysis their own way and sticking to it. Like all forecasters they've had their misses, but their independence of mind may explain some notable calls: no downturn as a result of the Asian financial crisis of 1997-98; a downturn in 2000-01 no one else was expecting; and no recession following the global financial crisis.

Read more >>

How economists changed their tune on minimum wages

When the Fair Work Commission announced a 3 per cent increase in the national minimum wage to more than $640 a week - or almost $16.90 an hour - from last week, employers hinted it would lead to fewer people getting jobs and maybe some people losing theirs.

And to many who've studied economics - even many professional economists - that seems likely. If the government is pushing the minimum wage above the level that would be set by the market - the "market-clearing wage" - then employers will be less willing to employ people at that rate.

That's because market forces set the market rate at an unskilled worker's "marginal product" - the value to the employer of the worker's labour.

Almost common sense, really. Except that such a conclusion is based on a host of assumptions, many of which rarely hold in the real world. And over the past 20 years, academic economists have done many empirical studies showing that's not how minimum wages work in practice. They've also developed more sophisticated theories that better fit the empirical facts. It's all explained in the June issue of the ACTU's Economic Bulletin.

As a result, there's been a big swing in academic thinking on the question of the minimum wage. Last year, researchers at the University of Chicago asked a panel of economists from top US universities whether they agreed with the statement that "the distortionary costs of raising the federal minimum wage to $US9 per hour and indexing it to inflation are sufficiently small compared with the benefits to low-skilled workers who can find employment that this would be a desirable policy".

Fully 62 per cent agreed and 16 per cent disagreed, leaving 22 per cent uncertain.

Earlier this year, more than 600 US economists - including seven Nobel laureates - signed an open letter to Congress advocating a $US10.10 minimum wage. They said that, because of important developments in the academic literature, "the weight of evidence now [shows] that increases in the minimum wage have had little or no negative effect on the employment of minimum-wage workers".

The first such study, published by David Card and Alan Krueger in 1994, compared fast food employment in New Jersey and Pennsylvania after one state raised its minimum wage and the other didn't. They did not find a significant effect on employment.

Since then, many similar US "natural experiments" have been studied and have reached similar findings. In Britain, the Low Pay Commission has commissioned more than 130 pieces of research, with the great majority finding that minimum wages boost workers' pay but don't harm employment.

There's been less research in Australia, but one study by economists at the Australian National University, Alison Booth and Pamela Katic, suggests that the facts in Australia seem to fit the "dynamic monopsony" model of wage-fixing.

Under the simple textbook, "perfect competition" model of the market for labour, individual firms face a horizontal supply curve: each firm is so small that its demand for labour has no effect on the price of labour. It can buy as much labour as it needs at an unchanged price.

In the dynamic monopsony model, however, each firm faces an upward-sloping labour supply curve. This is because more realistic assumptions recognise the existence of "imperfections" or, more specifically, "frictions".

Such as? Workers may not have perfect information about all the alternative jobs they could take and this could make them cautious about moving. Searching for a job may involve costs in time or money. Workers and jobs may be mismatched geographically, so changing jobs may involve greater transport costs. Workers - being humans rather than inanimate commodities - may not have identical preferences about the jobs available.

In other words, there are practical reasons why it takes a lot for a worker to want to leave their job.

These frictions, or "transaction costs", are assumed away in the simple model. But their existence can result in employers having market power, which they can take advantage of to pay workers less than the value of what they produce (their marginal product).
Economists call such power "monopsony" power. Just as a monopolist is a single seller, so a monopsonist is a single buyer. But don't take that word too literally. An employer with monopsony power doesn't need to be a monopolist in the market for its product (the "product" market), nor the sole buyer of labour in the region or the industry.
"A single employer in a market with many employers can have monopsonistic power if workers bear costs of job search," the article continues. In other words, it possesses a degree of monopsony power.

The point is, if a firm is facing an upward-sloping labour supply curve and wants to hire more workers, it may need to pay a higher wage than it is paying its existing workers. So, if it goes ahead with hiring, it will need to increase the wage rates of its existing workers.

And this means the firm's profit-maximising level of employment and wages will both be lower than they would be under perfect competition.

In such a model, if the minimum wage rate is set at or below the marginal product of labour, this won't cause employment to fall and may cause it to rise. Monopsonistic models don't have an unambiguous prediction for the employment effect of a minimum wage.

A paper by Bhaskar, Manning and To, published in the Journal of Economic Perspectives in 2002, concluded that "a minimum wage set moderately above the market wage may have a positive effect or a negative effect on employment, but the size of this effect will generally be small".

It will be interesting to see how long it takes those many Australian economists who don't specialise in studying the labour market to catch up with this change in their profession's thinking.

Read more >>

Ignoring climate change will cost the economy

Sometimes I fear Australia has decided to go backwards just as the rest of the world has decided to go forwards. Take climate change. If the repeal of the carbon tax gets through the Senate this week there will probably be celebrations in the boardrooms of all the business groups that lobbied so hard for its removal.

But if they imagine the lifting of this supposedly great burden on them and the economy will mean it's back to business as usual, they'll soon find out differently.

They may have rolled back the economic cost of doing something about climate change, but now they'll face the increasing cost of not doing something about it. As Martijn Wilder, an environmental lawyer with the Baker & McKenzie law firm, finds in a new report for the Committee for Economic Development of Australia, we're going to be hit from all sides.

There are the costly physical effects of climate change we've already started experiencing, there are the consequences for us of measures our trading partners are starting to take to limit their emissions, there's the growing reluctance of foreign institutions to fund new coalmines and power stations and there's the threat to our fossil fuel industries from ever-cheaper renewable energy.

In case anyone's forgotten, Wilder reminds us that the physical effects of climate change include a rise in the sea level, acidification of the ocean, change in rainfall patterns and an increase in the frequency of natural disasters, including droughts. Extreme weather may lead to more bushfires, while heavy rainfall and cyclones may lead to flooding.

Do you think all that generates no costs to business, no disruption to the economy? Take the Queensland floods in 2011, Wilder says. They not only hit insurance company earnings, they also halted production at various coalmines. This forced up world coal prices, with adverse effects for industries reliant on coal.

Since we've always had cyclones and floods, no one can say climate change caused this particular disaster. But the scientists tell us events such as these will become more frequent. And the insurance industry's records tell us the number of catastrophic weather events is already increasing, with the economic losses associated with weather rising.

As for the idea there's no hurry in preparing for problems that may not become acute until later this century, consider this. Had a levee to protect Roma, in Queensland, been built in 2005, it would have cost $20 million. Since it wasn't built, $100 million has been paid out in insurance claims since 2008 and a repair bill of more than $500 million incurred by the public and private sectors since 2005.

This sort of thing is happening in other countries, too. Hurricane Sandy, in October 2012, caused widespread damage in New York, crippling electricity infrastructure and leaving downtown Manhattan without power for four days. The record-breaking storm surge alone cost the local electricity company $500 million and New York businesses $6 billion.

Perhaps such events explain why many other countries are moving forwards rather than backwards in their efforts to combat climate change. Australia's coal and natural gas industries won't escape being affected by tougher regulation of the use of fossil fuels in the countries to which they export.

While Europe has had a weak emissions trading scheme since 2005, the Chinese are trialling such schemes in six provinces. South Korea, one of our main trading partners, is to introduce a scheme next year. The US is taking direct action to cut power station emissions.

China is moving to limit coal to 65 per cent of energy consumption by next year and has banned new coal power generation in Beijing, Shanghai and Guangzhou. Wilder says this will cut demand from the largest importer of Australian coal and thus affect the value of big mining and loading assets in Australia.

The more the rest of the world seeks to reduce its use of coal and other fossil fuels, the more Australian businesses need to contemplate the possibility of their mines becoming "stranded assets" - assets that suddenly become unprofitable and so lose their value.

Until recently, foreign investors and financiers haven't taken climate-change risk into account. Now they're starting to worry not just about the morality of emitting more greenhouse gas, but the risk that investments in new mines and power stations will lose their value before they reach the end of their useful lives. The change started with international agencies such as the World Bank, but is spreading to pension-fund investors.

Then there's the threat from the rise of renewable energy. China's goal of becoming a world leader in renewable energy has made it the world's largest maker of renewable energy equipment and the single largest destination for investment in renewables.

Wilder says renewables are reaching a "point of disruption" and will displace coal and gas power stations in many parts of the world. In Australia, the sharply rising price of gas is increasing the cost-competitiveness of renewables.

"Unlike natural gas and coal, the input for renewable energy is not subject to the volatility of global energy markets and with renewable costs continuing to decline, renewable generation represents a safer long-term investment," he says.

I know, let's get the government to put the kybosh on renewables. That would be a smart move.

Read more >>

Tough times restore productivity performance

It's official: Australia's rate of improvement in the productivity of labour returned to normal during the reign of Julia Gillard.

How is that possible when big business was so dissatisfied and uncomfortable during Gillard's time as prime minister? The latter explains the former.

According to figures in a speech by Reserve Bank governor Glenn Stevens last week, labour productivity in all industries improved at an annual trend rate of 2.1 per cent over the 14 years to the end of 2004, but then slumped to an annual rate of just 0.9 per cent over the six years to 2010.

This is what had big business rending its garments over the productivity crisis. Egged on by the national dailies, chief executives queued to attribute the crisis to the Labor government's "reregulation" of the labour market, its failure to cut the rate of company tax, plus anything else they didn't approve of.

Except that, according to the Reserve Bank's figuring, labour productivity improved at the annual rate of 2 per cent over the three years to the end of 2013.

So why no crisis after all? Well, as wiser heads said at the time, much of the apparent weakness in productivity was explained by temporary factors such as, in the utilities industry, all those desalination plants built and then mothballed and, more significantly, all the labour going into building all those new mines and gas facilities.

No doubt much of the recent recovery is explained by the many mines now starting to come on line - meaning we can expect the productivity figures to remain healthy for some years. Few extra workers are being employed to produce the extra output - another way of saying the productivity of the miners' labour is much improved.

But mining hardly explains all the improvement, so what else? At the time when business complaints were at their height, many businesses - particularly manufacturers - were suffering mightily under the high dollar.

Many have been forced to make painful cuts, abandoning unprofitable lines and laying off staff. Some have gone out backwards, with the best of their workers being taken up by rival employers.

Guess what? Such a process is exactly the sort of thing that lifts the productivity of the surviving firms. In their dreams, chief executives like to imagine their productivity - which they perpetually conflate with their profitability - being improved by governments doing things to make their lives easier.

But requiring them to be lifters rather than leaners - which is pretty much what That Woman did - usually gets better results. And since the dollar remains too high and seems unlikely to come down anytime soon, it's reasonable to expect the non-mining sector's productivity performance to continue improving. Who told you productivity was soft and cuddly?

As for the convenient argument that the productivity slump must surely be explained by Labor's "reregulation" of the labour market under its Fair Work changes, it's cast into question by some figuring reported in another speech last week, from Dr David Gruen, of Treasury.

Gruen examined the rise in nominal wages over the decade to March this year, as measured by the wage price index, then compared this aggregate rise with the rise for particular industries. In contrast to the days when wage-fixing really was centrally regulated, he found a far bit of dispersion around the aggregate.

Wages in mining, for instance, rose a cumulative 9.7 percentage points more than the aggregate. Wages in construction rose by 5.4 percentage points more and wages in the professional, scientific and technical sector rose by 2.5 points more.

By contrast, wages in manufacturing rose by a cumulative 0.9 percentage points less than aggregate wages. Those in retailing rose by 4.3 points less and those in the accommodation and food sector rose by 7.6 points less.

Notice any kind of pattern there? It's pretty clear. Wages in those industries most directly boosted by the resources boom rose significantly faster than aggregate wages, though not excessively so considering it was a 10-year period.

By contrast, wages in those industries worst affected by the boom-induced high exchange rate - manufacturing and tourism - rose more slowly than the aggregate. Retail had its own problems, with the return of the more prudent consumer, and its wages grew by less than the aggregate.

That's just the dispersion you'd expect to see in a "reregulated" labour market? Hardly.

What it shows is that we now have a genuinely decentralised and more flexible wage-fixing system, delivering wage growth in particular industries more appropriate to their circumstances.

If that's reregulation, let's have more of it.

Read more >>

We've handled the resources boom surprisingly well

Are we in for big trouble in the aftermath of a misspent resources boom, or has the boom been over-hyped, leaving us in good shape to face the future?

This is a matter of debate among some of Australia's most prominent economists. Professor Ross Garnaut, of the University of Melbourne, advanced the former argument last year in his book Dog Days: Australia After the Boom, and Dr John Edwards, a fellow of the Lowy Institute and member of the Reserve Bank board, makes the counter-argument in his new book, Beyond the Boom.

This week Dr David Gruen, of Treasury, weighed into the argument in a speech written with help from Rhett Wilcox. Gruen took a middle position, agreeing with each man on some points and disagreeing on others. Appropriately, he was speaking at the annual conference of economists in Hobart. They enjoy that kind of thing.

Gruen strongly disagrees with Edwards' claim that the resources boom "hasn't been as important for Australian prosperity as widely believed", saying the boom was "one of the largest changes in the structure of our economy in modern times" which "generated the largest sustained rise of Australia's terms of trade ever seen".

"The result was that resources investment increased from less than 2 per cent of gross domestic product pre-boom to around 7.5 per cent in 2012-13, an increase, in dollar terms, from around $14 billion to more than $100 billion a year," he says. "This has seen an additional 180,000 workers employed in the resources sector since the boom began and will see the capital stock in the resources sector almost quadruple by 2015-16."

But Gruen disagrees with Garnaut's implication that the economy was not well managed during the boom. He notes that all previous commodity booms - including the rural commodity boom of the early 1970s - led to blowouts in wages and inflation, followed by recessions after the boom busted.

This time, however, wages have been well controlled and the rise in prices has rarely strayed far from the Reserve Bank's 2 per cent to 3 per cent target range. The boom in the resources sector has not led to excessive growth in the economy overall. Real GDP growth averaged 3 per cent a year over the decade to 2012.

Edwards supported his claim that the resources boom has not been as important for our prosperity as commonly believed by comparing this 3 per cent growth rate unfavourably with the 3.8 per cent annual rate achieved over the decade to 2002.

But Gruen counters by noting the earlier decade "saw above-trend growth as the economy recovered from the deep early-1990s recession, with unemployment falling from above 10.5 per cent to below 6 per cent over the course of that decade".

So why has the upside of the resources boom been handled so much better than in earlier commodity booms? Gruen gives much of the credit to three micro-economic reforms: the floating of the dollar in 1983, the move to letting the Reserve Bank set monetary policy (interest rates) independent of the elected government, formalised by Peter Costello in 1996, and the decentralisation of wage-fixing, largely completed by the Keating government before 1996.

(This to me is a point worth noting: the greatest continuing benefit from the era of micro reform - but also from the move to set formal "frameworks" for conducting the two arms of macro-economic policy - is a much more flexible economy, one that is less inflation-prone and less unemployment-prone. By the way, Garnaut and Edwards can take their share of credit for these reforms.)

Next Gruen rebuts Garnaut's argument that the income the nation earned from the boom was misspent.

Garnaut might have in mind the Howard government's decision to respond to the temporary increase in collections from company tax and capital gains by cutting income tax for eight years in a row, a move that does much to explain the trouble we are having getting the budget back into surplus.

But there is more to the economy than what the feds do with their budget. And Gruen points out that, over the decade to March 2014, national consumption spending (by households and governments) actually declined from about 76 per cent of GDP to 73 per cent. If so, the nation's saving must have increased by 3 percentage points of its income (remember: income equals consumption plus saving).

Against that, over the same period bar the last few quarters, national investment has been high and rising, relative to income. "Rather than the income gains from the boom having been consumed, it would be more accurate to conclude that they were invested," Gruen says - a point Edwards also made.

(Had the nation been "living beyond its means", that would show up as a widening in the current account deficit. Instead, the deficit has been narrower in recent years.)

But what about the downside of the boom? Will the bust result in a period of contraction for the economy as a whole? Gruen's answer is "so far, so good", but he concedes that, over the next three or four years, investment spending by the miners is expected to fall from about 7 per cent of GDP to about 2 per cent or 3 per cent, a subtraction from growth of about 2 per cent to 2.5 percentage points (remembering that about half of mining investment is in imported equipment).

Remember, too, that mining production and export volumes will be growing strongly. Even so, avoiding recession will require a further significant fall in the dollar.

Gruen agrees with Garnaut that for the economy to benefit from such a "nominal" depreciation in the currency, it will need to be translated into a "real" depreciation by only moderate wage growth. But this could be achieved provided real wages grow by less than the growth in labour productivity.

Read more >>

The news on our health is good

It's good news week. There are lots of bad things happening in the world and journalists regard it as their job to dig them out and wave them in front of your face. No piece of disheartening news should go unreported.

But good things are happening, too. And I often think people would enjoy reading the news more if we didn't ignore so many of them.

One of the main jobs of the federal government's Australian Institute of Health and Welfare is to produce a report card on the state of Australia's Health every two years. The latest edition is just out and it's crammed with good news.

Perhaps our most basic desire is to delay our death, and on this score we're doing particularly well. "Australians have one of the highest life expectancies in the world and can expect to live about 25 years longer, on average, than a century ago," the institute says.

In 1910, a baby boy could expect to live for 55 years and a baby girl 59 years. Today it's 80 and 84. That puts us sixth highest on the world league table for boys and seventh for girls, but the countries coming top - Iceland and Japan - beat us by less than two years. And we leave the Yanks for dust.

Of course, that's just for babies. Those of us who survive beyond our youth can expect to live longer again. A man turning 65, for instance, can expect to live another 19 years to 84. Women can expect another 22 years to reach 87.
All that's on average, of course. It happens because, by the time you reach 65, you've successfully avoided having your life cut short by accidents or other causes of premature death. You've become one of those who'll exceed the at-birth average.

But even if we are living longer, is that so wonderful if it means we're spending more years living with some kind of disability? Well, some disabilities are worse than others. And my guess is most people would tell you that, though their particular disability isn't fun, it beats the alternative.

The news is better than that, however. The institute's figuring shows that as our years of life are lengthening, our years of living with disability aren't increasing commensurately. And though they're increasing slowly for women - to almost 20 years for a newly born girl - they're falling slowly for men, to less than 18 years for baby boys.

The rate of daily smoking has been falling for 50 years, from 43 per cent of adults in 1964 to 16 per cent today. Quitting smoking can increase your life expectancy by up to 10 years if you do it early enough.

The institute says vaccination is one of the most successful and cost-effective health interventions. And the proportion of five-year-olds who've been vaccinated rose from 79 per cent to 92 per cent over the four years to 2012. Thank God for the nanny state.

The proportion of new cases of cancer each year is steady - kept up by the ageing of our population - but rates of death from cancer are continuing to fall. Over the 20 years to 2011, the mortality rate for all cancers fell by 17 per cent to 172 deaths per 100,000 people.

This is because of reduced exposure to the risk of cancer (such as fewer smokers), improved prevention (such as better sun protection), advances in cancer treatment and, for some cancers, earlier detection through screening programs (bowel, breast and cervical).

The reduction was mostly the result of falls in lung, prostate and bowel cancer deaths among men, and falls in breast and bowel cancer deaths among women.

The five-year survival rate from all cancers has increased from 47 per cent to 66 per cent over the past 20-odd years. And among people who've already survived five years, the chance of surviving for at least another five is 91 per cent.

There's been a 20 per cent fall in the rate of heart attacks in recent years and death rates from heart disease have fallen by almost three-quarters over the past three decades. The rate of strokes has fallen by 25 per cent in recent years and the death rate from strokes has fallen by more than two-thirds.

In just over 20 years, the death rate from asthma has fallen from a peak of 6.6 per 100,000 people to 1.5 deaths. The rate of people being hospitalised for asthma has fallen by 38 per cent.

And the rates of death through most causes of injury - accidents, drowning, suicide and homicide - are down by 3 per cent to 5 per cent in less than a decade.

We're even feeling better. More than half of those 15 and over consider themselves to be in excellent or very good health, with another 30 per cent saying their health is good. This is up a bit on a similar survey in 1995.

What's more, even the oldies are feeling pretty good. Among people aged 65 to 74 living in households, more than three-quarters rated their health as excellent, very good or good. Among those 75 and older, it was two-thirds.

It would be wrong to think everything about our health and healthcare is fine but, just this once, we'll celebrate what's going right.

Read more >>

Ulterior motives abound in privatisation push

The trouble with the latest round of state government privatisations is that those who oppose them do so for the wrong reasons, but their promoters are also pushing them through for the wrong reasons.

Joe Hockey's 15 per cent incentive payment to encourage "asset recycling" - selling existing government-owned businesses to fund the building of new infrastructure - has fallen on receptive pockets in the NSW and Queensland governments, which are worried about their credit ratings and, unlike the Victorian government, still have valuable electricity transmission and distribution businesses to flog off.

The previous, Labor government in NSW tore itself apart over electricity privatisation, with the cabinet supporting it but the powerful public sector unions bitterly opposing it. It wasn't much better with the previous, Labor government in Queensland.

Now Labor is free of the responsibilities of office, it will be completely united in its opposition and its unceasing claims that privatisation will lead to big rises in electricity prices.

Since voters in all states strongly oppose privatisation, Labor will hope to do well with this argument at the NSW election in March. But polling also shows voters are much less opposed when the sale of businesses is linked to the building of specific new projects.

Labor's counter-argument is deceptively simple: government-owned businesses act in the best interests of their customers, whereas privately owned businesses seek to maximise their profits by raising their prices.

The truth is far more complicated than that. Whether publicly or privately owned, the monopoly business that doesn't seek to overcharge its customers has yet to be discovered by archaeologists. Monopolies that don't seek to maximise profits usually succumb to overstaffing and overpaying workers and managers. Why wouldn't they?

The public sector unions understand this full well, which is their real reason for opposing privatisation so vehemently.

They know that whether or not the private owner succeeds in raising prices, it will seek to improve its profitability by moving in on union perks and rorts. They know even Coalition-government owners give them an easier ride than a private owner would.

So voters would be mugs to believe Labor and its union mates have consumers' best interests at heart.

Unfortunately, that doesn't mean Coalition privatisers can be trusted to do their best by customers. The temptation facing all privatising governments is to seek to maximise the price they get for the asset they're selling.

If you can't see why that would be a problem, you're helping demonstrate why privatisations so often fail to deliver their promised benefits.

The main thing that protects customers from being overcharged is effective competition between the privatised entity and other businesses.

So the main way governments seek to inflate the price they get for a privatised business is to protect it from competition, or otherwise ensure its ability to overcharge. They tie the hands of the price regulator in some way, or explicitly guarantee freedom from certain future sources of competition, or sell the business to some player who already owns businesses in the industry and so can use the acquisition to increase the player's pricing power.

The simple truth that escapes so many privatisation supporters on the non-Labor side is that privatisation is only worthwhile if it leads to greater competition in the market. If it doesn't, it will be of little benefit to anyone bar the new private owners.

When the Keating government privatised Sydney airport, it guaranteed the purchaser first refusal on control of any second Sydney airport, thus virtually ensuring that even with two airports there'd be no competition between them.

When the Kennett government privatised Victoria's electricity industry in the 1990s it took care to ensure a wide range of buyers.

But it seems the Baird government in NSW has no such scruples. It planned to sell Macquarie Generation, the state's largest power producer, to AGL, one of the state's three largest power retailers.

The Australian Competition and Consumer Commission tried to block the deal, judging it would have resulted in a substantial lessening of competition in the electricity market. But last week the commission was overruled by the Competition Tribunal, so the deal is likely to go ahead.

Only a couple of days earlier, however, the chairman of the commission, Rod Sims, reiterated his view that "electricity companies have a strong commercial incentive to have all players vertically integrated ... If electricity retailers can tie up most of the generation then they can create a stable oligopoly with high entry barriers and so higher prices and better returns."

I'd be wary of believing any politician who tried telling you electricity privatisation won't lead to higher prices.

Read more >>

Why weaker demand means lower pay rises

Just about everyone assumes we can never have enough jobs. So it's funny that our unending discussion about how the economy's growth is doing rarely delves into the detail of what's happening in the labour market.

But that's what Dr Chris Kent, an assistant governor of the Reserve Bank, did in a speech last week. He shows it really is a market, with the demand for labour interacting with the supply of labour to help determine the price of labour (wages) and the quantity demanded (employment). Unlike textbook markets, however, this one never "clears" - there's always some labour left unsold (unemployment).

It shouldn't surprise you that, in studying developments in the labour market in recent years, one big thing stands out: the effect of the resource boom as it moves through its three stages of high export prices, booming mine construction and rising production of minerals and energy.

The demand for labour is "derived" demand - it flows from the demand for goods and services. To produce those things you need machines and workers. The more you produce, the more workers you need.

For most of the two years since the middle of 2012, the economy (real gross domestic product) grew at less than its 3 per cent annual trend rate, held back by the decline in mineral export prices, the decline in mining construction, the high level of the dollar and the weak growth in public demand (government spending).

A big part of the problem was that the downturn in mining-driven activity came at a time when the non-mining economy was subdued.

This below-trend growth in the production of goods and services meant weaker growth in the demand for labour, as we can see from the various indicators of labour demand.

The rate of unemployment is high relative to its recent history. The rate at which people of working age (15 years and above) are participating in the labour force, either by holding a job or actively seeking one, is at about the lowest it's been over the past eight years. And since 2010 there's been a significant decline in the ratio of employed people to the working-age population.

It's true the economy seemed to grow more strongly in the last quarter of 2013 and the first quarter of 2014. And we can see some small improvement in the indicators. Using the trend estimates, employment grew by 0.7 per cent over the first five months of this year, unemployment seems to have stabilised at 5.9 per cent and the participation rate at 64.7 per cent.

But much of the growth in real GDP over the past two quarters has come from greatly increased production and export of minerals and energy, as newly built mines start working. Trouble is, mines are so capital-intensive that all this extra production would have created few extra jobs.

So, for once, the growth in real GDP overstates the increase in demand for labour. Kent suspects the growth in employment is explained partly by slightly stronger growth in the non-mining economy and by a catch-up from weaker-than-you'd-expect employment growth last year.

If so, we're not out of the woods yet. And Treasury's forecast is that unemployment will have risen a little further to 6.25 per cent by June next year.

Now let's turn to the supply of labour. At the most basic level, growth in the population of working-age adds to the supply of labour, whether that growth comes from "natural increase" - more young people joining than old people retiring - or immigration.

But not everyone of working age chooses to participate in the labour force, of course. And, in practice, changes in the participation rate are a key indicator of the strength of labour supply.
Kent says growth in labour supply has slowed substantially over the past year or so, with the "part rate" down from 65.1 per cent.

This is a sign of the interaction between labour demand and supply: when demand is strong, more is supplied, but now it's vice versa. So it's usual for the part rate to fall during periods of weak demand.

"As jobs become more difficult to find (at the prevailing wage), some individuals become discouraged from searching," Kent says. If they are still available to work these people are "discouraged workers", many of whom will resume the search for work when conditions improve.

But Kent says that, since 2010, the rise in the number of discouraged workers accounts for only less than a quarter of the fall in the part rate. Some of these other people may have chosen to make themselves unavailable to work by embarking on a period of study or accepting involuntary early retirement.

But another, more structural, factor helping to explain the fall in the part rate is the ageing of the population. Ageing means a higher proportion of the population is in older age brackets which tend to have lower rates of participation. (And if oldies are still working, they're more likely to be part-time).

Kent says ageing is estimated to have subtracted between 0.1 and 0.2 percentage points a year from the part rate over the past decade-and-a-half. But now the rate is a clear 0.2 points. In recent decades this purely demographic change has been offset by the decisions of individual oldies to continue working, but now this second trend seems to have stopped.

In textbooks, prices adjust automatically to bring supply and demand into balance. In the real-world labour market, it ain't that simple. Even so, the weaker demand for labour has seen wage growth decline to well below its average over the past decade. Pay rises of more than 4 per cent are now far less common and rises of 2 to 3 per cent are more common than 3 to 4 per cent. So are rises of 1 per cent or less.

Read more >>

No handouts for miners not paying enough tax

It's in the nature of the news media to focus on the new, on the bit that's changing. So when people like me bang on about the resources boom - as we've been doing for about a decade - it's probably inevitable we leave many people with an exaggerated impression of the size of the oh-so-important mining industry.

Most people have little idea how mining compares with the rest of the economy. Some, when asked, say it may account for a third of the total.

Sorry to mislead. It's actually a bit over 10 per cent of all the goods and services we produce. If that doesn't seem like much, it is. It's a bit more than the whole of the manufacturing industry contributes and about three times what agriculture does.

More to the point, it's up from about 4 per cent before the boom began. And it's a big deal for any industry to go from 4 per cent to 10 per cent in the space of a decade. That couldn't happen without having big implications for other parts of the economy, with the high dollar just one example. So it's little wonder the economists have been so obsessed by it.

It's the biggest single development affecting the economy - the whole of the economy - in that time. And though the smarties began proclaiming the boom's death a year or two ago, its closing stages will still have big effects on the economy - favourable and unfavourable - for at least another couple of years.

Many people are uneasy about the expansion of mining. Digging non-renewable resources out of the ground and shipping them overseas seems such a dead-end occupation. People's reservations are compounded when they realise how amazingly capital-intensive mining is. That is, how few people it employs.

Mining may account for 10 per cent of our total production, but it accounts for only about 2 per cent of total employment. Building new mines is labour intensive, but running them isn't. If so, why bother?
It's a mistake to think it's only direct employment of people that makes an industry worthwhile. What matters is how much income an industry generates. Why? Because when that income is spent it will generate jobs elsewhere in the economy. That's what spending does: generate jobs.

In the case of mining, however, there's a complication. Though the powers that be don't trumpet the fact, mining is about 80 per cent foreign-owned. Even BHP Billiton is, essentially, a foreign company. And most of the extensive capital equipment mining uses is imported.

Mining in Australia is a highly profitable activity because we possess a large share of the minerals and fuel the world values highly, and because our deposits are generally high quality and easily extracted.

If mining creates so few jobs directly, and so little of its profits accrue to Australians, that leaves two key concerns to ensure Australians get suitable recompense for the exploitation of our natural inheritance: make sure miners pay adequate royalties on the minerals we grant them and make sure their profits are adequately taxed.

Business people tend to portray taxes and revenue received by governments as dead money. The opposite is true. The government spends the money it receives, and when it's spent it creates jobs, like all spending does.

The Labor government bungled its attempt to ensure the miners' profits were adequately taxed. But, rather than correcting Labor's errors, Tony Abbott has pledged to abolish the tax and let the foreign miners off the hook. Then he'll wonder why the huge expansion in mining production we're now seeing is creating so few jobs.

It gets worse. Not only are we under-taxing the miners, we're giving them lots of subsidies. Not only does the federal government give them a rebate on the excise on their diesel fuel, the state governments give them assistance by building the roads, railways and ports they need to ship their minerals abroad.

According to calculations by the Australia Institute, the states gave the mining industry $3.2 billion in concessions in the financial year just ending. Queensland gave assistance worth almost $1.5 billion, mainly by providing railway infrastructure and freight discounts.

Western Australia spent almost $1.4 billion, mainly on roads and port infrastructure. Other states' subsidies are much smaller - $140 million in NSW, $40 million in Victoria - but so too are their receipts from mining royalties.

It turns out the Queenslanders' subsidies to mining are equivalent to almost 60 per cent of the royalties they receive. In WA it's about a quarter, and in NSW it's less than 10 per cent. In Victoria, however, it's three-quarters.

And this while governments, federal and state, are crying poor and cutting spending on many worthy causes.

As Ian McAuley, of the University of Canberra, has pointed out, we're slashing our planned spending on foreign aid because we can no longer afford such generosity, but by abolishing the mining tax we're being very generous to big foreign mining companies. This makes sense?

Read more >>

Economists face criticism over poor ethics

Are economists ethical? Short answer: no more than most. Long answer: well, it's not something they think about much.

The question of ethics is starting to raise its head among economists, both overseas and in Australia, particularly in NSW. It's an issue the Sydney branch of the Economic Society is likely to start debating in the next few months.

The issue is arising as more economists find ways to sell their services to big business for big bucks. Business is attracted by the status, expertise and authority economists bring, and is willing to pay for it.

Various aspects of conventional economics make economists susceptible to such transactions. Almost all economists believe in the market system and believe that the bigger the economy grows the better off we are. So they have an inbuilt sympathy with business and its objectives.

They believe self-interest is a good thing because it's what motivates a market economy. It should never be a bad thing because it's held in check by countervailing market forces.

And there's a belief among economists that their discipline is "positive" rather than "normative". It's a "value-free" description of how the economy actually works, not a statement of opinion about how it should work.

It's because of this belief that, for example, many economists take no account of the implications of their recommendations for the way income is distributed between rich and poor. That's a "value" question they aren't qualified to comment on and so leave to others, such as politicians.

That's what they say when challenged. When they're not challenged they usually give the impression that distributional issues don't arise and economic efficiency is the only issue worth considering.

In truth, the neo-classical model is loaded with values, the most important being that individualism is superior to communitarianism.

So you see why ethics isn't something economists think much about. And this is reinforced by the profession's lack of organisation. Economics is unregulated; anyone can call themselves an economist (I don't, by the way).

Economics has no true professional body. The Economic Society is the closest they come, but it's essentially a discussion group that anyone can join. Its other function is to sponsor the academic economists' annual conference and the main Australian economic journal (which the academics don't rate highly because it's only Australian).

Without a proper professional association you could argue economists aren't a profession, just an occupation. Most are employed by governments and, these days, by banks and other financial services firms, which means they're not free to express opinions at variance with those of their employer. Academic economists are free, but often don't bother.

The question of economists' ethical standards arose in the US after the global financial crisis, when impertinent journalists pointed out that academic economists were writing articles posing as independent experts, without disclosing the financial firms they were affiliated with or for whom they had done consultancy work.

In Australia the spur is the rise of the new breed of economic consultancy firms, which are paid to provide allegedly independent modelling to private interests seeking to lobby governments. Sometimes even governments commission private modelling to provide evidence supporting some policy the pollies are pursuing.

For some reason, when the independent consultants run their models they invariably reach conclusions that support their paying customer's proposal. Remarkable.

These carefully contrived conclusions are then used to bamboozle the public, politicians and even judges who don't know enough economics to know how dodgy many modelling exercises are and how easily models can be tweaked to produce whatever answer you're seeking.

The issue has reached a head in NSW, where Dr Richard Denniss, of the Australia Institute, has appeared as an expert witness in a couple of court cases disputing the "independent" modelling being used to claim the development of a new mine will bring huge economic benefits to the district.

One judge was scathing in his condemnation of the use of an "input/output model" to exaggerate the indirect job creation from a project. A report by the independent Planning Assessment Commission on another project criticised the NSW Department of Planning for its uncritical acceptance of estimates of the project's economic benefits that had been challenged and were "not credible".

Last week the department's new minister, Pru Goward, announced that it would commission separate expert economic analysis of all future major mining projects. Good luck.

Issues of independence and conduct will be discussed during the NSW Economic Society's forum on cost-benefit analysis on July 18. And a later meeting of the society is expected to debate whether economists need a code of ethics. I'd start with an ethical code for modellers.

Read more >>

States change lanes in two-speed economy

You've heard of a Goldilocks economy where everything is just right. Well, when it comes to the states, welcome to the biblical economy, where the last shall be first and the first shall be last.

We're still looking at a two-speed economy, but the fast lane is turning into the slow lane and the slow lane into the fast.

During the 10 years of the resources boom to 2012-13, the West Australian economy grew by 62 per cent in real terms, against 48 per cent in Queensland, 30 per cent in Victoria and 23 per cent in NSW.

But, in the year to March, the mining states' "state final demand" - not as full a measure as gross state product - contracted, while NSW and Victoria steamed on.

The Victorian budget papers last month said the state was "well placed to take advantage of the national shift from mining investment towards more broad-based drivers of economic growth.

"Lower interest rates and a moderated exchange rate, compared with the highs in 2011 to 2013, are expected to benefit Victoria's industry structure."

Whereas the national economy (real gross domestic product) grew by 2.6 per cent in the 2012-13 financial year, Victoria managed only 1.6 per cent growth. And, in the financial year just ending, while the nation is expected to have managed growth of 2.75 per cent, Victoria is looking at an expected 2 per cent.

But the federal budget papers show the nation's rate of growth is expected to slow to 2.5 per cent in the coming financial year as Victoria's growth accelerates to 2.5 per cent. It's expected to reach 2.75 per cent in 2015-16.

And this week's NSW budget papers show its government expects its acceleration to be even faster. NSW managed growth of just 1.8 per cent last financial year, but it's expected to have accelerated to 3 per cent in the year just ending, and to stay at that rate in the coming year and the following one.

So, while Victoria is expecting to catch up with the national average in the coming financial year, NSW believes it has already exceeded it, and will continue growing faster than average in 2014-15. Only by the following year, 2015-16, will the nation have caught up.

Well, that's all very lovely, but how's it supposed to happen? What changes will bring it about?

You may already have noticed that whenever the economy improves, there's always a politician on hand ready to take the credit. Well, here's a tip: when they're at the national level, they're probably taking more credit than they should; when they're at the state level, they almost certainly are.

The truth is we live in a single, national economy. The six states and two territories that make up our national economy are different but highly integrated. So, to the - limited - extent that what's happening to a particular state is influenced by politicians, it's more likely to be federal politicians than state. Macro-management of the economy happens at the most macro level.

State governments don't do macro, they do micro. They manage their own financial affairs, and make decisions about planning and the regulation of particularly industries - how heavily we should tax companies developing new housing on the outskirts of the city, for instance - that do affect the growth of their state economies, but slowly and to a small extent.

So, for the most part, differences in the rates at which particular states are growing are determined by differences in the industrial structures of their economies - for instance, some have a lot of mining, some don't - and in their histories. NSW and Victoria are long established with large populations; WA and Queensland have smaller populations with more scope for development; they're frontier states.

This is why an event such as the resources boom, which has essentially come to the Australian economy from overseas, can affect states so differently.

The point, however, is that the most spectacular stage of the resources boom - the surge in construction of mining and natural gas facilities - which did most to foster the rapid growth of WA and Queensland in recent years, is going from boom to bust.

The rapid fall-off in mining construction in the coming financial year and the year after will cause those two states to grow far more slowly - maybe even contract in WA's case - while NSW and Victoria steam on.

Victoria's big advantage is that, since it has little mining, it has nothing to lose. NSW does have some mining, mainly for steaming coal, but says its big advantage is that its mining construction activity has already fallen about as much as it's going to.

It's their knowledge that we have two years of big falls in mining construction activity to come - along with the dollar's failure, so far, to fall back as much as we'd hoped - that has made the macro managers so obsessed by the need to get the "non-mining sector" growing much more strongly.

They've done this primarily by cutting interest rates to their lowest level in yonks, trying to encourage any spending that also involves borrowing, but particularly home building and home-related consumer spending.

Victoria will get some stimulus from this, but not much because it has already had a lot of building activity and may have some oversupply.

In contrast, NSW has a big backlog of home construction - arising from problems on the supply side that are the product of micro-economic mismanagement by this state government's predecessors. Its home building activity has already taken off, with much further to run.

Put all that together and you see why the last are about to start coming first.

Read more >>

How to get more happiness per dollar

If I wanted to get more happiness into my life, I wouldn't do it by trying to earn more money. I'd concentrate on spending more time with family and friends and getting more satisfaction from work itself rather than the money it brings in.

That's because, though money does buy happiness, it buys far less than we expect it to. It suffers from rapidly diminishing "marginal utility" - each extra $1000 you spend brings less satisfaction than the one before.

Since economists are in the money business, it's surprising how little they know about its ability to make us happy. They don't study it, they just assume more money equals more "utility" or satisfaction.

The professionals who study the relationship between money and happiness are the psychologists. And three of them, Elizabeth Dunn, Daniel Gilbert and Timothy Wilson, of the universities of British Columbia, Harvard and Virginia respectively, have published, in the Journal of Consumer Psychology, a useful guide to their profession's finding on how to get more satisfaction from your spending.

"Money is an opportunity for happiness, but it is an opportunity that people routinely squander because the things they think will make them happy often don't," they say.

Why not? Because humans turn out to be quite bad at "affective forecasting" - predicting how happy or unhappy particular events will make them feel. We tend to overestimate how good we'll feel about good things and how bad we'll feel about bad things.

That's mainly because we underestimate our ability to adapt to positive and negative events. We quickly adapt to some improvement in our circumstances and take it for granted. Fortunately, it also works the other way: we soon come to accept, possibly major, setbacks in our circumstances.

But another reason our forecasting goes astray is that how we're feeling at the time we make the forecast has too much influence on how we imagine we'll feel at the time it happens. Haven't you noticed? If it's cold when you're packing for a summer holiday, you tend to take too many warm clothes.

The authors use well-established research findings to offer some tips on how to get more satisfaction from spending. One is to buy experiences instead of things. "Experiential purchases" are those made with the intention of acquiring a life experience; an event, or series of events, we live through.

One reason experiences are better is it takes longer to adapt to them. Objects don't change after you've bought them, but each session of a year-long cooking class is different. Experiences offer more scope for pleasurable anticipation and, particularly, remembering them fondly. It's easier to tell your friends about a great holiday than to boast about a new car.

Another tip is to help others instead of yourself. Humans are the most social animal on our planet, the authors say. We have highly complex social networks that include people who aren't related to us. So it's not surprising the quality of our social relationships is a strong determinant of our happiness.

Almost anything we do to improve our connections with others tends to improve our happiness. And studies show that people who devote more money to "pro-social" spending - gifts to others or to charities - are happier, even after allowing for how high their incomes are.

A third tip is to buy many small pleasures instead of a few big ones. "As long as money is limited by its failure to grow on trees," the authors say, "we may be better off devoting our finite financial resources to purchasing frequent doses of lovely things rather than infrequent doses of lovelier things."

In many areas of life, happiness is more strongly associated with the frequency than the intensity of people's positive experiences.

Another tip is to be wary of comparison shopping. Economists are great believers in shopping around to find the best deal. Indeed, competition doesn't work very well unless consumers are willing to shift their business.

But the psychologists have a different take. "By altering the psychological context in which decisions are made, comparison shopping may distract consumers from attributes of a product that will be important for their happiness, focusing their attention instead on attributes that distinguish the available opinions," the authors say.

The comparisons we make when we are shopping are not the same comparisons we will make when we consume what we shopped for.

Their final tip is another odd one: follow the herd instead of your head. Research suggests that the best way to predict how much we will enjoy an experience is not to evaluate its characteristics ourselves, but to see how much other people liked it.

We're usually not so different from them and, in any case, most people like having plenty of company.

Read more >>

Mike Baird's high-risk election strategy

Mike Baird is nothing if not game. His first budget as Premier is a model of fiscal rectitude - which wins him high marks from people like me, but makes this a most unusual budget for a politician facing an election early next year he can no longer be certain of winning easily.

The budget offers little in the way of tax breaks and few new spending initiatives, save for more money on child protection, disability services and homelessness.

Hardly a standard way to buy votes. The cynical may see this as the reversal of earlier budget cuts that led to political embarrassment, but I think I see signs of a more tender conscience - another rare commodity in politics.

A fourth budget of tight control on spending and steadfast revenue-raising cements the new Treasurer Andrew Constance's claim to have got the budget back on track and heading steadily into the land of surplus. If voters are looking for good managers of the state's finances, this lot is the best we've seen in a long time.

Of course, Baird is promising to spend big on a new hospital, highway or rail link near you. That's sounding more like pre-election vote gathering. But even here he's not planning to do anything that could possibly endanger the state's much-prized AAA credit rating.

As his opponents will lose no time in reminding anyone who has forgotten, almost all the goodies he's promising are dependent on him raising the money by partially privatising the state's electricity distribution businesses - a proposal the electorate has so far found utterly unattractive.

It's also a proposal that caused bitter division within the previous Labor government. It led to the demise of a premier and a treasurer, and was ultimately the greatest single contributor to Labor's ignominious defeat in 2011.

The election next March is shaping as a referendum on electricity privatisation which Labor, freed from the obligations of office, will vehemently and gleefully oppose with blood-curdling predictions about how power prices would rise.

This time, however, Baird has upped the stakes by giving all of us something to lose in the way of improved infrastructure. If you want all those goodies you have to vote for him, not the other lot. But if we vote him back, the privatisation comes too. He's nothing if not game.

It would be nice to say Baird's budgetary virtue had been rewarded by a much-improved outlook for the NSW economy. But state budgets don't have much influence over state economies.

Sometimes, however, the virtuous can have good luck. And Baird's luck is looking fine. With the mining investment boom ending, there has been a changing of the guard between the states. As Western Australia falls back, NSW takes the lead.

The whole of federal macro-economic policy is directed at encouraging growth in the non-mining economy and the non-boom states, making NSW a prime beneficiary.

The Reserve Bank is holding interest rates exceptionally low to encourage borrowing and spending, particularly on housing, and NSW is Exhibit A to show it's working. Baird's budget is getting its cut, with collections from the tax on property conveyancing now very high.

After a long period of below-average growth, the NSW economy is already growing faster than the national average and this seems likely to continue for at least another few years. That means better growth in employment and lower unemployment. Not a bad time to have an election.

Read more >>

We're a nation of stay-at-homes

Would you be surprised if I told you the resources boom and its two-speed economy had led to a big increase in the number of people shifting between states? No, I thought not.

Well here's my surprise: it hasn't gone up, it has gone down. Research by Professor Jeff Borland, of the University of Melbourne, finds that the rate of interstate migration has declined over the past decade.

The eternal lament of oldies (me included) is that we're getting more and more like America. But this is one respect in which we aren't. The Americans are inveterate movers between states, but we have never moved as much as they do, and now even fewer of us are doing it.

"Australians have never been big movers," Borland says. "Most of us complete our schooling in the same state. We're not likely to shift states to find employment if we lose our jobs. And when we move in retirement, this is mostly to another place in the same state."

Borland's paper shows that, in 2003, the proportion of the population moving between states was 2.1 per cent. Last year it was just 1.5 per cent, a decline equivalent these days to 130,000 fewer people.

This was the lowest rate for at least 40 years. And it was no flash in the pan. It was the continuation of a decline that's been occurring steadily for 10 years. The rate of interstate migration rose between the mid-'70s and the late-'80s, then stayed pretty stable at about 2 per cent a year until the early noughties.

The rate of decline was reasonably similar in all states, with one exception. No, it wasn't Western Australia. It was Queensland. And Queensland's share of the decline wasn't disproportionately smaller than for the other states, it was larger.

The decline has occurred among people of all ages. But that's not to say people of all ages are equally likely to pack up and move interstate. They aren't.

Borland finds that the peak ages for state migration are the 20s and 30s. "People above 40 years move progressively less as they get older," he says.

If we take the example of the late 1990s, one in 25 people aged 20 to 24 moved interstate in the previous year, whereas for those aged 70 to 74 it was one in 200.

So why has interstate migration declined? If moving tends to be concentrated among people in their 20s and 30s, could such migration be down because, with the ageing of the population, people in that age range now constitute a smaller proportion of the total population?

No, the overall decline is explained by declines in all age groups, although it's true that the decrease has been larger at younger ages.

It seems clear to me that most interstate migration is work-related. Or, as Borland puts it, "suppose we think of the main rationale for interstate migration as being to match the location of the population to the location of jobs".

In that case, could the decline in movement between states be caused by less reallocation of jobs between states? Doesn't seem so. An index of the annual change in the distribution of employment by state shows no downward trend in the extent of change.

So what is the reason? Borland isn't certain, but he finds evidence to support the idea that the change is in the behaviour of recent immigrants to Australia, not that of people long resident here. There's been an increase in the correlation between the states immigrants first come to and the states where employment is growing fastest.

My guess is it gets back to the Howard government's move to a much greater proportion of skilled migration, with greater employer nomination of migrants via 457 visas. Migrants are now more likely to come straight to a particular job than to land in Sydney or Melbourne and start hunting for one somewhere in Oz.


RIVALRY between the Coalition and Labor can reach petty levels. The budget papers always had white covers until the Rudd government decided dark blue would be a good reform. Under the Abbott government they've reverted to white.

For many years the federal government spelt "program" the way this newspaper does. But John Howard, spiritual son of Bob Menzies, insisted it revert to the fancy English spelling. Labor changed it back to the no-bulldust way. Now Tony Abbott, spiritual son of Howard, has reverted to "programme".

Pedants who know their stuff know the Poms - including Shakespeare in his day - used the simple spelling until the 19th century, when it was prettied-up during a bout of francophilia.

Read more >>

Botched reform causes higher power prices

There's no subject more likely to stir people up than rising electricity bills. With prices roughly doubling since 2007, that's hardly surprising. But why have prices risen so fast? And will they keep rising?

It has suited various business lobbies and Coalition politicians - federal and state - to leave people with the impression the main reason is the carbon tax and the renewable energy target, which requires that 20 per cent of Australia's electricity come from renewable energy sources by 2020.

In truth, the price rises started well before these measures took effect and they explain only a small part of the increase. Which suggests the politicians will suffer yet another loss of credibility when eventually (and stupidly) the carbon tax is abolished and the renewables target is dropped, as seems on the cards, but power prices don't seem to fall by much.

The more important reasons were given by Professor Ross Garnaut, of the University of Melbourne, in a recent speech. Here's my version of his explanation.

One part of the reason is that more people have been using renewable energy and this reduced their demand for conventional electricity from the grid, which is produced mainly by coal-fired generators, of course.

Apart from all the wind turbines, governments - federal and state, Coalition and Labor - have offered incentives to people to incur the significant expense of installing rooftop solar power systems.

The most generous of these incentive schemes have been abandoned but, at the same time, the cost of photovoltaic systems has been falling rapidly, partly because of advances in technology, partly because more purchasers mean greater economies of scale.

The most important economic characteristic of renewable energy is that once you've incurred the high "fixed cost" of installing a system, the "variable cost" of using the system to produce more energy is negligible. Sunshine is free. So once you've got a system, you use it.

A second important part of the reason for rising power prices is that many businesses and households have reacted to the rising price by being more economical - less wasteful - in their use of electricity.

Another factor (one many economists tend to ignore) is that all the talk about the need to reduce emissions of carbon dioxide to stop climate change, and all the talk about how much power we waste, has made more firms and householders waste-conscious. Some people are being careful in their use of electricity as a self-interested response to its rising price, while others - including businesses - are doing it from a sense of duty to society.

By now, I trust, a big red light is flashing in your head. If people are using less power from the grid because more of them are collecting their own and more are reducing their wastage of electricity, doesn't that mean demand for conventional power is falling?

Indeed it does. According to figures from the Grattan Institute, since late 2009 electricity demand in eastern Australia has fallen by about 7 per cent.

But hang on, is this guy saying the price of electricity has gone up because demand for it has gone down? Isn't it supposed to be the other way round? Isn't a fall in demand supposed to lead to a fall in the price?

Well, assuming no change in supply, yes it is. So you're right to be to be puzzled. The relationship I've described between price and demand is, as an economist would say, "perverse".

But why? Because, as Garnaut explains, we've stuffed up the deregulation of the electricity market. (Moral: as we're being reminded by the plan to "deregulate" university fees, if you deregulate or privatise without knowing what you're doing you can make things worse rather than better.)

Before the reform process began, each state had its own, government-owned electricity monopoly, with little trade between the states. From the late 1980s it was decided to break the integrated state monopolies into their component parts - generation, transmission, distribution and retailing - and form one big eastern Australian electricity market with as much competition and as little monopoly as possible.

The power stations were separated into individual businesses - some of which were privatised, particularly in Victoria - and made to compete in a highly sophisticated "national" wholesale market for electricity. Garnaut says this has worked well, with competition keeping the wholesale price low in response to the reduced demand.

But transmission (high-voltage power lines) and distribution (local poles and wires to the premises) are natural monopolies. That is, it's not economic to have more than one network. So whether these businesses are publicly or privately owned, the prices they charge have to be regulated to prevent them overcharging.

Trouble is, Garnaut says, we've done this by fixing the maximum rate of return the businesses are allowed to earn on the capital they have invested. Economists have known for 60 years that this always causes problems because it's so hard to pick the right rate of return.

If it's too low it leads to underinvestment in the physical network, causing blackouts. If it's too high, however, it leads to overinvestment in the network at the expense of business and household customers.

But as well, when monopoly businesses that are guaranteed a certain rate of return suffer a loss of demand, the regulator has to allow them to restore their profitability by raising their prices.

Another red light flashing? Surely if you keep responding to a fall in demand by raising prices, this will lead to a further fall in demand (particularly as the cost of renewable energy keeps falling) and the whole thing will keep going round and round and getting worse and worse.

Just so. People in the know call it a "death spiral". One day soon the regulators of the regulators - aka federal and state governments - will have to step in and call the madness to a halt. Until then, prices will keep rising.

Read more >>