Our kids need social skills, not just high marks

My father raised me to be contemptuous of fashion in all its forms, and I try not to be overawed by the rich and powerful. But, like my mum, there's one thing I am impressed by: brains.

My job brings me into regular contact with the econocrats at the top of the Reserve Bank, Treasury and other departments. Let me tell you, they're the brightest of the bright. I have to keep telling myself this as I struggle to keep up with them. All of them could hold down jobs as professors, or earn a lot more money in business.

These days, most have PhDs - though it's disturbing that, so far in his time as Prime Minister, Tony Abbott has relinquished the services of five economist department secretaries: Dr Martin Parkinson, Dr Don Russell, Blair Comley, Dr Ian Watt and now Dr Paul Grimes. Not sure we have that many brains to spare.

In recent years, however, I've realised that being super-bright ain't enough. To be really successful you also need "people skills". I've decided an extra unit of EQ - emotional intelligence - is worth a lot more than an extra unit of IQ. And if a genie appears from a bottle, that's what I'll ask for.

Most of our politicians have heard that the development of children's brains is hugely significant in influencing their success throughout the rest of their lives. Hence governments' increasing attention to early childhood education and care.

What people may not realise is that brain development doesn't matter just because of its effect on kids' intellect. As a new report from the Organisation for Economic Co-operation and Development, The Power of Social and Emotional Skills, makes clear, it matters also for children's social development.

We don't need telling about the importance of "cognitive" skills. These days, governments conduct periodic tests of children's literacy, numeracy and scientific literacy as they progress through the school system.

They make the results available directly to parents, but also put them on websites so the whole world can compare the academic performance of particular schools. Teachers object that good teaching involves a lot more than the three Rs and that the emphasis on competition via "metrics" encourages schools to "teach to the test" and spend much time drilling for coming tests.

The OECD's PISA exercise now compares our cognitive tests with those undertaken in other countries, so that every year or so we agonise because we've slipped back in the international comp on this cognitive measure or that.

The point of this latest report is to agree with the teachers: there is a lot more to the adequate development of our kids than just nurturing their IQs. It finds that children and adolescents need a balanced set of cognitive and social and emotional skills in order to succeed in modern life.

Cognitive skills - as measured by achievement tests and academic grades - have been show to influence the likelihood of individuals' success in education and the jobs market. They also predict broader outcomes such as our self-perceived health, social and political participation, and trust.

But social and emotional skills - such as perseverance, sociability and self-esteem - have been shown to influence numerous measures of social outcomes, including better health, improved subjective wellbeing (aka happiness) and reduced odds of antisocial behaviour.

If that doesn't impress you, try this: cognitive skills and social and emotional skills interact and cross-fertilise each other, empowering children to succeed both in school and out of school.

For instance, social and emotional skills may help children translate intentions into actions, and thereby improve their likelihood of graduating from university, sticking to healthy lifestyles and avoiding aggressive behaviours, the report says.

For children who are talented, motivated, goal-driven and collegial, and thus more likely to weather the storms of life, cognitive skills aren't enough. They need to be combined with social and emotional skills, which include conscientiousness and emotional stability.

The report stresses that "skills beget skills". They build on each other, and the earlier kids start acquiring them and the firmer their foundation the more skills are gained and the better the kids do in life.

You may say that children from "good" homes will acquire social skills from their parents without any fuss. That's fairly true and it's why, apart from making attendance at preschool universal, early intervention programs are best targeted at disadvantaged families, offering parents training and mentoring.

But though an early start is best, children's acquired skills remain malleable through adolescence. Programs aimed at older children emphasise teachers' professional development. Among adolescents, mentoring seems to work well, while hands-on experiences in the workplace can instil skills such as teamwork, self-efficacy (strong belief in your ability to reach goals) and motivation.

Improvements in social skills don't necessarily require major reforms or resources but can be incorporated into existing curricular and extracurricular activities, the report says. A lot of social and emotional skills can be gained from sport, arts clubs, student councils and voluntary work.

The report finds that recent developments allow us to measure social and emotional skills reliably within a particular culture and language. I reckon that as long as we retain our obsession with measuring and comparing academic performance we need to balance this with regular measurement of progress in acquiring social skills.

Surely our econocrats are bright enough to see that.

Read more >>

We're not taking productivity seriously

Given our obsession with materialism, productivity "isn't everything, but in the long run it is almost everything," as Paul Krugman famously said. If so, the intergenerational report's consideration of the topic is quite inadequate.

It's partial in both senses. It mentions most of the key factors that influence productivity improvement - defined as increased goods and services produced per hour worked - but doesn't do justice to many, including climate change.

That's partly because, though the report purports to be about the future of the economy, its real target is Treasury's eternal top priority, the future of the budget balance.

But it's also because the econocrats are leading us towards their preferred policy response to our alleged productivity problem and away from those responses their "priors" - preconceived beliefs about how the world works - cause them to disapprove of.

There are two broad approaches to government efforts to improve productivity: one which involves more intervention and spending and one which involves less intervention and little change in spending. Guess which one Treasury's priors lead it to favour?

For the past 200 hundred years, most of the world's productivity improvement has come from technological advance - people inventing better machines and thinking of better ways to do things.

But the other fish Treasury wants to fry prompt it to embrace an extreme view held by a few American economists that we've entered a period of much less rapid technological change.

When you consider all the disruption the digital revolution is unleashing on so many industries this is hard to believe.

In the era of the knowledge economy, you'd expect much long and earnest discussion about what governments should and shouldn't be doing to encourage acquisition of the "human capital" that comes from education and training.

Should we be cutting budgetary support for science and research and development? Is now the right time to be pushing university funding off the budget and on to students and universities' money-making schemes?

Why would a government that professes to believe in "equality of opportunity" welch on its professed support for the Gonski reforms to school funding? Why would it view Gonski as about private versus public rather than about lifting the future participation and productivity of kids at the bottom of the distribution?

Instead, the issue of human capital is airily dismissed with the line that "there is little evidence that slower productivity growth has been the result of inadequate investment in skills, education and innovation more broadly".

Maybe. But it's probably equally true there's little evidence it hasn't been. All you're really saying is that there's little evidence - because we've never been willing to run to the expense of adequately measuring such a vital ingredient in our future wellbeing.

The other key element of productivity improvement that gets short shrift is public infrastructure spending. To what extent are its inadequacies limiting the productivity of businesses and adding to commuting times (an important part of our wellbeing that doesn't show up in gross domestic product)? But do workers who spend an hour getting to work arrive at their productive best?

No discussion of our present and future productivity performance is adequate without assessment of the role being played by our policy of high immigration. But all we get is the throwaway line that "there is some evidence that" high levels of migration increase productivity because our focus on skilled migration raises the workforce's average skill level and because "migrants can be highly motivated".

This is true and quite dishonest at the same time. It minutely examines the dog in the room while studiously ignoring the elephant. What economists know but try not to think about - and never ever mention in front of the children - is that immigration carries a huge threat to our productivity.

The unthinkable truth is that unless we invest in enough additional housing, business equipment and public infrastructure to accommodate the extra workers and their families, this lack of "capital widening" reduces our physical capital per person and so reduces our productivity.

Think of it: the very report announcing that our population is projected to grow by 16 million to 40 million over the next 40 years doesn't say a word about the huge increase in infrastructure spending this will require if our productivity isn't to fall, nor discuss how its cost should be shared between present and future taxpayers.

No, none of that. Just another repetition of that peculiarly Australian doctrine that pretty much the only way to improve productivity is to engage in unceasing micro-economic reform.

Read more >>

EXPLORING STRUCTURAL CHANGE IN THE AUSTRALIAN ECONOMY

Comview 2015

Big changes in the structure of our economy have been happening before our eyes in recent years. But you well know - and each of your students needs to learn - that there’s nothing new about structural change. It may move faster in some periods than others, but it has been happening continuously in Australia since white settlement. It’s fascinating to trace changes in the structure of our economy, but it’s also illuminating, helping improve our understanding of the economic development process. In what follows I’ll be quoting extensively from the 2014 Australian Industry Report, produce by the chief economist of the federal Department of Industry, Innovation and Science.

What is structural change?

Structural change refers to shifts in the distribution of output, investment and employment across industries or regions. It refers to medium to long-term changes, not short-term changes attributable to the economy’s movement through the business cycle.

Structural change reflects the collective responses of individuals and firms to changing relative prices. Without structural adjustments, economies cannot respond to changes in relative prices, and therefore can’t achieve optimal allocation of resources under new conditions. The decade-long mining boom, for instance, would not have been possible without a rapid reallocation of resources towards that industry and away from other, less profitable industries.

Structural change is a continual process as relative prices are constantly fluctuating and economic resources constantly flow into and out of industries to take advantage of this. To show the economy’s constant state of flux, in the 12 months to February 2013, more than a million workers changed jobs, 9 per cent of the workforce. Of these, about 600,000 changed industry and about 460,000 changed occupation. Similarly, almost 240,000 new businesses entered the economy and about 300,000 businesses left the economy. The net effect of this constant flux is an ever-changing structure of the economy. The creation of new businesses and the decline of less competitive businesses are key to the economy’s long-term growth.

Prices change a lot more quickly than resources are able to move, however. Workers take time to respond to changes in relative wages because it can be difficult to relocate, or because it takes time to reskill and change occupations. Similar barriers effect the timely adjustment of capital and land use. These barriers can lead to unemployment and other inefficiencies such as idle machinery and equipment, which can have costly economic and social consequences. If adjustment occurs as a result of a short-term shock rather than a longer-term trend, the economy can take time to re-adjust and some businesses may not be able to return to their industry as quickly or easily as they left. So structural change is beneficial, but it does have costs. It may have adverse consequences for individuals, particularly those not easily able to move between industries, and so could lead to long-term unemployment. But it may also benefit workers able to take advantage of the new opportunities it offers.

Drivers of structural change

The main drivers (or sources or causes) of structural change are new technology, globalisation, consumer preferences and government policy. We’ll discuss these in turn.

Technology. Technological change is a basic driver of productivity improvement and economic growth. It has played a major part in globalisation, thanks to advances in transport and communications. In turn, globalisation exposes countries to more competition, which leads to a greater number of technological advances.

Technological change includes the development of new products, improvements to existing products and improvements to the processes by which products - services as well as goods - are produced and delivered to customers. So while much technological advance comes via machines or software, some comes via new ways of organising work in factories and offices.

Closely tied with technological change is the diffusion of knowledge, which determines how quickly and efficiently new technology emerges and can be adapted by industry for various purposes. This, in turn, can result in changes in the skills required of workers. Both the pace at which new technology can be adapted and the degree to which labour can be shifted between industries can alter the competitiveness and performance of firms. It’s the behaviour of firms that ultimately drives structural changes in the economy.

Technological change has driven structural change across the economy in a number of ways. Developments in computers, for example, have increased the range of occupations that can be automated, while improved communications and transfer of data have allowed transactions to occur over greater distances. These developments have allowed a greater variety of services to be exported without the need for the physical movement of people between countries.

Globalisation. Globalisation refers to the increasing connections between economies and between particular markets within each of those economies. In recent decades this process has been driven by a combination of technological advances - which have reduced transport costs and improved flows of information - and changes in government policies that have reduce barriers to trade, flows of capital and workers’ movements between countries.

In Australia, effective rates of protection of locally-made manufactured goods have fallen from 35 pc on top of production cost in the late 1960s to less than 5 pc today. Freight and insurance costs for imported goods have fallen from 8 pc to 5 pc since the late 1980s. Over the past two decades, Australia’s international trade (exports plus imports) has increased from 26 pc of GDP to 47 pc. But increasing international linkages also mean our economy is more exposed to international shocks.

Consumer preferences. Changes in consumer preferences also induce changes throughout the economy. As real incomes rise over time, households tend to spend the increase differently to the pattern of their existing spending. The increase goes disproportionately to luxury goods (including leisure activities, travel and fine dining) or to superior goods (such as health, education and housing) and “positional goods” (goods and services that demonstrate your higher social status). The biggest change in consumer preferences, therefore, has been slower growth in spending on goods and faster growth in spending on services. Since the beginning of the 1960s, the proportion of household disposable income spent on goods has fallen from 49 pc to 27pc, while the proportion spent on services has risen from 37 pc to 63 pc (with household saving falling from 14 pc to 10 pc).

As well, the ageing of the population is changing the composition of consumer spending. Over the past four decades, the median age of the population has risen from 27 to 37 years.

Government policy. All government policy potentially affects the sectoral composition of the economy, including by its effect on relative prices. Policy changes may have the effect of driving structural change or influencing the way or extent to which it occurs - eg the state governments’ response to the advent of Uber. Sometimes policy is motivated by a desire to prevent structural change.

Changes in the composition of government spending will affect the allocation of resources in the economy and thus its industry structure. Industry policy is obviously intended to affect the structure of industry. Even a policy to put a price on carbon is intended to bring about structural change, with more growth in renewable-energy industries and contraction in fossil-fuel industries.

The move from centralised wage-fixing to bargaining at the enterprise level has allowed relative wages to adjust more efficiently across industries and regions and given workers a stronger price signal of the relative demand for skills. It has also helped to prevent the wage inflation that has limited the gains from commodity price booms in the past.

The long-term pattern of structural change

The pattern of structural change in Australia over the past century or more is similar to that experienced in other developed countries. Stage one: pre-industrial economies are dominated by agriculture.

Stage two: productivity improvements due to technological advances free up resources, particularly labour, that were producing food to work in other industries, as less labour is required to feed the population. This results in the long-term decline of agriculture and the rise of manufacturing.

Stage three: as economies further modernise, manufacturing declines and services emerge as the dominant sector. This is typically a result of a more than proportionate change in demand from goods to services as incomes increase.

In Australia, the share of output from agriculture fell from over a third in the 19th century to just 3 pc in the 2000s. Similarly, the share of manufacturing output and employment fell by more than half between the 1960s and 2000s - output falling from 26 pc to 12 pc and employment falling from 26 pc to 11 pc. While services already accounted for about half of output in the 19th century, their share had grown to 59 pc by the 1960s and to 78 pc by the 2000s.

Note that a decline in a sector’s share of total output or employment may or may not imply an absolute decline in its output or employment. Despite the dramatic decline in agriculture’s share of total output over the past century, the quantity or volume of its output has continued to grow, by a factor of six. Never in human history have we feed so many mouths with so few farm hands. So agriculture’s share of the economy has declined not because it has been contracting, but because other industries have grown faster than it has.

Recent structural change in Australia

Mining. The resources boom, which lasted about a decade from the early noughties, had big effects on the business cycle, but nonetheless constituted a major and lasting change in the structure of our economy. This is because the boom in the prices we received for our exports of coal and iron ore prompted a huge expansion in our capacity to produce minerals and energy, including natural gas. Over the decade to 2014, mining’s share of total output doubled to 10 pc - probably the highest it’s been since the days of the gold rush.

You might expect an industry’s share of total output to be similar to its share of total employment, but this isn’t always the case. It depends on the extent to which its production is labour-intensive or capital-intensive. Mining is our most capital-intensive industry, so although its share of total output has doubled to 10 pc, its share of total employment has increased only from 1 pc to a little more than 2 pc.

Our other capital-intensive sectors are the other goods-producing industries, agriculture and manufacturing. Continuous advances in labour-saving technology have made them progressively more capital-intensive. It follows that the services sector accounts for most of our labour-intensive industries.

Manufacturing. Manufacturing’s shares of total output and total employment have been decline since the mid-1960s, with the share of employment falling faster than the output share because of computerisation. Note that, despite an absolute fall in its employment, the absolute quantity of manufacturing output continued growing until 2008. This, of course, is evidence of the industry’s ever-improving labour productivity. From 2008 on, the exceptionally high exchange rate caused by the mining boom greatly reduced the industry’s international price competitiveness, causing its output to fall in absolute terms and its declining shares of output and employment to accelerate. It remains to be seen to what extent the industry recovers now the exchange rate has returned to more comfortable levels.

Manufacturing employees are generally less geographically mobile than in other industries. Even so, manufacturing in regional areas has demonstrated considerable capacity to adjust in the face of the recent decline in employment. Employment outcomes for automotive workers have been better than feared. More broadly in manufacturing (and other declining industries), workers were mainly able to transition smoothly to new employment, as unemployment among these workers was not significantly higher than across all industries. Over the five years to 2011, the largest proportion of workers who moved into mining came from manufacturing - about 18,500 of them.

Despite impressions to the contrary, manufacturing remains an important part of the Australian economy, producing about $100 billion-worth of output each year and so making it the sixth biggest industry. It still employs more than 930,000 workers, making it our fourth largest employing industry. And not all parts of manufacturing are declining. The food, beverage and tobacco industry increased its employment by nearly 50,000 over the decade to 2012, making it the largest employer in the sector. Job losses have been greatest in textiles, clothing and footwear, and machinery and equipment manufacturing.

The relative decline of manufacturing can be attributed to various factors as well as reductions in import protection: increased competition from low-cost countries such as China and India and a shift in domestic consumer preferences towards services.

Manufactures have accounted for about 80 pc of the value of Australia’s total imports over the past four decades, a sign of our lack of comparative advantage in this sector.  About half these imports come from other OECD countries, with China accounting for about a quarter.

Services. The Australian economy is transitioning to a knowledge-based economy. This implies a smaller role for primary and secondary sectors and an even greater role for services in the economy. As well, a richer and older population is demanding more health care, more tourism and more education.

This shift to services is associated with changes in the skill and education levels of employees. Areas of employment growth are dominated by tertiary qualified workers, while employment losses are concentrated among those without post-school qualifications. The long-term structural shift towards service industries has resulted in a vast increase in highly skilled occupations, such as professionals (accountants, lawyers, engineers etc) and managers. This suggests that the structural shift towards services has necessitated a transition to an increasingly highly-skilled workforce. The resulting increase in demand for highly skilled workers can also be traced back to technological change. The rise of computer technology, for example, has led to an increase in demand for workers with the skills to use and maintain them. This is known as skill-biased technological change.

Structural change by state

Just as the industrial structure of the Australian economy is always changing, so its spatial structure across the continent is always changing. Increases in population cause increases in economic activity, but increases in activity in particular industries also attract higher population. There is much internal migration between Australia’s six states.

The oldest states - NSW and Victoria - have the biggest populations and shares of the national economy, but the younger states - particularly Queensland and Western Australia - have had the fastest rates of population and economic growth in recent decades, meaning their shares of the national population and economy are growing at the expense of the other states. As we were reminded by the resources boom, Western Australia and Queensland also enjoy a greater natural endowment of minerals and energy. This has left South Australia and Tasmania’s shares of the national population and economy small and getting smaller. They don’t have a lot of minerals, are suffering from the decline of manufacturing and aren’t at the centre of the growing business services sector.

I now turn from quoting the Australian Industry Report to quoting heavily from an article about The Economic Performance of the States in the March quarter, 2015, issue of the Reserve Bank’s Bulletin.

Over the decade to 2013-14, real gross state product has grown at an annual rate of almost 5 pc in WA and 3.5 pc in Queensland, compared with 2.5 pc or less in the other states. This has caused NSW’s share of Australian GDP to fall by 4 pc points to 31 pc. Victoria’s share has fallen by 2 pc points to 22 pc, while Queensland’s share has increased by 1 pc point to 19 pc and WA’s share has increased by 6 pc points to 17 pc. SA’s and Tasmania’s shares have fallen a little to 6 pc and 2 pc respectively.

You would expect the states’ population shares to be similar to their shares of the national economy. This is generally true, but with two notable exceptions. Victoria has 25 pc of the population (and of national employment) but only 22 pc of the economy (which may imply that it has a relatively high proportion of low-paid service sector jobs). And WA’s heavy dependence on capital-intensive mining means it has a 17 pc share of the economy, but just 11 pc of the national population.

For the most part, each state’s industrial structure is not very different from the national average, measured by output. But there are some notable divergences. NSW’s greatest strength is in business services, which account for 30 pc of its total output. Victoria’s manufacturing sector accounts for 7 pc of its total output, little different from the national average of 6 pc. Its greatest strength turns out to be, like NSW’s, business services, accounting for 27 pc of its output, compared to an average of 16 pc for the other four states. Queensland’s industrial structure is surprisingly similar to the national average, apart from a larger mining sector. But WA’s mining sector really dominates its economy, accounting for an amazing 30 pc of its output, compared with an average of about 2 pc for the other four states. SA and Tasmania are notable for their well above-average dependence on agriculture.

Good graphs from the Australian Industry Report for 2014

http://www.industry.gov.au/Office-of-the-Chief-Economist/Publications/Pages/Australian-Industry-Report.aspx

Chart 2.11 Output share by sector (1993-94 - 2013-14) report page 91   (PDF page 105)

Chart 2.16 Employment share by sector (1993-94 - 2013-14) report page 97  (PDF page 111)

Chart 2.17 Change in employment (2003-04 to 2013-14) report page 98  (PDF page 112)

Chart 2.23 Employment growth by occupation (2004 - 2014) report page 107  (PDF page 121)

Table A3: Industry Share of State Production

Good tables from RBA Bulletin, March quarter, 2015, article, The Economic Performance of the States

http://www.rba.gov.au/publications/bulletin/2015/mar/pdf/bu-0315-2.pdf

Appendix A

Table A1: Relative Size of States, 2013-14

Read more >>

Why monetary policy stimulus is less effective

The advent of "stagflation" in the 1970s - the previously unknown combination of high inflation with high unemployment - led to a loss of confidence in Keynesian policies, with primary responsibility for management of the macro economy being shifted to monetary policy and with fiscal policy taking a lesser role.

Four decades later, the wheel may be turning again. The two hot stories in the world of macro management are the decline in effectiveness of monetary policy and a consequent resurgence of interest in active fiscal policy.

Last week Dr Philip Lowe, deputy governor of the Reserve Bank, gave a speech explaining the monetary policy story, so let's look at that today and leave the fiscal story for another day. (Monetary policy refers to the central bank's manipulation of interest rates - and, these days, its creation of money - and fiscal policy refers to the government's manipulation of taxation and government spending in the budget.)

In the aftermath of the global financial crisis of 2008, the big developed countries' central banks cut their official interest rates virtually to zero in their efforts to stimulate demand, avert a depression and get their economies moving again.

When this didn't seem to be having much effect, but being unable to cut their official rates below what economists pompously call "the zero lower bound", first the US and Britain, then Japan, then the euro zone resorted to an unorthodox practice known as "quantitative easing": central banks buying bonds from the commercial banks and paying for them by creating money out of thin air.

The main way this stimulated their economies was by pushing down their exchange rates relative to the currencies of those countries that didn't resort to QE - us, for example.

The Europeans got so desperate to get their economies moving their next step was to do something formerly believed impossible: they cut their official interest rate below zero - meaning the central bank charges its commercial banks a tiny percentage for allowing them to deposit money in their central-bank accounts. In a few cases, the commercial banks have passed on this "negative interest rate" to their business depositors.

As Lowe says, the present global monetary environment is "quite extraordinary". There's been unprecedented money creation by major central banks, official interest rates are negative across much of Europe, long-term government bond yields (interest rates) in most advance countries are the lowest in history and lending rates for many private-sector borrowers are the lowest ever.

Had anything like this much stimulus been applied in earlier decades, economies would be booming and inflation would have taken off. Instead, though the US and British economies are now growing moderately, Japan and the rest of Europe remain mired, with considerable idle capacity. Inflation rates are low almost everywhere and inflation expectations have generally declined, not increased.

But why have things changed so much? Lowe says it's partly because the GFC was the biggest financial shock since the Great Depression and so has required a much bigger dose of monetary stimulus than usual, which is taking longer than usual to work.

But it's also partly because monetary policy is less effective. "Economic activity does not appear to have responded to the stimulatory monetary conditions in the way that occurred in the past and inflation rates have been very low," he says.

The single most important factor causing the change, he says, is the very high levels of debt now existing in many advanced economies.

One of the "channels" through which stimulatory monetary policy works is by the lower interest rates encouraging people to borrow so as to bring forward future spending. This has worked well in the past, but the high stock of debt acquired from past episodes has left many households, businesses and banks (and even in some cases, perversely, governments) unwilling to add to their debt.

Rather, they're using the low interest rates to help "repair their balance sheets" by paying down their debts.

One aspect of easy monetary policy that is still working normally, however, is the rapid rise in the prices of assets such as property and shares.

Another thing that's different is the flow-on from demand to prices. Both workers and firms seem to perceive their pricing power to have been reduced. More worried about keeping their jobs, workers are accepting much lower wage rises. More worried about losing customers, firms are more cautious about putting up their prices.

So how is all this affecting us in Australia? Lowe says one big effect is to leave us with an exchange rate that's higher than it should be; that hasn't fallen as much as the fall in our mineral export prices implies it should have.

This has required the Reserve Bank to cut our official interest rate by more than it thinks ideal. It's done this partly to reduce our interest rates relative to other advanced countries' rates and so put some downward pressure on our dollar, but mainly to make up for the inadequate stimulus coming from the still-too-high exchange rate.

The big drawback to our very low interest rates is the boom in asset prices: for shares and, more worryingly, houses.

Second, Lowe says, the same factors affecting global monetary policy are evident in Oz, although to a lesser extent. Our banks, businesses and governments don't have excessive levels of debt, but our households do. So, many are using the fall in mortgage interest rates to step up their repayments of principal rather than increase their consumer spending.

Retirees living on interest earnings seem to have cut their consumption rather than eat into their capital.

Our wage growth is surprisingly low, contributing to low inflation.

Lowe's conclusion, however, is that our monetary policy is still working. And once the major advanced economies have fully recovered from the Great Recession - which could take as long as another decade - global monetary policy will return to normal.

Read more >>

Tears for first-home buyers the crocodile kind

Joe Hockey wants to help young people buy their first home by letting them dip into their superannuation, while NSW Labor leader Luke Foley wants to improve affordability by letting them pay off the stamp duty on their purchase over five years. Really? I often wonder whether our politicians are knaves or just fools.

But while we're questioning the sense and morality of our pollies, we shouldn't neglect to ask whether they're just reflecting our own weaknesses. There are few subjects on which more crocodile tears are shed than housing affordability.

At bottom, the economics of housing affordability is dead simple. Sometimes housing can be hard to afford because mortgage interest rates are way too high. But that hasn't been the case since we got inflation back down to normal levels in the mid-1990s.

And at present just the reverse applies. Mortgage interest rates are abnormally low. They won't stay that way, of course.

Advertisement

So if interest rates aren't the problem, the other factor is home prices. In a market economy like ours, the price of anything – whether ordinary goods or services, or an asset such as a house – rises when the demand for it exceeds its supply.

For some years now, the supply of additional houses and units has failed to grow in line with "household formation" – young people getting married, people immigrating to Australia and couples splitting up.

So inadequate growth in supply has been the real problem, caused by state and local governments placing too many legal obstacles and charges in the path of developers seeking to build new estates on the edge of the city and – perhaps more important – seeking to provide medium- and high-density "infill" closer in, where people increasingly prefer to live to avoid long commutes.

The NSW Coalition government claims to have made progress in reducing these obstacles, and it's true that housing construction is growing faster in Sydney at present than it has been.

But though the basic problem has been maintaining an adequate supply of appropriately located housing to meet the growing demand, the supply side of the problem isn't terribly visible to you and me.

We're more conscious of the demand side, represented by the high and ever-rising cost of buying a place faced by our kids and other young people. What's more, we suffer from a kind of optical illusion. Your daughter and her partner are just sitting there saving, watching some invisible force push house prices further and further out of their reach.

The trick is that while no single purchaser can move the market price, the combined demand of all purchasers can – and does, as we watch.

Our natural, uneducated tendency to see the house price problem from the viewpoint of the individual buyer makes us susceptible to the pseudo solutions peddled by politicians seeking votes.

If only my daughter could get a bit of a leg-up in either putting together a sufficient deposit (say, by being allowed to dip into super) or in lowering the initial cost of the purchase (say, by staggering the cost of stamp duty), she could afford to take on the mortgage and she'd be right.

See the weakness in that logic? If it helps your daughter and her partner, it also helps all the couples they're competing against to buy a place. Which means it gets your daughter nowhere. Actually, she's worse off. Since everyone can now more easily afford to pay the existing price, the prices of the homes they want to buy go even higher.

As economists say, the benefit from the caring pollie's supposed helping hand is "capitalised" into the price of "ideal first homes". And that means the benefit of the measure ends up going not to first-home buyers but to first-home sellers.

Economists have understood this perverse outcome since the year dot. Their rule is simple: when demand for housing is running ahead of supply, anything you do to make it easier for people to afford the high prices ends up only making prices higher, to the cost of buyers and the benefit of existing home owners.

It's possible Hockey and Foley aren't sufficiently economically literate to have worked out that their proposals would be counterproductive. (Not to mention that Hockey's would leave young people's eventual retirement payouts significantly diminished because of their loss of compound interest, or that Foley's would leave fully financially committed couples with additional large lump-sum payments for five years.)

What's not credible is that these guys' economic advisers would have failed to warn them of the perverse consequences of their proposals. So they may just be fools, but my practice is to give their intelligence or competence the benefit of the doubt and assume they're knaves: they knew it was a con, but were confident most voters wouldn't see through it, so they proposed it anyway.

And remember this: in any year, the number of voting home owners far exceeds the number of would-be home owners. So how could proposing a scheme that pretended to help first-home buyers while actually helping existing home owners cost you more votes than it gained?

The pollies know that proposing phoney schemes to help young home buyers without actually lowering the value of the homes owned by the rest of us is exactly the kind of help we prefer them to offer.

Read more >>

Econocrats doubt our ability to grow

So, how fast can we expect the economy to grow over the next 40 years? And, more to the point, where's that growth supposed to come from? That's a doubt you expect from people without the benefit of an economics education, but the intergenerational report reveals the econocrats are going through a crisis of confidence about growth.

First, a disclaimer: not being as materialist as the economists, I don't see maximising our material standard of living as the ultimate objective. I worry more about what climate change and resource depletion will have done to the economy in 40 years' time, and the social price we'll be paying for our obsession with the material.

But back to the dominant paradigm.

The report projects that growth in real gross domestic product will slow to an average rate of 2.8 per cent a year over the next 40 years, down from 3.1 per cent a year over the past 40.

A third of this decline is explained by slightly slower population growth, leaving average growth in real GDP per person falling from 1.7 per cent a year in the past to 1.5 per cent a year in the future.

I trust you're suitably shocked and dismayed. This projected decline is explained essentially by the ageing of the population, leaving the average rate of improvement in the productivity of labour unchanged between the past and the future at 1.5 per cent a year.

So, where will the growth be coming from? Exclusively from improving productivity: from the economy's output of goods and services growing faster than its inputs of labour.

It's productivity the econocrats and other economists are so pessimistic about. So how did they estimate that productivity will grow by an average of just 1.5 per cent a year?

They didn't. They simply followed previous practice and plugged in the same figure for the coming 40 years as for the past 30. Since it's impossible to know what will happen to productivity in the future, this neutral assumption is better than any other you could make.

But that hasn't stopped some economists from claiming that 1.5 per cent a year is overly optimistic. Really? This tells you something about the reigning mood of pessimism among economists.

But if income per person is driven by productivity improvement, what drives productivity? If you rely on the things economists say in public, you could be forgiven for not knowing that overwhelmingly – and for the past 200 years – it's technological advance.

Every economist knows that's true but they rarely say so. That's partly because they know little about how technological advance works and partly because they believe there's little they can do to affect it.

But in recent years, some leading overseas economists have lost their faith that rapid technological advance will continue lifting material living standards. Two centuries of innovation have hit a dry spot, we're told.

It seems Treasury agrees. It admits a fact rarely included in economists' unceasing sermons on the evil of our low rate of productivity improvement in recent times: "Australia has not been alone among advanced economies in experiencing slower productivity growth over the 2000s, which suggests that the rate of growth in technological advance . . . may have been slower than in previous decades."

So if we can't rely on a continuing stream of new technology to keep our living standards growing at a rate economists find acceptable, what does Treasury suggest? It was hoping you'd ask because it's got just the solution we need: more microeconomic or "structural" reform.

For several years, all right-thinking economists have been badgering us to pressure governments for more micro reform. To bolster its argument that micro reform is the missing elixir, Treasury says "the increase in productivity growth rates seen in the 1990s is widely attributed to significant policy reforms of that decade and the 1980s".

But even if you believe this (I'm sceptical), it's hardly a great advertisement for the benefits of reform. You can make the most sweeping reforms – reforms which, having been made, can't be repeated – and all you get for your pains is four or five years of improved performance before lapsing back into mediocrity.

Reform, we're asked to believe, is only a fleeting fix. To maintain an acceptable rate of productivity improvement, reform must be unceasing (and defy the law of diminishing returns).

This portrays our economy as hopelessly inefficient and unproductive, despite all our efforts. Other countries can grow satisfactorily without continuous reform, but we can't.

Really? Such a view is so deeply pessimistic as to verge on economic apostasy. It's also bizarre.

Read more >>