We need more agile thinking about "reform"

What do we want of our government? What should it to do for us? It's clear from his recent observations that our new Prime Minister is thinking hard about these things. Good. But we – the governed – should be thinking about them, too.

Malcolm Turnbull says his government's goal will be to set Australia up "to remain and be secure as a high-wage, generous-social-welfare-net, first-world country".

Speaking in Parliament, he said that "the business of government is to get things done. Australians expect us, their elected representatives, to deliver practical, commonsense policy that will improve economic security and general wellbeing".

The coming election, he told interviewers, will be fought primarily "on economic management and competing visions for Australia".

The fact is, Turnbull's predecessor wasn't much interested in the stuff of economics.

So it's not surprising that Turnbull has arrived at a time of great frustration – and expectation – among those business people, economists and media commentators who see the economy growing only slowly and have convinced themselves that major "reform" – especially changes to taxation – is the only thing that will secure our future.

There's no denying that the economy isn't performing particularly well at present, that it needs to be continuously and carefully managed and that, with the world continually changing around us, there's often a need to change the way we regulate particular aspects of the economy.

But we need to use the government's new start to think through something more basic: how do economic concerns fit with all our other concerns?

We've been living in a period where the people with the loudest voices want economic concerns to be paramount. What we need most is faster economic growth, because that's the way we keep increasing our material standard of living.

The implications of all this extra economic activity for the environment, for the distribution of income between rich and poor, for the adequacy of the help given to the disadvantaged, are things we can't afford to worry too much about.

This may be the attitude of some powerful people, but I doubt if it's what most of us want. So if Turnbull wants to be a successful, long-lasting leader of the nation, he'll need to be on about a lot more than changing the tax system in ways that suit big business.

He'll need a "competing vision for Australia" that's a lot broader than good economic management. He needs to remember that "economic security" is about more than having more money than you had last year. And "general wellbeing" covers a lot more than income and jobs.

What do we want of our government? There is much Turnbull could do to improve our "general wellbeing" that doesn't involve what's normally classed as economic reform.

For instance, he'll do a lot to protect our general wellbeing if he resists pressure from commercial interests to reduce penalty wage rates and increase shopping hours and thereby avoids making it much harder for many husbands and wives to socialise with their children – let alone relatives and friends – at the weekend.

How exactly does weakening the weekend leave us better off? Is it OK if avoiding work on the weekend remains possible for the well-paid but not the poorly paid?

Our efforts to reduce domestic violence – which probably need to be greater – can't be classed as economic reform, but would do much to improve the daily lives of many wives and children.

Right now Turnbull is being urged by business people and economists to make the economy more efficient with "reforms" that would do so at the expense of widening the gap between high and low income-earners.

But there are plenty of changes Turnbull could make that raise productivity and participation in the labour force while actually benefiting the less well-off.

It's so commonplace that economists have stopped noticing it, but by far the greatest source of inefficiency in our economy is our high rate of unemployment and underemployment. All those people willing to work but unable to find suitable employment.

Most of the unemployed are unskilled. Many are early school-leavers with inadequate literacy and numeracy. This at a time when technological change is reducing job opportunities for the unskilled but increasing demand for the well-educated.

For decades we've been allowing kids with learning difficulties to get through school unassisted, to live a life in and out of employment, on and off the dole.

The Gonski funding changes could have done much to reduce this problem, but they're dismissed as an expensive social welfare measure we can't afford, rather than an economic reform that could pay big dividends.

It's a similar story with the national disability insurance scheme, where the Productivity Commission itself estimates that its proper implementation could make a significant contribution to economic growth.

Professor Allan Fels has argued that better assistance to people with serious mental illness could greatly benefit the economy by getting more of them off the disability pension and into jobs.

Better public transport could not only reduce the long commuting times faced by people in outer suburbs, but also make our big cities more productive.

Turnbull will be a great prime minister if he's smart enough to see that there's more to improving the lives of Australians than giving tax cuts to the well-off.

Read more >>

To be great, Turnbull must govern for the other side

A great attraction of my job is that I'm paid to offer gratuitous advice to everyone from the prime minister down. So step up, Malcolm, it's your turn.

Everyone has high hopes that Malcolm Turnbull will be the successful, long-lasting prime minister so many of us have been seeking. Business people are hoping he'll deliver the economic reform we need to rejuvenate and energise the economy.

Though his performance won't fail to disappoint those hoping for a perfect politician, it's reasonable to hope for a big improvement on his immediate predecessors, Liberal and Labor.

Turnbull is so intelligent, so articulate, so self-assured it's become possible to believe he can do something that, until now, seemed impossible: reverse the continuing decline in standards of political behaviour.

It's doable if he uses his present commanding lead in the polls to keep the political "conversation" positive, adopts some necessary if controversial policies and devotes all his effort to explaining and defending those policies, rather than incessantly telling us how terrible his political opponents are.

He starts with much goodwill and needs now to turn it into abiding respect by the way he conducts himself as the nation's leader, not a barroom brawler. A leader who brings us together in a common cause, not one seeking to divide and conquer.

It's already becoming apparent that when a new and popular leader chooses the high road, his opponents feel a need to match him, putting up a contest of ideas and policies, not negativity and electoral bribes.

As the election approaches, Turnbull should protect his credibility by keeping promises to a minimum, being sure those he does make are deliverable or setting out up-front the circumstances that would oblige him to abandon them.

Turnbull is no political apparatchik. He came to politics late after successful careers as a journalist and a barrister, having made his fortune as a merchant banker.

This is a good sign. The guy could have retired to count his millions – or make a few more – but entered and stayed in politics to have a crack at being PM.

Why? It's more likely to be because he hopes to be seen as one of our great leaders than because he wants to keep the seat warm for as long as possible.

This suggests he'll be more willing to run a few calculated risks in the interests of notching up some memorable achievements.

It's true Turnbull has already had one short-lived and undistinguished stint as leader of the Coalition. But that's just as true of the Liberals' most long-lasting and celebrated leaders, John Howard and Bob Menzies.

As with those two, Turnbull's first, abortive attempt will prove an asset provided he's used his time in the wilderness to correct the personal weaknesses that caused his initial failure.

If a high IQ is Turnbull's greatest strength, his greatest weakness is a low EQ – a shortage of emotional intelligence. He can be charming when he wants to be, but mostly he prefers you to stand back and admire while he demonstrates his towering intellect. Hardly endearing.

All successful politicians understand that, though they hold more power than most, in any democracy power is widely diffused, so you must always be trying to add other people's power to your own to ensure you've got enough to prevail.

To this end you need to consult widely, include others in the decision-making, listen patiently while people give you free advice, and school yourself to suffer fools gladly.

But if Turnbull really wants to make a difference, his notion of reform needs to be a lot more creative than simply bringing to reality all the rent-seeking "reforms" long advocated by big-business people and their economist handmaidens, who've never had an innovative, intellectually agile policy idea since they encountered the neo-classical model in first year uni.

Turnbull's unlikely to get far if he allows himself to seen as a rich man delivering for his well-off mates at the expense of the rest of us. Every new PM promises to "govern for all Australians"; more than most, Turnbull must demonstrate he really means it.

Paul Keating and Bob Hawke made their names as micro reformers by implementing changes that gave their own supporters more heartburn than the other side's; by doing things the Libs should have done but weren't game to.

Similarly, Turnbull needs to show up his opponents, proposing reforms they could only dream of – but can't now oppose without losing all credibility.

The key is to look for reforms that improve equity at the same time as they enhance efficiency. There are plenty if you look.

Read more >>

Timid financial changes get Turnbull started on reform

Since the election of the Coalition government we've heard a lot more talk about the need for micro-economic reform than we've had actual reform.

Indeed, the main "reform" we've had so far has been abolition of the previous government's chief reforms: the carbon tax and the mining tax.

But all that changed this week, with the announcement of the Turnbull government's response to the recommendations of the Murray inquiry into the financial system.

Next will come the government's response to the Harper inquiry into competition policy, then its proposals for tax reform – and possibly for changes to industrial relations – both to be taken to next year's federal election for approval by voters.

There's no doubting the importance of the financial system and the need to ensure it's performing well.

According to the Australian Centre for Financial Studies, our financial services industry is a cornerstone of the economy – the largest industry, the largest payer of company tax, a major employer of highly skilled workers and a large source of service exports.

The finance industry carries out all the payments made by households, businesses and governments. Its banks act as "intermediaries", taking the money of savers and lending it to investors, in the process affecting "maturity transformation" by borrowing for short periods (say, "at call") but lending for long periods (say, 30 years).

The industry – particularly its insurance companies – helps the community manage risk (say, that your house burns down, or that the person to whom your savings have been lent goes broke). It also manages our financial assets, such as our superannuation savings.

Of course, to say the finance industry is vital to the functioning of the economy is not to say it may not be a lot bigger than it needs to be, nor that all the trading in financial assets it engages in is necessary and productive, nor that its top people should be paid the eye-popping salaries they are.

But that's a story for another day. Today's story is that though the financial sector is a key part of the economy, the reforms announced this week aren't terribly major. There are a few reasons for this.

For one thing, you can only deregulate the industry once. We did that in the 1980s, and the few rounds of reform since then have been progressively less sweeping and more in the nature of fine-tuning.

For another thing, the global financial crisis in 2008 was a harsh reminder that deregulation can go too far, that banks and other financial institutions can do stupid, short-sighted things in their search for profit, that some degree of regulation is essential and that regulators who only pretend to be regulating can end up allowing great damage to be done to the real economy.

Of course, we in Australia did keep our banks under tight supervision and did prohibit our big four from merging any further, which stood us in good stead when the Americans and Europeans were getting themselves into so much trouble.

So regular fine-tuning of our regulatory arrangements is about all we need. Even so, this week's decisions do err on the timid side. They were worked up before the ascension of Malcolm Turnbull, and the previous administration seemed keenly aware of the power of the big banks and their many lobbyists.

The government accepted almost all the inquiry's 44 recommendations and added half a dozen of its own. The main proposal it rejected was that it ban self-managed super funds from borrowing to buy property. A courageous decision, minister. Hope we don't live to regret it.

The government says its response to the inquiry covers five "strategic priorities". The first is to strengthen the financial system's resilience by reducing the impact of potential financial crises. We need to be better able to weather them and to lessen their cost to taxpayers and the economy.

Australia is a capital-importing country, which makes us more reliant on foreign capital markets than some other economies are. To account for this, the main measure is the Australian Prudential Regulation Authority's requirement that the banks – particularly the big four – hold more shareholders' capital (the cost of which they're now busy passing on to their mortgage customers).

The second priority is to improve the efficiency of the superannuation system. The government will ask the Productivity Commission to develop measures of the rival super funds' efficiency and propose ways of making funds compete for the right to be "default" funds (when employees express no preference for a particular fund).

The government has already moved to require the boards of funds to have at least a third of their members as independent directors (that is, more retired business people and fewer union secretaries).

It would be nice to believe these "reforms" were aimed at getting fund members a better deal rather than getting super funds out of the orbit of the Liberals' long-hated class enemies and into the hands of the banks and other mates.

The third priority is to stimulate innovation to "facilitate competition and reduce costs for consumers". Which is fine, provided it doesn't involve wasteful product differentiation and advertising campaigns, or new products aimed at avoiding taxation or getting around the regulation.

Fourth, to support consumers of financial products being treated fairly. The standards of financial advice will be lifted by improving the training and ethical standards required of advisers.

The Australian Securities and Investments Commission will be given power to ban or order modification of harmful financial products, but only after the government has "consulted widely" with lobby groups.

The government's final priority is to strengthen the capabilities and accountability of the prudential regulator and the securities regulator.

The absence of industry complaint about all this reform is a sign it's not ruffling many feathers (and that the lobby groups remain hopeful of being able to water down the changes before they're applied).

Read more >>

It's fine to be well-off so long as you pay your whack

It's no doubt true, as many commentators are saying, that Labor has won itself no points by reminding us how wealthy Malcolm Turnbull is. We hear frequently about "the politics of envy", but actually there isn't a lot of it about these days. You've done well? Good luck to you.

In any case, I think there's huge goodwill towards Turnbull. Everyone can see how super smart he is, and we're hoping he'll use that smartness to make Australia a better place to live. A nation with less divisiveness, less fear that baddies are out to get us, more unity, a more positive vision of what we can become and more of us doing our bit to make it a reality.

As with any politician, he'll have his share of policies we disagree with, but it would be so nice to have a prime minister all of us can be proud of.

We might even vote to keep him, despite some disagreement on particular issues. Politicians come as a package, and you never like every item that's in the Christmas hamper.

But to say few Australians envy the well-off is not, I hope, to say we don't mind how little tax they contrive to pay, or how hard they struggle to avoid their obligations to the rest of the community.

Turnbull says of himself and his wife, Lucy, that "we've worked hard, we've paid our taxes, we've given back". It's the giving-back bit I like. And, of course, paying your taxes – in Australia, and in full, according to Turnbull – is the first and most basic way we "give back".

What really gets to me is not the people who've done well for themselves, but their seemingly growing inclination to be mean and grasping about it. I hate their selfishness and their self-congratulation.

I've worked hard for all I've got, it's all mine, but now you have the effrontery not just to make me pay taxes, but want me to pay a lot more than other people.

Taxation isn't theft and never was. Taxes are the price we pay for a civilised society, as someone once said. And he was even an American.

Expecting the better-off to pay a higher proportion of their income than the less well-off isn't socialism – as the better-off increasingly tell each other on social media - it's the Australian way. You put more in and you get back less. Why? Because you're fortunate enough to be able to afford it.

The Aussie way is that if you don't need the dole or the pension, you shouldn't get it. What's more, you should be too proud to ask for it.

It's not the Aussie way to boast about how much tax you pay, but perhaps we'd be better off if it was. Tax-paid as a status symbol. I paid far more tax than you did last year – see how successful I am?

As for self-congratulation, the bit I liked best in Turnbull's defence of his wealth was his lack of it.

"The fact is that Lucy and I have been very fortunate in our lives ..." he said. "I don't believe that my wealth, or frankly most people's wealth, is entirely a function of hard work.

"Of course, hard work is important but, you know, there are taxi drivers that work harder than I ever have and they don't have much money. There are cleaners that work harder than I ever have, or you ever have, and they don't have much money."

The world is full of people – mainly men – claiming to be "self-made" who are anything but. They seem utterly oblivious to the extent to which their wealth is owed to good fortune rather than hard work.

We're all fortunate to live in Australia. Baby boomers are fortunate to have been born at a time when few were required to go to war, when you could get a good education at little cost, leading to a good job and little unemployment. When buying a home wasn't all that hard and you got in early for a 40-year stint of ever-rising house prices.

It's only relatively recently that many people have begun inheriting sums of money worth talking about. But to see yourself as self-made merely because you inherited no wealth is self-delusion.

IQ is, to a large extent, inherited. And EQ – self-discipline and the ability to get on with other people – is often something we gain from our parents' example. It's good fortune to be born into a family of readers.

All this is why "equality of opportunity" is a worthy goal for public policy, but something no government could ever get anywhere near attaining.

Back to Turnbull: "There is a lot of luck in life and that's why all of us should say, when we see somebody less fortunate than ourselves, 'There but for the grace of God goes me'."

You don't have to be any kind of believer to believe that – and be better for it.

Giving a helping hand to those who weren't issued with as much grace as we were is why, brothers and sisters, we should pay our fair whack of tax and do it cheerfully, grateful we can so easily afford it.

Read more >>

Banks ponder their next game with interest

Actual mortgage interest rates have fallen from 7.1 per cent to 4.7 per cent over the past five years, but let one bank – Westpac – increase its rate by 0.2 percentage points and the righteous indignation knows no bounds.

It may not be the end of the world, but it's certainly the end of the housing boom as we know it. Well, maybe.

But outrage is a poor substitute for understanding. Why did Westpac move? Why now? Will the other three big banks match it? And will the Reserve Bank cut the official interest rate to counteract the banks' "unofficial" increase?

Standard economic theory offers little guidance to the classic oligopolistic behaviour we get from our banks. "Game theory" is supposed to be the way economists analyse the strategic decisions of oligopolists, but I doubt it offers much help, either.

Westpac made its rate move at the same time as it joined the other big boys in announcing plans to raise more share capital. The big four are acting in expectation that the government will accept a recommendation of the Murray report that it make Australia's banking system "unquestionably strong" (that is, safe) but requiring it to hold a lot more equity (shareholders') capital.

Part of this is the intention to increase the big four's capital requirement by more than the smaller banks' increase so as put the two groups on a more equal regulatory footing. Westpac gave the cost of this requirement that it hold more capital as its justification for increasing mortgage interest rates.

It's true the requirement does increase the big banks' "cost of intermediation" – that is, the cost of borrowing from some people and lending to others, which is represented by the size of the gap between the interest rate paid to depositors and the rate charged to borrowers.

In principle, this extra cost could be passed back to depositors in the form of lower deposit rates, passed forward to borrowers in the form of higher borrowing rates, or left with the banks' shareholders in the form of lower profits. Or some combination of the three.

Obviously, bank customers would prefer that the banks and their shareholders bear the cost. And there's no reason it shouldn't happen. Our big banks have long been extraordinarily profitable – making a return on equity of 15 per cent a year – in a business that's virtually government-guaranteed.

They could easily take the hit. There's nothing sacred about 15 per cent. And in an intensely competitive banking market that's probably what would happen. In our world, however, "greedy" (read profit-maximising) banks will protect their profitability to the extent that market conditions allow.

And right now they do. It's clear Westpac's intention is to pass the higher cost on to its borrowers. Its three big competitors now must decide whether to follow suit or leave it hanging out to dry as they try to win market share from it.

Going on past behaviour, they'll follow suit. After all, a few months ago when ANZ bank raised its interest rate on investor mortgage loans by about 0.25 percentage points, the other three lost little time in doing the same. The justification was the same: the cost of the tighter capital-adequacy requirement.

But this doesn't guarantee that, this time, the others will follow Westpac immediately or by as much as 0.2 per cent – which, by the way, also applies to investor loans.

One question all this raises is whether the banks are raising rates by more than required to recoup their higher costs. The Murray report said a 0.1 or 0.15 percentage-points rise would cover it.

So, why so much, and why now? Because, at the present exceptionally low rates, the demand for home loans exceeds supply, with the banks under pressure from the authorities and sharemarket analysts to avoid lending too much – to ordinary home-buyers, not just investors.

If you have to cut back your rate of lending, why not do it by raising your prices? This suggests the housing boom may indeed be reaching its closing stages.

One reason the other banks may delay following Westpac is the talk that the Reserve will respond by cutting the official interest rate on Melbourne Cup day. They'd love to be able to hide a rate rise behind a less-than-full pass-through of a rate cut.

The Reserve may oblige, but I won't be holding my breath. Nothing in its rhetoric to date suggests it's keen to cut rather than wait. And I doubt if it would want to be seen as trying to prolong the house-price boom.

Read more >>

Nitty-gritty of unemployment shows small improvement

Why does unemployment increase? For a lot more reasons than you probably imagine.

It's a good question to ask this week when the media informed us that, last month, the number of people in employment fell by 5000, the number unemployed fell by 8000 and the proportion of people participating in the labour force fell from 65 per cent to 64.9 per cent, but the rate of unemployment was unchanged at 6.2 per cent.

I could devote the rest of this column to trying to explain that puzzle. Or I could say that the media and the markets make the jobs figures more puzzling than they need to be by focusing on the version of them that jumps about from month to month for no apparent reason, rather than looking at the smoothed, "trend" figures the Bureau of Statistics calculates for the express purpose of helping us see what's going on.

Those figures show the rate of participation rising by a fraction in September, as employment rose by more than 12,000 and unemployment rose by 4000, which wasn't sufficient to change the rate of unemployment from 6.2 per cent – pretty much where it's been sitting for a year.

So back to the question: why does unemployment increase? You can answer that at the macro-economic level or the strictly mechanical level.

From an economy-wide perspective it's obvious: unemployment increases when the economy turns down. But that's not the full story. Unemployment can increase even when the economy's growing steadily and employment's increasing.

Why? Because the labour force is always growing, thanks to "natural increase" (more young people entering than retired people leaving) and immigration. This means the economy and employment have to be growing at a certain rate just to stop unemployment rising.

With that sorted, let's look at the mechanics. Why does unemployment increase? Because people lose their jobs?

Yes, but that's just the biggest reason. As well as those workers who are sacked or laid off are those leaving their jobs voluntarily, hoping to find a better one.

Then there are former workers re-entering the labour force to look for work and, finally, the new entrants to the job market, including young people leaving school or university.

Set beside that, the oppose question – why does unemployment decrease? – is easier: either because people find a job, or because they give up looking and so get reclassified as NILF – not in the labour force.

I raise all this because, Kieran Davies, chief economist of Barclays Bank, has been delving deep into the official figures to get a better idea of what components have been driving unemployment in recent years.

In very round figures, he found that "job losers" account for about 40 per cent of all the unemployed, with "job leavers", "re-entrants" and "new entrants" accounting for about 20 per cent each. Bet you didn't know that.

Next Davies looked more finely at how each of the four categories has been contributing to the rate of unemployment since its most recent low point of about 5 per cent in 2010-11.

He found that most of the increase in unemployment since then is explained by an increase in job losers, caused by "job shedding" by employers.

Unemployment resulting from job shedding rose from a low of 1.7 per cent of the labour force in 2010 to reach 2.4 per cent in late 2014. This was just under the peak of 2.6 per cent reached during the global financial crisis.

Most of these job losses were in mining, manufacturing, professional services and education, Davies finds.

Since late last year job shedding has eased a little, so the stock of job losers has fallen a fraction to 2.3 per cent of the labour force. A good sign, even if a small one.

The stock of (voluntary) job leavers reached a multi-decade low of 1 per cent just before the global financial crisis, when it was easier to line up a new job before jumping.

It then moved up to 1.4 per cent in 2014, its highest level since 2002. This is a sign of increasing confidence – don't worry, I'll soon find one – though it's recently eased back a little to 1.3 per cent.

Former workers seeking to re-enter the workforce accounted for just 0.9 percentage points of the overall rate of unemployment during the global financial crisis, another multi-decade low.

Clearly, not many married women and others thought it a good time to be actively seeking a job.

But with returning confidence since then the rate has steadily increased to 1.4 per cent, its highest since 2003.

That leaves new entrants to the jobs market. The proportion of these people who'd failed to find work fell to a multi-decade low of 0.9 per cent just before the financial crisis, before rising to just over 1 per cent following the crisis.

The proportion rose to 1.3 per cent in 2013, according to Davies' calculations, a sign that education leavers have borne much of the brunt of the relatively weak economic and employment growth in recent years.

Fortunately, the proportion has since eased to 1.1 per cent, which may suggest education leavers are having less trouble finding a berth, though it may mean we've had fewer overseas people – including students and backpackers – coming to Oz and looking for work.

Putting all this together, it's reasonably good news. We already know – and this week's jobs figures confirm – that unemployment has been steady for a year or more, even though the economy hasn't been growing all that strongly.

Davies' delving tells us the worst contributor to unemployment – businesses shedding jobs – has stopped getting worse and fallen back a little, to have its place taken by more hopeful contributors, former workers re-entering the market.

Davies' prediction is that the unemployment rate will remain steady, though there's a chance it may fall a little.

Read more >>

Moratorium on new coal mines makes economic sense

What are we meant to do about coal? For some time now it's looked like Australians face a painful choice between doing the right, moral thing by the rest of the world and continuing to make a living from our rich endowment of natural resources.

The burning of coal is by far the biggest source of the greenhouse gas emissions that are causing climate change. Australia is one of the world's biggest producers of coal.

Greenies have been arguing for years that, although it's too much to ask that we just stop exporting the stuff, we should at least get in no deeper by ceasing to build any new mines or expand existing mines.

In August, Anote Tong, President of the Republic of Kiribati, called for an international moratorium on new coal mines as a way of underpinning the efforts to get increased commitment to reduce emissions at the Paris summit in December.

Not surprisingly, Tong's call for a moratorium has been supported by 11 other Pacific island nations worried about rising sea levels. But he's also winning support from such influential figures as the Nobel Prize-winning scientist Peter Doherty and the British economist Lord Nicholas Stern.

For such an international moratorium to be effective, we'd have to be part of it. At present, we have 52 proposals to build new coals mines or expand existing ones.

But isn't it too much to ask us to leave all that black gold in the ground? Mining and exporting coal is an important way this economy makes its living.

The developing countries – including China and India – have a lot more developing to do, meaning they'll need a lot more energy, much of which will be coal. What's so bad about them trying to get rich like us? And why shouldn't it be we who supply that coal?

We need more jobs, and think of all the jobs building more big mines would create.

So what's it to be? Conscience or self-interest? Well, how about both?

The Australia Institute think-tank has begun campaigning hard for a moratorium, and a forthcoming paper by its chief economist, Richard Denniss, argues that economic and political considerations actually say we should be joining the moratorium.

Why? In a nutshell, because coal's days are numbered. The rapidly falling price of renewable energy such as wind and solar, combined with the growing resolve of China, the US and others to reduce their emissions, put a dark cloud over the future of coal.

Coal mines are intended to have lives of 50 to 90 years. Will coal prices be high enough in 30 or 40 years to make continued production profitable? If not, investors in new coal mines won't get their money back, but will be lumbered with "stranded assets" – assets that no longer earn much of a return.

Denniss says it's now widely accepted by international agencies that meeting the goal of limiting global warming to 2 degrees requires keeping most fossil fuels unburnt and in the ground.

All this helps explain why the world's big banks, including our own, have become markedly less enthusiastic about financing new coal mines. That – plus the present flat state of the world coal market.

According to the BP company's energy outlook, global coal consumption grew by just 0.4 per cent last year, well below its 10-year average growth rate of 2.9 per cent.

Within that, China's consumption grew by just 0.1 per cent. And Professor Ross Garnaut, of the University of Melbourne, is predicting a significant decline in China's demand for coal for the foreseeable future.

Were we to build all our proposed new mines, we'd double our annual exports. According to Denniss, just proceeding with the five biggest projects in Queensland's Galilee Basin would increase the world's seaborne coal trade by 18 per cent.

What do you reckon that would do to world coal prices at a time when coal demand is weak?

See the point? In such circumstances, preventing further coal development – including by governments declining to subsidise new mine railways and ports – wouldn't just reduce future greenhouse gas emissions.

By avoiding causing further decline in coal prices, it would also benefit the owners of existing mines, the banks that have lent to them and those who work for them, as well as the owners of present and future renewable energy projects. Not to mention the governments dependent on revenue from price-based mining royalties and company tax collections.

On its face, by causing coal prices to be higher than otherwise, it would harm the users of coal and coal-fired electricity. But when you remember that, without something like a carbon tax, the price of coal fails to include the cost to the community of the environmental damage that coal-burning does (including the death and ill health caused by the particulate air pollution from power stations), that's not anything to feel bad about.

But what about all the jobs that building new mines would have created? They're temporary and often exaggerated by the projects' proponents. Once they're built, open-cut coal mines employ surprisingly few workers.

The construction workers not employed to build more mines than are good for us could be better employed building more useful infrastructure.

When you think it through, the case for a moratorium on new coal mines has a lot going for it.

Read more >>

Competition does have its drawbacks

Competition is billed by economists as a wonderful thing, the invisible restrainer of a capitalist economy and essential to ensuring consumers get a good deal.

But many economists aren't as conscious as they should be that competition has costs as well as benefits.

It's true, of course, that monopoly is usually a terrible thing, allowing arrogant, inflexible behaviour on the part of producers, with little pressure on them to keep prices down or to provide much choice. Dealing with government departments shows you what monopolies are like.

Economists tend to assume the more competition the better and that customers can never get too much choice. But this shows how – despite their loud protestations to the contrary – their thinking is excessively influenced by their most basic, least realistic model of "perfect competition".

Psychological experiments show that when shoppers face too much choice, they tend to avoid making a decision. That's because the information they need to make informed choices isn't freely available and because the human mind hasn't evolved to be good at choosing between more than two items with differing characteristics.

Many real-world markets are characterised by oligopoly: a few large firms accounting for most of the sales. Oligopolies make economic sense because they're needed to fully exploit economies of scale (which are assumed away under perfect competition). So, in reality, competition and scale economies are in conflict.

In oligopolies and even in markets with a relatively large number of producers, competition is blunted by product differentiation, much of which is cosmetic. As with most advertising, product differentiation is intended to induce consumers to make decisions on an emotional rather than rational basis.

Phoney differentiation is also intended to frustrate rational comparison. It's not by chance that it's almost impossible to compare mobile phone contracts.

When economists speak of competition, they're usually thinking of competition on price. But though oligopolists watch their competitors like hawks, they much prefer to avoid price competition, competing rather via advertising, marketing, packaging and other differentiation.

Mackay's Law of competition states that the key to competition is to focus on the customer, not your competitor. But this is what oligopolists don't do.

In the real world – including the media – competitor-oriented competition is rife. This robs customers of genuine choice. It's a form of risk aversion: if I do the same as my competitor, I minimise the risk of him beating me.

It's what, in Harold Hotelling's classic example, prompts two ice-cream sellers to be back-to-back in the middle of the beach, regardless of whether some other positioning would serve customers better. It explains why business economists' forecasts tend to cluster, usually around the official forecast.

In his book The Darwin Economy, Robert Frank, of Cornell University, argues that lefties tend to see inadequate competition as the most prevalent form of market failure, whereas it's actually "collective action problems".

A collective action problem arises when the players in a market realise they're doing something mutually destructive, but no one's game to stop doing it for fear of being creamed by their competitors.

Usually in commercial markets the only answer is for the government to intervene and impose a solution on all players; for which they're grateful.

However, that's no help to our political parties, which have got themselves locked in a game of ever-declining standards of behaviour they don't know how to escape from. It's collective action problems that make it so easy for the politicians to manipulate the media.

The advocates of federalism believe it's good to have the states free to be different and competing against each other. In reality, the competition is mainly negative. The states compete to attract foreign investors with special tax concessions and the foreigners play them off against each other.

In the early 1970s, the McMahon government transferred its payroll tax to the states to give them the "growth tax" they needed to cover their growing spending. In the decades since then, they've done little but compete with the others by raising their tax-free thresholds and cutting their rates.

The huge increase in federal grants to private schools over recent decades was justified as increasing parents' choice and imposing competitive pressure on public schools. There's little evidence it's worked, nor much even that it's held down private school fees.

Similarly, Julia Gillard's My School website, with all its information about the academic performance of particular schools, intended to increase competition between them, has failed to produce any increase in the proportion of students achieving national minimum standards in reading, writing and numeracy over the five years to 2014.

Depending on circumstances, competition can make things better or worse – or little different.

Read more >>

Why the Trans-Pacific Partnership is no game-changer

Think you know a bit about economics? Try this quick quiz: what's your impression of the Trans-Pacific Partnership Agreement reached between the United States and 11 other Pacific Rim countries, including Australia, this week?

Would you say it is: a) a gigantic foundation stone for our future prosperity that will boost growth, create jobs, raise living standards and increase productivity; b) a terrible deal that advantages big American multinationals at our expense, or c) not a big deal either way?

Malcolm Turnbull and his ministers' exaggerated claims about the benefits likely to flow from the agreement rest on the expectation that it will allow our farmers to sell more sugar, beef, cheese, wool and rice to the other economies, at higher prices.

Since these gains have been achieved at little cost in terms of increased access to our market for the other countries' exports, we're surely well ahead on the deal.

Does that make sense? Only if you don't know much economics.

As for the claim that it's a terrible deal, it has some truth to it, but is itself exaggerated. It's true that part of the deal involves our acceptance of "investor-state dispute settlement" arrangements, which allow foreign companies – but not local businesses – to take actions for damages against governments that make decisions which adversely affect their profits.

This is an unwarranted imposition on democratic governments' sovereignty which, at best, will involve them in significant legal costs in fending off vexatious claims.

It's true, too, that trade deals with the US have involved attempts to advantage American companies holding intellectual property – patents, copyright and trademarks – at the expense of local consumers.

And the intense secrecy in which the TPPA has been negotiated – we still don't know the details of the agreement and won't for some months – raises justified suspicion in many people's minds. What is it that big companies and lobby groups may know, but the public may not?

Even so, it does seem that Trade Minister Andrew Robb has fended off American attempts to further advantage foreign pharmaceutical companies at the expense of Australian patients and taxpayers.

In the old days trade agreements were about increasing trade between countries. These days, they're at least as much about imposing restrictions on governments' freedom to legislate as they see fit.

But to assess the likely effects on the economy – on growth, incomes, jobs and productivity – we need to set this legislative aspect to one side and focus more directly on trade and investment.

Be clear on this: there's no doubt that reducing barriers to trade between countries increases the material prosperity of the countries involved. Reduced protection and increased trade have played a significant part in the greater prosperity enjoyed first by the developed economies and then the "emerging" economies since World War II.

Most of those gains were achieved by successive rounds of multilateral reductions in import tariffs and quotas. That is, the reductions applied to all of a country's trading partners, not just some.

But the World Trade Organisation has been trying unsuccessfully since 2000 to organise another multilateral agreement. In the meantime, countries have taken to making bilateral trade deals, where the concessions made to the other country aren't available to any other economy.

This makes them preferential trade agreements, not the free trade agreements they are known as.

They're greatly inferior to multilateral agreements because they tend to divert trade from more efficient to less efficient supplier countries, simply because the less efficient suppliers happen to be subject to lower import duties.

And the picking and choosing between which countries get preferential treatment and which don't creates a need for complex "country of origin" rules that add much red tape to international trade.

This week's regional preferential trade agreement between 12 countries representing 40 per cent of world gross domestic product will still be trade-diverting to some degree, particularly since it excludes such significant trading partners as China, India and Indonesia.

But it could lessen the burden of red tape if, as mooted, it involves uniform country-of-origin rules.

The other weakness of trade deals is their encouragement of mercantilist thinking – the notion that countries get rich by exporting as much as they can and importing as little as they can – a fallacy economists have been fighting since the days of Adam Smith.

The nature of bargaining is to gain as many concessions as you can while making as few of your own as you can. But this is the exact opposite of the way you maximise the economic gains from trade.

You gain most not by inducing trading partners to reduce their barriers to your exports, but by reducing your own barriers to their exports. You gain when you shift productive resources from things you aren't very good at doing to things you are.

That's the first reason for believing a modest increase in sales for our farmers and little change for our import-competing industries won't do much to increase growth, jobs and productivity.

The second reason – and another reason mercantilism is fallacious – is that if we did get a lot higher prices for our agricultural exports without much change in import prices, this improvement in our terms of trade could be expected to lead to a rise in the value of our dollar.

If so, our farmers might be better off but this would be at the expense of our manufacturers, tourist industry and other exporters of services.

As yet we've done no modelling of the likely economic benefits of the TPPA. But various American modelling exercises – and our officially commissioned modelling of our recent bilateral deals with South Korea, Japan and China – all suggest the gains will be small – say, a level of GDP that's just 0.5 per cent higher than otherwise after 10 years. No big deal.

Read more >>

MUST WE DESTROY JOURNALISM IN ORDER TO SAVE IT?

Talk to the New News conference, Wheeler Centre, Melbourne Friday, October 9, 2015

In the last phase of my career as a journalist - I’ve just published my memoirs, A Life among Budgets, Bulldust and Bastardry - I, like many journos, have become greatly exercised by the challenge that the digital revolution presents to the continued existence of “quality” or “serious” journalism - journalism that has a serious intent, even though it’s perfectly capable of seeing the funny side of things. The ABC’s journalism is serious enough, but since it’s already electronic I don’t see it as being under the degree of threat that faces the newspapers. I’m not sure how the traditional tabloid papers will survive, but I’m concerned mainly about the two papers I work for - the SMH and The Age - and also the Financial Review and The Australian which, according to Eric Beecher, between them “provide most of Australia’s coverage of politics, justice, economics, business, science, health, welfare, public policy, international affairs, arts, culture and ideas”.

There are two issues of concern: first, finding a future for the occupation of journalist in the digital world, but second, ensuring the news media continue to fulfil their “higher purpose” of reporting important information about our society that otherwise wouldn’t be brought to many people’s attention, and helping to hold governments accountable to the public. It’s the news media’s higher purpose - rare, maybe even unique, among profit-making industries - that makes its survival a matter of great importance for the community, not just to those who make their living from it.

Of course, this isn’t the first time the practice of journalism has been disrupted by changes in technology, though I doubt any previous change has been as disruptive as this one. It’s possible that in a decade or two we’ll look back and wonder what all the fuss was about, but at present we can’t know whether things will turn out well or ill and, in any case, it may well be that all the agonising and debating we do will play its own part in ensuring the ultimate outcome is satisfactory.

One thing I don’t fear is that the public could ever lose its interest in news. Humans are curious, pattern-seeking, threat-searching and intensely social animals, so an insatiable desire to know the latest news - and to know it as soon after it happens as possible - is hardwired in all of us. Humans have been seeking out news since we sat around the camp fire yarning after a hard day’s hunting and gathering.

So I don’t doubt that news will survive in the digital age. But that’s not the same as saying the present “legacy” providers of news are bound to survive - particularly those formerly oriented to providing it on dead trees. A knowledge of previous waves of technological change in any industry makes it easier to believe the place of the old, huge, lumbering incumbent suppliers will be taken by new smaller, more flexible and more innovative suppliers in the changed market for news. That would be bad news for all those journalists presently employed by the legacy news outlets, but not necessarily for the consumers of news, or for journalism’s fulfilment of its higher purpose.

In all this I don’t want to be seen as imply that the digital disruption of the news media is a bad thing. I have no doubt that, like most widely adopted technological advances, it is bringing considerable benefits to users. To take one simple example, the move of classified advertising from broadsheet newspapers to the internet has hugely improved the quality and flexibility of classified advertising, while also hugely reducing its cost to people taking out ads. The problem is that this difference in the price of classifieds is what used to be used to pay the wages of journalists on broadsheet newspapers.

To the legacy newspapers, the challenge of the digital revolution comes at two, interrelated levels. One is the shift of readers from newspapers to the various online platforms: the website, the tablet apps and, increasingly, the mobile phone apps. The other is the shift of classified and display advertising from newspapers to online platforms. The newspapers’ online platforms have captured only a small part of the shifted advertising, with much of it going to search engines and social media sites. In any case, the prices received for digital advertising are very much lower - exceptionally so for ads on mobile phone.

I’d be delighted if time proved me wrong, but I don’t doubt that newspapers’ days are numbered. That’s likely both because of the continuing shift of advertising to online and because most of the younger generation favours screen-based information and simply doesn’t read newspapers. I don’t know of any survey evidence, but my guess is that few people younger than baby boomers still read newspapers - and not even all the oldies do. To me, the only uncertainly is how long newspaper revenue will continue to exceed newspaper costs and thus how long before they are closed. Two years? Five? Ten? Probably sooner than 10.

At present, however, newspaper revenue from advertising and cover price accounts for about two-thirds of total news-related revenue at Fairfax Media. The challenge facing the company as a purveyor of news is clear: to build up digital revenue - from advertising and subscriptions - to the point where it more than covers the editorial and other costs of a digital-only news provider. The challenge is less daunting than it seems when you remember that the newspaper revenue comes with considerable costs in addition to the wages of journalists, in the form of printing and physical distribution costs. Obviously, we won’t have to raise sufficient digital revenue to cover the cost of printing and distributing the papers when we no longer produce them. By the same token, however, the considerable costs of printing and distributing make the challenge of getting the digital-only business up to critical mass more urgent. That’s because the two-thirds of total revenue coming from newspapers won’t need to fall all that much further before it ceases to cover the printing and distribution costs and thus makes it no longer profitable to continue printing papers and earning newspaper advertising and cover-price revenue.

So the key question is, what do we have to do to greatly increase our digital revenues? What changes do we have to make not just to our digital platforms but to our journalism - our news offering, if you like - to get our revenues up to where we’ll soon need them to be? Well, one approach would be to focus most of our effort on increasing our advertising revenue while collecting whatever subscription revenue comes our way. An alternative approach would be to focus most effort on increasing our subscription revenue, while being more targeted in our efforts to attract ad revenue. I call the first approach Plan A - because it’s closer to the approach Fairfax is actually pursuing at present - and the alternative approach, Plan B, because it’s the one I believe we’ll have to turn to if Plan A can’t be made to work. Let me describe the features of these rival “business models”.

Plan A

Plan A is the approach most likely to instinctively appeal to journalists because, on the surface at least, it seems to involve no fundamental change in news gathering as we’ve always done it. Indeed, it actually involves a return to journalism as it used to be practiced. The main change seems to be in the way we package the news for a digital age, rather than in the nature of the news we report.

From a commercial perspective, the plan involves maximising what critics call “clicks”, but digital editors prefer to call “page impressions” or, with a slight refinement, “unique browsers”. It’s believed that what digital advertisers want is “reach” - the biggest audience possible - and their preferred measure of this is the monthly total of unique browsers.

How do you get lots of clicks? Well, not so much by resorting to click bait or “churn” - appropriating the successful stories of other news outlets - but by reverting to the breaking news business. You focus on reporting the big stories of the day, getting them onto the site and apps as soon as possible, then improve your offering with side-bar stories, pictures, graphics, videos and commentary as soon as they can be organised.

For the most part your competitors are offering essentially the same stories you are, but you hope that your timeliness, the quality of your reporting, photos and videos, combined with the reputation of your masthead, will win you more clicks than the others. It’s clear some headlines attract more clicks than other headlines, so much attention is given to writing the best ones.

The digital delivery of news is so new that outlets are still experimenting with different ways of presenting it and users are changing their behaviour in response to developments in technology, meaning the news environment is ever-changing and digital editors aiming to keep increasing their clicks are continually responding to these changes.

A declining proportion of clicks is from people coming direct to our website, with more coming via referral from social media such Facebook and search engines such as Google. Fewer people are using the site and an ever-growing proportion are using their mobile phone app to check the latest. As digital readers’ habits over the course of the day change, so does the need to update our platforms. We haven’t quite got to the point where they’re updated 24/7, but we’re getting closer, with journos now working early and late shifts and more effort being made to respond to the recent surge in Sunday browsing.

By their nature, digital platforms provide numerical feedback in real time about the popularity of particular stories and general topic areas. Responding to this feedback is a big part of the way we try to get more clicks.

All this says there’s more change in the way we package our news than in the stories and topic areas we cover. We still chase every story we believe our readers will find newsworthy. So I think most journalists and editors remain reasonably comfortable with this response to the digital challenge. Journalists like to compete with each other, and they’re attracted to the simple, objective, numerical and frequent measure of their success provided by the click count. It’s the closest the digital world provides to the old newspaper world’s ultimate measure of journalistic success: circulation. It seems to replicate the old bargain between journalists and management: our contribution to the company’s commercial success is to maximise circulation; how you convert that circulation into revenue is up to you and none of our business.

This is Plan A, but I have worries about it on two levels. First, I’m not sure it’s sufficient to secure our future financially. It’s not clear to me that simply maximising clicks will gain all the revenue we need to more than cover the cost of our news gathering effort. Too much of the advertising revenue in the digital world is captured by the two social media and browser giants that presently dominate the provision of breaking news. And advertising rates seem sure to shrink rather than fatten as users move to getting most of their news via mobile phone.

Further, I find it hard to believe that “reach” - maximum eyeballs - is the most advertisers want from us, much less the most valuable thing the quality news media are capable of offering them. My guess is that advertisers and ad agencies are just as much at sea in the digitally disrupted world as the former newspaper companies are. If advertisers aren’t sharp enough to see that we’re capable of offering them something more valuable than mere “reach” we should be doing more to educate them. We should be developing and promoting “metrics” that better demonstrate what we’ve got to offer advertisers.

Plan A doesn’t sufficiently “leverage” the serious news providers’ brand, reputation and following. Presumably, we’re hoping our reputation for trustworthiness will bring us more clicks than go to the former tabloid papers or to the digital upstarts. But is this the best we can do? In the old world the readership of the serious press came predominantly from the best-educated and most highly paid part of the market, known to advertisers as the ABs. Our circulations were always smaller than those of the tabloids, but our charges for ads were always higher because of our clientele’s greater buying power. We got the ads from David Jones and Myer, they got ads for the weekly specials at Coles and Woolies supermarkets. Can it be true that up-market advertisers are no longer willing to pay a premium to advertise on up-market digital news platforms? Alternatively, is it true that, by our efforts simply to maximise clicks from all comers, our clicks have become worth little more to advertisers than the tabloid sites’ clicks?

Another advantage of attracting a predominantly AB audience is that these are people well able to afford a digital subscription should they judge the service we offer to be of sufficient value to them. But if we’re simply trying to maximise clicks by offering breaking news that’s just faster and better than all our many competitors, why would this be something many people would be willing to pay for?

But this question of quality - of seriousness - brings me to my second and more important worry about Plan A: will it allow us to adequately discharge our higher purpose - a purpose that not only contributes to the quality of the nation’s governance but also provides serious journalists with much of their job satisfaction?

Editors committed to the Plan A business model may deny it, but it’s hard to see how aiming to maximise clicks by beating our competitors on all the big breaking stories of the day leaves much room or resources for self-initiated, proactive reporting. For investigative reporting and the search for scoops that tell Australians things they wouldn’t otherwise find out about how they are being governed. Room even for the vast amount of news that usually falls into the important but not terribly exciting category, including a lot of the topics on Eric Beecher’s list: science, health, welfare, public policy, international affairs, arts, culture and ideas.

Putting the great bulk of our resources into fabulous coverage of the great excitements of the day puts too much of what we do into the lap of chance occurrence and the efforts of governments and other vested interests to use the media for their own ends. It doesn’t leave much room for anything but the most immediate, top-of-the-head comment and analysis. It favours the emotional assertion of strong opinions, not the careful weighing of pros and cons. It leaves little room for mature reflection, for the how and why as well as the who, what, when and where. It feeds the ever-shorter attention span, leaving too many news stories only partially digested. Nor does it leave much room for newspapers to exploit their former strength of having well-known columnists - “personal brands” - who help distinguish your outlet from its rivals and attract their own crowd of loyal followers. Such columnists contribute not quantity of clicks but quality of “engagement” - users who stay on the page not 30 seconds but however long it takes them to read most of an article.

Plan B

So what’s the alternative approach that offers legacy serious newspapers a better chance commercial survival and continued discharge of their higher purpose? As I outline in greater detail in the last chapter of my book, Plan B starts by accepting that the digital revolution is leading to the “commodification” of news, which leads inevitably to the bifurcation of the news task. A basic news service is now available from any number sites. It’s all much the same and it’s almost always free. It’s so freely available that you can’t charge for it, nor can you expect that, by being a little better than all the others, you’ll attract a disproportionate share of the eyeballs and advertising revenue.

Plan B accepts that, once the present period of multiplying news sites gives way to a period of consolidation - as some platforms survive but most run out of money - the journalistic task will divide into two: a smaller number of journalists producing the basic, breaking news, working mainly for the wire services and the ABC, plus a smaller number of journos working for outlets that specialise in adding value to the commodified news produced by others.

This other category of news outlet adds value by using more experienced and more specialised journalists to add background and analysis. Value-adding makes news less incremental. Rather than adding to the confusion, it seeks to dispel it. It limits its value-adding to a narrower range of topics, giving great emphasis to reporting “local” news - city and state politics, transport, health and education - where the competition from other sites is least. It pursues exclusive stories and investigative reporting. It highlights the contribution of its big-name columnists, using them to attract loyal readers.

Commercially, it focuses most on revenue from subscriptions, while adding high-end ad revenue attracted by its AB audience. The gated access to value-adding, exclusives, investigations and name-brand columnists gives people sufficient reason to buy a subscription. And the value-adding is what does most to continue the news media’s discharge of its higher purpose.

If I’m right in believing Plan A is unsustainable, leading to continued rounds of redundancies, it will be only a matter of time before the legacy providers of serious news gravitate to Plan B - provided, of course, they don’t run out of money or damage their brands too badly before they complete the transition. Should they fail, however, I don’t doubt that various new, unencumbered and enterprising digital platforms will arise to fill the need they left unmet.

We won’t have to destroy journalism in order to save it, but I fear we will have to change the way it is practiced more radically than we have so far.

Read more >>

How digital disruption allows higher prices

Do you think much about the process involved when you decide to buy something some seller is offering you? If you're like most consumers, probably not. But the businesses doing the selling do, which ought to be a warning.

And the study of exchange – the buying and selling of goods and services – is the central element of economics. Economists long ago concluded they had it all figured.

Trouble is, the digital revolution is changing the way sellers behave when we buy things online or use the internet to check out the choice before deciding what to buy.

These hidden changes are revealed in the eye-opening book, All You Can Pay, by former Fairfax Media journalist Anna Bernasek and her husband, D. T. Mongan.

None of us wants to pay more than we have to to buy the things we decide we need. But the great insight of economists is that we'd often be prepared to pay more for something we want than we're required to.

The difference between what we're willing to pay and what we actually have to is known to economists as the "consumer surplus". It's a measure of how much better off the purchase has left us.
The more successful competition is in holding down the market price, the greater is our consumer surplus and thus the more we've gained from living in a market economy.

By the same token, sellers are often able to sell their wares for a higher price than the minimum at which they'd be willing to sell. This difference is the "producer surplus". The smaller the producer surplus, the more competition in the market is advancing the interests of consumers.

It's obvious that producers would like their surplus to be as great as possible. The history of the modern market economy is the story of how businesses have discovered ways of increasing that surplus even while competition between them has been working to keep it small.

For most of the past century we lived in the era of mass-produced consumer goods, as epitomised by Henry Ford. He invented the production line as a way of more fully exploiting economies of scale and keeping the price of his cars as low as possible.

The lower the price, he reasoned, the more people who could afford a car. And the more cars he sold, the higher his profits. To keep costs and prices low he produced just one kind of car, in one colour, black.

But, as Bernasek and Mongan record, Ford was eventually overtaken by General Motors, pursuing a different strategy of selling a range of models at differing prices, aimed at different segments of the market. GM even started changing each model slightly every year.

This "product differentiation" involved selling more than just a car: style, fashionability, social status, even self-expression. From an economist's perspective, however, it was about gaining the freedom to charge a higher price, making the "market price" harder to discern, reducing consumer surplus and increasing producer surplus.

If each consumer has their own price they're willing to pay, the ideal from a profit-maximising producer's perspective is to charge each individual a price that matches their willingness to pay. That some people would pay a price much lower than others are paying won't matter provided you're getting as much as you can out of each of them.

Trouble is, how do you know how much a person is willing to pay? You don't. But for years many businesses have practiced various forms of "price discrimination" involving charging broad categories of customers higher prices than others.

Cinemas, for instance, charge adults more than children. Airlines charge business travellers more than holidaying families. They do this not out of the goodness of their hearts, but to maximise their producer surplus.

But this is where the online revolution is making it a lot easier for sellers to assess the willingness to pay of particular customers. The more information they have on file about you – your age, sex, address, occupation and record of previous purchases – the more accurately they can estimate how much they can get away with charging you.

The authors explain that the trend to "customisation" is actually a way of asking you to disclose more about what you're looking for, giving the seller greater control over what you're offered and at what price.

Chain stores' loyalty cards are primarily a way of gathering information about your buying habits and preferences. If I know you invariably buy brand X, I know I don't need to offer you a lower price.

These days, prices are often framed as discount off what's purported to be the usual price. But how do you know the price wasn't bumped up before it was discounted? And how do you know the discount you're being offered isn't lower than others are getting?

Most of us still do only some of our shopping online rather than in stores, so it's early days for the trends Bernasek and Mongan see emerging.

But it's not hard to believe it's getting ever easier for businesses to convert consumer surplus to producer surplus by charging us more than they used to.

The more prices become personalised, the harder it becomes to know the actual market price – even the average price – customers are paying. If that day dawns, the benefits of living in a market economy will be greatly reduced.

Read more >>