Lower dollar boosts services exports

Did you know that when the value of our dollar falls, imports become dearer? When the Business Bible learnt this last week, it got so excited it led the paper with the news.

Every smarty knows that the economic turmoil in Greece and China must spell bad news for us, so when the turmoil caused the Aussie dollar to fall below US75¢, this was obviously the start of the badness.

Apparently, it means the "global purchasing power" of Australian households has fallen. Who knew?

Immediately, our ever-vigilant media sprang into action to determine which purchases were likely to be more expensive. Don't you love the way the media can find the downside in any piece of economic news?

The fact that for months the nation's macro-economists and many of our business people have had their tongues hanging out, thirsting after a lower exchange rate, was something no one considered worth mentioning.

Nor that Reserve Bank governor Glenn Stevens' wish to see the dollar fall to US75¢ had finally come true.

It's true that if you view the position solely from the perspective of consumers, a higher dollar is good news and a lower dollar is bad.

However, from the perspective of Australia's trade-exposed industries and their employees, it's the other way around.

A high dollar means you get fewer Aussie dollars for anything you export, whereas the imports you compete against in the local market are now cheaper than they were.

So a higher dollar means Australian tradeable industries suffer a loss of international price competitiveness, which almost always leads to them reducing their production and their job opportunities.

In other words, a higher dollar has a contractionary effect on economic activity (which at least has the advantage of reducing inflation pressure). And that's been our story since the mining boom caused the Aussie to appreciate so strongly.

However, with mineral commodity prices having been falling since mid-2011 and mining construction projects winding up since the end of 2012, the dollar finally began falling back; though, thanks to the advanced economies' resort to "quantitative easing" (creating money), not by as much as the fall in commodity prices implied should happen.

It follows that a lower dollar has an expansionary effect on economic activity. Since our exporters now get more Aussie cents for each US dollar they earn, they're able to export more. And, since imports are now more expensive to their domestic customers, they're able to recapture a larger share of the local market.

The consequence is that our tradeable industries increase their production and the job opportunities they provide.

In our attempts to explain why relatively strong growth in employment – particularly since the start of this year – has caused the official unemployment rate to stay steady at 6 per cent, you'd have to give the lower dollar a fair bit of the credit.

That's particularly evident in the strong growth in employment in the services sector and in exports of services. Historically, services were regarded as non-tradeable, but globalisation and advances in transportation, telecommunications and digitisation are making that less true every year.

The tradeable services sector's improved price competitiveness comes at a time when Asia's middle-class is growing in size and income, with its consumption preferences shifting towards Western goods, services and destinations.

No service industry better demonstrates the lower dollar's beneficial effect on production and jobs than tourism: an industry where import replacement is just as important as exporting. The lower dollar not only attracts more foreigner visitors, it encourages Australians to holiday at home rather than abroad.

Estimates from Paul Bloxham, of HSBC bank, show spending on tourism accounts for about 3 per cent of gross domestic product, with about a third of this coming from foreign tourists.
The industry employs more than 500,000 people.

Overall, the value of tourism exports reached $14 billion in 2014, up 8 per cent. Tourist arrivals from China over the year to May were up 21 per cent on the previous year, Bloxham says. Chinese visits to Oz have increased to 920,000 over the past year, up from 370,000 five years ago.

Turning to education exports, Bloxham says international student enrolments reached a new high of almost 147,000 at the start of this year. Last year, the value of education exports reached $17 billion, surpassing the previous record in 2009.

And Joe Hockey has reminded us that the value of all services exports over the year to March was up 8 per cent, their fastest growth since 2007.

So if the fallout from the present international turmoil involves further falls in the Aussie, don't let anyone tell you it's a bad thing.

Read more >>

Slower immigration keeps unemployment steady

While we're busy scaring ourselves silly imagining all the terrible consequences that may or may not flow from the turbulence in the eurozone and China, forgive me for intruding with some good news closer to home: unemployment has stopped rising.

The employment figures we got from the Bureau of Statistics this week confirm – and so make a lot more believable – the amazing figures we got a month ago saying the official rate of unemployment had stabilised at 6 per cent.

Barring some unexpected disaster, it's now looking less likely the Reserve Bank's forecast that unemployment will rise to 6.5 per cent by June next year will be realised.

Let's cut through the month-to-month volatility that so many in the markets and media love by sticking to the smoothed seasonally adjusted estimates known as the "trend" figures.

They show that total employment grew by 215,000 over the year to June, an increase of 1.9 per cent. More than half these extra jobs were full-time.

Since the labour force – all those people either in a job or actively seeking one – grew at about the same rate as employment, this was sufficient to get the rate of unemployment back down to where it was in June last year – 6 per cent.

And this happened despite the rate of participation in the labour force – the proportion of the population aged 15 or over who were either employed or unemployed – rising from 64.7 per cent to 64.8 per cent during the year. Not bad considering the retirement of the baby-boomer bulge is working to lower the participation rate.

As I say, this is the same story the figures were telling us a month ago. So where have the extra jobs come from? Well, Kieran Davies, of Barclays bank, has used somewhat different figures – they say we had employment growth of 240,000 over the year to May – to tell us.

He follows the Reserve Bank's practice of splitting the economy into five broad sectors: household services (including accommodation and food services, education, health, recreation and other services), business services (information technology, media and communication, finance, real estate services, professional services and administrative services), goods (farming, mining, manufacturing, utilities and construction), distribution (retail and wholesale trade and transport and storage), and public administration.

Davies found very strong jobs growth in household services of, in round figures, 180,000, with strength in healthcare (90,000), accommodation and food services (50,000), and recreation and arts (40,000).

He makes the point that household services account for a third of total employment, and have driven total jobs growth since the global financial crisis.

Business services, which account for almost a fifth of total employment, have been the next most important sector, with growth of about 80,000. This was driven by professional services, up 90,000, offset by falls in employment in other categories, such as real estate services (20,000) and finance (10,000), but small gains in other categories.

Modest contributions to total jobs growth came from goods distribution (20,000) and public administration (10,000).

Against this, however, there were job losses in mining (30,000), farming (30,000), manufacturing (5000) and utilities (5000), which more than offset jobs gains of 20,000 in construction.

As you see, as well as this quite strong growth in employment overall, there's been a change in the composition of employment, with relatively small contractions in various goods industries more than offset by big increases in service industries.

If this news of strong overall employment growth comes as a shock to you, that's hardly surprising. The economy's been growing at below its "trend" (medium-term potential) growth rate of 3 per cent for a number of years.

And it's often repeated that the economy has to grow at its trend or potential rate of 3 per cent a year just to stop unemployment rising.  (This 3 per cent rate of growth in the economy's potential capacity to produce goods and services comes from labour force growth of 1.7 or 1.8 per cent a year, plus growth in the productivity of labour of 1.3 or 1.2 per cent a year).

So, with real gross domestic product growing by just 2.3 per cent over the year to March (and needing to achieve an unlikely 0.8 per cent growth in the June quarter to achieved the Abbott government's budget-time forecast of average growth of 2.5 per cent in 2014-15), how on earth is it possible for employment to be growing fast enough to hold unemployment steady?

Well, one possibility is that the economy's actually growing a lot faster than the national accounts say it is, but this doesn't seem likely.

A more likely explanation is that the economy's potential rate of growth is no longer as high as 3 per cent a year. It's more likely to have fallen to 2.75 per cent – or even 2.5 per cent, as some are suggesting.

Why? Because slower growth in the population than we've had in recent years –  slower than the econocrats were expecting – is causing slower growth in the labour force.

Population growth is slower because fewer Kiwis are coming to Oz and more are going back home where, for the moment anyway, the economy's prospects are brighter. As well, the end of the mining construction boom means fewer workers and their families are coming in under temporary 457 visas.

If the economy's potential growth rate is lower, that means we can stabilise unemployment at a lower rate of actual growth. In our present circumstances, employment growth is probably being encouraged by the lower dollar and the exceptionally slow growth in wage rates.

Note that when the economy grows more slowly because the population is growing more slowly, we're not left worse off in terms of growth in income per person. But lower immigration does make it easier to get on top of unemployment – something economists prefer not to mention.

Read more >>

Material success is coming at a social price

While there's been much worry of late that the economy isn't growing fast enough to get unemployment down, it remains true that our economic performance since the global financial crisis has been the envy of most other rich countries.

But it's old news that, while economic growth matters for employment – especially with our immigration-fuelled population growth – gross domestic product is a quite inadequate measure of the nation's wellbeing.

No doubt it was such criticism that, in 2002, prompted the Bureau of Statistics to introduce a four-yearly "general social survey" of about 13,000 households to give us more information on how Australians are faring from a personal and social perspective.

The bureau has now released the results of its fourth survey, for 2014. So what is this more humanistic second guess telling us about whether we're making progress?

On the face of it, we're doing fine. Look deeper, however, and cracks are apparent.

The survey measured our "subjective wellbeing" by asking people to assess their overall satisfaction with life – not how they feel at the moment, or how they feel about particular aspects of their life – on a scale of nought to 10.

Our average answer was 7.6, which is significantly higher than the average of 6.6 for all the countries in the Organisation for Economic Co-operation and Development. It was also up on what we said four years ago.

But the most useful thing to note is the categories of people whose ratings were well below the nationwide average: people with a disability (7.2), one-parent families with children (7.0), the unemployed (6.8) and people with a mental health problem, 6.6. Governments wanting to raise the nation's wellbeing now know where to start.

And when the bureau delved deeper, areas of slippage became apparent. One important factor affecting us that's ignored in the calculation of GDP – and in the thinking of most economists, politicians and business people – has been dubbed "social capital".

Social capital is seen as a resource available to both individuals and communities, arising from such things as networks of mutual support, reciprocity and trust. You can break it down into more measurable components, such as community support, social participation, trust and trustworthiness, the size of people's networks and people's ability to have some control over issues important to them.

There's plenty of research showing these things are strongly linked to the wellbeing of individuals and communities. But the survey reveals all is not well with various aspects of our social capital.

One indicator of how much we support each other is the amount of voluntary work we do for organisations. This has declined for the first time since the bureau began measuring it in 1995.

By 2010, the proportion of people aged over 18 who were volunteering had reached 36 per cent. But by last year it had fallen back to 31 per cent. There's also been a decline in the proportion of people providing informal help to neighbours and the like.

Voluntary work not only helps the people who are helped, of course, it also helps increase the wellbeing of the helpers. Not a good sign.

On social participation, the survey shows people are now less likely to be involved in social groups such as sport or physical recreation, arts or heritage groups and religious groups.

Civic participation – involvement in a union, professional association, political party, environmental or animal welfare group, human or civil rights group, or even a body corporate or tenants' association – is also down.

Of course, as the bureau notes, the way people meet and interact is changing. Some people suggest that young people in particular prefer to engage in politics by means of online activism – joining online advocacy groups or using social media to collect and disseminate information.

Other ways people support each other have been stable. In 2014, the proportion of people caring for someone with a disability, illness or old age was 19 per cent, little changed from previous years.

The proportion of people providing support to relatives living outside the carer's home, 31 per cent, was also little changed. This is likely to reflect the ageing of the population.

Last year nearly everyone – 95 per cent – felt able to get support from outside their home in a time of crisis, unchanged from earlier years. Similarly, weekly electronic contact with family and friends by telephone, text message or video link remained high at 92 per cent.

By contrast, face-to-face contact fell from 79 per cent to 76 per cent.

And people were less likely than they were in 2010 to feel able to have a say within their community all or most of the time – 25 per cent compared with 29 per cent.

There's been no change in the proportion of people agreeing that most people can be trusted – 54 per cent – but, to me, that seems a lot lower than it should be.

On the question of work-life balance, Australians are feeling time-poor, with 45 per cent of women and 36 per cent of men saying they were always or often pressed for time. This is higher than for other rich countries.

We may be doing better in the GDP stakes than most other advanced countries are, but we seem to be paying a high social price for our greater material success.

Read more >>

How growth can make us worse off

Just about every economist, politician and business person is a great believer in a high rate of immigration and a Big Australia. But few of them think about the consequences of that attitude – which does a lot to explain our economic problems.

The latest figures from the Bureau of Statistics show our population grew by 1.4 per cent to 23.6 million in 2014. Less than half this growth came from natural increase (births exceeding deaths), with most of it coming from net migration.

When I saw the 1.4 per cent growth figure, I thought it much of a piece with the 1.5 per cent growth over the year to September. It confirmed us as having one of the fastest growing populations among the advanced economies.

But, the Business Bible assured us, growth of 1.42 per cent was a big worry. It was clearly less than the 1.49 per cent average rate of the past 15 years and was, indeed, our weakest growth in eight years.

Slower population growth meant slower growth in real gross domestic product and this would also make it harder to get the federal budget back into surplus, we were told.

Really? This is crazy talk. It shows even our economists have turned off their brains on the question of immigration and lost their way between means and ends. Now they believe in growth for its own sake, not for any benefits it may bring us.

Of course slower growth in the population means slower growth in the size of the economy. But what of it? What do we lose?

The economic rationale for economic growth is that it raises our material standard of living. But this happens only if GDP grows faster than the population grows. So it doesn't follow that slower GDP growth caused by slower population growth leaves us worse off materially.

That would be true only if slower population growth caused slower growth in GDP per person. I suspect many people unconsciously assume it does, but where's the evidence?

I doubt there is any. The most significant recent study, conducted by the Productivity Commission in 2006, concluded that even skilled migration would do little to increase income per person. And what little growth the commission could find was appropriated by the new arrivals.

I doubt it's by chance that economists rarely, if ever, adjust the GDP figures they obsess about for population growth. Meaning we're constantly being given an exaggerated impression of how well we're doing in the materialism stakes. I can't remember GDP per person rating a mention in the budget papers.

Politicians are always boasting about record government spending on this or that, but they never make allowance for population growth in making such claims. (Why would they when often they don't even allow for the effect of inflation?)

As for the claim that slower population growth will make it harder to reduce the budget deficit, it reveals just how unthinking we've become on immigration. It's true enough that slower growth in the workforce means slower growth in tax collections.

But is that all there is to it? What about the other side of the budget? Aren't we assuming a bigger population is costless? Skilled immigrants and their dependents never use the health system? They don't have kids needing to be educated?

They don't add to traffic congestion, wear and tear on roads and 100 other taxpayer-provided services? Since there's often a delay while they find jobs, who's to say budgets, federal and state, wouldn't be better off with fewer immigrants?

But what's strangest about the economic elite's unthinking commitment to high immigration is the way they wring their hands over our weak productivity growth and all the "reform" we should be making to fix it, without it crossing their minds that the prime suspect is rapid population growth.

It's simple: when you increase the population while leaving our stock of household, business and public capital unchanged, you "dilute" that capital. You have less capital per person, meaning you've automatically reduced the productivity of labour.

So you have to do a lot more investing in housing, business structures and equipment and all manner of public infrastructure – a lot more "capital widening" – just to stop labour productivity falling.

The drive for smaller government – and the refusal to distinguish between capital and recurrent government spending – simply doesn't fit with a commitment to rapid population growth and a rising material standard of living.

Lower immigration would help reduce a lot of our economic problems – not to mention our environmental problems (but who cares about them?).

Read more >>

Two other ways globalisation is changing things

We're still learning to cope with a globalised world. Things work a bit differently now, and we have to adjust our thinking accordingly.

Globalisation – the breaking down of barriers between countries – is leading to increased trade between economies and increased flows of financial capital around the world, not to mention greater flows of people.

Another dimension of globalisation that's having big effects without being widely noted is the globalisation of news.

News of important happenings somewhere around the world now reaches most people in the rest of the world with a delay of maybe only a few minutes.

Because humans have evolved to continuously monitor their environment in search of threats, the news that interests us most is bad news. The news media are only too happy to oblige. They ignore all the good things that are happening, and all the everyday things as well, to give us a concentrated dose of any highly unusual, bad thing that's happening anywhere in the world.

The question is whether we're capable of absorbing this quite unrepresentative picture of what's happening around us without unconsciously reaching the conclusion that the world is in much worse shape than it actually is.

One lesson we've learnt is that everything in different parts of the world is now much more interconnected. That's true – particularly in the global economy – but we can take it too far.

The classic example of the heightened economic effects of globalised news was the global financial crisis of 2008, when news of crashing sharemarkets and teetering banks in America and Europe was beamed into living rooms all around the world every night for a month.

Ordinary people in distant countries such as Australia had to judge how this absolutely frightening news might affect them. They assumed the worst. Business and consumer confidence plunged and households and businesses began battening down the hatches, moving money between banks and cutting their spending.

It turned out all our banks were safe. Thanks to our tight supervision of them, they had no "toxic debt". But the government did have to help them when the international financial markets in which they borrowed stopped operating briefly.

The point is, our consumers and businesses were so frightened by all they'd heard about troubles overseas that we could have had a local recession anyway, had the Rudd government – and the Reserve Bank – not acted so quickly and effectively to calm people down with "cash splashes" and news of its plans for stimulus spending.

Now the big news is Greece's financial troubles, about which the media assume our curiosity knows no bounds. The obvious question for news consumers to ask is, how will this affect me?

Short answer: probably it won't. We can feel sorry for the Greeks, or not, but we need to remember Greece is a country of just 11 million people, with an economy representing about 0.4 per cent of the world economy and the tiniest share of our exports.

It is true that, should Greece exit the eurozone, this would raise uncertainly about pressure on the other weak and heavily indebted member countries, and this could lead to the euro currency union coming to a messy end.

If that were to happen – which wouldn't be any time soon – it would have flow-on implications for every country. But you'd have to say that, just as living on a Greek island would be a good way to get as far away as possible from any problem in Australia you were trying to escape, the reverse also applies.

Another way we're still adjusting to how globalisation is changing things concerns the way we've always measured international trade. This story is told in the Productivity Commission's annual report on trade and assistance.

Every country has always measured the "gross" value of its trade. The full value of each exported good or service has been attributed to the last industry that handled the item and to the country it was sent to.

But the advent of "global value chains" – where the production of manufactured goods in particular is spread between countries, with parts coming from various countries to be finally assembled in another country – has made this gross value approach ever more misleading.

So the World Trade Organisation is now making more use of individual countries' "input-output tables" to measure exports on a "value-added" basis. That is, each industry sector that contributed to the production of an export item gets the credit for the value it contributed to the final price.

Doing the numbers on this more accurate basis makes a big difference. The final price of manufactured goods, for instance, includes the value of raw materials provided by agriculture or mining, plus the value provided by service industries such as transport and providers of professional and scientific services.

Looking globally, manufactured goods' share of total world exports drops from 67 per cent to 40 per cent, while services' share doubles to 40 per cent. The shares of agriculture and mining increase from 13 per cent to 20 per cent.

The new story for Australia is different because our exports are dominated by primary products. Using the most recent figures available, for 2008, the commission estimates that manufacturing's share of our total exports drops from 36 per cent to 14 per cent, while services' share jumps from 18 per cent to 42 per cent.

Agriculture's share is unchanged at about 4 per cent, while mining's share drops only a little to 40 per cent.

As for the destination of our exports, looking at the period from 2002 to 2011, North America and Europe's share rose from 23 per cent, measured on a gross basis, to 32 per cent on value-added. The shares of our Asian customers fell.

One lesson: we should worry less about the decline of manufacturing and think more about the rise of the services economy.

Read more >>

Security scare intended to hide economic failure

Am I the only person who isn't cringing in fear, looking for a rock to hide under and hoping Tony Abbott and Peter Dutton will save us from the tide of terrorism surging towards our shores?

As is their wont, the media are enthusiastically indulging our desire to dwell on all the gruesome details of a spate of terrorist acts in faraway countries of which we know little.

But this seemingly innocent nosiness is leaving us with a quite exaggerated impression of the chances of our ever coming into contact with such an event.

Apparently, all you have to do to be in mortal danger is attend the making of an ABC current affairs program. It's a field day for any attention-seeking nut of Middle Eastern background.

Would you say our Prime Minister is seeking to calm our overblown fears or is playing them for all he's worth?

Precisely. And I'll tell you why. Because he's discovered he's not much chop at leadership - at inspiring us with a vision of a better future, at explaining and justifying necessary but unpopular measures - but he is good at running scare campaigns, to which the Aussie punter seems particularly susceptible.

But, above all, because he wants to divert our attention from the hash he's making of managing the economy.

In opposition, and facing a Labor government that lacked all confidence in its own ability as an economic manager, Abbott assured us the Liberals had good management in their DNA. I thought he had a point, but what we didn't discover until too late was that he and his chosen Treasurer just didn't have that gene in their bodies.

They started by telling us that, apart from the immense damage being done by Labor's carbon and mining taxes, the economy's big problem was the budget, something they, being Libs, could fix in a jiffy.

They had one go at fixing the budget, got themselves into terrible trouble in the polls, then gave up. Pretty much the sole purpose of this year's budget was to reverse their poor political standing by ditching or modifying many of their unpopular policies.

From that day to this, we've heard little more of the evils of debt and deficit. Almost all of what little improvement in the budget deficit is expected will come from bracket creep.

Fortunately, the budget deficit and the still-small level of public debt to which it has given rise was never the central, pressing problem for the economy the oppositional Abbott & Co made it out to be.

We will have to deal with the deficit eventually, but it's not pressing. And fortunately, thanks to the good offices of Peter Costello, primary responsibility for the day-to-day management of the economy was long ago shifted from the politicians to the econocrats of the Reserve Bank.

Trouble is, no matter how many more times the Reserve cuts interest rates, it's having little success in getting the economy moving at a satisfactory clip. And with more mining construction projects being completed as each day passes, the economy is in danger of drifting into recession.

It may not happen, but the possibility that it will is too high for comfort. The Reserve has been calling out for help from Canberra, but Abbott and Hockey have been turning a deaf ear, far too busy coping with the confected national security crisis.

Now we've received a very could-do-better annual report card from the International Monetary Fund. Far from urging Abbott and Hockey to redouble their efforts to reduce deficit and debt, it's telling them they have plenty of "fiscal space" relative to other advanced economies - room to increase debt - and should be doing more to encourage spending on infrastructure by the state governments.

The problem is that while the Reserve has been using too-low interest rates to get the "non-mining" private sector moving, the public sector has been doing nothing to help. Indeed, despite the incessant talk - federal and state - about the greater efforts being made to ensure the adequacy of our infrastructure, nationwide public capital expenditure actually fell by 8 per cent over the year to March.

The decline came from the state governments, not Canberra. But since it's the national government that's primarily responsible for the health of the national economy, this provides Abbott and Hockey with no excuse.

That covers the Abbott government's poor performance in the immediate management of the economy. But it's just as ineffectual in dealing with the less pressing, more structural need for us to lift our economic game if our continued material prosperity is to be assured.

Despite the ever-growing pile of reports it has commissioned on the financial system, competition, industrial relations, taxation and federalism, it's becoming increasingly clear that, having wounded itself so badly in last year's budget and still being behind a weak-led opposition in the polls, the government has no stomach for taking reform proposals to next year's election.

Economists, business people and even the government's own intergenerational report are warning that our productivity isn't likely to grow fast enough in coming years without further reform, but to no avail.

If the Liberals do have good economic management in their DNA you'd think by now they'd be turning to others among their number with greater leadership skills. But not, apparently, while they can hide behind the charade of concern about threats to national security.

Read more >>

Debt-and-deficit brigade may bring us down

If the economy runs out of steam in the next year or two – and maybe even falls backwards – with unemployment climbing rapidly, there'll be plenty to share the blame: federal and state governments, federal and state Treasuries, and the utterly discredited credit-rating agencies.

The one outfit that will deserve little blame – but will get plenty – is the Reserve Bank. It shouldn't be criticised because it's had its monetary accelerator close to the floor for ages.

The official interest rate has been at or below 2.5 per cent for almost two years, but growth in real gross domestic product has remained stubbornly below trend.

If the economy does run out of puff it will be for a reason macro-economists have known was a significant risk for several years: the mining construction boom – which at its height accounted for about 8 per cent of GDP – is now rapidly coming to an end, with little likelihood that non-mining business investment (or anything else) will be strong enough to fill the vacuum it's leaving.

It's possible the Abbott government's surprisingly poor management of the economy is damaging business confidence, but the more powerful reason business isn't investing is simply that it has plenty of spare production capacity and doesn't see that expanding its capacity would be profitable.

So what can we do to reduce the risk of the economy losing momentum? It ought to be obvious. The Reserve has been dropping hints for months and earlier this month governor Glenn Stevens came right out and said it.

Fiscal policy – broadly defined to include state as well as federal budgets – needs to be pushing in the same direction as monetary policy (interest rates), not pulling against it. As Stevens pointedly noted, "public investment spending fell by 8 per cent over the past year".

Breaking down that contraction, it was caused by the states, not the Feds, with NSW by far the greatest offender. I suspect its poles-and-wires businesses have slashed their investment spending (no bad thing), with general government failing to take up the slack for fear of losing its precious AAA credit rating. So much for all last week's boasting about record infrastructure spending.

All this may have escaped the notice of Joe Hockey and his state counterparts – not to mention their federal and state Treasuries – but last week's statement by the International Monetary Fund's review team gave it top billing.

"The planned pace of [budgetary] consolidation nationally (Commonwealth and states combined) ... is somewhat more frontloaded than desirable, given the weakness of the economy, the size and uncertainty around the resource boom transition and the possible limits to monetary policy," the statement says.

"Increasing public investment (financed by more borrowing rather than offsetting measures) would support aggregate demand [GDP] and ensure against downside risks." Hint, hint.

"It would also employ [construction] resources released by the mining sector, catalyse private investment, boost productivity, take advantage of record-low borrowing rates, and maintain the government's net worth." Oh, that's all.

"Indeed, IMF research suggests that economies like Australia – with an output gap [spare production capacity], accommodative monetary policy and fiscal space – benefit most from debt-financed infrastructure investment, with the growth boost largely containing the impact on the (low) debt-to-GDP ratio."

The statement says the Feds should broaden the scope of investments they support – which may be, and certainly ought to be, a hint that they should be supporting urban public transport projects, not just yet more expressways.

And as well as direct funding, the statement says, the Feds could consider guaranteeing states' borrowing for additional investment, which "would keep accountability with the states but reduce their concerns about credit ratings".

That's one way to overcome the state governments' obsession with the credit ratings set by outfits that contributed greatly to the global financial crisis by granting AAA ratings to securities ultimately written off as "toxic debt".

State governments are letting these operators decide what's responsible and what's not? It's time state Treasuries stopped paying these characters to set arbitrary limits on borrowing for infrastructure spending, and state governments stopped putting retention or restoration of their AAA-rating status symbol ahead of their duty to provide their states with adequate infrastructure.

As for the Feds, Treasury should make it easier for its political masters to walk away from all their debt-and-deficit nonsense by abandoning its age-old objection to distinguishing between capital and recurrent spending.

These two artificial Treasury disciplinary devices – bulldust credit ratings and pretending all federal spending is recurrent – threaten to cause us to slip into an eminently avoidable recession. If that happens, we'll know who to blame.

Read more >>

Why inequality is bad for growth

As any economist will tell you, it's all very well to care about "fairness" – whatever that is – but efforts to reduce the inequality of incomes in the economy usually come at the cost of lower economic efficiency.

So if you insist in reducing inequality you'll have to settle for slower economic growth. Much better to put up with inequality and enjoy a faster rise in our average material standard of living.

For decades that's been the economics profession's conventional wisdom on the question of inequality. But, next time some economist assures you of all that, it will be safe to assume they're not keeping up with the research.

Either that or they prefer sticking to their long-standing political preferences rather than changing their views in line with the empirical evidence.

That's the point: the economists' age-old assumption that "equity" (fairness) and efficiency are in conflict – that more of one means less of the other – fits with their theories, but is now being contradicted by empirical studies, many of them coming from such authoritative institutions as the Organisation for Economic Co-operation and Development and the International Monetary Fund.

Last year staff at the fund published a study finding that income inequality between households, as shown by an overall measure such as the "Gini coefficient" – which is zero when everyone has the same income, rising to 1 when one person has all the income – adversely affects economic growth.

Last week the fund's staff published a new study building on this analysis by looking at the experience of people in different positions at the bottom, middle and top of the distribution of incomes, in almost 100 advanced and developing countries over the 22 years to 2012.

The new study confirms that a high Gini coefficient for net income (income earned in the market, less taxes and plus government cash benefits) is associated with lower growth in real gross domestic product over the medium term.

But it also finds an inverse relationship between the size of the income share going to the rich (defined here as the top 20 per cent of households) and the speed at which the economy grows.

If the income share of the top 20 per cent increases by 1 percentage point, GDP growth is 0.08 percentage points lower in the following five years, suggesting that the benefits do not "trickle down" to the rest of us.

By contrast, if the income share going to the poor (the bottom 20 per cent) increases by 1 percentage point, GDP growth is 0.38 percentage points higher in the following five years.

This positive relationship between shares of disposable income and higher growth continues to hold for the second and third quintiles (blocks of 20 per cent) which, following American practice, the authors refer to as the middle class. (This must mean that people in the second top quintile are the upper middle.)

The paper's authors quote other studies to help explain why higher income shares for the poor and middle class are growth-enhancing.

They note research showing that higher inequality lowers growth by depriving lower-income households of the ability to stay healthy and accumulate physical capital (a home, a car, a heating system) and human capital (education and training).

"For instance, it can lead to underinvestment in education as poor children end up in lower-quality schools and are less able to go on to college," they say. "As a result, labour productivity could be lower than it would have been in a more equitable world."

Other research finds that countries with higher levels of income inequality tend to have lower levels of mobility between generations, with parents' earnings being a more important determinant of children's earnings.

As well, increasing concentration of income at the top could reduce total demand (spending), and so undermine growth, because the wealthy spend a lower fraction of their incomes than middle and lower-income groups do.

"Extreme inequality may damage trust and social cohesion and thus is also associated with conflicts, which discourage investment," the authors say.

Inequality affects the economics of conflict as it may intensify the grievances felt by certain groups or reduce the opportunity cost of initiating and joining a violent conflict. If you're poor you've got less to lose.

So what should governments that want faster economic growth be doing to promote it?

"Redistribution through the tax and transfer [welfare benefits] system is found to be positively related to growth for most countries, and is negatively related to growth only for the most strongly redistributive countries," they say.

"This suggests that the effect of stability could potentially outweigh any negative effects on growth through a dampening of incentives."

The redistributive role of the budget "could be reinforced by greater reliance on wealth and property taxes, more progressive income taxation, removing opportunities for tax avoidance and evasion, and better targeting of social benefits while also minimising efficiency costs in terms of incentives to work and save".

"In addition, reducing tax expenditures [tax breaks] that benefit high-income groups most and removing tax relief – such as reduced taxation of capital gains, stock options and carried interest – would increase equity and allow a growth-enhancing cut in marginal labour income tax rates in some countries."

Then there's the reform of the labour market. "Appropriately set minimum wages, spending on well-designed active labour market policies aimed at supporting job search and skill matching can be important."

"Moreover, policies that reduce labour market dualism, such as gaps in employment protection between permanent and temporary workers – especially young workers and immigrants – can help to reduce inequality, while fostering greater market flexibility.

"Labour market rules that are very weak or programs that are non-existent can leave problems of poor information, unequal power and inadequate risk management untreated, penalising the poor and the middle class,' they say.

Sounds like our economists have a lot to learn.

Read more >>

Oldies screw young in the labour market

If you're ever tempted to doubt that the world is run by older people who organise things to suit themselves and don't worry about any blowback on the young, consider how commonly employers resort to the practice of "natural attrition".

It's something businesses do when times are tough. They could lay off workers, but they choose a more considerate path: just stop hiring any new people, including replacing people who leave, and eventually get your numbers down to where you need them.

And all the oldies breathe a sigh of relief. Problem solved in the nicest possible way.

Except for one little thing: the oldies have just passed the buck to some unknown bunch of young people. What causes natural attrition to get quick results is the decision to abandon the annual intake of young people at the entry level.

For youngsters there's a form of bad luck that isn't widely recognised by those of us already ensconced in the workforce: to have the misfortune to be leaving school or university at a time when the economy has turned down and few employers are taking on recruits.

Kids complete their education bright-eyed and bushy-tailed, only to discover the world of work doesn't want them. It might take them a year, even 18 months, to get a proper, full-time job. That can be terribly dispiriting.

It's common at such times for young people to be caught in a trap where they can't get a job because they lack experience, but they lack experience because they can't get a job.

It's an appalling thing for the rising generation to get off on such a wrong foot. It can take years to recover, if you ever do.

At the time of the global financial crisis in late 2008 and 2009, we were all hugely relieved when, as it turned out, we escaped serious recession. The official rate of unemployment rose from 4 per cent to just 5.8 per cent before falling back.

We were all off the hook. Well, only the oldies. The truth is there was a sharp downturn and employers did react by going into natural-attrition mode, with some even moving briefly to four-day weeks.

Great. What few people noticed was that much of the burden of adjustment was shucked off on to that year's crop of education leavers. How much concern for their welfare? Not a lot.

We do hear a lot about the trouble some older people find in regaining employment should they lose their jobs. It's a genuine problem and one we should care about.

But the unemployment problems of the old seem to attract a lot more public attention – and sympathy – than the similar problems of the young.

Research by the Brotherhood of St Laurence using HILDA – the household income and labour dynamics in Australia survey – finds those aged 55 and over account for just 8 per cent of the unemployed, whereas those aged under 25 make up more than 40 per cent.

So unemployment is concentrated among the young. And, historically, the sad truth is it's concentrated among the less educated and less skilled.

In the modern technologically driven workforce, there are many fewer jobs for people who quit school early and for those who don't acquire post-school trade or tertiary qualifications. What unskilled jobs remain tend to be casual and occupied by university students or mothers.

In 2008, according to the Brotherhood's figures, 45 per cent of the unemployed had failed to complete year 12, with another 20 per cent having gone no further than year 12. That's almost two-thirds.

People with trade qualifications made up just 16 per cent of total unemployment, with those with university qualifications accounting for an unusually high 19 per cent.

In more recent years, unemployment has been rising slowly while, within that, the rate of unemployment among 15 to 24-year-olds has risen more rapidly. Among those teenagers who are either in jobs or actively seeking them, the rate of unemployment earlier this year was 20 per cent.

But now get this: by 2012, according to the HILDA survey, the proportion of the unemployed with uni qualifications had jumped to 25 per cent.

To me, that's easily explained: years of weak growth in the economy are leading many employers to engage in natural attrition, which is limiting job losses among established workers, but making it much harder for university leavers to find work.

Governments can't be blamed for the employment practices of businesses, but they can be held accountable for their punitive treatment of the young unemployed – even if they are reflecting the adult world's lack of sympathy for youthful job seekers. Oldies seem convinced that the young's only problem is that they don't want to work and so need to be starved back to the grindstone.

The dole has been allowed to fall way below the age pension so that it's now less than $260 a week for a single adult. The "youth allowance" is even lower. Now the ever-so-caring Abbott government wants to raise the age of adulthood from 21 to 25 and extend the non-adult waiting period from one week to four weeks.

And that's before we get on to the way successive governments' high immigration policy is allowing employers to neglect the training of young workers.

Why young voters cop this cruddy deal so meekly I don't know.

Read more >>

A flush budget staying tight for bad times ahead

Something tells me that when Mike Baird went to Sunday school he studied fully the story of Joseph (he of the lairy sportscoat) and Pharaoh's dream about seven fat years being followed by seven lean years.

Joseph's advice to Pharaoh was to save like mad in the fat years and use the proceeds to tide the Egyptians over the lean years.

It seems Baird and his Treasurer have taken that advice to heart.

With property booming, the government's revenue from conveyancing duty has doubled in the past three years to more than $7 billion a year, with Treasury predicting further growth of 12 per cent in the new financial year, a forecast that could easily prove too cautious.

So Gladys Berejiklian's "barns" are full to overflowing, with operating surpluses stretching as far as the eye can see.

And yet she is maintaining a tight rein on government spending (for which read public sector wage rises).

Though it's possible to point to some wasteful spending – subsidies to the thoroughbred racing industry, grants for real estate development by church-owned schools, and an excessive share of infrastructure spending going to rural areas to buy off the Liberals' country partners – the government's case for hanging tight is persuasive.

For a start, remember that all the operating surplus is used to help fund infrastructure spending without adding to borrowing and jeopardising the state's AAA credit rating. (Whether we should worry so much about ratings is another question.)

But, urged on by Treasury, the government is full of forebodings about revenue threats looming on the horizon, a good reason to save rather than consume in the good years.

For a start, the property boom won't go on forever, and the longer it lasts, the bigger the ultimate budgetary hangover.

For another thing, while it was nice to get our cut of Western Australia's mining royalties windfall from the resources boom, in the form of a higher share of national collections of the goods and services tax, now it's WA's turn to get a cut of our property boom windfall via the same mechanism.

Once the state's poles-and-wires businesses have been partially sold off, Treasury will be getting a smaller flow of dividend income, but that would have happened anyway now the national electricity price regulator has belatedly stopped those businesses from overcharging us (while their state government owners looked the other way).

Perhaps the greatest threat of lean years to come is Tony Abbott's plan, announced in last year's budget from hell, to cut federal grants to public schools and hospitals by $80 billion over 10 years from 2017.

NSW would cop about 30 per cent of the cuts. Berejiklian says they would be "unsustainable" and she's right, meaning they're a bigger problem for the Feds than for her. They're just the last bit of 2014 political stupidity remaining on Abbott's backdown to-do list.

Berejiklian claims the credit for NSW growing faster than the rest of Australia, after lagging in the years before the Coalition returned to office.

But it's a swings-and-roundabouts thing. Does she really want us to believe it was she who brought the mining construction boom to a halt? Or she who cut interest rates to record lows?

At least she'll be ready for the next downswing in our fortunes.

Read more >>

Don’t believe Abbott stands for lower taxes

Tony Abbott did so well at the last election with his scare campaigns against the carbon tax and the mining tax it seems he thinks his best chance of re-election is another scare campaign on tax.

An obvious conclusion from voters' overwhelming rejection of last year's budget as unfair was that the attempt to fix the deficit almost exclusively by cutting government spending - without touching any of the "tax expenditures" on the revenue side of the budget - was crazy.

So it wasn't surprising to see, a few weeks back, Joe Hockey edging towards the idea that repair of the budget would have to involve reform of the hugely generous superannuation tax concessions to the well-off.

With Labor making similar noises, Hockey might even eventually have edged as far as promising to do something about the "negative gearing" loophole, had Abbott not stepped in and stopped him in his tracks.

Why? Because Abbott thought he saw a brilliant opportunity to wedge Labor. If Labor was promising to fix super tax concessions and negative gearing, why not promise the Coalition wouldn't touch 'em?

That way, Labor could be portrayed as the party of high taxers, whereas the Liberals could portray themselves as the party committed to lowering taxes, implacably opposed to all tax increases. If you want to pay much higher taxes, vote Labor; if you don't, vote for us.

Not bad, eh? Abbott has telegraphed his game plan so clearly it will be interesting to see if Labor keeps its nerve and offers voters a genuine alternative.

But Abbott's claim to be opposed to all tax increases is not one to be believed. As the former top econocrat Dr Michael Keating has pointed out, this year's budget shows increased taxation is expected to be the main way the government is planning to get the budget deficit down.

In the Labor government's last year, 2013-14, total federal government revenue (including more than just tax collections) was equivalent to 22.8 per cent of gross domestic product. In the coming financial year it's expected to have risen to 24 per cent. And by 2018-19 it's supposed to be 25.2 per cent.

So the government is projecting that revenue will rise by 2.4 percentage points of GDP over the five years. At the same time, the budget deficit is projected to fall by 2.7 percentage points.

"Clearly," Keating writes on John Menadue's blogsite, "these figures show that revenues are doing almost all the work to reduce the budget deficit". Government spending is expected fall by only 0.3 or 0.4 percentage points of GDP over the five years.

So what's the story? Where will Abbott be getting all this extra revenue from? Does he have some new tax hidden up his sleeve? Is he counting on a big increase in the GST?

Well, some part of it will come from the changed accounting treatment of the annual earnings on the Future Fund. But, for the most part, it will come from what, in an earlier chapter of the Libs' professed campaign for lower taxes, Malcolm Fraser and John Howard used to call "the secret tax of inflation".

These days it's more commonly called "bracket creep" - as your income rises over time to (you hope) at least keep pace with the higher prices you're paying, a higher proportion of it is taxed at higher rates. This happens even if you aren't literally pushed into a higher tax bracket, but it happens with a vengeance if you are.

Keating says receipts from personal income tax are projected to increase from 10.4 per cent of GDP in 2013-14 to 12.1 per cent in 2018-19, and this increase of 1.7 percentage points is a rough measure of the contribution of bracket creep to the budget bottom line.

According to his figuring, bracket creep will account for 63 per cent of the projected improvement in the budget deficit over the five years to 2018-19.

But how politically realistic is such a projection? Already it implies that someone on average weekly earnings can expect to move into the second-highest tax bracket in the coming financial year. They'd be paying 39c in the dollar on the last part of their income and on any pay rise.

Keating says that, according to the budget projections, someone on average earnings would see their average tax rate (the rate paid on every dollar) rising from 21.7 per cent to 27.4 per cent over the next decade.

Don't worry, it's unlikely any politician would allow that to happen. But it does warn you not to believe Abbott's claim to be a low taxer.

Read more >>

Why monetary policy still packs a punch

Perhaps the biggest question in macro-economic management today is whether monetary policy has lost most of its power to get the economy moving. To many of us the answer seems obvious. But this week a Reserve Bank heavy popped up to challenge the newly emerging consensus.

Whether you look at the way the major developed countries' resort to massive "quantitative easing" (creating money) hasn't exactly got their economies booming, or at the way our big cuts in the official interest rate haven't seen us return even to average ("trend") growth, it makes you doubt if "monetary policy" - the manipulation of monetary conditions - still packs a punch.

Consider our story. The Reserve Bank began cutting the official interest rate as long ago as November 2011. By August 2013 it had reduced it by 2.25 percentage points to a historic low of 2.5 pc. This year it's made more cuts to 2 per cent.

And yet the economy continues growing below trend and isn't expected to return to healthy growth before 2016-17.

Enter Dr Christopher Kent, an assistant governor of the Reserve. In his speech this week he didn't deny the facts: interest rates have been very low for a long time without there being any noticeable pick-up in growth.

But he did dispute the conclusion that this meant monetary policy had lost its power to stimulate economic growth. His point is that when we look at the position in the way I've just done, we're implicitly assuming "ceteris paribus" - that all else remained equal while the only thing that changed was the level of the official interest rate.

Obviously, a lot of other things changed over the period. To take just the most obvious examples, the big fall in coal and iron ore prices, the movement in the dollar and the impact of "fiscal policy" - the effects of the federal and state budgets.

To try to take account of all the things that change, not just interest rates, you need to use a sophisticated econometric model of the economy. And when Kent's people at the Reserve do this, their estimates "tentatively suggest that the overall effect of monetary policy has not changed significantly in recent years".

Such models have two kinds of variables "exogenous" and "endogenous". Exogenous variables are set by the modeller, whereas endogenous variables are determined by the model and its assumptions about how the economy works.

Kent says that in modelling work using a "dynamic stochastic general equilibrium" model (don't ask), estimates of the endogenous relationships based on the figures up to 2008 (the time of the global financial crisis) are about the same as estimates based on figures since then.

"This suggests that the period of below-trend growth in gross domestic product over the past few years may not reflect a change in the monetary policy transmission mechanism," he says.

"Rather, the model attributes below-trend growth to sizeable exogenous forces or shocks. The sharp fall in commodity prices has played an important role of late. Also, weakness in private investment - beyond that which can be explained by subdued domestic demand and falling commodity prices - has made a sizeable contribution to below-trend growth."

I think here he's alluding to the adverse effect on business investment of the still-too-high dollar.

"The model also suggests that consumption growth has been a bit weaker than in the past," he says.

Measuring the effects of monetary policy in isolation from other changes that may be happening at the time, this modelling tells us that a cut in the official interest rate of 1 percentage point will lead the level of real GDP to be between about 0.5 per cent and 0.75 per cent higher than it otherwise would be in two years' time.

It will also lead the level of prices to rise by a bit less than 0.25 percentage points a year more than otherwise over the next two to three years.

Of course, one part of the economy that has strengthened in response to low interest rates is housing construction. It's up by about 9 per cent over the past year.

Kent says housing is typically the most interest-rate sensitive sector and its response to date is "broadly consistent with historical experience".

Consumer spending, however, has so far been "a bit weaker over recent years than suggested by historical experience".

But much of that history captures the unusual period, from the early 1990s to the mid-2000s, of adjustment to the easier access to housing credit permitted by the deregulation of the banks and to the economy's return to low inflation.

In that period, household debt increased substantially and household saving fell to rates much below earlier norms. This allow households' consumption spending to grow faster than their incomes.

Since then, however, households' behaviour has reverted to its earlier norms, with a higher rate of saving and greater emphasis on repaying mortgages as early as possible.

If you ignore the growth in borrowing for investment property, but take account of the rising balances in mortgage offset accounts, the rest of household debt has fallen by 4 percentage points of annual household disposable income since early 2000.

Kent thinks many households are using the lower rates to repay their mortgages more quickly (rather than to borrow and spend more) and that some retired households are responding to their lower interest income by limiting their consumption.

As for non-mining business investment, businesses will start expanding their activities when they're closer to running out of spare production capacity. Business investment doesn't usually lead, it follows.

Kent concludes that monetary policy is working pretty much the way it always has, but is pushing against "some strong headwinds", including the huge fall-off in mining investment, tightening budgets at state and federal level and an exchange rate that's still higher than you'd expect it to be considering how far export prices have fallen.

Read more >>

Governments let oldies screw the younger generation

When I see the way the Abbott government – like its Labor predecessor – happily presides over a system stacked against the younger generation, it makes me wonder why they're not rioting in the streets. Answer is, it's thanks to the evil genius of our politicians.

Young people tend to be more idealistic than those of us who've lived longer and seen more. So when they see the low level to which standards of political behaviour have fallen – the promises so casually broken, the lies told, the way the pollies profess to care about the welfare of the next generation but don't walk the walk – they're even more inclined than the rest of us to turn their back on politics and public policy.

Which means, of course, that most young people have only a vague inkling of the extent to which successive governments have been screwing them.

The pollies' problem is that they'd love to please everyone, but don't have sufficient resources. So they have to short-change someone, and the victims they pick – apart from those who have no friends to stick up for them – are the people who aren't paying attention to what the pollies are up to.

The people who pay most attention are the oldies – whose number is being swelled by the retiring Baby Boomers – who have so little else to worry about they even imagine injustices that aren't real. The great majority of oldies own their own homes, but other home owners are equally zealous in protecting their privileges.

This is the most topical instance in which governments are allowing the old to screw the young. Apart from the fact that our homes get bigger and better over the years, house prices rise when the demand for them exceeds their supply.

Both sides of politics believe in high levels of immigration, but haven't bothered to ensure sufficient additional homes are being built to accommodate the growing population. So reducing impediments to the building of additional homes – mainly a responsibility of the state governments – is the fundamental solution to the problem of housing affordability.

But distortions in our tax laws – distortions other countries long ago corrected – are adding unnecessarily to the demand for houses by making them a tax-preferred form of investment. This is "negative gearing", which means first home buyers are having to compete against well-established older investors with a lot more collateral.

It wouldn't be a problem if negatively geared investors were adding as much to supply as they are to demand, but they prefer buying established homes.

The government could easily fix this distortion, and do it in a way that didn't precipitate an immediate exodus of investors from the market but, to date, neither side has been prepared to do so.

Why not? Because the pollies are much more afraid of the anger they'd arouse among oldies benefiting from the tax lurk – and all the business people who see themselves as getting a cut of the proceeds – than they are of all the young people who don't quite understand how they're being worked over by their elders.

The fact is that the rate of home ownership – which once was as high as 70 per cent – is steadily falling as higher and higher proportions of people in younger generations fail to make it onto glittering merry-go-round of owner-occupation.

So, having got themselves ensconced on the merry-go-round, the older generation and the politicians in thrall to it are now effectively repelling boarders.

This means a high proportion of the younger generation will be renters all their lives, including in retirement. And that means they'll get screwed by the system which, in the name of encouraging home ownership, has always been loaded against renters.

For a start, our tenancy laws afford renters less security of tenure and fewer rights than in European countries where life-long renting is the norm.

But tax and benefit arrangements also discriminate against renters. Invest in your own home and you escape paying capital gains tax when you sell it; invest in anything else and you don't.

Own your home when you retire and its value, no matter how high, is excluded from the assets test in assessing your eligibility for a full pension; choose to save in any other way and you're zapped.

This crazy arrangement discourages the old from selling the family home and moving to something smaller and more appropriate.

The truth is, living on the age pension is bearable provided you own your home. In other words, the people who have most trouble getting by on the pension are those obliged to rent in the private market.

When Kevin Rudd inquired into the adequacy of the age pension he was told it was really only the private renters who had a big problem. He ignored the report, granting a big increase to single pensioners regardless of their housing status, plus a smaller increase to people on the married rate so they wouldn't feel left out.

All this is of little interest to young people, of course. They know they're never going to get old.

If I were a youngster I mightn't be rioting in the streets, but I certainly wouldn't be voting for any party that wasn't promising to fix negative gearing. If you're more afraid of greedy oldies than you are of me, I'll be voting against you.

Read more >>

Your charter of budget dishonesty

Thanks to abuses by both sides, it's hard to remember a time when standards of political behaviour have sunk to lower depths. The budget papers are no exception to that general decline.

Some of the tricks used to mislead us are so technically tricky it's hard to believe they could have been thought up by the politicians themselves or their youthful private advisers.

I suspect the econocrats are complicit in providing their masters with fancy tricks, though it's more likely to be the accountants in Finance than the economists in Treasury.

The worst example of that was the attempt in last year's budget to use a "medical research future fund" to allow the government to break its promise not to cut health spending while pretending it hadn't.

The Labor government's greatest offence was to conceal the pace at which its spending was growing - and its ever-growing inability to pay for its expensive new programs - by claiming it was sticking to its policy of limiting real spending growth to 2 per cent a year "on average over the forward estimates".

That proviso allowed it to claim spending was under control: every year the lack of restraint in the budget year would be made up for by super-human restraint in the later years. After Labor departed, the econocrats dubbed this the "magic asterisk" budgeting device.

The present government's greatest crime was to exaggerate the size of the budget deficit it inherited from Labor by claiming some of its own policy decisions were part of what Labor left it with. Its unrequested $8.8 billion transfer to the Reserve Bank - essentially a book entry - was only the worst of its fiddles.

In accordance with Peter Costello's charter of budget honesty act, the honest account of what Labor left for its successors was given in the pre-election fiscal outlook issued by the heads of Treasury and Finance.

But at the time of the Coalition's mid-year budget review months later, Joe Hockey claimed its figures to be the "line in the sand" separating Labor's legacy from his own efforts.

One small problem: the mid-year review incorporated the budgetary effects of all the Coalition's election promises, including its decisions to abolish the carbon and mining taxes.

Then we find this utterly dishonest claim formally incorporated into this year's intergenerational report, turning that document into grubby political propaganda.

One element of Costello's move to budget honesty - if you need an act of parliament imposing budget honesty, you clearly have an honesty problem - was to stop governments hiding the true extent of their deficits by including proceeds from the sale of assets, which he did by shifting the focus to the "underlying" cash budget balance.

Fine. But there was a loophole in the way the underlying deficit was defined, and successive governments have exploited that loophole so as to continue misleading us. Labor went for years refusing to disclose the items explaining the difference between the "headline" and underlying deficits.

But thanks to a deal the Greens did with this government, this information is now published each year in budget statement 3. Over the five years to 2018-19, the cumulative headline deficits are expected to exceed the underlying deficits by more than $68 billion, before allowing for future fund earnings of $18 billion.

The gap is explained mainly by the expected build-up in HECS debt of $49 billion, but also by $21 billion in further spending on the National Broadband Network, which is really infrastructure spending, but is excluded from the underlying deficit because it was set up as an equity investment in a business separate from the budget.

This trick - which, like all exploitation of loopholes, is technically in accordance with the rules - was initiated by Labor, as was the (reasonable) decision to switch future fund earnings back into the underlying budget balance from 2020. Just as well, since they're expected to make up such a high proportion the small surpluses projected from that time.

A final respect in which governments use the budget papers to mislead and conceal is the arbitrary exclusion of particular tables or graphs when they could prove embarrassing. Last year's unfair budget just happened to exclude the customary "cameos" showing how particular family types would be affected by the budget's welfare changes.

This year the graphs (and their underlying numbers) for revenue and spending were missing from the 10-year projection of the budget balance, which attempted to show that the budget's return to surplus hadn't been pushed back a year by all the backdowns in the budget.

All this dishonesty just adds to the political class' declining credibility in the eyes of voters.

Read more >>

Jobs and wellbeing are inescapably linked

Anyone who's sure they know what's happening in the economy is either a liar or a fool. Last week the Bureau of Statistics' national accounts told us things weren't too flash in the economy up to the end of March. This week its employment figures told us things were looking quite a bit brighter in the labour market up to the end of May.

The jobs figures are good news – which is why the media didn't shout about them - but also puzzling news. The two key economic indicators – for the increase in production of goods and services, and for the increase in employment – don't fit together.

I wrote last week that real gross domestic product grew by only 2.3 per cent over the year to March, whereas it needs to grow by about 3 per cent just to stop unemployment rising.

That general rule remains true, but it's contradicted by this week's jobs figures. Let's step back and look at the movement in the figures over the year to May, and let's get a clearer picture by using the "trend" (or smoothed seasonally adjusted) estimates.

They show that total employment grew over the 12 months by more than 200,000 people, with a bit more than half those jobs being full-time. That's an annual increase of 1.75 per cent.

Over the same period, the size of the labour force – that is, the number of people either in work or actively seeking it - grew by 1.8 per cent.

So employment grew at essentially the same rate that the labour force did, meaning the unemployment rate in May last year was 6 per cent and in May this year is also 6 per cent – something the production figures imply shouldn't have happened.

Which is good, if puzzling, news. The best – and even more puzzling – news is that between last May and this May the unemployment rate rose to 6.2 per cent by last August and stayed there for the seven months to February, before falling back to 6 per cent in May.

Get it? These numbers make it look very much as though unemployment has peaked and is now falling back a fraction – which I'd have to say may be too good to be true. It's certainly no guarantee that unemployment won't resume its upward climb if, as seems likely, production continues to grow at a below-average rate.

Remember that the demand for labour is "derived demand" – it's derived from the growth in the demand for goods and services. As businesses increase their production of goods and services in response to the public's greater demand for them, those businesses need to hire more workers to help increase their production.

This is one of the biggest reasons economists (and journalists like me) obsess so much about the quarterly figures for the growth in real GDP. They're the best indication we've got of what's likely to happen to unemployment in coming months (and I, for one, care a lot more about unemployment than about economic growth, as such).

When the two indicators are telling us different stories – which isn't all that uncommon – economists have to don their overalls and climb inside the numbers to see what's going on, who's right and who's wrong. I'll keep you posted.

Meanwhile, someone asked me this week why there was so much focus on GDP when it was such a poor indicator of our wellbeing.  I've just given you the answer: if you care about unemployment you have to care about GDP.

But economic growth and our overall wellbeing are quite different things, and every economist will tell you that whereas GDP is (usually) a reasonably accurate measure to use in managing the economy, it's not, and was never designed to be, a good measure of our wellbeing.

This is why, some years ago, Fairfax Media commissioned Dr Nicholas Gruen, chief of Lateral Economics, to construct a better measure of wellbeing, the Fairfax-Lateral Economics wellbeing index.

The index is calculated quarterly, with its results published on the Saturday following the release of the quarterly national accounts. (Sorry, at present the background to the index is between websites.)

The beauty of our wellbeing index is that it's built on GDP, modifying it to turn it into a broader measure of Australians' wellbeing, while leaving it directly comparable to GDP. Last week's figures showed that while real GDP grew by 0.9 per cent in the March quarter, our measure of wellbeing fell by 0.4 per cent.

As I wrote last weekend, GDP is only one of the bottom lines that can be derived from the Bureau of Statistics' national accounts. Many economists agree that the broadest and most appropriate bottom line available for Australian households is "real net national disposable income" (nicknamed "rinndy").

The national accounts showed that whereas real GDP grew by 0.9 per cent, rinndy grew by only 0.2 per cent, mainly because falling export prices have reduced the international purchasing power of our incomes.

The wellbeing index takes rinndy and adjusts it for various important influences over our wellbeing not  taken account of in the national accounts: the change in human capital (the value of our "know how"), the depletion of natural capital (the using up of non-renewable resources, less resources added through exploration), the change in the inequality of income, the change in our health, and the change in work satisfaction (the costs of unemployment, under-employment and overwork).

But the change that did most to turn a rise in rinndy of 0.2 per cent into a fall in wellbeing of 0.4 per cent was a sharp rise in long-term unemployment and the consequent increased cost of "skills atrophy" – the longer you're unemployed, the more your skills are lost, to yourself and to the rest of us.

If you care about wellbeing, you have to care about employment.

Read more >>

We've become a nation of graspers

Did you see an older bloke with a goatee beard ask Joe Hockey a question about the budget's changes to the assets test for the age pension on the ABC's Q&A program a few weeks back?

He was Dante Crisante, a retired chemist, according to a subsequent interview he did with the Financial Review.

A lot of relatively well-off retirees have been complaining about the changes, which could reduce or eliminate their entitlement to the pension. They've been wondering what changes they could make to their finances to get around the new rules.

Hockey probably assumed Crisante was asking on his own behalf. He replied that he wasn't an investment adviser. But Crisante was asking a policy question, aimed at highlighting the long-standing anomaly that someone's home is excluded from the value of their assets for the purposes of the assets test. (Bad luck for people who've rented all their lives.)

Turns out Crisante doesn't receive the pension and says he never wants to get it. Which means that the man who wanted to "end the age of entitlement", and who drew invidious distinctions between lifters and leaners, missed a golden opportunity to congratulate Crisante and hold him up as an example for other comfortably off old people to follow. Maybe put him up for a gong on Australia Day.

It's possible, however, that even had Hockey known Crisante didn't have his hand out for a handout, he wouldn't have been game to praise him for his self-reliance. He might have been afraid of offending too many people; too many of his own supporters (not that a Labor politician would have been any braver).

The point is, something bad has happened to Australians over the years: we've become a nation of graspers. There was a time when the comfortably off were too proud to put their hand out for the pension. "The pension is for those people who need it. I don't need it, so I won't be joining the queue at Centrelink, thanks."

But those days are long gone. These days we display our wealth by the suburb we live in, the flash house we live in, the flash car we drive and the flash clothes we wear. But none of that stops us arranging our affairs so as to claim a pittance more from the taxpayer.

I suppose it's a good thing there's now no shame attached to being an age pensioner. But it's gone too far when it means there's no shame in claiming a pension or part-pension you don't really need.

And, as I've experienced myself in recent years, there's a whole industry of financial advisers out there these days making their living – a lucrative one, by all accounts – advising older people on how to maximise their call on other taxpayers.

Not just how to minimise the amount of tax you pay on your superannuation – how to put as little as possible into the community kitty – but also how to maximise the pension and associated benefits you receive; how to get as much as possible out of the kitty.

We do all that, most other people do all that, then we wonder why our governments have so much trouble getting their budgets to balance. We even tell ourselves how worried we are about these governments leaving so much debt to be picked up by our grandkids.

Notice how it's always those terrible politicians doing terrible things to our grandchildren. It's never the collective consequences of their grandparents being selfish.

Actually, it's funny. An important part of our motive in using our last years to pay as little tax as possible and make the biggest claim on other taxpayers as possible is our desire to maximise our children's inheritance.

It's a form of selfishness we see as unselfish. Ripping off the system to help our children. Rip off your fellow taxpayers before they rip you off, a great philosophy of life to pass on. Surprisingly, selfishness is catching. Some people find their children even more anxious than they are to maximise their inheritance.

In vain do politicians protest – quietly, and only occasionally – that the billions lost in tax breaks on super every year are sacrificed to help people with their living costs in retirement, not to help the old maximise their kids' inheritance.

In the popular reaction to the latest changes to the assets test, angry oldies are talking of finding ways to prevent the government from cutting their pension. Move to a more expensive house, one far bigger than you need or want to look after?

Give a lot away to your kids in advance? The government has low limits on how much you can give away each year without reducing your pension entitlement, but that's OK, just lie to the government. Lying to governments isn't really lying, is it?

This wouldn't be the first time old people, in their mania for extracting the last dollar of supposed entitlement from the government, have done crazy things. Years ago people would keep thousands in non-interest-bearing cheque accounts so as to avoid reducing their pension.

Rather than losing one dollar of pension they preferred to lose two dollars of interest. Volunteer for the big banks to rip you off? Sure.

The government had to introduce "deeming" to stop pensioners from self-harming. We've become a nation of graspers.

Read more >>

KPIs a dumb way to encourage good performance

You've been doing good work lately, and the boss is thinking of acknowledging your contribution. How would you like to be thanked? With a bonus, or with some kind of award?

If you want the money rather than the glory you'd be in good company. That's how most bosses want their own good work rewarded (and arrange their compensation package accordingly).

And it's how almost every economist would advise your boss to reward you. But don't be so sure it is what you really want, what would yield you the most lasting satisfaction.

One of the big issues in business - particularly big business - is how best to motivate and reward good performance.

Since economics is defined by some economists as the study of incentives, you'd think this was right up their alley. But economics is so focused on monetary incentives that most economists tend to assume away any non-monetary motivations.

They'll tell you the best way to "incentivate" people is performance pay: promise them a particular bonus provided they meet the targets you've set on a few "key performance indicators". Apart from that, just pay the good performers more than the poor performers.

But there's a lot more to human motivation than that and, fortunately, some economists are starting to take a less narrow approach to the topic. One is Professor Bruno Frey, of the University of Zurich.

In a paper with Jana Gallus he discusses The Power of Awards and puts them into the context of other forms of reward. Money is obviously the most common form and it has the great advantage of "fungibility" - you can spend it however you choose. And it can be applied marginally - do a bit more, get a bit more; do a lot more, get a lot more.

A second form of reward is non-monetary, but still a material award: fringe benefits, such as a company car or a particularly attractive office. These have the disadvantage of lacking fungibility (I might prefer money to a car), but usually carry a tax advantage. Even a corner office brings me status that isn't taxed.

Money and cars are "extrinsic motivators" - you do a good job as a means to getting what you really want. The message is slow to get through to business, but among behavioural economists there's now more interest encouraging "intrinsic" motivation - you do a good job because it makes you feel good. You're good at what you do and you enjoy doing it. You like knowing you've done a lot to help your customers.

The way to foster intrinsic motivation is to treat your staff well, of course, but the key is to give people discretion in the way they do their jobs. It's the opposite of trying to tie them up with KPIs.

Frey and Gallus say awards fall somewhere between these two approaches - they're extrinsic, but often not material. They include titles, prizes, orders, medals and other decorations. They are ubiquitous in society, if not business.

They're widely used in public life (various ranks of the Order of Australia), the entertainment industry (Oscars, Grammys, Logies), journalism (Walkleys, journalist of the year), sport (Brownlow medal, Dally M medal, Olympic medals), academia (fellowships of prestigious scholarly bodies, honorary doctorates, Nobel prizes) and the Catholic Church (canonisation and papal knighthoods).

The point is that the many advantages of awards suggest they should be used more in the business world.

For one thing, they're cheap to confer, but highly valued by the recipient because of the recognition as well as status they bring - provided you don't give out too many, make them too easy to attain or award them to the clearly undeserving.

More significantly, they avoid the drawback of KPIs and performance pay. The authors say such inducements are appropriate only if the performance criteria are precisely determined and measured. But for many complex activities, this is  not possible.

If it isn't, KPIs encourage what social scientists euphemistically call "strategic behaviour" - gaming the system by performing well only on those dimensions that are measured.

Monetary rewards may reduce work effort by crowding out intrinsic motivation, training people to try hard only when there's money to be gained. Why spend time helping a colleague when this might help them achieve their KPIs at the expense of your own?

The authors say monetary rewards don't induce employee loyalty. They're a strictly commercial transaction. But awards do encourage loyalty, as well as intrinsic motivation.

Overpaid chief executives shouldn't assume their workers are as materialistic as they are, nor should they imagine their firm would do better if their workers' materialistic tendencies were heightened.

Read more >>

A far from wonderful set of growth numbers

The economy may have grown faster last quarter than business economists were expecting, but that tells you more about their forecasting ability than the economy's strength. Despite what Joe Hockey says, the numbers weren't all that wonderful.

According to the national accounts released by Bureau of Statistics this week, real gross domestic product grew by 0.9 per cent in the March quarter and by 2.3 per cent over the year to March.

This, of course, is well below the economy's "trend" (long-term average) rate of growth of 3 per cent a year, the rate needed just to hold unemployment steady in an economy with a growing number of people wanting to work.

But that's just the first reason the figures aren't as good as they initially appear. Another - one economists perpetually forget to remind us about - is that we have a population growing at the rapid rate of about 1.5 per cent a year, thanks to high immigration.

So we need quite a bit of growth just to stop average income per person falling. Turns out real GDP per person grew by just 0.8 per cent over the year to March.

Another thing to remember is that the growth in real GDP - the quantity of goods and services produced in Australia - is just one way, the most common way, of measuring economic activity.

It's usually assumed that the growth in the nation's production is the same as the growth in its income. But, first, the assumption breaks down if there's a significant change in Australia's terms of trade - in the prices we're getting for our exports relative to those we're paying for our imports.

That's because changes in our terms of trade affect the international purchasing power of the nation's income. When our terms of trade improve, the goods and services we produce are worth more when we buy goods and services overseas; when our terms of trade deteriorate, the stuff we produce is worth less when we're paying for imports.

With the prices we received for our mineral and energy exports rising greatly in the years before their peak in 2011, our "real gross domestic income" grew a lot faster than our production, real GDP.

Now, however, with coal and iron ore prices falling sharply, our real gross domestic income is growing much more slowly than our production, even falling. In the March quarter, real GDP grew by 0.9 per cent, while real GDI grew by only 0.2 per cent.

Over the year to March, real GDP grew by 2.3 per cent, but real GDI fell by 0.2 per cent. This matters because the real value of our income has an indirect effect on future real GDP, which is what drives growth in employment.

But a second assumption implicit in our almost exclusive focus on real GDP is that all the goods and services produced in Oz belong to Australians. They don't. In particular, maybe as much as 80 per cent of the value of the minerals and energy we produce and export is essentially the property of the foreign owners of our mining companies.

The Bureau of Stats highlights gross domestic product in conformity with international convention. But the fact is we'd be better off using gross national product, which measures how much of GDP actually stays with us rather than going to foreigners in interest and dividend payments.

And, because the deterioration in our terms of trade arises mainly because of the fall in prices of mineral exports, real GDI overstates the fall in our income. Real gross national income grew by 0.4 per cent in the quarter, and by 0.6 per cent over the year to March.

But, turning back to real GDP and its components, another reason the figures aren't as good as they appear is their heavy reliance on growth in exports. The volume (quantity) of our exports grew by 5 per cent in the quarter and by 8.1 per cent over the year to March.

This means exports contributed 1.7 percentage points to our overall growth of 2.3 per cent for the year. That's almost three-quarters of it.

Normally, this wouldn't be a worry. But when you remember that most of the export growth came from mining, and that mining is highly capital-intensive, you see there is a worry. It means that real GDP growth of 2.3 per cent isn't contributing as much to employment growth as we usually assume.

The figures show that the Reserve Bank's efforts to stimulate growth in the "non-mining" economy are having mixed success. They're working well with investment in new housing, which grew by 4.7 per cent in the quarter and 9.2 per cent over the year.

But they're getting nowhere with encouraging non-mining business investment to offset the sharp fall in mining investment. Overall, business investment fell by 2.7 per cent in the quarter and by 5.4 per cent over the year.

And get this: fiscal policy (including the budgets of the state governments) is hindering, not helping. Public investment in infrastructure fell by 2.4 per cent, its fifth successive quarterly decline, to be down by 9.1 per cent over the year, which subtracted 0.4 percentage points from overall growth over the year.

Consumer spending grew by an improved, but still below-trend, 2.6 per cent over the year, despite weak growth in wages and employment, and a rising tax bite from household disposable income.

What's keeping consumption reasonably strong is a falling rate of household saving. It fell from 8.8 per cent of household disposable income to 8.3 per cent in the quarter, down from 9.6 per cent a year ago.

It's normal and rational for households to adjust their saving to smooth their consumption spending as the economy moves through the ups and downs of the business cycle.

Even so, it's yet another respect in which the numbers weren't all that wonderful.

Read more >>