Materialist era a qualified success

Tired of obsessing over what happened in the economy yesterday? Let's go to the other extreme and look at what's been happening in the past 200 years, and broaden the focus from poor, ailing Australia to the world.

In October, the Organisation for Economic Co-operation and Development published a report, How Was Life? Global Well-Being Since 1820. It's an extension of the work of great economic historian Angus Maddison.

His life work was to piece together estimates of real gross domestic product for all the big countries and regions of the world between 1820, which he took to be the end of the (first) industrial revolution, and 2000.

This latest study has extended the GDP figures to 2010, but also tried to estimate measures of various other socio-economic indicators of well-being.

It paints a picture of the way economic development has spread throughout the world, raising living standards, widening but then narrowing the gap between incomes, fostering population growth and, when you combine the two, causing great damage to the globe's natural environment.

The world's population was about 1 billion at the start of the 19th century, but has grown to more than 7 billion today. That growth was both a cause and a consequence of economic development and the technological advance it promotes.

Advances in public health, particularly sewerage and clean water, led to falling death rates, which slowly encouraged people to have fewer children. Then advances in medical science took over, eventually including more effective means of contraception.

However, these improvements took a long time to spread from Western Europe and the "Western Offshoots" (Maddison's name for the United States, Canada, Australia and New Zealand) to the rest of the world.

This is the story of the huge challenge the world economy has faced in the past 200 years: how to feed, clothe and house this growing population. Overall, we've done it.

Between 1820 and 2010, the world's average real GDP per person increased by a factor of 10. Multiply that by the sevenfold increase in population and world real GDP rose by a factor of 70.

The first weakness in this materialist success story is obvious: this economic growth was spread very unevenly. In 1820, the richest country, Britain, was at most five times as wealthy as the poorest countries. By 1950, the richest countries were more than 30 times as well off.

Only recently has the spread of industrialisation to China and India, which between them contain about one-third of the world's population, caused global income inequality to begin to decline.

Another indicator the study examines is the movement in the real wages of unskilled labourers. They rise more or less in line with real GDP, suggesting that some income does indeed trickle down, even if it has to be helped along by government interventions such as minimum wages.

During the first half of the 19th century, unskilled wages were above subsistence level only in Europe and the Western Offshoots. Now, however, world unskilled real wages are about eight times what they were then.

They were always highest in the Western Offshoots, with Western Europe catching up only since World War II, and they are still low in south-east Asia and Africa.

Turning to education, in 1820 less than 20 per cent of the world's population was literate, and most of these were in Europe and its offshoots. Today, literacy is nearly 100 per cent almost everywhere, although in south-east Asia, the Middle East and North Africa, it's about 75 per cent, and in the rest of Africa it's only 64 per cent.

Much of the increase in literacy has been achieved since the war and decolonisation. It has been accompanied by rising average years of education in all parts of the world. Levels of global inequality are much lower for education than for income.

At the start of the industrial period, average life expectancy was about 40 years in Europe and its offshoots, and 25 to 30 in most of the rest of the world. Only after the late 1890s did life expectancy start to rise significantly. Now, it's about 80 in the rich countries. Elsewhere, the catch-up started after the war, with most of the other world regions now up to about 60 to 70, and only Africa lagging significantly behind.

Income inequality within particular European and offshoot countries has followed a U shape, declining between the end of the 19th century and about 1970, since when it has risen sharply. In other parts of the world, particularly in China, recent trends have led to greater income inequality.

However, when we look at global income inequality, it was driven largely by increasing inequality between countries, as opposed to within them. It worsened until the 1950s, but has since stabilised.

The other big weakness in the success story is, of course, what we have done to the quality of the environment. There has been a long-term decline in biodiversity worldwide. Emissions of carbon dioxide have been rising since the industrial revolution, with its shift to fossil fuels such as coal and oil.

Although almost all the greenhouse gases that have built up in the atmosphere since the early 19th century are the result of economic activity in the developed countries, China's huge population and remarkably rapid industrialisation mean that it has now taken over from the US as the world's largest emitter.

Something tells me that, from here on, climate change and other environmental damage will be the main factor limiting the spread of industrialisation and prosperity to the remaining less-developed parts of the world.

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Greenery has magic properties

I've just got to get through extended Christmas festivities - and subsequent mopping up - and I'll be off on my hols. What am I doing this year? Same as most years: heading for the bush. This time, we're going to the mountains.

As a denizen of the inner city, I've long had a great desire to get out into the country whenever possible. Get into the grass and trees, where the air is clean and the sleeping seems better.

There's a place we rent not far up the coast that backs on to a national park. I call it Lyrebird Lodge. And even when we go overseas, I often find the country towns beat the big cities.

In recent times, I've been singing the praises of big cities: how efficient they are and how they promote creativity and productivity, particularly in the era of the information economy.

But cities have their dark side and insufficient grass and trees is it. That's more than just a personal preference. Environmental psychologists and others have been gathering impressive evidence of the health-giving properties of greenery.

It's evidence to support the US biologist E. O. Wilson's "biophilia" hypothesis: because humans evolved in natural environments and have lived separate from nature only relatively recently in their evolutionary history, people possess an innate need to affiliate with other living things.

Research published last year found that people who live in urban areas with more green space tend to report greater well-being - less mental distress and higher life satisfaction - than city dwellers who do not have parks, gardens or other green space nearby.

Mathew White and colleagues at the University of Exeter Medical School used a national longitudinal survey of households in Britain to track the experience of more than 10,000 people for 17 years to 2008.

They found that, on average, the positive effect on well-being was equivalent to about one-third of the difference between being married rather than unmarried and a 10th of the effect of being employed rather than unemployed.

A different study followed the experience of more than 1000 people over five years, in which time some moved to greener urban areas and some to less green areas. The results showed that, on average, people who moved to greener areas felt an immediate improvement in their mental health. This boost could still be measured three years later.

"These findings are important for urban planners thinking about introducing new green spaces to towns and cities, suggesting they could provide long term and sustained benefits for local communities," the lead author of the study said.

A study from Canada began by summarising all the various benefits from contact with nature that other research had found: it can restore people's ability to pay attention, improve concentration in children with attention-deficit hyperactivity disorder, and speed recovery from illness. It might even reduce the risk of dying.

Yet another study notes that the first hospitals in Europe were infirmaries in monastic communities where a garden was considered an essential part of the environment in that it supported the healing process.

This study of studies, from Norway, says: "In most cultures, both present and past, one can observe behaviour reflecting a fondness for nature. For example, tomb painting from ancient Egypt, as well as remains found in the ruins of Pompeii, substantiate that people brought plants into their houses and gardens more than 2000 years ago."

Many studies find health benefits from contact with nature. The Norwegian paper says a key element in this may be nature's stress-reducing effect. Stress plays a role in the causes and development of cardiovascular diseases, anxiety disorders and depression.

Contact with nature may help "simply by being consciously or unconsciously pleasing to the eye".

Office employees seem to compensate for lack of a window view by introducing indoor plants or even just pictures of nature. One study found that having a view to plants from the work station decreased the amount of self-reported sick leave.

One of my favourite blog sites, PsyBlog, conducted by the British psychologist Dr Jeremy Dean, notes research estimating that people now spend 25 per cent less time in nature than they did 20 years ago. Instead, recreational time is often spent surfing the internet, playing video games and watching movies.

But this is more up my line: Dean reports a study finding that taking group walks in nature is associated with better mental well-being and lower stress and depression.

The study evaluated a British program called Walking for Health, and involved nearly 2000 participants, divided into two matched groups of those who took part in the walks and those who did not.

The walks, which extended over three months, combined three elements, each of which you'd expect to make people feel better: walking, being in nature and being with other people.

Those who seemed to benefit most were those who had been through a recent stressful life event, such as divorce, bereavement or a serious illness.

"Our findings suggest that something as simple as joining an outdoor walking group may not only improve someone's daily positive emotions, but may also contribute a non-pharmacological approach to serious conditions like depression," one of the study's authors said.

You beaut. When I get to the mountains, I'm hoping to do a lot of bush walking.

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Midyear forecasts do add up - sort of

Did you catch the apparent contradiction in this week's mid-year budget update? It left unchanged the forecast that the economy would grow by 2.5 per cent this financial year, but then blamed a weaker-than-expected economy for most of the $10 billion blowout in the expected budget deficit.

How on earth is that explained? By a widening gap between real gross domestic product and nominal GDP.

We tend to focus on the growth in real GDP - GDP adjusted for inflation - as the best guide to how many additional jobs are being created and, in normal circumstances, what's likely to be happening to our material standard of living.

Trouble is, as former treasurer Wayne Swan kept saying, we live - and work, earn income and pay taxes - in the nominal economy, not one that's already been adjusted for inflation.

At budget-time Treasury was expecting nominal GDP to grow by 3 per cent and real GDP by 2.5 per cent, implying that the prices of all goods and services Australia produces would rise by 0.5 per cent.

Now, however, it's expecting nominal GDP to grow by just 1.5 per cent, implying it's expecting the overall price of the stuff we produce to fall by 1 per cent.

So initially Treasury was expecting "producer" prices to rise only a little overall and now it's actually expecting them to fall. Why? Because of falls in the prices our producers of commodity exports receive, particularly for iron ore.

The budget in May assumed the price of iron ore would stay at $95 a tonne, but now Treasury's assuming it will stay at its recent level of $60. Lower export prices mean lower mining company profits which, in turn, mean lower collections of company tax - by $2.3 billion this financial year, and more in subsequent years.

But there's another major factor contributing to the lower growth in nominal GDP: nominal wage rates are now expected to grow by only 2.5 per cent, not 3 per cent. This (plus lower growth in employment) is expected to reduce the growth in collections of income tax by a further $2.3 billion.

Adding a few other items, expected total tax receipts have been cut by $6.2 billion, with all the delays and deals in the Senate explaining most of the remainder of the $10 billion increase in the now-expected budget deficit of $40 billion.

The mid-year document says that if nominal GDP grows by only 1.5 per cent in 2014-15, this will be its weakest growth in more than 50 years. But the truth is nominal GDP has been growing by much less than its usual 5.5 per cent or so (real growth of 3 per cent plus inflation of 2.5 per cent) ever since mining export prices peaked in 2011.

The writedown in expected tax receipts of $6.2 billion this financial year increases to $31.6 billion over the four years of the "forward estimates". And that brings the total writedown in tax receipts since the Abbott government was elected to more than $70 billion.

Wow. The prices we get for our mining exports have been falling much further and faster than Treasury has expected. Of course, the rot set in during Julia Gillard's term. It was the biggest reason she failed to keep her promise to get the budget back to surplus in 2012-13.

Back then, Joe Hockey was having none of Swan's claim that nominal GDP and tax collections had collapsed under him. No, there was just a single explanation for the continuing budget deficit: Labor's uncontrolled spending.

Different story now you're Treasurer, eh Joe. You've got it right now.

But there's a lesson in this week's budget blowout for Labor, too. In last year's mid-year update, Hockey produced an estimate for the 2013-14 budget deficit of $47 billion, up $17 billion on the $30 billion the secretaries of Treasury and Finance signed off on during the election campaign.

About $10 billion was creative accounting and other dubious transactions Hockey claimed were Labor's fault. The remaining $7 billion was explained by Treasury revising down its forecasts for employment and wage growth and, hence, tax collections.

Former Labor ministers were convinced Hockey lent on Treasury to make its revenue forecasts worse than they needed to be and so make Labor look bad. My guess, however, is that Treasury had been over-forecasting revenue for so long it seized the opportunity to try to get ahead of the game and, if anything, start under-forecasting revenue.

Subsequent events have confirmed the wisdom of Treasury's downward revisions at that time. They proved pretty right. But as this week's further downward revisions for the following financial year show, Treasury is yet to get ahead of the game in accurately forecasting the extent of the slowdown in the growth of tax receipts.

So, Labor, no conspiracy, just the usual stuff-up. That's to say, the usual human frailty. Treasury is no better at predicting what will happen to commodity prices than the rest of us.

There remains one more puzzle to be explained. If Treasury is now expecting slower growth in employment and wages this financial year, how can this not have led it to revise down its forecast of real GDP growth of 2.5 per cent?

Good question, but you'll be sorry you asked. Part of the explanation is a change in the expected composition of the growth - some components were revised up, some down.

But longstanding convention requires official forecasts to be expressed in fractions of a quarter, so as to avoid "spurious accuracy". Strictly, the forecast is 2 1/2 per cent, not 2.5 per cent. Treasury's actual, decimal-point forecast has been revised down, from a bit above 2 1/2 to a bit below.
But not enough below to be closer to 2 1/4 than to 2 1/2.

Don't say I didn't tell you.

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There has to be more to our future than the budget

The end of last year was too early to make judgments about Tony Abbott and his government, but by now we can make a reasonable assessment. And it's hardly a favourable one, even by those who couldn't wait to see the back of infighting Labor.

But though it's easy to bang on about the Abbott government's failings, I'm beginning to think it's too easy. Maybe our politicians are an uninspiring lot because their citizens aren't much better.

My strongest feeling in recent days is what a mentally incestuous, intellectual backwater we've allowed Australia to become, even in an age of instant access to the newest and best ideas.

It's all there to enlighten and guide us into better paths, but few of us seem to be taking it in - not our politicians, our bureaucrats, our media commentators, maybe not even our academics. Just a few of our think-tanks - most notably, the Grattan Institute.

The future is pregnant with exciting possibilities, but we sweat the small stuff and keep chasing the same tired old reform ideas round and round the track.

Monday's midyear budget review was a depressing reminder that this government or the next is likely be wrestling to get the budget back to surplus for up to a decade.

Can you imagine how much effort and attention from our politicians, econocrats and media this will consume? This year's argument played out every year for many years?

And for what? To get the budget back to balance. I'm not saying balancing the budget is unimportant; of course it's important. But it's just housekeeping. It has to be done, but once it has been it's just the avoidance of a problem.

It doesn't achieve anything positive. And yet we're hoping that, sometime within the next decade, we'll be able to list it as one of our great achievements.

So bogged down and obsessed by the budget has our elite become that, in all our fiddling with government spending and taxation, an attitude is developing - especially in the purse-string departments - that it doesn't much matter what measures we take so long as they reduce the deficit.

This is impoverished, desperation thinking. We ought to be choosing budget measures that kill two birds with one stone; that improve the government's efficiency or the economy's efficiency or the fairness of our tax-and-transfer system - or even, dare I say it, improve the quality of our lives - as well as cutting the deficit.

But when you look at this year's budget you see little sign of such broader thinking. Take the way successive governments have imposed Orwellian "efficiency dividends" on government departments and agencies, which by now actually sets off another round of compulsory redundancies.

Such savings draw approval rather than complaint from a shiny-bums hating public, but the notion that so many jobs can be cut without impairing the public service's ability to do its job - and to give the government high quality advice - is crazy.

Staff cuts in the Taxation Office are one reason tax collections have fallen short. Staff cuts in Treasury and Finance are one reason the budget was so bad. And why do you think the Bureau of Statistics is having so much trouble telling us what's happening to unemployment?

We're indebted to a think-tank - not the econocrats - for reminding us how unequal the distribution of wealth between the generations has become. To a fair extent this arises from longstanding and increasing discrimination between the generations in the government's tax and spending policies.

Did the budget seize the opportunity to fashion its savings in ways that reduced this problem? Did anyone even think to assess the proposed savings from the perspective of their effect on this imbalance? What do you think?

Similarly, we're indebted to the Grattan Institute for bringing to us relatively new research showing how important the efficient functioning of big cities is to the efficiency of the economy and to promoting economic growth.

To boil it down, a key issue is how long it takes people to get from their home to work. Did it occur to anyone to suggest to the government that this efficiency consideration should affect its choice of state infrastructure projects to fund?

Then there's all the orthodoxy-busting research - now coming even from the official international economic agencies - finding that that income inequality acts as a drag on economic growth. Did the government know - or did anyone warn it - that by preferring budget cuts biased against the bottom half it could be hindering its professed goal of faster growth?

In any time remaining after it has struggled with the budget, the government plans reviews of the tax system and industrial relations, leading to major proposals to reform the economy and get it growing faster.

Really? One more time? That's the best advance you've been able to think of? That's the best the whole nation has come up with? Another argument about the GST? Another argument about bringing back Work Choices?

The tax system will always need running repairs, but for so many of us to see tax reform as the Stairway to Heaven is delusional. Same goes for another fiddle with wage bargaining.

It reveals the limits to our ambition, the incestuous nature of our policy debate, the limits to our imagination and even the limits to our use of Amazon.
 

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Hockey reacts wisely to budget deficit blowout

The news from the mid-year budget review isn't as bad as it might seem. And I give Joe Hockey high marks for his wise response to it.

Despite any contrary impression the denizens of Canberra might have left you with, the budget is not the economy.

The economy, in which you and I live, work and spend, is much bigger and more important than Hockey's budget.

The $10 billion blowout in the expected budget deficit for this financial year is largely the result of falling mineral commodity prices and weaker-than-expected growth in employment and wages, leading to lower growth in tax collections, plus a bit from the government's troubles with the Senate.

In other words, the blowout is mainly a reflection of problems in the economy, not a cause of them.

It doesn't add to those problems, so it's not a reason for people to be any less confident than they have been about our economic future.

Indeed, the blowout is good news in the sense that it represents the budget helping to maintain growth in the economy by having the government's spending exceed tax collections, at a time when private spending isn't as strong as we would like.

So Hockey is, as he says, allowing the budget to act as a kind of shock absorber, which is exactly what he should be doing.

What he's promising not to do is attempt to get the budget back into surplus in short order by cutting government spending or raising taxes at a time when the economy is far from strong.

To pursue such a policy of "austerity" - as conservative parties in the United States, Britain and Europe have done - would be counterproductive. It would most likely make the economy even weaker and thus make the budget deficit bigger rather than smaller.

In setting his face against austerity, as he said he would in the last weeks before the election, he is affirming the policy he pursued in the May budget.

That budget proposed many cuts in spending but, in net terms, their dampening effect wouldn't have hit the economy until 2017-18, by which time it was expected to be growing strongly and capable of withstanding the drag.

The fact that the public and the Senate judged many of the specific spending measures Hockey proposed to be unfair shouldn't cloud the truth that, in its long-delayed dampening effect on the economy, Hockey was acting with commendable judgment and restraint.

So, whatever his failings as a judge of fairness or as a salesman, as a manager of the economy Hockey has proved much wiser in government than he seemed likely to be when in opposition.

Don't take much notice of the opposition's outraged criticisms of this midyear budget update.
That's just Labor trying to get even after all the unfair criticism and silly things Hockey said when it was in government.

None of this means returning the budget to surplus doesn't matter. It does - we can't run deficits forever. But the time for that is once the economy is back to strong growth. Until then, it can wait.

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How the medical research fund is a trick

As an accountant turned journo, I try to ensure the creative accounting used to make the budget figures look better than they really are doesn't go unexposed. But I've never seen a con as audacious as the proposed medical research future fund.

I wrote at length about all the accounting tricks perpetrated by the Gillard government, but now it's the Abbott government's turn.

In their budget update during last year's election campaign, the heads of Treasury and Finance signed off on a deficit estimate for 2013-14 of $30 billion. But four months later Joe Hockey and Mathias Cormann popped up with their own mid-year review claiming the deficit they'd inherited would be closer to $47 billion.

Today you'll hear Hockey repeat that claim. But that higher number was largely the result of our heroes indulging in a little creative accounting of their own.

About $7 billion of the $17 billion increase since the election was explained by Treasury revising down its forecasts for employment and wage growth and, hence, tax collections. Fair enough. But most of the remaining $10 billion involved dubious transactions our heroes claimed to have been forced to make because Labor had left them hanging.

The biggest was a transfer of $8.8 billion to the Reserve Bank - an amount the Reserve hadn't asked for and Treasury had recommended against. Its effect was to make Labor's last deficit look bigger and to make it easier for the Reserve to pay higher dividends into Hockey's subsequent budgets.

When in this year's budget Hockey announced the GP co-payment and various other cuts in health spending, he explained that these savings would be put in a new medical research future fund.

Once the money in the fund had built up $20 billion, the annual interest on the money in the fund would be used to pay for medical research. But under the changes announced last week, these payments from the net interest earned would instead begin in 2015-16.

This is an accounting trick, but it seems only students of government accounting rules can see it. People think that since the savings are being spent building up the fund, there won't be any net saving to the budget until after the $20 billion target has been reached.

Not so. The saving to the budget bottom line is immediate, though the change means this saving will be reduced a fraction by the increased spending on research.

Like many budget fiddles, this one relies on exploiting loopholes in the definition of the bottom line, the "underlying cash deficit".

The best way of thinking of it is that transactions recorded "above the line" affect the size of the deficit, whereas those recorded "below the line" don't. Below-the-line transactions are regarded as affecting only the way the deficit is financed.

The Medicare spending cuts are recorded above the line, but the decision to put an amount of money equivalent to those savings into a special fund goes below the line. It is, after all, only a decision to move money around the government's balance sheet. It doesn't involve the government spending a cent, just moving money between its accounts.

Of course, since the government is in deficit, it doesn't actually have any money to put into its medical research future fund account. So to its normal borrowing to cover the deficit it will have to add borrowing to finance the money it puts into the research fund.

This extra will add to the size of its gross public debt, but not to its net debt, since the latter is the gross debt (everything the government owes other people) minus all the money in the various parts of the future fund, which has been used to buy shares and bonds, and so represents all the money other people owe the government.

However, when the government spends the interest on the medical fund on medical research, this spending will be recorded above the line and so will add to the deficit.

Once the dust has settled, however, I expect to see a second leg of the trick brought to fruition. In a subsequent budget the government may decide that, now it's spending more on medical research via the future fund, it's able to spend less on medical research via the National Health and Medical Research Council. This brilliant con job will be complete.

What's the point of it all? Partly it's an attempt to bamboozle doctors, but mainly it's designed to allow the government to break its election promise not to cut health spending while claiming it hasn't broken it, just "reprioritised" health spending.

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Widening income gap slows economic growth

One of the most significant developments in applied economics in recent times is something we've heard little about in Australia, where we seem to be living in our own little cocoon, oblivious to advances in the rest of the world.

For decades, economic policy in Australia - and most other developed countries - has been based on the assumption that there's a trade-off between economic efficiency and fairness (or "equity" as economists prefer to call it).

If governments try to make the distribution of income between households less unequal by, say, using taxes and government spending to redistribute income from rich to poor, or by setting a reasonable minimum wage, it's long been believed, this will make the economy less efficient and so cause it to grow more slowly.

On the other hand, if governments don't do as much to redistribute income away from high-income earners, this will provide stronger incentives for people to work harder, invest and accept risk in the pursuit of greater profits.

This, in turn, will cause the economy to grow faster, leaving us all better off. What's more, the rich have a higher propensity to save, and greater saving will finance additional productive investment.

So, sorry about that, but we have to go easy on high-income earners because this makes the economy work better.

This belief that fairness reduces growth but unfairness fosters it lies behind many of the tax "reforms" we've seen over the years.

The moves to cut the top income tax rate from 67 per cent to 47 per cent, to tax capital gains at half the rate applying to other income, to end the double taxation of dividends and to use introduction of the goods and services tax to increase indirect taxation and cut income tax, are all motivated by the belief this would be better for the economy.

Trouble is, there's been surprisingly little empirical evidence to support this theory - a theory, you'll be surprised to hear, rich people really like (just ask the Business Council).

In recent years, however, the academic tide has turned and researchers are finding increasing evidence that inequality may actually be bad for economic growth. The tide has turned so far it's reached the international economic agencies (though not our econocrats).

Early this year, three researchers at the International Monetary Fund, Jonathan Ostry, Andrew Berg, and Charalambos Tsangarides, published a paper on Redistribution, Inequality and Growth, which found that lower inequality was reliably correlated with faster and longer-lasting economic growth.

What's more, they found that redistribution - the thing economists have long assumed would dampen incentives - seems to have no adverse effect on growth, except perhaps in extreme cases.

"We should be careful not to assume that there is a big trade-off between redistribution and growth. The best available macro-economic data do not support that conclusion," they found.

And now, this week, the Organisation for Economic Co-operation and Development has published a paper by Federico Cingano, Trends in Income Inequality and its Impact on Economic Growth, that comes to similar conclusions.

In most OECD countries, the gap between rich and poor is at its highest in 30 years. In the 1980s, the top 10 per cent of households earnt seven times what the poorest 10 per cent earnt. Today it's 9 1/2 times. (In Oz it's 8 1/2 times.)

Cingano says that doing something about this trend has moved to the top of the policy agenda in many countries.

"This partly due to worries that a persistently unbalanced sharing of the growth dividend will result in social resentment, fuelling populist and protectionist sentiments and leading to political instability," he says.

But another, growing reason for policy-makers' interest in inequality is its possible effect in reducing economic growth and slowing the recovery from the Great Recession.

His econometric comparisons of the performance of OECD countries over the past 30 years confirm earlier findings that increasing income inequality has an adverse effect on later economic growth. In New Zealand, for instance, its total growth over the 20 years to 2010 would have been more than 10 per cent greater had its income disparity not widened as much as it did over the 20 years to 2005.

For both the United States and Britain, their cumulative growth would have been more than 20 per cent greater.

You could argue that just because inequality reduces the rate of economic growth, this doesn't mean government measures to redistribute income will make things better. Those measures could, by reducing economic incentives, make their own contribution to reducing growth.

You could argue it, but you'd get no support from Cingano's analysis of the evidence. "These results suggest that inequality in disposable incomes is bad for growth, and that redistribution is, at worst, neutral to growth," he finds.

But get this: he found that what does most to inhibit growth is an increasing gap between low-income households (the bottom 40 per cent) and the rest of the population.

"In contrast, no evidence is found that those with high incomes pulling away from the rest of the population harm growth," he says.

So the rich attract most envy and resentment, but they're not what inhibits growth. What is it about inequality in the bottom half of the distribution that leads to weaker economic growth in later years?

Cingano finds support for the "human capital accumulation theory", suggesting that lower relative increases in the incomes of families in the bottom half make it harder for them to invest in the education and training that increases the value of their labour and the size of their contribution to growth.

But I've got an idea. Why not get a businessman, say, David Gonski, to propose ways of making sure the socially and economically disadvantaged get a good education?

And why don't we hugely increase university fees? That's bound to make us grow a lot faster.

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Growing signs young won't do as well as their olds

Will today's young people end up better off than their parents? That used to be a stupid question. Of course they will. But these days, it's much less certain.

We've come to expect that each generation will be better off than its parents, with more income, better housing and better healthcare.

But many young adults have begun to doubt it. According to one opinion poll, only 22 per cent of respondents under 30 considered they would have a better life than their parents.

And now a report by the Grattan Institute think tank, The Wealth of Generations, has found evidence to support the fear that today's generation of young Australians may have lower standards of living than their parents at a similar age.

It's a question of what's likely to happen to their incomes and what's happening to their wealth.

Our wealth is our assets (property, superannuation and other financial investments, and money in the bank) less our liabilities (mainly debts).

Wealth is like congealed income. We can usually turn it back into money should we need to. Some of it produces income (rental properties, financial investments) and some reduces our need for income, such as when we live in our own homes rather than renting.

We add to our wealth when we save some of our annual income. Most of us save more than we think we do, by paying off a mortgage over 20 or 30 years, or by having our employer fulfil the government's requirement to put 9.5 per cent of our wage into super.

We also add to our wealth when the market value of the assets we own rises – "capital gain". And, of course, when we inherit the wealth of our relatives or receive a gift of money from them.

The wealth of Australian households has grown a lot over the years, even after allowing for inflation, as all the figures I'll quote do. But the report, by John Daley and Danielle Wood, finds that over the past decade, older households captured most of the growth in the nation's wealth.

Despite the global financial crisis, households aged between 65 and 74 in 2011-12 were, on average, $215,000 better off than households of that age range were eight years earlier. Those aged 55 to 64 were $173,000 richer, on average.

But the average household in the 35 to 44 age group was only $80,000 richer. And get this: those aged 25 to 34 actually had less wealth than people of the same age 8 years earlier.

Why? Various developments have conspired to bring this disparity about. Probably the biggest is what's happened to house prices and home ownership.

Rates of home ownership have fallen over the past two decades for all but the oldest households, the report finds. Going further back to 1981, more than 60 per cent of 25 to 34-year-olds were home owners. Thirty years later only 48 per cent of people in that age group were owners.

An increasing proportion of those born after 1970 will never get on the property ladder, according to the authors. If increasing education debts aren't already discouraging younger households from taking out mortgages, it sounds like it won't be long before they will be.

This means a higher proportion of the younger generation missed out on rising housing wealth as house prices boomed. Between 1995 and 2012, house prices increased by an average of 4.3 per cent a year faster than inflation. This was much faster than the rise in full-time wages.

The boom was caused by the greater availability of home loans, the return to low inflation in the mid-1990s and by our failure to build enough new dwellings to keep up with population growth.

The later you were to get in on it, the less the boom's capacity to increase your wealth, particularly because you had to borrow so much to join. But the worst of it for young people is that, though house prices are likely to stay high (making it hard to afford the entry fee), they can't possibly keep rising at the same rate (meaning the prize for getting in won't be as big as it used to be).

There's more to the problem than housing, however. Incomes also grew fastest for older people, allowing them to add more to their wealth through saving. In 2004, households aged 55 to 64 were net spenders; by 2010, with average annual incomes $4600 higher, their net annual saving was $2700.

Although households aged 25 to 34 kept their spending controlled, their average incomes increased by $3100 and their saving by $1500.

A big part of the reason for this is that, over the years, government spending and taxation policies have become more favourable to the elderly than they were. The age pension's been made more generous while income from super is now tax-free.

Who has gained most from the big budget deficits we've been running since 2009? The old. Who will eventually have to pick up most of the tab? The young.

All this wouldn't be such a worry if we could be confident that incomes will keep growing as strongly in the future as they have been for 70 years. They may.

But it isn't hard to think of reasons why they may not – including the thing none of us is allowed even to think about: climate change.

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Economy: not good, but not disastrous

Don't drop your bundle. It's not clear the economy has slowed to the snail's pace a literal reading of the latest national accounts suggests. As for the talk of a "technical income recession", it's just silly.

What is clear is that, at best, the economy continues to grow at the sub-par rate of about 2.5 per cent a year, a rate insufficient to stop unemployment continuing to edge up. This has been true for more than two years.

A literal reading of last week's national accounts from the Bureau of Statistics says the economy - real gross domestic product - grew by a mere 0.3 per cent in the September quarter, down from growth of 0.5 per cent in the previous quarter and 1 per cent in the quarter before that.

But if we've learnt anything by now, it's that it's folly to take the quarterly national accounts too literally. They're just a first stab at the truth, based on incomplete and often inaccurate data.

The initial estimate for growth in any quarter will be revised - up and down - up to a dozen times before the bureau is satisfied it has got it pretty right. Reserve Bank governor Glenn Stevens referred recently to "the vagaries of quarterly national accounting".

Frankly, I don't believe the economy slowed markedly in the three months to September, or the six months, for that matter. If it were true, surely we wouldn't need to be told about it by the national accounts two months after the fact.

Since all individual economic indicators have their weaknesses and inaccuracies - meaning none should be taken too literally - the only adult way to proceed is to see if the signal coming from one key indicator fits with the overall message coming from the other indicators.

On the basis of what all the other indicators are saying, the forecasters - official and unofficial - expected growth in the September quarter of 0.6 per cent or 0.7 per cent, which would be consistent with the view we're still travelling at about 2.5 per cent a year.

When the published figures turn out to be half that, this suggests either that all the forecasters got something badly wrong, or that it's the published initial estimate that's wrong and likely to be revised up to something closer to what we expected.

The way we'll be able to tell whether the economy really has slowed to a crawl is by watching the rate at which unemployment rises in coming months. At the 2.5 per cent a year speed, it's worsening at a rate averaging 0.1 percentage points a quarter.

If that average rises, we'll know things are much worse than they were.

As for the "technical income recession", it proves little. Make a note that, in this context, the word "technical" is warning that what follows is based on an arbitrary rule with little sense to it.

"Technical" means two quarters of contraction in a row equal a recession. So one quarter of huge contraction isn't a recession, and two negative quarters separated by a zero quarter aren't a recession, but two consecutive negative quarters are a recession no matter how tiny the falls (or whether one is subsequently revised away).

"Real gross domestic income" is real gross domestic product adjusted for the change in our terms of trade during the quarter. Since, as we've seen, real GDP growth was weak in the past two quarters, the deterioration in our terms of trade in both quarters caused real income to decline by 0.3 per cent in the June quarter and by 0.4 per cent in the September quarter.

What happens to our terms of trade - and, hence, our aggregate income - is important. But, in this particular case, it's hard to get too excited.

As Dr Shane Oliver, of AMP Capital, has explained: "There is a danger in dwelling too much on the slump in real gross domestic income flowing from the falling terms of trade ... while swings in the mining and energy export prices are very important for resource companies, and hence for government revenues, their impact on the rest of the economy is far more modest."

In other words, the main impact is on mining company profits, and mining is about 80 per cent foreign owned. More their problem than ours.

If I thought the economy was sliding into genuine recession I'd say so. But I don't believe in exaggerating the bad news because it makes for more exciting betting on financial markets, makes a better story or because you've always hated whichever party happens to be in power at the time.

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Why we're doing so much better on recessions

With the economy growing below par and spirits so flat that people have started making up new and silly terms like "technical income recession" just to spook us, it's time we put our present discontents into context.

And who better to provide it than the unfairly sacked secretary to the Treasury, Dr Martin Parkinson, who on Friday gave the last of his final speeches in a farewell tour equal to Johnny Farnham's (though well short of Nelly Melba).

On his last day in the job, Parko reflected on all the economic reforms he'd seen since he joined Treasury in 1981 and the economy's greatly improved performance since then. We are, after all, in our 24th year of growth since the severe recession of 1990-91.

Parkinson observed that about half the people of working age today weren't old enough to work at the time of that recession. They thus have little conception of how terrible recessions are. Or why oldies like me object to the R-word being invoked with such flimsy justification.

In that recession, the official unemployment rate rose from 5.8 per cent in December 1989 to 11.1 per cent in October 1992, an increase of more than 5 percentage points.

But, as Parkinson reminds us, up to that point we were used to having recessions about every seven years. In the Whitlam government's recession of the mid-1970s, which continued for some years into the Fraser government's term, the unemployment rate rose by about 4 percentage points.

Then came the Fraser government's own recession, in which unemployment rose from 5.4 per cent in June 1981 to 10.3 per cent in May 1983.

It was the era of "stop-start growth". In banging on about 23 years of uninterrupted growth, however, it's important to remember there were several periods of slower growth in that time, as Parkinson acknowledges.

Indeed, Reserve Bank governor Glenn Stevens observed recently that "but for the vagaries of quarterly national accounting we might well have called the end of 2000 a recession; we would have called the end of 2008 one, in fact I would call it that ... I think we had a recession then, but it was a brief one.

"It wasn't terribly deep and we got out of it fairly quickly. The question isn't how you can go another 23 years without a recession, it is how you have small ones and get out of them quickly."

Just so. Parkinson notes that, in 2000-01, the unemployment rate increased by about a percentage point, and during the global financial crisis of 2008-09, it went up by about 2 percentage points.

But this acknowledgment that we've had a few mini-recessions in the past 23-plus years only enhances Parkinson's point: compared with the previous 20 years, we've got vastly better at macro-economic management, at smoothing the business cycle.

"Those recessions of the 1970s, '80s and '90s were devastating to the economy," Parkinson said. "There was the direct loss to economic output of having around 5 per cent of our workforce thrown out of jobs.

"And there were the social and personal costs of increased unemployment that are more difficult to measure, but likely just as large, or larger, and more persistent, than the direct loss to economic output.

"Large numbers of people experienced long periods of unemployment following these recessions. In many cases, those long-term unemployed never worked again."

In the past 23 years we weren't knocked off course by the Asian financial crisis of 1987-88 or by the bursting of the technology bubble and subsequent recession in the United States in the early 2000s.

You can't put such a record down to good luck. So what changed to make our economic performance so much better than it had been? Parko identified three main factors.

First, all the micro-economic reforms of "product markets" (for oil, air travel, telecommunications, manufacturing, agriculture, rail, waterfront, water and electricity, bread and eggs) and "factor markets" (the exchange rate, banks and financial markets; labour market decentralisation).

These reforms not only improved the allocation of resources and so added to national income, they also made the economy more flexible in its response to economic shocks: less inflation-prone and unemployment-prone.

This, in turn, made the economy's growth more stable and the macro managers' job easier.

Second, there were reforms in the way macro-economic management was conducted, with the introduction of "frameworks" (rules and targets) and greater transparency. Monetary policy (control of interest rates) is now conducted independently by the Reserve Bank, guided by an inflation target.

Fiscal policy (the budget) is now conducted according to the Charter of Budget Honesty with a "medium-term fiscal strategy" and regular reviews.

Third, the building of economic institutions with operational independence in regulating the economy (Australian Prudential Regulation Authority, Australian Securities and Investments Commission, Australian Competition and Consumer Commission and Australian Taxation Office) and in advising the government (Productivity Commission).

Parkinson stressed that these reforms were "an important pre-condition for stronger and more stable growth" but the growth itself was produced mainly by Australia's businesses and households.

"Australia is not immune from economic cycles," he concludes. "But the economic reforms of the 1980s, 1990s and 2000s mean recessions will happen less frequently and be less severe, on average, than if we still had the economic policies and structures of the 1970s."

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War on drugs succeeding from economists' perspective

How goes the war on drugs? On the face of it, not well. But in thinking about the drug problem it helps to know a bit of economics. When you do, you see things aren't as bad as they seem.

Most people agree that the use of heroin, cocaine and amphetamines such as speed and ice can become highly addictive and, when they do, a lot of harm is done to users and their families.

So most of us agree that governments should be working to limit the use of such harmful drugs. The arguments come over how best to do it. The conventional approach is to make the production, importation, distribution, sale and consumption of such drugs illegal. Problem solved.

But we've been pursuing this prohibition approach for years, spending a fortune on policing, the courts and the high proportion of drug offenders in our jails. With all this has come a fair bit of police corruption.

And yet illegal drug use remains widespread, with still too many drug overdoses and drug deaths. The seizures, arrests and prison sentences roll on, seemingly to little effect. People may be using less heroin, but its place has been taken by ice which, if anything, seems worse.

If prohibition so clearly isn't working, shouldn't we try a different approach?

Last week the NSW Bureau of Crime Statistics and Research published research that seems to provide powerful support for the contention that the conventional approach is broken.

We've all seen TV news reports of police proudly displaying the seemingly huge quantity of drugs they've just seized after an intricate detection operation. We're told the "street value" of the seized drugs, with the implication that this success will put a hole in drug consumption.

The take-away message is clear. See? The tide has turned and we're winning the war after all.

But the study took the figures for seizures and arrests of suppliers of illegal amphetamines, cocaine and heroin, and compared them with the figures for two indirect measures of drug use: hospital emergency department admissions for drug overdoses and arrests for drug use or possession. The figures were for the whole of Australia, over the 10 years to June 2011.

The study found no evidence that increases in drug seizures and arrests of drug suppliers reduced the number of emergency department admissions or the number of arrests for use or possession.

The study also analysed three specific NSW police operations - named Balmoral Athens, Tempest and Collage - identified by the NSW Crime Commission as being so successful they had the potential to affect the market for cocaine.

It found that the operations did have the effect of reducing arrests for use or possession of cocaine, but that effect was only temporary.

In fact, the study found that increases in drug seizures were often associated with increases in hospital admissions and arrests of users. Huh? The likely explanation is that at times when there is a lot more of the drugs available, the police will be able to increase the amount they seize.

What more proof do you need? Prohibition isn't working and we should try something else. Many medical people would like to see less emphasis on criminalisation and more on harm reduction. Just imagine if we could take all the money poured into catching and punishing people and use it to help people get off drugs and sort out their lives.

But Dr Don Weatherburn and the other authors of the study argue strongly against using its findings to conclude that drug law enforcement is a waste of money.

Why not? Because, when you look at the issue the way an economist would, you realise there's more to prohibition than just attempting to stamp out all illicit drug use.

The other thing it does is force up the price of drugs. Research suggests the black-market price of cocaine in the US is between 2 1/2 and five times what it would be in a legal market. For heroin it was between eight and 19 times higher.

Economists, as you know, are great believers in the power of prices, and in using prices to change people's behaviour. There's little reason to doubt that the high price of illegal drugs hugely reduces the number of users and the amount each user uses.

Before we write off prohibition we need to consider what economists call the "counterfactual": what would the world be like if these drugs weren't outlawed? Far more people would be using them and the amount of harm needing to be reduced would be infinitely greater.

But the law enforcers need to remember what it is that's keeping the price of drugs so high. It's obviously not their success in greatly limiting the supply of drugs relative to the demand.

No, it's the high incomes drug producers and traffickers need to earn to induce them to run the great risk of imprisonment that working in this industry entails. As an economist would think of it, it's the big "risk premium" suppliers add to the prices they charge that keeps prices so high.

This suggests that rather than trying to maximise the size of the seizures they can parade on telly to prove how successful they are, law enforcers should maximise the risks of traffickers getting caught, thereby inducing them to charge a higher risk premium.

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