Sensible communities set boundaries for business

A highlight of our trip to New York after Christmas was a visit to the Tenement Museum down on the lower east side, where the movie Gangs of New York was set. It was the area where successive waves of Irish, German and Russian immigrants first settled, crowded into tenements.

We were taken around the corner to see inside a tenement building restored to its original condition.

As we climbed the back stairs, we were shown a row of dunnies and a water tap in the backyard. This, we were told, was one of the first tenements required to have outside toilets and running water under a new city ordinance.

Can you imagine any developer today thinking they could get away with building multi-storey units without adequate (indoor) toilets and plumbing? Unthinkable.

But I can imagine the fuss the developers of that time would have made when the city government – no doubt acting under pressure from citizens worried about the spread of disease – was passing the new ordinance.

These excessively luxurious requirements would be hugely expensive and could send some tenement owners bankrupt – owners who had families and elderly parents to support. The additional cost would have to be passed on to tenants, of course, making rents prohibitive. Some families would be forced onto the street.

I bet few of those dire predictions came to pass. Why? Because business people still play this game and once the bitterly opposed legislation goes through and the new status quo is accepted, the exaggerated forebodings are soon forgotten.

Another highlight was a tour of Carnegie Hall. Once, when it fell on hard times, someone acquired it with a view to tearing it down and building high-rise apartments. A public outcry stopped it.

Then, our guide reminded us, there was the time Jacqueline Kennedy Onassis led the fight to stop Grand Central Station being replaced by an office block.

It reminded me of how that ratbag commo Jack Mundey – being quietly urged on by respectable National Trust-types – was frustrating go-ahead developers all over Sydney.

Just think how better off we’d be today had those those pillars of industry not been prevented from doing away with the crumbling old Queen Victoria Building – with its verdigris domes and rickety lifts – and building a shiny new office block.

Gosh, by now we’d be ready to tear it down and build a taller one. And just think how many jobs that would create.

Do you see where this travelogue is heading? I’m an unfailing believer in the capitalist system. We’d all be much poorer than we are were it not for those ambitious, hard-working, enterprising, optimistic souls who set out to make themselves rich by engaging in some business.

But that doesn’t stop them being thoroughly self-interested and often short-sighted. Whatever new project it is they’ve decided will make them more money, they want to get started yesterday and get terribly angry with those who won’t step out of their way and let them get on with it.

My point is, it was ever thus. Market economies work best – and all the people within them do best – when governments act on behalf of the community in setting boundaries within which entrepreneurs are free to be entrepreneurial.

It’s the community’s economy, and it’s the community that decides the rules that ensure businesses make their profits – good luck to them – in ways that do more good than harm to the rest of us.

The huge hurt and cost of the global financial crisis – from which the world is still recovering, 10 years later – is but the latest reminder of something we should have known: how easily an economy can run off the track when we fall for the line that self-interested, short-sighted business people should be free to do as they please.

I remind you of all this because we’re just emerging from a period of more than 30 years in which the Western world flirted with the notion that economies work best when businesses are given as free a hand as possible.

The present royal commission into the misbehaviour of the banks is just one response to the consequences of that ill-considered notion.

You have to be at least in your 50s to remember the world as it was before then, when governments felt free to limit businesses’ freedom of action in respects they judged necessary and to impose obligations on them.

Where do you think the minimum wage, four weeks annual leave, long service leave, sick leave and many other employee benefits came from? Governments decided to impose them on business so as to ensure workers got their share of the benefits of capitalism.

Many of our young people are deeply pessimistic about the working world they’re inheriting – the “gig economy” where most employment is “precarious” – because they’ve grown up in a world where businesses seemed to be free to do whatever suited them.

They think the gig economy would be a terrible world to live in. They’re right, it would. Which is why I’m sure it won’t be allowed to happen. Governments will stop it happening.

Why will they? Because workers have infinitely more votes than business people do. In the end, the economy is moulded to serve the interests of the many, not the few. Governments keep getting thrown out until they get that message.

Read more >>

Retailers affecting the economy in ways we don’t see

As uncomprehending punters complain of the soaring cost of living, and the better-versed ponder the puzzle of exceptionally weak increases in prices and wages, don't forget to allow for the strange things happening in retailing.

It's a point the Reserve Bank's been making for months without it entering our collective consciousness the way it should have.

The debate over the cause of weak price and wage growth has been characterised as a choice between a "cyclical" (temporary) problem as we recover only slowly from the resources boom, and a "structural" (long-lasting) problem caused by the effects of globalisation and industrial relations "reform" that's robbed employees of their power to bargain collectively.

To the annoyance of protagonists on both sides, I've taken a bit-of-both position. But the Reserve has raised a different structural contributor to the problem: the consequences of greatly increased competition in a hugely significant sector of the economy, retailing.

The media have focused on the digital disruption aspect, with the arrival in Oz of the ultimate category killer, Amazon Marketplace.

But that happened only late last year and, although retailers may already have been tightening up on wage increases and other costs in anticipation of greater threat from online competitors, much of those consequences are yet to be felt.

Of greater significance to date is the arrival of new foreign bricks-and-mortar competitors such as Aldi and Costco.

As Dr Luci Ellis, an assistant governor of the Reserve, said last month, "Australia has seen a marked increase in the number of major retail players. Foreign retailers have entered the local market in recent years and continue to do so.

"This has also induced the existing players to reduce their costs to stay competitive, for example by improving inventory management. This has probably been a bit easier for larger or less-diversified retailers than for smaller firms.

"Whether through lower costs, narrower margins or a combination of both, this competitive dynamic has weighed on prices for consumer durables.

"And for staples such as food, competition and related changes in pricing strategies (such as 'everyday low price' strategies) have contributed" to keeping prices low.

If you doubt that adds up to much, try this. According to the consumer price index, prices of food and non-alcoholic beverages (including restaurant and take-away meals) were almost unchanged over 15 months to December, and rose only 3.6 per cent over the previous six and a half years.

Prices of clothing and footwear fell by 3.5 per cent over the 15 months to December, and fell by 4.6 per cent over the previous six and a half years.

Prices of furniture and household equipment fell by 1.5 per cent over the 15 months to December, and rose by just 4.5 per cent over the previous six and a half years.

As Reserve Bank governor Dr Philip Lowe has remarked, this is good news for consumers, although not for some retailers – nor their employees, for that matter.

Sometimes I think everyone would be a lot happier if prices and wages were growing by 4 per cent a year rather than 2 per cent. This would be a delusion, of course, but the beginning of behavioural economic wisdom is to realise that illusions abound in the economy.

Low inflation is not a bad thing to the extent that it's caused by increased competition forcing down businesses' profit margins – and goodness knows the two big supermarket chains have plenty of profitability to cut into.

Indeed, the benefit to consumers – who, remember, include all employees – makes competition-caused low inflation a good thing. (What's not a good thing is low inflation caused by weak demand.)

And particularly where increased competition involves innovation and digital disruption, it usually brings consumers greater choice and convenience, not just lower prices.

The downside of increased competition and digital disruption, however, is the adverse consequences for employees. Some may lose their jobs; many may find pay rises a lot harder to extract from bosses worried about whether their business has a viable future.

Retailing is our second biggest employer, with about 1.2 million full-time and part-time workers. And whereas the overall wage price index rose by 2.1 per cent over the year to December, in retailing it rose by only 1.6 per cent. This was lower than all other industries bar mining, on 1.4 per cent.

It's likely to be some years yet before the disruption of retailing has run its course, and this may mean structural change in the sector acts as a continuing drag on wage growth overall.

Read more >>

Free-trade agreements aren't about freer trade

You may think spin-doctoring and economics are worlds apart, but they combine in that relatively modern invention the "free-trade agreement" – the granddaddy of which, the Trans-Pacific Partnership, is presently receiving CPR from the lips of our own heroic lifesaver, Malcolm Turnbull.

It's not surprising many punters assume something called a "free-trade agreement" must be a Good Thing. Economists have been preaching the virtues of free trade ever since David Ricardo discovered the magic of "comparative advantage" in 1815.

Nor is it surprising the governments that put much work into negotiating free-trade agreements – and the business lobbyists who use them to win concessions for their industry clients – want us to believe they'll do wonders for "jobs and growth".

What is surprising is that so many economists – even the otherwise-smart The Economist magazine - assume something called a free-trade agreement is a cause they should be supporting.

Why's that surprising? Because you can't make something virtuous just by giving it a holy name. When you look behind the spin doctors' label you find "free trade" is covering up a lot of special deals that may or may not be good for the economy.

This is the conclusion I draw from the paper, What Do Trade Agreements Really Do? by a leading US expert on trade and globalisation, Professor Dani Rodrik, of Harvard, written for America's National Bureau of Economic Research.

Rodrik quotes a survey of 37 leading American economists, in which almost all agreed that freer trade was better than protection against imports, and were in equal agreement that the North American Free-Trade Agreement (NAFTA) to eliminate tariff (import duty) barriers between the United States, Canada and Mexico, begun in 1994, had left US citizens better off on average.

Their strong support for freer trade is no surprise. One of the economics profession's greatest contributions to human wellbeing is its demonstration that protection leaves us worse off, even though common sense tells us the reverse.

And that, just as we all benefit from specialising in a particular occupation we're good at, then exchanging goods and services with people in other specialties, so further "gains from trade" can be reaped by extending specialisation and exchange beyond our borders to producers in other countries.

What surprised and appalled Rodrik was the economists' equal certainty that NAFTA – a 2000-page document with numerous exceptions and qualifications negotiated between three countries and their business lobby groups – had been a great success.

He says recent research suggests the deal "produced minute net efficiency gains for the US economy while severely depressing wages of those groups and communities most directly affected by Mexican competition".

So there's a huge gap between what economic theory tells us about the benefits of free trade and the consequences of highly flawed, politically compromised deals between a few countries.

Rodrik says trade agreements, like free trade itself, create winners and losers. How can economists be so certain the gains to the winners far exceed the losses to the losers - and that the winners have compensated the losers?

He thinks economists automatically support trade agreements because they assume such deals are about reducing protection and making trade freer, which must be a good thing overall.

What many economists don't realise is that the international battle to eliminate tariffs and import quotas has largely been won (though less so for the agricultural products of interest to our farmers).

This means so-called free-trade agreements are much more about issues that aren't the focus of economists' simple trade theory: "regulatory standards, health and safety rules, investment, banking and finance, intellectual property, labour, the environment and many other subjects besides".

International agreements in such new areas produce economic consequences that are far more ambiguous than is the case of lowering traditional border barriers, Rodrik says, naming four components of agreements that are worrying.

First, intellectual property. Since the early 1990s, the US has been pushing for its laws protecting patents, copyrights and trademarks to be copied and policed by other governments (including ours). The US just happens to be a huge exporter of intellectual property – in the form of pharmaceuticals, software, hardware, music, movies and much else.

Tighter policing of US IP monopoly restrictions pits rich countries against poor countries. And though free trade is supposed to benefit both sides, with IP the rich countries' gains are largely the poor countries' losses. (Rich Australia, however, is a huge net importer of IP).

Second, restrictions on a country's ability to manage cross-border capital flows. The US, which has world-dominating financial markets, always pushes for unrestricted inflows and outflows of financial capital, even though a string of financial crises has convinced economists it's a good thing for less-developed economies to retain some controls.

Third, "investor-state dispute settlement procedures". These were first developed to protect US multinationals from having their businesses expropriated by tin-pot governments.

Now, however, they allow foreign investors – but not local investors – to sue host governments in special arbitration tribunals and seek damages for regulatory, tax and other policy changes merely because those changes reduced their profits.

How, exactly, is this good for economic efficiency, jobs and growth?

Finally, harmonisation of regulations. Here the notion is that ensuring countries have the same regulations governing protection of the environment, working conditions, food, health and safety, and so forth makes it easier for foreign investment and trade to grow.

Trouble is, there's no natural benchmark that allows us to judge whether the regulatory standard you're harmonising with – probably America's - is inadequate, excessive or protectionist.

Rodrik concludes that "trade agreements are the result of rent-seeking, self-interested behaviour on the part of politically well-connected firms – international banks, pharmaceutical companies, multinational firms" (not to mention our farm lobby).

They may result in greater mutually beneficial trade, but they're just as likely to redistribute income from the poor to the rich under the guise of "free trade".

Read more >>

WHY FISCAL POLICY IS BACK IN FASHION

Comview 2018

Why fiscal policy fell out of favour

• Advent of “stagflation” in mid-1970s
• Breakdown of simple Phillips curve
• Monetarist attack on Keynesianism
• Monetarists’ slogan: Money matters! 
• Consciousness of “crowding out”
• Monetary policy’s shorter “implementation lag”
• MP became primary instrument for fiscal policy from late 1970s

How the float changed form of crowding out

• Original belief was that govt borrowing to cover fiscal stimulus would force up interest rates and crowd out private investment.
• Assumes fixed exchange rate (ER) and closed capital market.
• Floating ER and globalised capital market mean Aust borrowing too small to influence world interest rate
• Thus higher spending caused by fiscal stimulus leads to higher CAD and higher capital account surplus (KAS) ie increased capital inflow 
• Increased capital inflow pushes up $A
• High ER crowds out exports and import-competing production

Since GFC macro conventional wisdom has flipped

• Monetary policy now seen as less effective than it was
• Fiscal policy now seen as more effective
• Particularly in the case of a synchronised global downturn
• But also because of seeming “secular stagnation”

Monetary policy now less potent

• Developed economies: very low interest rates leave central banks less scope to cut policy interest rates – “zero lower bound”
• Seeming secular stagnation means lower real neutral interest rate and lower inflation rate and inflation expectations 
• Monetary stimulus works by getting the real policy interest rate lower than the real neutral rate – hard when can’t go below zero
• Quantitative easing (QE) shown to do more to increase asset prices than demand. Works mainly by lowering ER (ie bad for trading partners)
• Australia’s story: our rates still a bit above zero, but MP less effective because very high level of household debt makes households reluctant to borrow more, even at very low interest rates
• Glenn Stevens said he’d never believed that MP had much effect on business investment ie main effect is on households
• But Philip Lowe says this effect is asymmetric: high debt means interest rate increases will be highly effective in dampening household spending via the cash flow channel
• Wind-back of QE and rising US interest rates have lowered our ER, providing us with external stimulus 

Fiscal policy now more attractive

• If MP is now less effective, FP simply becomes more attractive
• Fiscal multipliers now seen to be much higher than believed in 1980s
• With inflation now of little concern, less likelihood that FP effectiveness (and size of multipliers) is reduced by “monetary policy reaction function”
• Although MP’s “implementation lag” is shorter, FP’s “response lag” is shorter (eg cash splash)
• FP more effective than MP in the case of a synchronised world downturn 

Why synchronisation favours fiscal policy

• When one country uses fiscal stimulus, some of the higher demand leaks into imports, thus lowering multiplier
• But when all countries use fiscal stimulus together there are external injections as well as leakages
• Thus co-ordinated response turns tables in favour of FP
• Globalisation may make synchronised downturns more likely
• Existence of G20 (and initial success after GFC) makes co-ordinated response easier and more likely

New views on fiscal multipliers

• Higher than previously thought when:
• Low inflation risk removes MP reaction function
• Co-ordination reduces net external leakage
• Empirical evidence shows:
• Higher for govt spending than for tax cuts
• Higher for capital works spending than public consumption spending
• Higher for cash bonuses (cash splash) than for tax cuts

IMF's concept of "fiscal space"

• “The room in a government’s budget that allows it to provide resources for a desired purpose without jeopardizing the sustainability of its financial position or the stability of the economy”
• Moody’s: the difference between a nation’s actual sovereign debt-to-GDP ratio and the limit beyond which the nation could default

Australia's story

• IMF estimates we have plenty of fiscal space and urges us to use it
• OECD also urges Coalition govt to use fiscal stimulus to help MP (very low interest rates) get economy moving
• RBA governors repeatedly urge govt to reduce recurrent budget deficit, but assist hard-pressed MP by increasing infrastructure spending
• Govt responds in 2017 budget  

Read more >>

Too many school leavers are off to uni

If you had a youngster leaving school, what would you encourage them to do? Get a job, go to university, or see if there was some trade that might interest them? For a growing number of parents, that's a no-brainer: off to uni with you. But maybe there should be more engaging of brains.

It's widely assumed that, these days, any reasonably secure, decently paid career must start with a university degree.

Don't be so sure. The latest projections by the federal Department of Employment (since renamed by Malcolm Turnbull's spin doctors as the Department of Jobs and Small Business) are for total employment to grow by 950,000 over the five years to 2022.

The department projects that fewer than 100,000 of those extra jobs – less than 10 per cent – will be for people with no post-school qualifications.

More than 410,000 of the jobs – 43 per cent – will be for people with a bachelor degree or higher qualification.

But that leaves more than 440,000 of the jobs – 47 per cent – for people with the diplomas or certificates (particularly the "cert III" going to trades people) that come from TAFE.

Now, even the Department of Jobs possesses no crystal ball. But these educated guesses should be enough to disabuse you of the notion there'll be no decent jobs for people who haven't gone to uni.

But graduate jobs are better paid, right? Yes, but not by as much as you may think.

Figures issued by the Australian Bureau of Statistics on Monday show that, in August last year, the median (middle) pre-tax earnings of employees with a bachelor degree were $1280 a week, whereas for employees with a cert III or IV trade qualification it was $1035 a week.

And my guess is, if we keep stuffing things up the way we have been – taking in too many uni entrants and too few TAFE entrants – that gap will narrow, with certificate-holders' wages growing faster than graduates' wages.

While we were engrossed watching the Barnaby show, Labor's shadow education minister, Tanya Plibersek, was announcing its election policy to conduct a "once-in-a-generation" review of post-school education, with a view to establishing a single, integrated tertiary education system, putting universities and TAFE on an equal footing.

Her announcement was welcomed by the ACTU and the Business Council. Both sides know well how badly we've stuffed up young people's choice between uni and TAFE.

Plibersek was hardly going to admit it, but the problem goes back to missteps by the sainted Julia Gillard when education minister, made worse by state governments of both colours.

In 2010 she replaced the system where the feds set the number of new undergraduate places they were prepared to fund, and the numbers in the various degree categories, introducing a system where uni entry numbers were "demand-driven".

After decades in which their federal funding had been squeezed, the vice-chancellors couldn't believe their luck.

Particularly those at regional and outer suburban unis went crazy, lowering their admission standards and admitting hugely increased numbers. Did they employ a lot more academics to teach this influx of less-qualified students? Not so much.

It's likely many of these extra students will struggle to reach university standards – unless, of course, exams have been made easier to accommodate them.

Those who abandon their studies may find themselves lumbered with HECS-HELP debt without much to show for it. Many would have done better going to TAFE.

Meanwhile, TAFE was being hit by sharp cuts in federal funding (no doubt to help cover the extra money for unis) and subjected to the disastrous VET experiment.

The problem was that parts of the states' union-dominated TAFE systems had become outdated and inflexible, tending to teach what it suited the staff to teach rather than the newer skills employers required and students needed to be attractive to potential employers.

Rather than reform TAFE directly, however, someone who'd read no further than chapter one of an economics textbook got the bright idea of forcing TAFE to shape up by exposing it to cleansing competition from private providers of "vocational education and training".

To attract and accommodate the new, more entrepreneurial for-profit training providers, the feds extended to the VET sector a version of the uni system of deferred loans to cover tuition fees. State governments happily played their part in this cost-saving magic answer to their TAFE problem.

The result was to attract a host of fly-by-night rip-off merchants, tricking naive youngsters into signing up for courses of dubious relevance or even existence, so the supposed trainers could get paid upfront by a federal bureaucracy that took an age to realise it was being done over.

Eventually, however, having finally woken up, the present government overreacted. Now it's much harder to get federal help with TAFE fees than uni fees.

Far too little is being done to get TAFE training properly back in business after most of the for-profit providers have faded into the night.

The Turnbull government surely knows more must be done to ensure all those who should be training for technical careers are able to do so. In last year's budget it established an (inadequate) Skilling Australians Fund, and more recently suspended the demand-driven uni funding system.

It would be better if it joined Labor in supporting a thorough-going review of our malfunctioning post-school education arrangements.

Read more >>

Not even the IMF is worried by our huge foreign debt

In its latest report on Australia, the International Monetary Fund says it isn't worried by our net foreign debt, now just a squeak short of $1 trillion. Just as well, since none of us ever worries about it either.

Still, it's nice to have the fund's judgment that "the external position of Australia in 2017 was assessed to be broadly consistent with medium-term fundamentals and desirable policies".

Australia's negative "net international investment position" – consisting of our net foreign debt plus net foreign equity investment – has varied between 40 and 60 per cent of gross domestic product since 1988, it says. At the end of 2016, it was equivalent to 58 per cent.

That's high. So why's the fund so relaxed? Because, it says, both the level and the trajectory of our net international investment position are "sustainable".

It has calculated that a current account deficit between 2.5 and 3 per cent of GDP, which is larger than the deficit of 1.9 per cent it expects for 2017, would allow our total net foreign liabilities to be stabilised at about 55 per cent of GDP.

Note that, for some years now, our net foreign debt actually exceeds our total foreign liabilities (debt plus equity). That's because the value of our equity investments abroad (mainly foreign businesses owned by Australian multinationals and our super funds' holdings of foreign shares) now exceeds the value of foreigners' equity investments in Australia, to the tune of about $30 billion.

The fund derives much comfort from the knowledge that our foreign liabilities (both debt and equity) are largely denominated in Australia dollars, whereas our foreign assets (debt and equity) are denominated in foreign currencies.

Get it? In a globalised world of floating currencies and free capital flows between countries, the big risk for an economy heavily indebted to the rest of the world is a sudden loss of confidence by its foreign creditors, which would be manifest in a sudden drop in its exchange rate (as we experienced at the turn of the century, when the Aussie briefly fell below US50¢).

But when our foreign liabilities are expressed in Australian dollars, the depreciation doesn't increase their Australian-dollar value, whereas it does increase the Australian-dollar value of our foreign assets, leaving our net foreign liabilities reduced.

The broader conclusion is that an indebted country able to borrow abroad in its own currency has a lot less to worry about. And the fact that foreigners are willing to lend to us in our own currency is a sign of their confidence in our good economic management.

And, of course, a big drop in our dollar does improve the international price competitiveness of our export and import-competing industries.

Speaking of which, the fund estimates that, after the heights it reached in 2011 when prices for our coal and iron ore exports were at their peak, our "real effective exchange rate" (that is, the Aussie's average value against all our major trading partners' currencies, adjusted for the difference between our inflation rate and their's) depreciated by 17 per cent between 2012 and 2015.

Since then it's appreciated by about 5 per cent, up to September last year. The fund calculates that, by then, it was about 17 per cent above its 30-year average, leaving it between zero and 10 per cent higher than it probably should be, making it "somewhat overvalued".

The fund says our gross foreign liabilities (debt plus equity) break down into about a quarter as "foreign direct investment" (foreign control of Australian businesses, starting with our mining companies), about half as "portfolio investment" (mainly our banks' borrowings abroad, plus foreigners' holdings of Australian government bonds) and a quarter of odds and sods.

So the mining investment boom was mainly funded directly by the foreign mining companies themselves, including by ploughing back much of the huge profits they made while export prices were sky high.

But this was happening when, after the global financial crisis, our banks were increasing the stability of their funding by borrowing more from local depositors and less from overseas financial markets.

What most people don't know is that most of our net foreign debt is owed by our banks, though that's less true than it was, particularly because recent years have seen more central banks buying Australian government bonds from their original Aussie holders.

Though the central bankers like our higher interest rates, it's another indication that the rest of the world isn't too worried about our financial stability.

Read more >>

Current account deficit improves without us noticing

They say a watched pot never boils, so maybe it's a good thing we now spend so little time worrying about the current account deficit. While our attention's been elsewhere, it's got a lot smaller.

This news comes courtesy of the International Monetary Fund's latest country report on Australia, issued this week.

Settle back. The nation's "balance of payments" is a statement summarising all the transactions between Australians (whether businesses, governments, or individuals) and the rest of the world.

It's divided into two main accounts. First is the "current account", which summarises exports and imports of goods and services, plus inflows and outflows of income, particularly payments of dividends and interest on loans.

Then there's the "capital and financial account" which, as its name implies, summarises the inflows and outflows arising from the financial-capital dimension of the transactions included in the current account.

Because the balance of payments is calculated using the accountants' double-entry bookkeeping system of debits and credits, the balance of payments is always in balance. So if the current account sums to a deficit, the capital account must sum to a surplus of the same size.

The fund's report acknowledges that Australia almost always runs a deficit on the current account, with an offsetting surplus (net capital inflow) on the capital account.

This is because we've always invested a lot more each year (in new business equipment and structures, homes and public infrastructure) than we (businesses, households and governments) have saved each year, so we've always needed to call on the savings of foreigners to make up the gap.

Foreigners' savings come as either loans (known as "debt capital") or the purchase of shares in our businesses or real estate ("equity capital").

Worries about the size of the deficit on the current account go back to the days before 1983, when the Australian dollar's rate of exchange with other currencies was fixed at a certain level by the government.

It was the government's job to defend that fixed rate by making sure the current account deficit and the capital account surplus were never too far apart.

This "balance of payments constraint" meant that if the current deficit got too big relative to the capital surplus, the government would have to crunch the economy so as to get imports down and thus help it keep the dollar's value unchanged.

If this didn't happen, the government would suffer the ignominy of devaluing our dollar and hoping this would get the current deficit and capital surplus back together.

When, in 1983, we decided to allow the value of the dollar to "float", however, this allowed it to move up or down automatically and continuously by however much was needed to keep the current deficit and the capital surplus exactly equal at all times.

It took until some years after the float for economists to realise that, in the new, more globalised world of floating currencies and unrestricted flows of financial capital between countries, there was much less reason to worry about the excessive size of the current deficit.

The necessary "devaluation" of the exchange rate would be brought about by the foreign exchange market, not the government.

The fund's report notes that, in the 1960s and '70s, the current account deficit fluctuated around 1 and 2 per cent of gross domestic product.

During the 35 years since the float, however, the current deficit blew out, averaging about 4 per cent of GDP. In consequence, there was a huge increase in our foreign liabilities, particularly our net foreign debt – to a mere $990 billion at last count.

This is what worried many people – until the economists and politicians decided to stop talking about it and focus on something different, the federal government's budget deficit and net government debt.

But here, at last, is the news: the fund reports that, since the global financial crisis in late 2008, the current account deficit has been a lot smaller. It's expected to have been only 2 per cent in 2017.

Why the improvement? Since the current deficit and the capital surplus are two sides of the same coin, you can explain changes by looking at either side – or both. The report offers two reasons for the smaller current deficit and three for the smaller capital surplus.

On the current account, it says we suffered a larger slowdown in growth in domestic demand (spending on consumption and investment goods) following the crisis than did our major trading partners (which, remember, are mainly fast-growing Asian economies).

So our imports from them weakened by more than our exports to them.

As well, the current deficit has been reduced by a lower "net income deficit" – gone from 3 per cent of GDP before the crisis to 1.5 per cent since – because world interest rates are so much lower, and our interest payments to foreigners far exceed their interest payments to us.

On the capital account surplus – representing the amount by which national investment exceeds national saving - the report notes that households have been saving a higher proportion of their incomes since the crisis than before it (even though they're saving less now than they were a few years back).

Second, since the crisis, our companies have saved more by retaining more of their profits rather than paying them out in dividends and, despite the surge in investment spending by mining companies that's only now ending, other companies haven't been investing much until recently.

Finally, the tightening up of international capital adequacy requirements in reaction to the crisis has obliged our banks to increase their saving by retaining more of their profits.

The report foresees the current account deficit stabilising at about 2.5 per cent of GDP in the next few years – which would be almost back to its modest levels when our exchange rate was still fixed.

Read more >>

Governments only pretending to fix Murray-Darling

Genelle Haldane, my desk calendar tells me, has said that "only until all of mankind lives in harmony with nature can we truly decree ourselves to be an intelligent species". I've no idea who Haldane is or was, but she's right.

And you don't need to be terribly intelligent to realise it. Even most economists get it. It's blindingly obvious that the economy – that is, human production and consumption of goods and services - exists within the natural environment.

The economy is sustained by the natural resources the environment supplies to it and by the natural processes that are part of the human production process. We rely on the ecosystem also to deal with the mountains of waste and emissions we generate.

It's equally clear that economic activity can damage the environment and its ability to function. We're exploiting the environment in ways that are literally unsustainable, and must stop doing so before the damage becomes irreparable.

But if it's all so obvious, why are we having trouble doing what we know we should? Why, for instance, has more fighting broken out over our use and abuse of the Murray-Darling river system, a problem we've been told our governments – state and federal – are busy fixing?

One reason is that some people – not many of us – earn their living in ways that damage the environment, and don't want their businesses and lives disrupted by being obliged to stop.

Often, they don't bear the cost of the damage they're doing. It's borne by farmers downstream, or by the wider community, or the next generation.

Those bearing the direct and immediate cost of stopping invariably fight harder to keep going than those affected only indirectly and to a small extent.

In the case of the Murray-Darling, it's only the costs being born by downstream irrigators – and downstream water drinkers in Adelaide – that keep the fight alive.

Since it's hard to be sure when damage to the environment has reached the point of no return, there's a great temptation to say doing a bit more won't hurt. I'll be right, and the future can look after itself. Business people think that; politicians even more so.

Democracy has degenerated into a battle between vested interests. Get in there to fight for your own interests, and don't worry about whether it all adds up or what happens to those who lose out.

The political parties have succumbed to this approach. They're too busy keeping themselves in power by oiling enough of the squeakiest wheels to worry about showing leadership, about the wider community interest or about any future beyond the next election.

I don't trust any of them, nor the Murray-Darling Basin Authority they appointed, which seems to see its job as assuring us everything's fine, when clearly it isn't.

Just how bad things are – how little progress has been made, how little has been done and how much spent on subsidies to irrigators – is made clear in a declaration issued this month by a dozen academics - scientists and economists - led by professors Quentin Grafton and John Williams, of the Australian National University, who've devoted their careers to studying water systems and water policy.

The decades of degradation of the Murray-Darling Basin, exacerbated by the Millennium drought, finally led John Howard to announce a $10 billion national plan for water security (since increased to $13 billion) in the months leading up to the 2007 election. Its intention was to return levels of water extraction for irrigation to environmentally sustainable levels.

It took until late 2012 for federal and state governments to agree on a basin plan to reduce water diversion by 2,750 gigalitres a year by July 2019, even though this was known to be inadequate to meet South Australia's water needs.

So far $6 billion has been spent on "water recovery", with $4 billion going not on buying back water rights but on subsidies to irrigators to upgrade to more efficient systems which lose less water.

Trouble is, those loses were finding their way back into the system, but now they don't. This has left the irrigators better off, but it's not clear there's much benefit in greater flows down the river. And no one has checked.

Federal figures show that buying water from willing sellers is 60 per cent cheaper than building questionable engineering works.

But little money has been spent helping communities adjust to the effects of adverse changes.

There's little evidence of much environmental improvement as a result of all the money spent, and river flows have been declining since 2011.

Until the ABC's 4 Corners program in July last year, many Australians were unaware of alleged water theft, nor of grossly deficient compliance along the Darling River.

State governments don't seem to be trying hard to fulfil their commitments under the 2012 agreement. Nor did the feds seem to take much interest when Barnaby Joyce was the minister.

The blow-up over the Senate's refusal to go along with a new round of reductions in the amount by which water extraction from the river is to be reduced – supposedly to be offset by increased spending on dubious engineering projects – is just the latest in the various governments' pretence of fixing the environmental problem, while quietly looking after their irrigator mates.

Read more >>

Unions play their cards wrong in hopes for higher pay

You don't need to read much between the lines to suspect that Reserve Bank governor Dr Philip Lowe and his offsiders think the workers and their unions should be pushing harder for a decent pay rise.

Why else would he volunteer the opinion, in his testimony to a parliamentary committee on Friday, that average wage growth of 3.5 per cent a year would be no threat to the Reserve's inflation target?

This while employers are crying poor and Scott Morrison makes the extraordinary claim that big business needs a cut in company tax so it can afford to pay higher wages.

Why should Lowe care about how well the workers are doing? Because, as one of his assistant governors, Dr Luci Ellis, pointed out last week, our economic worries are shared by most of the other rich economies, except in one vital respect: they have reasonably strong growth in consumer spending, but we don't.

What's making our households especially parsimonious? No prize for remembering our world-beating level of household debt. Trouble is, consumer spending accounts for well over half the demand that drives economic growth.

Our economy won't be sparking on all four cylinders until consumption spending recovers, and that's not likely until our households return to annual wage growth that's a percent or more higher than inflation. That's why Lowe's encouraging workers to think bigger in their wage demands.

Even so, his proposed pay norm of 3.5 per cent, errs on the cautious side. That figure comes from 2.5 percentage points for the mid-point of the inflation target, plus 1 percentage point for the medium-term trend rate of improvement in the productivity of labour.

But 4 per cent a year would be nearer the mark because the trend rate of productivity improvement is nearer 1.5 per cent a year.

Even so, Lowe is acknowledging a point employers and conservative politicians have obfuscated for decades: national productivity improvement justifies pay rises above inflation, not just nominal increases to compensate for inflation (as is happening at present).

Lowe's concern that the present annual wage growth of about 2 per cent not be accepted as "the new norm" is an important point from behavioural economics: rather than calculate the appropriate size of pay rises based on the specific circumstances of the particular enterprise, as textbooks assume, there's a strong tendency for bargainers to settle for whatever rise most other people are getting.

That is, there's more psychology – more "animal spirits", as Lowe likes to say; more herd behaviour – and less objective assessment, in wage fixing than it suits many employers and mainstream economists to admit.

Which implies that, if the unions would prefer a wage norm closer to 4 per cent than 2 per cent, they should be doing a better job of managing their troops' fears and expectations.

In the Reserve's search for explanations of the four-year period of weak wage growth, it puts much emphasis on increased competitive pressure, present or prospective.

But in her speech last week, Ellis qualified her reference to the more challenging "competitive landscape" by adding ". . . or at least how it is perceived". Just so. It's about perceptions of reality.

It's easier for firms worried about a future of more intense competition to take the precaution of awarding minimal wage rises if they can play on their employees' own fears about losing their jobs to Asian sweatshops or robots or the internet.

There's little sign in the figures for business profitability that most firms couldn't afford much bigger pay rises than they're granting. But it's no skin off the employers' nose if their fears of future adversity prove exaggerated. Only their workers had to pay for the excessive fearfulness.

Workers - particularly those in industries with enterprise bargaining – are meekly accepting smaller pay rises than their employers' circumstances could sustain because the union movement has done too little to counter the alarmists telling their members they've lost the power to ask for more.

They've played along with the nonsense about 40 per cent of jobs being lost to robots, and that there's nothing to stop greedy businesses from making us all members of some imaginary "gig economy".

Worse, they've exaggerated the spread of "precarious employment" and encouraged the still-speculative belief that weak wage growth is explained almost exclusively by anti-union industrial relations "reform", which has stripped workers' bargaining power to the point where the right to strike has been lost.

Presumably, their game is to advantage their Labor mates by heightening disaffection with the Turnbull government, but this is coming at the expense of the economy's recovery, not to mention workers' pay packets.

Read more >>

How our economic prospects turn on wage growth

You know the world's behaving strangely when you hear a heavy from the central bank saying it's expecting more "progress" on the "turnaround in inflation", then realise they're hoping inflation will go higher.

That's just what Dr Luci Ellis, the Reserve Bank's third heaviest heavy, told a bunch of economists at a conference this week.

Why would anyone hope for prices to be rising faster than they are? Not so much because higher prices are a good thing in themselves, as because rising inflation is usually a sign of an economy that's growing strongly and keeping unemployment low.

By contrast, very low inflation – say, below 2 per cent – is usually a sign of an economy that's not growing strongly, with unemployment either rising or higher than it should be.

Ellis' remarks are a reminder that the economy's biggest problem at present is weak growth in wages. She knows that if prices started rising faster, the most likely explanation would be higher growth in wages, which employers were passing on to their customers by raising their prices.

What could oblige employers to increase the wages they pay? Their need to retain or attract more workers – particularly skilled workers – at a time when the demand for labour was rising, caused typically by increased demand for the goods and services businesses were employing people to produce.

The point to note here is that the Reserve's mental model of inflation is of what economists used to call "demand-pull" inflation. It's simple: the prices of goods and services rise when the demand for them is outpacing their supply.

Note, too, that this involves an inverse relationship between inflation and unemployment: when one goes up, the other goes down, and vice versa. Economists call this the "Phillips curve", named after its discoverer, Bill Phillips, a Kiwi economist.

Ellis confirmed that, although the economy (real gross domestic product) grew at a trend rate of just 2.4 per cent over the year to September, the Reserve's forecast that growth will pick up to about 3¼ per cent over this year and next remains unchanged.

This will involve a pick-up in wage growth and inflation, she said.

The Reserve is more confident of these forecasts than it was when it first made them in early November. Even so, Ellis admitted to some particular "uncertainties": how much production capacity in the economy is going spare at present, and how much, and how quickly, wage growth and inflation will pick up as spare capacity declines.

How much unused production capacity remains in the economy matters because, until it's used up, the economy can grow much faster than it can once the economy's at full capacity – full employment of labour and capital – without this causing inflation pressure to build.

Once the economy is at full employment, how fast rising demand can cause the economy to grow without also causing higher inflation is determined by the economy's "potential" growth rate – that is, by the rate at which rising participation in the labour force, increasing investment in capital equipment and improving productivity are adding to the economy's ability to produce more goods and services.

That is, how fast potential supply is growing. So the economy's potential growth rate sets the medium-term speed limit on how fast demand can grow before causing a build-up in inflation.

The Reserve's most recent estimate is that our potential growth rate has slowed to 2.75 per cent a year (mainly because of the retirement of the bulge of baby boomers).

But how do we measure how much spare production capacity we have at any time? We measure the spare capacity of our mines, factories and offices mainly by looking at answers to questions in the regular surveys of business confidence.

That's physical capital. In the labour market, idle production capacity is measured by the rate of unemployment.

But it's wrong to think full employment is reached when the unemployment rate falls to zero. That's partly because, at any point in time, there will always be some workers moving between jobs (called "frictional" unemployment).

Also because of a much higher rate of "structural" unemployment. The structure of the economy is always changing, with some industries expanding and some contracting. This increases the number of workers who don't have the particular skills employers are seeking, or who do have them but live far away from where the job vacancies are.

In the old days, there were a lot of low-skilled jobs that could be filled by people who had left school early and hadn't learnt much. These days, there a far fewer of those jobs, so people with inadequate skills are often out of a job.

Economists measure full employment by estimating the rate to which unemployment can fall before shortages of skilled labour cause employers to bid up wages and thus cause price inflation to accelerate.

They call this the NAIRU – the non-accelerating-inflation rate of unemployment – and the Reserve's latest estimate is that it's "around 5 per cent". It says "around" because every economist's estimate is different, so it's wrong to be too dogmatic.

This week's trend figures from the Australian Bureau of Statistics for the labour force in January show the unemployment rate has been steady at 5.5 per cent since July. That's well above the NAIRU.

Over the same six months, however, employment has grown by almost 180,000, or 1.5 per cent, causing the rate at which people are participating in the labour force to rise by 0.4 points to 65.6 per cent – its highest for seven years and a record high for participation by women.

If the laws of supply and demand still hold – a safe bet – this unusually strong growth in the demand for labour should lead to higher wages and then higher prices sooner or later. But Ellis warns it's likely to be "quite gradual".

Read more >>

Private health insurance is a con job

You won't believe it, but my birthday was on Tuesday and I got a present from the federal government. I also got a card from my state member, sending his "very best wishes" for reaching such an "important milestone" in my life.

I almost wrote back asking him to alert the Queen to be standing by in 30 years' time. Instead, my ever-sceptical mind told me the pollies have awarded themselves privileged access to the private information we're obliged to give the electoral commission.

So, what was my fabulous federal birthday present? Apparently, I'm now so ancient and infirm I get a bigger private health insurance tax rebate.

I never tire of pointing out that, contrary to what people say, our cost of living, overall, has not been rising strongly, unless you regard 2 per cent a year as "soaring".

It is true, however, that a few, easily noticed prices have risen a lot – including the government-regulated price of private health insurance.

My "important milestone" reminds me that people have been complaining about – and I've been writing about – the high cost of private health insurance for as long as I've been an economic journalist.

And the opposition leader of the day – Bill Shorten, as it happens – hasn't resisted the temptation to exploit people's disaffection by putting it firmly on the agenda for this maybe-there'll-be-an-election year.

The popular view is that everyone needs private insurance – if only they could afford it. Which about half of us can't.

Opinion polling by Essential has found that, although a clear majority of people believe "health insurance isn't worth the money you pay for it", 83 per cent of people believe that "the government should do more to keep private health insurance affordable".

The former opinion is right; the latter is delusional. Governments have been trying to keep health insurance affordable on and off for decades, while its cost just keeps climbing.

Why? Because it's a self-defeating process. The more you do to make insurance affordable, the easier you make it for the people running the health funds, the owners of private hospitals and the surgeons and other procedural specialists who work in hospitals, to raise their prices and fatten their profits.

Which the pollies fully understand.

In the old days, health funds were owned by their members, except for the government-owned Medibank Private. These days, three of the biggest funds – Medibank Private, Bupa and NIB – are for-profit providers, thus increasing the pressure on the government to allow big price rises and reducing the chance of getting value for money.

As Ian McAuley, of Canberra University, has written, from a policy perspective health insurance is a high-cost and inequitable way to fund healthcare.

Only 85 cents of every dollar passing through private insurance makes its way to paying for healthcare. And only if you can afford it do you share in the government subsidies taxpayers provide.

From the customers' perspective, it's a con job. Most people under 60 get back only a fraction of what they pay. Often when you do claim you don't get what you expected, because you don't get choice of doctor or a private room, you're caught by ever-changing exclusions from your policy, or because no one warned you about a huge gap payment.

Many buy insurance to avoid waiting times for elective surgery. But if private insurance didn't exist, surgeons would have to earn more of their income from public hospitals and waiting times would be shorter. It creates the problem it purports to solve.

Health insurance is such bad value that, when John Howard sought to prop up the private system, he had to make it subject to a tax rebate. When that didn't work he imposed a Medicare levy surcharge on better-off people who don't have insurance, and imposed escalating prices for people who aren't in a fund by the time they're 31 (which is a con trick on the innumerate).

When the Hawke government reintroduced Medicare, it intended that the universal, taxpayer-funded provision of high quality hospital and medical care would make private insurance unnecessary. Those who preferred the snob status of private care could pay for it from their own pocket.

This is why Labor long opposed public support for private insurance. Shorten, however, has taken a populist line, carrying on about the big increases in premiums and promising to cap them at 2 per cent a year for two years.

Another con. The profit-driven funds would respond either by excluding more procedures from coverage, or by demanding catch-up increases once the cap was lifted (as happened last time).

Private insurance is so counter-productive and so unfair that the best thing would be to end the subsidies and use the saving to improve the performance of the public system. (Howard's claim that his tax rebate would reduce the pressure on public hospitals was always just a fig-leaf to hide his attempt to prop up the two-class system.)

A less politically controversial alternative was first proposed in an Abbott government federalism discussion paper: use the saving to introduce a commonwealth hospital benefit, where the same amount would be paid to the hospital someone chose to go to, whether public or private.

Private hospital beds would stay in the system – at a price fixed by the government – but the parasitic private funds would be out on their own.

Read more >>

Economists do little to promote bank competition

The royal commission into banking, whose public hearings start on Monday, won't get a lot of help from the Productivity Commission's report on competition within the sector. It's very limp-wristed.

The report's inability to deny the obvious - that competition in banking is weak, that the big four banks have considerable pricing power, abuse the trust of their customers and are excessively profitable – won it an enthusiastic reception from the media.

Trouble is, its distorted explanation of why competitive pressure is so weak and its unconvincing suggestions for fixing the problem. It offered one good (but oversold) proposal, one fatuous proposal (to abolish the four pillars policy because other laws make it "redundant") and a lot of fiddling round the edges.

It placed most of the blame for weak competition on the Australian Prudential Regulation Authority, egged on by the Reserve Bank, for its ham-fisted implementation of international rules requiring banks to hold more capital, and for its use of "macro-prudential" measures to slow the housing boom by capping the banks' ability to issue interest-only loans on investment properties.

The banks had passed the costs of both measures straight on to their customers. It amounted to an overemphasis on financial stability (ensuring we avoid a financial crisis like the Americans and Europeans suffered) at the expense of reduced competitive pressure on the banks.

This argument is exaggerated. Even so, it's quite likely that, in their zeal to minimise the risk of a crisis, APRA and the Reserve don't worry as much as they should about keeping banking as competitive as possible.

The report's proposal that an outfit such as the Australian Competition and Consumer Commission be made the bureaucratic champion of banking competition, to act as a countervailing force on the committee that makes decisions about prudential supervision, is a good one.

The report's second most important explanation for weak competition is inadequacies in the information banks are required to provide to their customers. Really? That simple, eh?

See what's weird about this? It's blaming the banks' bad behaviour on the regulators, not the banks. If only the bureaucrats hadn't overregulated the banks, competition would be much stronger.

Why would the bureaucrats in the Productivity Commission be blaming other bureaucrats for the banks' misdeeds? Because this is the prejudiced, pseudo-economic ideology that has blighted the thinking of Canberra's "economic rationalist" econocrats for decades.

Whatever the problem in whatever market, it can never be blamed on business, because businesses merely respond rationally (that is, greedily) to whatever incentives they face. If those incentives produce bad outcomes, this can only be because market incentives have been distorted by faulty government intervention.

Market behaviour is always above criticism; government intervention in markets is always sus.

When the report asserted that the big banks had used the cap on interest-only loans as an excuse for raising interest rates, and would pass the new bank tax straight on to customers, there was no hint of criticism of them for doing so. They were merely doing what you'd expect.

In shifting the blame for these failures onto politicians and bureaucrats, the report fails to admit that the distortion that makes interest-only loans a worry in the first place is Australia's unusual tolerance of negative gearing and our excessive capital gains tax discount.

In criticising the bank tax, the report brushes aside the case for taxpayers' recouping from the banks the benefit the banks gain from their implicit government guarantee, and the case for taxing the big banks' super-normal profits (economic rent), doing so in a way that stops the impost being shunted from shareholders to customers.

Here we see a hint that the rationalists' private-good/public-bad prejudgement​ is only a step away from Treasury being "captured" by the bankers it's supposed to be regulating in the public's interest, in just the way it (rightly) accuses other departments of being captured.

The report's criticism of existing interventions would be music to the bankers' ears. Its fiddling-round-the-edges proposals for increasing competitive pressure have one thing in common: minimum annoyance to the bankers.

The Productivity Commission's rationalists can't admit that the fundamental reason for weak competition in banking comes from the market itself: as with many industries, the presence of huge economies of scale naturally (and sensibly) leads to markets dominated by a few big firms.

Market power and a studied ability to avoid price competition come with the territory of oligopoly. Have the rationalists spent much time thinking about sophisticated interventions to encourage price competition in oligopolies? Nope.

Have they learnt anything from 30 years of behavioural economics? Nope. When you've learnt the 101 textbook off by heart, what more do you need?

Read more >>

Indigenous middle class arises despite slow closing of the gap

It's easy for prime ministers to make big promises at some emotion-charge moment of national attention, but a lot harder to keep those promises when the media spotlight (and that prime minister) are long gone.

I could be alluding to the promise Kevin Rudd made that the federal government would never forget the needs of the victims of Victoria's Black Saturday bushfires in 2009, but I'm referring to the promise he made a year earlier, at the time of his apology to the stolen generations, to Close the Gap between Indigenous and non-Indigenous Australians.

The gap needing to be closed – and the commitments Rudd made – referred particularly to health, education and employment.

But all of those gaps contribute to another one: the gap between Indigenous and non-Indigenous incomes. What's been happening there?

I'm glad you asked because Dr Nicholas Biddle and Francis Markham, of the Centre for Aboriginal Economic Policy Research at the Australian National University, have just written a paper on the subject.

And, on the face of it anyway, the news is reasonably good.

First, however, some background. You won't be surprised that there is a gap between the two group's incomes. But it's worth remembering that gap has existed since the early days of European settlement of the Wide Brown Land.

To be euphemistic, it's a product of our colonial history. To be franker, Indigenous people were systematically and violently deprived of access to economic resources, especially land, a process that continued until well into the second half of the 20th century.

And though Aboriginal and Torres Strait Islander people engaged with the settler-colonial economy in many ways, underpayment or theft of wages was systematic in many parts of the country until the 1950s and '60s.

This colonial legacy endures into the present, Markham and Biddle say.

They quote another academic saying that "Aboriginal people, families, households and communities do not just happen to be poor. Just like socioeconomic advantage, socioeconomic deprivation accrues and accumulates across and into the life and related health chances of individuals, families and communities" (my emphasis).

The authors use the censuses of 2006, 2011 and 2016 to study what's been happening to the level and distribution of incomes within the Indigenous population, and between it and the non-Indigenous population.

The good news is that the median (the one dead in the middle) disposable equivalised​ household income for the Indigenous population rose from 62 per cent of non-Indigenous income in 2011 to 66 per cent in 2016. ("Equivalised" just means adjusted to take account of differences in the size and composition of households.)

That's the highest the percentage has been since reliable data started in 1981. And, in fact, it's been trending up since then.

There's progress, too, on the Indigenous "cash poverty rate", which measures the proportion of Indigenous incomes falling below 50 per cent of the median disposable equivalised household income of the nation's entire population.

So, as is usual in rich countries, it's a measure of relative poverty (how some incomes compare with others) rather than absolute poverty (whether people's incomes are high enough to stop them being destitute).

It's called "cash poverty" in recognition of the truth that there's more to poverty than how much money you have. As well, it acknowledges that no account is taken of "non-cash income", such as the value of food gained by hunting and gathering in remote areas.

Remember, however, that there are also costs involved in hunting. And the prices of basic necessities are much higher in remote areas.

Measured this way, the Indigenous poverty rate has declined slowly over past decades. More recently, it's gone from 33.9 per cent in 2006 to 32.7 per cent in 2011 and 31.4 per cent in 2016.

Sorry, that's where the good news runs out.

For a start, the rate of improvement is far too slow. Markham and Biddle calculate that if the gap kept narrowing at the rate it did over the five years to 2016, the medians for Indigenous and non-Indigenous incomes would be equal by 2060. That fast, eh?

Now get this: while the gap between the two groups has been narrowing, the gap within the Indigenous group has been widening.

If you take the weekly disposable personal incomes of all Indigenous people aged 15 or older, adjust them for inflation, rank them from lowest to highest, then divide them all into 10 groups of 10 per cent each, you discover some disturbing things.

Between 2011 and 2016, the average income of those in the top decile rose by $75 a week, compared with $32 a week for those in the middle decile. Individuals in the bottom decile had no income (possibly because they were students or home minding kids), while those in the second and third lowest deciles saw their incomes fall.

But what explains this growing gap between the top and the bottom within the Indigenous population?

Turns out it's explained by where an Indigenous person lives. Household disposable incomes are highest – and have grown fastest - in the major cities, with a median of $647 a week, but then it's downhill all the way through inner regional areas, outer regional, and remote, until you get to "very remote", where the median income is $389 a week.

Over the five years to 2016, the real median income in remote areas hardly changed, and in very remote areas it actually fell by $12 a week.

Got your head around all that? Now try this: despite the weakness in median incomes in remote (but not very remote) areas, the incomes of the top 20 per cent are higher and have been growing relatively strongly.

Get it? However poorly we're doing on Closing the Gap, we are getting an Indigenous middle class.

Read more >>

If we had more sense, we'd push early childhood education

Did I tell you that my grandson, fast approaching his second birthday and not many months away from losing his status as our one and only grandchild, is a budding genius?

His educational development is supervised by his father, who, being a doctor, started with identifying parts of the body. My grandson's always being quizzed, and loves showing off how much he knows.

Already he can count – provided you don't test him too closely above two or three – and, courtesy of Play School, can sing the alphabet song, whether or not he's invited to. He misses no more than a few of the letters, and is always careful to sing zed rather than zee.

Do I worry about how he'll manage to scratch out a living in the looming, frightening world of robots and artificial intelligence? No I don't. Not with the parents he's got.

For centuries the great advantage has been seen as inherited wealth. But, as The Economist magazine pointed out a few years ago, in the knowledge economy it's probably just as advantageous, maybe more, to inherit your intelligence from two highly educated, well-paid, education-conscious and bookish parents.

Of course, not every Aussie kid is as fortunate as any grandchild of mine. Which is why I worry a lot about the continuing high high-school dropout rate. Join the workforce without even a good grasp of the basics and the rest of your working life is likely to be "problematic", as mealy mouthed academics say.

It's also why I get so annoyed with politicians – and Treasury and Finance econocrats – who regard early education as just another of the outstretched hands that must be given something, but never enough to fully exploit its potential to improve our wellbeing, social as well as economic.

The good news is that Simon Birmingham, federal Minister for Education and Training, announced over the weekend the government's decision to spend $440 million extending for a year the "national partnership agreement" on universal access by four-year-olds to early childhood education, while federal and state ministers continue "negotiating" (haggling over) a new long-term agreement.

The bad news is that, when it comes to making sure all children attend preschool, we started much later than most of the other rich countries, and aren't catching up nearly as fast as we would be if we had more sense.

Our politicians on both sides think their interests are best served by using the limited funds available to placate as many interest groups as possible, rather than spending money where it's likely to yield the most lasting benefit.

Our econocrats ought to be encouraging their masters to spend more wisely, but if they are it's news to me. They seem to think it their job to disapprove of all extra spending equally. Not working well so far, guys.

There are no magic bullets in government spending, but putting money into early education – whether by lifting the quality of childcare, or beefing up preschool – comes a lot closer than most of the other things governments spend on.

We've known it for decades, but the evidence keeps growing. According to the Ontario early learning study, "the early years from conception to age six have the most important influence of any time in the life cycle on brain development and subsequent learning, behaviour and health".

Early experiences and stimulating, positive interactions with adults and other children are far more important for brain development than previously realised, it says.

According to a paper on early childhood education, issued last year by Dr Stacey Fox and others, of the Mitchell Institute at Victoria University, "investing in early learning is a widely accepted approach, backed by extensive evidence, for governments and families to foster children's development, lay the foundations for future learning and wellbeing, and reduce downstream expenditure on health, welfare and justice".

While all children benefit from high-quality early learning, research also shows that children experiencing higher levels of disadvantage benefit the most, and can even catch up to their more advantaged peers, the paper says.

In an earlier Mitchell report, Fox says that nearly a quarter of Australian children arrive at school with significant vulnerabilities – in their knowledge and communication, their social skills and emotional wellbeing, or in their physical health.

Here's a surprise: a child's risk of being developmentally vulnerable is closely, but inversely, correlated with their socio-economic status.

After five or six years, we've got close to achieving universal access by four-year-olds to a potential 15 hours a week of preschool. The only state dragging the chain is NSW (yeah, but look how much bigger its budget surplus is).

But kids from disadvantaged homes are less likely to be getting the full 15 hours. And there's strong evidence that two years of preschool – that is, starting at three – yields more than twice the benefit.

British research shows 16 year olds who attended at least two years of preschool were three times more likely to take a higher academic pathway after leaving school.

It's easier to get kids up to speed in preschool than at any later level of education. Clearly, the smart way to improve the performance of the whole system is to start at the bottom. Make sure we get preschool right, and the benefits will flow on to schools, TAFE and uni.

Nah, too much trouble. Let's just give ourselves a tax cut. My grandkids will do fine.

Read more >>

Next election will offer voters more genuine, wider choice

Even if we don't end up having a federal election this year, rest assured, it will feel like a year-long campaign. But whenever it occurs, it's likely to determine the fate of neo-liberalism, aka "bizonomics".

Though the two sides like to paint every election as a clear choice between good (us) and evil (them), many voters have concluded all politicians are the same – liars and cheats.

But that's truer of the way they behave than of the policies they espouse on some key issues.

The plain fact that neither side has enough committed supporters to guarantee it election means victory goes to the party that attracts more of the uncommitted voters in the middle.

This has long been a factor encouraging both sides away from extremes of left or right and towards the more moderate, "sensible centre". They've retained only enough pro-business or pro-worker positions to keep their voting, donating and polling-booth-staffing "base" motivated, as well as to provide some product differentiation.

The standard approach of recent decades has been for each side to seek to neutralise those issues where the other side is perceived by voters to have the advantage, by saying "me too", while trying to highlight those issues where it has the perceived advantage over its opponents.

Polling released last week by Essential, shows the Liberals' great perceived strengths are national security and terrorism, and management of the economy, whereas Labor's strengths are (in ascending order) education, health, housing affordability, the environment, industrial relations and climate change.

Note that almost all the contentious issues are economic, broadly defined. Voters see little to distinguish the two sides on population growth and asylum seekers. The government's already pushing hard on national security and terrorism, but Labor will run from any argument over these issues, where it starts well behind in voters' estimations.

Of late, however, the parties have departed from the standard script. Realising he lacked the charisma to get away with mimicking Tony Abbott's virtuoso performance of total negativity against the death-wish Rudd-Gillard-Rudd Labor, Bill Shorten thought he had little to lose by abandoning the small-target strategy of most oppositions, and went to the 2016 election with some relatively daring proposals on tax increases, particularly on restricting negative gearing and the capital gains tax discount.

Despite the conventional wisdom that touching negative gearing would be political suicide, Shorten's bravery was rewarded. Now look at the speeches Shorten and Malcolm Turnbull gave last week, and you see both sides planning to widen, rather than narrow, the policy distance between them.

Abbott was someone with conservative social values and hard-right economic views that fitted well with a party base that's be drifting to the right for many years. But he knew better than to highlight such views when seeking enough middle-ground votes to win the 2013 election.

Which leaves Turnbull with a big problem. His oft-stated position as a small-l liberal means much of his parliamentary party neither likes nor trusts him. To keep them behind him, he's had to loudly espouse policy positions – on big business tax cuts, weekend penalty rates and saving coal mines, for instance – that are far to the right of majority, middle-ground opinion.

The further Turnbull's party base has forced him away from the centre, the more Shorten has been emboldened to move his own policies further leftward from the centre than his predecessors would ever have dared.

It's clear Turnbull will go to the election offering no real plan to achieve Australia's Paris climate change commitments and making no more than sympathetic noises about the supposedly soaring cost of living, while claiming that big business tax cuts would trickle down and allow big pay rises.

In the meantime, the ever-continuing budget deficit won't stop the government also promising a tax cut for ordinary workers.

In echoes of Labor's winning policies at the 2007 election, Shorten will promise concrete action on climate change and on winding back the parts of Work Choices' attack on collective bargaining that Kevin Rudd and Julia Gillard weren't game to.

A rhetorical challenge for Shorten will be to shift the punters from their misconceived concern with the soaring cost of living, to the real problem: weak wage growth.

Despite that weak growth, I doubt many voters will be greatly tempted by the promise of modest tax cuts. A test of Shorten's leadership credentials will whether he has the courage to avoid matching Turnbull's promise.

But with Turnbull sticking to his plan for big-business tax cuts, and his resistance to reform of negative gearing and wage-fixing, this election may well determine the fate of the era of bizonomics.

Read more >>

CPI a more accurate measure of living costs than we imagine

Ask any pollie, pollster or punter in the pub and they'll all tell you there are no political issues hotter than the soaring cost of living. But this week the Australian Bureau of Statistics issued its consumer price index for the December quarter.

Oh no. It showed prices rising by 0.6 per cent in the quarter and a mere 1.9 per cent over the year to December.

That's a soaring cost of living? What are these guys smoking? Has the government got to the statisticians? Or do the bureaucrats sit in some office in Canberra making up the numbers?

None of the above. In truth, the bureau puts an enormous amount of expertise, care and effort into making the CPI as accurate as possible. Which is not to say the indicator is without its limitations – nothing in the real world is.

The care is shown in an explanatory paper the bureau issued this week to accompany its latest six-yearly updating of the index.

The CPI is purpose-built to measure changes in the price of a fixed quantity of goods and services bought by people living in metropolitan households.

"Metropolitan" means the eight capital cities, and the households include wage-earners, the self-employed, self-funded retirees, age pensioners and social welfare beneficiaries. That covers almost two-thirds of all Australian households, leaving out only those in regional areas.

The index measures the change in the price of a metaphorical basket containing fixed quantities of goods and services bought in each of the capital cities. It looks at thousands of prices of individual items, divided into 87 expenditure classes, 33 sub-groups and 11 major groups.

These are: food and beverages (accounting for 16 per cent of the total basket), alcohol and tobacco (7 per cent), clothing and footwear (4 per cent), housing (23 per cent), furnishings, household equipment and services (9 per cent), health (5 per cent), transport (10 per cent), communication (3 per cent), recreation and culture (13 per cent), education (4 per cent), and insurance and financial services (6 per cent).

How does the bureau know which particular goods and services to include in the basket and, more especially, what "weight" (relative importance) to give each class of expenditure?

Every six years it conducts a survey of more than 10,000 households, asking them to keep diaries of the spending they do. As spending patterns change over time, it updates the contents and the weights given to the items in the basket.

This week it applied new weights derived from the household expenditure survey it conducted in 2015-16.  From now on, however, the weights will be updated yearly.

The bureau checks the prices consumers are being charged by regularly visiting shops and offices, by phoning businesses, and, increasingly, by checking online supermarket sites and records of scanner transactions in stores.

It checks the prices of items at least once a quarter, but more frequently if prices – petrol, for example – keep changing. It aims to show the average price charged during the quarter.

It measures the retail prices we actually pay, so prices include the goods and services tax, and excise taxes, embedded in them, but also any government price subsidies for items such as private health insurance or childcare.

It takes account of widespread "specials", provided the items are of normal quality. It seeks to measure "pure" price changes, meaning it tries to exclude price changes attributable to a change in the quality or quantity of the latest version.

If some producer tries to disguise a price increase by leaving the price of a can of baked beans unchanged, but reducing the amount of beans, the bureau uses the actual price increase per gram.

When the latest laptop or mobile phone is more powerful than the previous model, or does more tricks, the bureau tries to take account of this quality improvement by calculating the underlying or "pure" price change – often a price fall.

But if the bureau takes so much care to measure price changes accurately, why do its figures invariably seem much lower than our impression of the price rises we've experienced?

Short answer: because we don't take nearly as much care as it does. We don't keep meticulous records, but form impressions. And, as behavioural economists tell us, our memories of prices changes are subject to predictable biases.

Price changes we don't like stick in our minds, while those we don't mind are soon forgotten. We remember clearly a few big price increases – the shock we got when we saw our quarterly electricity bill – but don't remember price falls (of which there are far more in these days of digital disruption). And it never occurs to us to take account of all the many items whose prices hardly change.

As a statistician would say, we don't attach the right weights to the price changes (including zero changes) that come our way.

So, for instance, we carry on (justifiably) about ever-rising power prices, but forget that electricity accounts for just 2.2 per cent of the average household's total consumer spending.

Of course, no particular household's experience is likely to be perfectly represented by such a broad average. The index lumps together people in different cities, smokers and non-smokers, drinkers and non-drinkers, renters, mortgagees and outright home owners.

The bureau tries to reduce this problem by also publishing special living cost indexes for certain types of households. Over the year to September, in which the CPI rose by 1.8 per cent, living costs rose by 1.5 per cent for employee households, 1.6 per cent for self-funded retirees, 1.7 per cent for age pensioners, and by 2.1 per cent for unemployed households.

Sorry, but the notion that the prices I pay rose way more than other people's did is just another of our happy self-delusions.

Read more >>

Wage growth the key to lasting economic strength in 2018

So, no train strike in Sydney because unionists were ordered to keep working by the Fair Work Commission. Is that good news or bad? Depends on the point from which you view it – but don't assume you have only one of 'em.

And if your viewpoint's from somewhere in Victoria, don't assume it's a matter of little relevance to your own pay packet.

A 24-hour train strike would have caused great inconvenience to commuters and disruption to many businesses – which is precisely why the unionists were ordered to abandon their strike. Thank goodness. Damage averted.

Or maybe not. The union wanted to strike for better wages and conditions during the very brief period following the end of an enterprise agreement when industrial action is legally protected.

I don't want to shock you, but all strikes are designed to impose financial costs on an employer – that's what gives bosses an incentive to agree to pay rises they don't fancy. Inconvenience to the employer's customers is usually unavoidable.

It's no bad thing that such disruption has become rare – always provided employers and their workers are able to reach agreement on reasonable wages and conditions without the need for disruption.

That's what gives the averted rail strike its wider significance. If the rail workers can't strike even during their brief "bargaining period", when can they? Maybe never. In which case, what's to stop employers driving ever more one-sided bargains?

The union movement's response is to claim that the right to strike is "very nearly dead". I'm not convinced. But, equally, I'm not certain it contains no element of truth.

And get this: if it is true that the past few decades of industrial relations "reform" have robbed the nation's workers of much of their power to bargain collectively, that's not just bad news for more than 12 million employees, and their dependents, it's bad news for the entire economy – including most of the nation's grossly overpaid chief executives.

This is an issue we'll keep hearing about this year. Much – even the fate of the Turnbull government – will turn on an issue it doesn't want to talk about: what happens to wages.

There's great optimism among economists and business people about a return to strong growth in the economy this year.

Everyone's convinced the world economy will grow faster than it has in years and, at home, the amazingly strong growth in employment last year – most of it in full-time jobs – is expected to continue.

What could be better calculated to lift the survival prospects of Malcolm Turnbull and his band of not-so-happy siblings, who must face an election by the middle of next year at the latest?

While economists and business people sing eternal praises to the great god of Growth in the size of the economy, voters care most about increased Jobs. The two usually go together, but they're not the same.

There's just one problem with the rosy prospects for Jobson Grothe this year: wages have grown no faster than consumer prices for the past four years. Employees have gained nothing from the improvement in productivity during that time, with all the lolly going to profits.

Does that sound like heaven on a stick for our business people? Many are yet to realise it's a fool's paradise. But, rest assured, if it keeps up for another year, light will dawn.

There are rival explanations for the weakness in wage growth. Some say it's temporary, others that it's lasting.

The econocrats – whose forecasts for wage growth have been way too high for years – say it's just a result of the economy's slow recovery from the resources boom, plus maybe a little digital disruption, and will go away if we're patient a bit longer.

They say it's simple supply-and-demand: as employment keeps growing, suitable labour becomes harder to find, obliging employers to pay higher wages to attract the staff they want.

Others fear the problem is deeper and long-lasting: it has been only the collective bargaining strength conferred on employees by industrial relations law that has allowed them to extract from employers the wage growth (above inflation) that has been their rightful share of improved productivity.

By now, however, years of "reform" have swung the industrial relations pendulum too far in favour of employers, thus allowing them to avoid sharing any of the productivity gains with their workers.

What do I think? My guess is it's a bit of both. It's too soon to be sure how much of the problem is temporary and how much is permanent, requiring governments to do more to roll back the Howard government's measures to discourage collective bargaining.

But time's running out for the not-to-worry brigade. If we don't see some quickening in wage growth as the year progresses, suspicions will increase that the economy's stopped working the way it's supposed to.

It's weak growth in wages that's really driving voters' complaints about the rising cost of living.

Worse, consumer spending is by far the biggest contributor to growth in the economy. Consumer spending is driven by the growth in household incomes, which in turn is driven partly by rising employment, but mainly by real wage rises.

Take away the real growth in wages and neither the economy nor jobs will stay growing strongly for long. If so, neither voters nor business people are likely to be happy.

Read more >>

Who’s doing best in the rent-seeking business

Economists joke that, whereas they are taught that any barriers to new firms entering a market are bad, allowing profits to be too high, MBA students are taught that "barriers to entry" are good, and shown ways to raise them.

Economists have no quarrel with businesses making profits. The shareholder-owners who provide the financial capital needed to sustain those firms are entitled to a return on their investment, one that reflects not only the (opportunity) cost of their capital, but also the riskiness of the particular business they're in.

Economists call such a return on equity "normal profit". But sometimes the various barriers to new firms entering a market limit competition, allowing the incumbents to make profits in excess of those needed to induce them to stay in the industry.

These are called "super-normal" profits (super as in "above"). Now get this: the other name for super-normal profits is "rents" – economic rents, to be precise.

We're used to thinking of rent-seekers as businesses or industries that ask governments for special treatment. But it's common for rents to be sought in situations that have nothing to do with government favours.

One of the most informative pieces of economic research undertaken last year was conducted by Jim Minifie, of the Grattan Institute, who made detailed estimates of the economic rents being earned in particular industries – something no government agency would be game to do.

He focused on the two-thirds of the economy made up by the "non-tradable private sector", excluding export and import-competing industries and the public sector.

He found that the annual return on equity in the most competitive part of this sector averaged 10 per cent. That compares with returns exceeding 30 per cent in internet publishing, which includes online classified advertising of homes, jobs and cars.

Then came internet service providers on 25 per cent and wired telecom on a fraction less. Supermarkets were on about 23 per cent, sports betting on 22 per cent, liquor retailing on 19 per cent, and wireless telecom and (get this) private health insurance on about 18 per cent.

Delivery services and fuel retailing are on 15 per cent, with banking not far behind on 14 per cent, level pegging with electricity distribution and airport operations.

But the rate of an industry's super-normal profit or economic rent isn't the same as its absolute amount. Most industries with very high rates of profit are quite small.

Measured in dollar terms, the most rents are in banking, followed by supermarkets, electricity distribution (just the local poles and wires), wired and wireless telecom.

Minifie estimates that rents account for 20 per cent of the non-tradable private sector's total annual after-tax profits of $200 billion. This is equivalent to more than 2 per cent of gross domestic product.

Another way to judge the significance of super-normal profits is to express them as "mark-ups" – as proportions of total sales.

The average mark-up across the whole non-traded private sector is 2 per cent. So, if rents were eliminated, but costs didn't change, average prices would fall by 2 per cent.

Within that average, however, the mark-up in internet publishing is 26 per cent. Then come airport operations on 20 per cent, wired telecom on 19 per cent and electricity distribution on 12 per cent.

Further down the league table, electricity transmission – the high-voltage power lines, not the local poles and wires – has an estimated mark-up of 7 per cent.

But get this: the banks' mark-up is just 4 per cent and the supermarkets' is a bit over 3 per cent.

How come, when super-profits account for more than half the supermarkets' total profit? Because supermarkets are a high-volume, low-margin business (as are banks).

Minifie notes that Coles and Woolworths are so big they achieve huge economies of scale. And, as dairy farmers well know, they achieve further cost savings by using their market power to force down the prices they pay their suppliers.

Trick is, they pass much of these cost savings on to their customers, but keep enough of them to remain highly profitable.

Coles and Woolies have substantially higher profit margins than their smaller rival IGA, even though their average prices are lower than IGA's prices. So the big two's costs must be a lot lower than IGA's.

The list of industries with the highest super-profits reminds us how badly governments have stuffed-up the national electricity market, how much better they could be doing in controlling the prices of monopoly businesses such as Telstra, airports and port terminals, and in charging for liquor and gambling licences, not forgetting the indulgent treatment of private health funds.

Read more >>