How Labor is taking on the greedy elderly

Talk about missing the point. The media spent all last week working themselves into a lather over Labor's newly announced policy to abolish cash refunds for unused dividend imputation credits. (If you have no idea what that means, it probably wouldn't affect you.)

This promise would be terribly unfair to dirt-poor self-funded retirees, we were told. And it was utter stupidity for Bill Shorten to drop such a monumentally unpopular proposal in the last week of the Batman byelection, which he was now safe to lose.

Except, of course, that Labor won comfortably, with little sign the policy had much effect.

The media smarties' greater failure was their inability to see the bigger picture: the next federal election is shaping as a battle between the generations, with Labor championing the put-upon young and the Coalition defending the privileged old.

According to Canberra conventional wisdom, this too is crazy-brave territory for Labor. The ageing of the population means Grey Power is our fastest growing political force.

Those of retirement age (which includes me) have little more pressing to do than to worry incessantly about their finances, and have developed an unshakable sense of entitlement ("I've paid taxes all my life ..."). Any concession they've been granted, no matter how unjustified or unaffordable, can't be taken back, we're assured.

Well, I'm not so sure.

As a political force, Grey Power has one huge weakness: of all the age groups, the over-65s are those least likely to change their vote. The great majority vote for the Coalition, so Labor doesn't have a lot to lose.

It's among the non-aged (sorry) that most swinging voters are found, and it's by picking up enough swingers that a party wins.

Haven't you noticed how, since 2013, the Coalition has been reacting to Labor's pro-younger policies by flying to the defence of the better-off old? The conservatives are allowing themselves to be "wedged" – separated from the majority of voters.

The Canberra smarties also used to believe negative gearing was politically untouchable. But Labor went to the 2016 election promising to curtail it – while the Libs predicted it would send house prices crashing – and came within a whisker of winning. Labor's persisting with the policy.

Labor went to that election with another pro-younger policy: cutting the tax breaks going to exceptionally well-off superannuants (including me). This time, Malcolm Turnbull, needing help to pay for his company tax cuts, produced his own, Treasury-crafted version of Labor's idea.

The issue didn't feature greatly in the election campaign, but after the Coalition had won, the exceptionally well-off superannuants in the Liberal heartland turned on Turnbull. This advantaged Labor by adding to the disunity in the Coalition's ranks. Turnbull modified his super changes, but not greatly.

And now Labor is planning to remove another super tax concession that goes overwhelmingly, but not exclusively, to superannuants with large share portfolios. The Coalition hasn't resisted the temptation to side with its well-off elderly heartland, nor have the media resisted the temptation to promote its (and the super industry's) misrepresentation of the policy as an attack on struggling retirees (who just happen to own a lot of shares).

How is this another of Labor's pro-younger policies? That will be easier seen if, as seems likely, Labor uses the saving to pay for a promise of income tax cuts for people earning less than $87,000 a year – few of which would go to the retired rather than to the workers who pay for the retired's largely income tax-free status.

If you think an election campaign based on conflict between the generations is not a good thing, I agree. Unless what you mean by that is that the better-off aged should be allowed to retain their relatively recently conferred tax advantages, and the taxpaying non-old should continue to lump it.

It's a pity John Howard and Peter Costello (the chap who kept issuing reports warning that population ageing would play merry hell with the budget) didn't worry more about future generational conflict when they spent most of their 11 years in office slipping new benefits for the aged, particularly self-funded retirees, into the budget.

They started with the private health insurance tax rebate (the biggest users of private health insurance services are 60 to 79-year olds) and moved on to giving the alleged self-funded retirees the "seniors and pensioners tax offset", also making it easier for them to get health cards and pay the pensioners' rate for pharmaceuticals.

In 1999, they gave negative gearing a huge boost by introducing a 50 per cent discount on capital gains tax. And they decided that anyone who paid so little income tax they couldn't take full advantage of their dividend imputation credits should be sent a refund for the balance.

On the younger side of the ledger, while they didn't invent HECS debts for university students, they greatly increased them.

Then, in 2007, Costello introduced sweeping super changes, making super payouts completely tax-free for people over 60. He also made a lot of supposedly self-funded people eligible for a part pension.

Since this largesse was quite unaffordable, Labor and Coalition governments have been chipping it back ever since.

Even so, we retain an income tax system where how much you pay sometimes depends on the size of your income, but other times on how old you are. And that's not going to lead to intergenerational conflict?

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Immigration the cheap and nasty way to grow the economy

The ABC's temerity in hosting a debate about the merits of high population growth has drawn predictable repostes from the economic establishment. Shades of the legendary note in the margin of a politician's speech: "shout here - argument weak".

There are at least four counts against the advocates of high immigration. First, their refusal to engage with the academic environmentalists arguing that we've exceeded the "carrying capacity" of our old and fragile land. Scientists? What would they know?

Second, they keep asserting high immigration's great economic benefits, blithely ignoring the lack of evidence. Whenever the Productivity Commission has examined the issue carefully it's found only small net effects, one way or the other. Its latest modelling found only a "negligible" overall impact.

Third, the advocates not only decline to admit the high social and economic costs that go with high rates of immigration, they decline to accept their share of the tab, doing all they can to shift it to the young, the poor and those on the geographic outer, including many of the migrants.

You rarely hear pro-immigration economists acknowledging the clearest message economic theory gives us on the topic: more population requires more spending on additional public and private infrastructure if material living conditions aren't to deteriorate.

The more we invest in such "capital widening" to stop the ratio of capital to labour declining, the less scope for investment in "capital deepening" to keep the ratio increasing, and so improving the productivity of our labour.

When we fail to invest sufficiently in capital widening – which we have – the decline in living conditions is manifest in overcrowding, traffic congestion and long commuting times.

Why have we failed to invest sufficiently? Partly because a high proportion of the promoters of high immigration are also promoters of Smaller Government, never acknowledging the two are incompatible.

A bigger population requires a bigger government, with more debt, not less. When you persist with high population growth, but put the clamps on government, you end up with overcrowding, congestion and the rest.

Another truth the high immigration advocates refuse to acknowledge is that a much bigger population must lead to much bigger cities and higher-density living in those cities.

The Reserve Bank's estimates of the huge addition to Melbourne and Sydney house prices caused by state governments' acquiescence to resistance to higher density in inner and middle-ring suburbs, are partly a consequence of successful attempts to shift the spatial cost of high immigration onto the less well-placed.

The fourth criticism of high immigration is that it's the cheapest and nastiest way to pursue economic growth. You get a bigger economy, but not the promised benefits. The studies repeatedly fail to show high immigration leads to a significant increase in real income per person.

Of course, the business lobby has no reason to care whether high immigration yields economy-wide benefits. All they're after is a bigger domestic market, allowing them to sell more widgets, make a higher profit and justify a bigger salary package.

Few economists can see this is a cop-out. An escape hatch. As a way of achieving corporate growth, it's even easier than taking over your competitors. And it sure beats the hard graft of trying to increase profits by being more efficient and contributing to national productivity improvement.

As we've seen, high immigration probably comes at the expense of productivity-enhancing (capital-deepening) business investment and public infrastructure. To the extent that inadequate capital-widening leads to overcrowding and congestion, it worsens productivity.

In principle, one productivity-enhancing effect of high immigration is that you get greater human capital on the cheap by pinching it from other (mainly poor) countries.

After foreign students have come here and paid full freight for Australian qualifications, you let them stay and work. You select permanent immigrants on the basis of their skills, or you let skilled workers on temporary visas stay on.

But as Dr Bob Birrell, of the Australian Population Research Institute, has shown, there's a big gap between the claims made for our skilled migration program and the reality. We let in people whose skills aren't in high demand, and plenty of them end up driving taxis because the local professions' gatekeepers refuse to recognise their qualifications.

So it's not clear the benefits of our skill-pinching program exceed the cost of discouraging businesses from incurring bother and cost training enough of our own young people, when you can always get the government to let you bring in someone ready-trained.

High immigration may suit our rent-seeking business people, but it's a hell of a way to pursue the professed benefits of economic growth.

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Why protection from imports isn't smart

With The Donald now busy playing poker with Little Rocket Man, the threat of a trade war has receded. Good. Gives us time to get our thinking straight before the threat returns.

Everyone knows a trade war would be a terrible thing, but most people's reason for thinking so is wrong. This misunderstanding means such a war could happen, even though everyone knows it would be bad.

It seems common sense for a country to want to protect its industry by imposing a tax – known as a tariff or import duty – on imports competing with locally-produced goods. After all, we win and foreigners lose.

The problem arises only if the foreigners retaliate and slap a tariff on our exporters. That's bad for us because it may lead to job losses among those of our workers who earn their living making goods for export.

Is that the way you figure it? Sorry, it may be common sense, but it's wrong. You need to have learnt a bit of economics to see why, because the case against protection is "counterintuitive" – it doesn't seem right, but it is.

The reason people can't see what's wrong with protection is that every baby is born with a disease called mercantilism.

Mercantilism is the belief that exports are good, but imports are bad. Why? Because we – Australia – make money selling exports to foreigners, whereas it costs us money to buy imports, the foreigners' exports.

So mercantilists see Australia as like a company, and our balance of trade as like a company's profit and loss statement. The more you can export and the less you can import – the higher your trade surplus - the richer you become.

What's wrong with that way of thinking? Plenty. For a start, it's the mentality of a miser – someone who loves money for its own sake, not for what it will buy.

Money is just a means to an end, not an end in itself. The economic game is about producing goods and services so we can consume them. Production is the means; consumption is the end. Focus on one at the expense of the other and you've actually done badly in the game.

Similarly, jobs are just a means to an end. Why do people want jobs? So they can earn money and then spend it.

Exports are production, imports are consumption (although much of our imports are of machines we use in the production process). Production without consumption makes sense only to a miser.

Get this: 80 per cent of the way Australia makes its living is by all the workers and businesses and governments producing goods and services and selling them to other Australian workers, businesses and governments, so they can be consumed.

In principle, we could raise the 80 per cent to 100 per cent by only selling to and buying from ourselves. So why do we sell about 20 per cent of the things we produce to foreigners?

Not because it makes us richer, nor because it creates more jobs. It's solely so we can afford to buy some of the goods and services produced by businesses and workers in other countries, when we judge them to be better or cheaper than the stuff made locally.

Exports are good solely because we can use the proceeds to pay for imports – and imports are also good because they raise our material standard of living by giving all of us (workers, would-be workers and dependents) access to goods and services that are better or cheaper than those made in Australia.

If we weren't willing to use the proceeds from our exports to pay for imports from other countries, those countries would refuse to buy our exports.

Refusing to buy our exports would leave those countries worse off (because they'd lose their ability to buy the things we can produce better or cheaper than they can), as well as leaving us worse off because we lost our ability to use our export income to buy their exports.

This, BTW, is why trade wars are mutually self-harming. A group exercise in cutting off your nose to spite your face.

Why wouldn't it be better to be 100 per cent self-sufficient? Because this would limit the benefits to us from "specialisation and exchange". Our domestic economy is organised on the basis that we're all better off if each of us specialises in producing what we're good at, then uses money to exchange what we've produced with what other specialists have produced.

Opening our economy to trade with other countries merely extends this principle, on which we've always run our domestic economy, beyond our borders.

This is why the mercantilists' assumption that trade is a zero-sum game – if you win, I lose – is wrong. Both sides win because both benefit from the "mutual gains from trade".

It follows that the mercantilist notion that foreigners are the only people who lose when we decide to protect some of our industries is wrong. The biggest losers are every other industry and every Australian who loses their access to cheaper or better imported goods and has to pay more for the local version.

That is, tariffs are a tax, not on foreigners, but on Australian producers and consumers. A way of favouring some Australian industries at the expense of all the others. A redistribution of income to favoured industries from those that aren't favoured, and from Australian consumers generally. A form of rent-seeking.

And thus, an attempt to protect some jobs at the expense of all other jobs. Great idea.

Trade wars are destructive not primarily because it's crazy for other countries to retaliate – which it is – but because the country that provokes the retaliation by protecting some favoured industries is damaging itself.

Better to let it stew in its own juice than punish it by harming yourself.

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RENT SEEKING, THE GAME OF MATES, AND THE STUFF-UPS OF ECONOMIC REFORM

Talk to Newcastle Institute, Wednesday March 14, 2018

When Malcolm Turnbull knocked off Tony Abbott as Prime Minister in 2015, Turnbull decided to get rid of some older ministers to make room for young blood, and – surprisingly – got rid of his mate Ian Macfarlane, who’d been minister for minerals and industry for many years. Macfarlane, who was 60, decided to get out of politics. In a speech farewelling him, Abbott observed that Macfarlane had served the mining industry well over the years, and now he was leaving politics Abbott hoped the industry would remember this service. It’s hard to remember any more blatant hint.  Macfarlane left the parliament in July 2016 and two months later it was announced he’d been appointed as chief executive of the Queensland Resources Council.

After the Liberal’s Andrew Robb, who’d spent his time as minister for trade – Abbott govt – negotiating many free trade agreements with Korea, Japan and China, resigned from parliament in 2016 he soon took up a $880,000-a-year job as a “high level economic consultant” with the Chinese company that bought the lease on the Port of Darwin.

After the Liberal’s Bruce Billson, who’d been minister for small business, left parliament it became known that he’d taken up a job as executive director of the Franchise Council of Australia – and that his salary began before he’d actually left the parliament.

Note that none of these men have been found to have done anything against the rules. But before you get too indignant about the appalling behaviour of those terrible Liberals, don’t forget Martin Ferguson, the former ACTU president turned Labor minister who, as minister for resources and energy, was deputised by Julia Gillard to negotiate the miners’ rejig of Kevin Rudd’s resource super profits tax. Sometime after he left parliament in 2013, he turned up as chairman of the Advisory Board of the Australian Petroleum Production and Exploration Association. He’s spoken out strongly in support of coal seam gas exploitation.

Then there’s Gary Gray, who ended his career as a Labor party official to work in WA for Woodside, entered parliament, became minister for minister for minerals and energy, then lost his preselection for being “too close to the Industry”.

Or Stephen Conroy, former Labor minister for communications, who’s now executive director of an outfit lobbying for online betting companies.

Last year, Cameron Murray and Prof Paul Frijters, published a book you can find via the internet called Game of Mates. It argues that a small class of well-connected operators hanging around the levers of government power are lining their own pockets at the expense of the rest of us.

This is a game of mates doing what mates do, look after each other. I do you a favour and maybe one day you'll do me one. This game is played particularly in land zoning, but also in many other areas. It can be played wherever government departments are supposedly regulating the activities of powerful industries in the interests of the public.

How many times have we seen politicians and top bureaucrats retire, but then pop up a few months later on the board or as a consultant to one of the companies they used to regulate? How many times have we seen lobbyists brought in to head departments that regulate particular industries? How many times have we seen people leave the offices of Labor prime ministers to go and work for Rupert Murdoch or, in earlier times, Kerry Packer.

Players in the game exploit flaws in our laws and regulations that create an economic honeypot to be snatched. The mates need to work as a group to capitalise on these flaws by establishing their networks of favour exchanges. They need to shield their true actions from public scrutiny with plausible myths suggesting their dodgy dealings are good for Australia.

The authors stress that people playing this game aren't necessarily acting illegally, and in that sense may not be corrupt. "The rules surrounding conflicts of interest, cooling-off periods for politicians [before they begin] working in industry, and exercising political discretion, are weak," they say.

We’re witnesses the rise of the lobbying industry and its incestuous relationship with bureaucrats, ministerial staffers and politicians.

The individual politicians, staffers and senior bureaucrats playing these games are themselves engaged in “rent seeking” on their own behalf, but they’re orchestrating rent-seeking by very big companies and industries. In this context, rent seeking means firms or industries seeking favours from government that increase their profits and make their lives easier by reducing the competition they face.

This brings me to the third element of my topic, the program of economic reform, which began in the mid-1980s with the Hawke-Keating government’s big reforms – floating the dollar, deregulating the financial system and other industries, removing import protection, introducing the fringe benefits tax and capital gains tax, and moving from centralised wage fixing to enterprise bargaining.

I believe most of these major reforms were inevitable, and have left our economy better off. But I also believe that, under later governments – Labor and Coalition; federal and state – the reform agenda has degenerated into much more dubious reforms, including some – but not all – privatisations, much outsourcing of the provision of government services, the creation of markets by allowing for-profit providers to compete against public or not-for-profit providers, and the whole notion of making the provision of taxpayer-funded services more efficient by making them “contestable”.

By now the list of economic reforms that have turned out to be stuff-ups is a long one. The collapse of the for-profit ABC Learning in childcare, the utter disaster of trying to turn TAFE into VET – vocational education and training, John Howard and Julia Gillard’s failed idea of improving public schools by hoping they’d compete with private schools, the way 30 years of putting the squeeze on our universities has made them obsessed by money-raising at the expense of their teaching, the way the unis are trying to attract students who should be going to TAFE. The huge scope for improving the performance of our public hospitals and our system of “primary care” by GPs and others.

And all that’s before you come to the mismanagement of the move to turn five state-owned electricity monopolies into a single, privately owned, competitive National Electricity Market, which has seen the real retail cost of electricity double over the past decade. The market has three levels – wholesale generation of electricity, transmission and distribution of electricity, and the retailing of electricity – and costs have blown out at all three levels. We’ve gone from five largely unconnected state monopolies to a single national market dominated by three big, vertically integrated, highly profitable companies, AGL, Origin Energy and Energy Australia. Then there’s the stuff up in the gas market, which has seen Australian industrial users of gas, and gas-fired power stations, paying prices far higher than we’re getting for the gas we now export in huge quantities.

What most of these stuff-ups have in common is successful rent-seeking by businesses doing business with the government (say, for the provision of childcare or vocational education services), or being regulated by politicians and bureaucrats that they’ve managed to turn into mates.

And then we wonder why so many voters are disillusioned with both sides of politics and turning to Clive Palmer one minute, Pauline Hanson the next, and some other crazy to come.

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What's making homes hard to afford and what we could do

There aren't many material aspirations Australians hold dearer than owning their own home - but dear is the word. There are few greater areas of policy failure.

The rate of home ownership, of which we were once so proud, has been falling slowly for decades. And as the last high home-owning generations start popping off, it will fall much faster.

We've been debating this issue for years, while it's just got worse. Yet we have a better handle on the causes of the problem, and what needs to be done, than ever.

Let me see if I can pull a lot of the elements together and give you the big picture.

Don't let anyone tell you the younger generation would be happy to stay renting forever. Nuh.

And while the hurdle of owning a home and a mortgage seems almost insurmountable to the young, jumping it is just the start of our property ambition. Most people want to keep moving up to a bigger and better home. Every promotion we get makes us wonder whether we can afford a better place.

This preoccupation with the quality of our housing is the first part of the reason house prices have risen so high: ever growing demand.

Don't forget that our newly built houses are much grander than they were even 10 years ago. And most older houses have been renovated and extended to make them better.

When two-income families became common people thought "great, now we can afford a bigger mortgage on a better place".

When we got on top of inflation in the early 1990s and interest rates fell so far, people could have paid off their mortgage faster, or bought a boat, but more people said "great, now we can afford a bigger mortgage on a better place".

Trouble is, you can't satisfy increased demand for better houses – particularly better-located houses - by building more places on the outskirts of the city. And when a lot of people decide to move to a better place at the same time, the main thing they do is bid up the prices of existing houses.

One change in recent decades is the growth of the services sector and the knowledge economy (more workers knowing how to do things; fewer workers making things), which means many of the jobs have gravitated to the CBD and nearby suburbs.

So the meaning of "position" has changed from good views to "proximity" to the centre. In theory, the amount of land within 10 kilometres of the GPO is fixed. In practice, factories and warehouses can be moved further out, while detached houses can be replaced by townhouses and low-rise or high-rise units.

Even so, in every city, property prices have risen more the closer homes are to the centre.

Another source of increased demand for housing is our high population growth, caused by our policy of high immigration.

Then there's foreigners' investment in our housing, though this isn't as big a cause of higher prices as many imagine because – in principle but not always practice - foreigners are only supposed to buy newly built or "off-the-plan" homes. That is, create their own supply.

Another source of greater demand is Paul Keating's introduction of capital gains tax in 1985 and John Howard's introduction of a 50 per cent discount on the tax in 1999. This has made owner-occupied homes (which are exempt from the tax) and, thanks to negative gearing, rented-out homes, more attractive as a form of investment, relative to shares.

So house prices are higher partly because we've acquired a second motive for home-ownership: not just the security and freedom of owning the home you live in, but also the prospect of homes becoming much more valuable over time.

Of course, increased demand leads to higher prices only if supply fails to keep up. And that's where our governments – state and federal – have failed us.

It's better now, but for ages state governments failed to do enough to permit the building of more homes on the edge of cities. We got more immigrant families, but not more homes to put them in.

Worse, state governments have allowed people in inner and middle-ring suburbs and their councils to resist the pressure for more medium-density housing – more units – from people wanting to live closer to where the jobs and facilities are.

Just last week the Reserve Bank published estimates that this resistance to higher density had added more than $300,000 to the average Melbourne house price and almost $500,000 to the Sydney price, over the past two decades.

So, who pushed housing prices so high? We did. Who failed to do what was needed to counter the increase? Our governments.

The feds failed to limit the growth in demand (by limiting immigration and fixing the tax system), while the states did too little to increase supply (by discouraging the building of new homes on the outskirts and by permitting a first-in-best-dressed mentality by people in inner and middle-ring suburbs).

Why are they allowing the proportion of home owners to decline? Because most things they could do to genuinely help first home buyers would come at the expense of existing home owners, who have more votes than the youngsters.

If young people and their parents don't like that, the answer's more pressure at the ballot box. Wheels that squeak more.

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How we could gang up against a Trump trade war

A possible trade war looms and, as always, an adverse overseas development has caught poor little Oz utterly unprepared. Well, actually, not this time.

Just as Treasury had been war-gaming the next big world recession well before the global financial crisis of late 2008, so the Productivity Commission began thinking about our best response to a trade war soon after the election of Donald Trump.

In July last year it published a research paper, Rising protectionism: challenges, threats and opportunities for Australia, to which Dr Shiro Armstrong, co-director of the Australia-Japan Research Centre, at the Australian National University, made a major contribution. (During a visit to ANU last week I also benefited from discussion with Professor Jenny Corbett.)

Trump's tariffs (import duties) on steel and aluminium were never a great threat to our economy. It'll be only when he decides to take a crack at the Chinese that there'll be a lot to worry about.

But the chest-thumping by our pollies (on both sides) over steel is a demonstration of the way populism can crowd out clear-headed self-interest where protectionism is involved.

Trade wars happen by accident. They start out in a small way, the perceived victims feel their manhood demands they stand up to a bully by retaliating, the bully hits back and pretty soon everyone in the bar is throwing chairs and punches.

As the research paper puts it, "significant worldwide increases in protection would cause a global recession."

Economic modelling by Armstrong estimates that, for every extra dollar by which our revenue from import duties rose, economic activity in Australia would fall by 64¢.

In total, the level of real gross domestic product would be 1 per cent lower each year. This would equate to a loss of about 100,000 jobs. (As with all modelling, take these figures as, at best, roughly indicative.)

A full-blown global trade war would take many months, even years to build up, so how should we respond to the provocative actions of others? What could we do to minimise the damage we'd suffer?

The research paper proposes what economists call a "first-best" response (here I'd call it the What-would-Jesus-do? cheek-turning response): not only should we resist the temptation to retaliate in any way, we should also cut what few remaining protective barriers we have.

If you think that would be plum crazy, you don't know as much about protection as you should. But you've demonstrated why any politician would find such advice almost impossible.

That's why I'm attracted by the paper's second-best suggestion: "working with a coalition of countries to keep their markets open is a strategy that would make it easier for Australia to resist protectionist pressures".

Good thinking. Our leaders want to be seen to be acting to defend our economy, and this response – "let's form our own gang and fight back" - is active rather than passive, and harder to portray as appeasing the bullies.

Oh yeah, what gang? What coalition of countries? That's obvious. We're already a member of a gang that, depending on how you measure it, is bigger than Trump's, or the Europeans'. And our gang's by far the fastest growing.

We do almost three-quarters of our two-way trade (exports plus imports) with Asia – in descending order, China, ASEAN, Japan, South Korea, New Zealand, India, Hong Kong and Taiwan. Europe accounts for only about 15 per cent and Trumpland​ for little more than 10 per cent.

Although it's true Asia needs to trade with North America and Europe, it's also true there's huge trade within our region. Just imagine the damage we'd suffer if we Asians started jacking up tariffs against each other. Or all of us against the rest of the world.

Australia and New Zealand are already members of various Asian trading clubs. And what greater incentive for Asians to pack down more closely than a threat from Trumpland, or from a Europe trying to repel boarders?

Nor is it presumptuous for Oz to take a (quiet) leadership role. Despite all their trade, there's a lot of mistrust between China, Korea, Japan and other countries. China and Japan, for instance, find it easier to work with us than with each other.

After all, we played significant roles in the formation of the Asia-Pacific Economic Co-operation group and in improving the governance arrangements for China's new Asian Infrastructure Investment Bank. We worked behind the scenes with Japan to keep the Trans-Pacific Partnership alive despite Trump's dummy-spit.

And guess what? Malcolm Turnbull will host a summit of the 10 leaders of the Association of Southeast Asian Nations in Sydney next weekend.

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The economy is readying for faster growth

The last three months of 2017 were yet another quarter of weak growth in the economy. Fortunately, however, they weren't as weak as we've been led to believe.

According to the national accounts, issued this week by the Australian Bureau of Statistics, real gross domestic product grew by 0.7 per cent in the previous quarter, but slowed to 0.4 per cent in the December quarter.

This caused the annual rate of growth to slump from 2.9 per cent to 2.4 per cent.

Trouble is, the sudden slowdown is largely the product of quarter-to-quarter volatility, caused by one-off factors and unexplained "noise" in the figures – noise that stops you hearing the signal those figures are trying to send.

This is why the bureau also publishes "trend" or smoothed figures, which reduce the noise and make it easier to hear the underlying signal.

The trend figures show the economy growing at a fairly steady rate of 0.6 per cent a quarter, and by 2.6 per cent over the year to December.

This is likely to be closer to the truth, though it's still weaker than we've been hoping for, especially since employment grew by a remarkably strong 3.3 per cent during 2017 – almost 400,000 more souls.

How can the economy's production of goods and services grow by only 2.6 per cent when the number of people employed to produce those goods and services has grown by 3.3 per cent?

Over a period of more than a few years, it can't. But over shorter periods it's surprisingly common for the standard relationships between economic variables not to show up in the figures. Why? In a word: noise. (And noise not even statistical smoothing can penetrate.)

Note, however, that for as long as employment is growing faster than production, the productivity of labour will be falling, just as a matter of arithmetic. If you think employment growth is a good thing, this temporary fall in productivity is nothing to worry about.

To emphasise how weak quarterly growth averaging 0.6 per cent is, consider this. Growth in GDP per person is averaging only about 0.2 per cent a quarter.

This gives annual growth in GDP per person of 1 per cent. (Huh? Four quarters of about 0.2 per cent adds up to 1 per cent? Yes. You can't just add 'em up, you have to allow for compounding - otherwise known as "interest on the interest", as in compound interest.)

To have GDP growth of 2.6 per cent, but growth per person of only 1 per cent, is a reminder of how fast our population is growing, and how much of our growth (almost invariably faster than the growth rates of those rich countries whose populations aren't growing much) comes merely from population growth – a point every economist knows, but few bother pointing out to the uninitiated.

And don't hold your breath waiting for any treasurer to point it out. To those guys, a big number is a big number – and what's more, it's solely the result of our government's wonderful policies.

But back to the reasons this week's news of further weak growth isn't as bad as it sounds.

The first is that annual growth of 2.6 per cent isn't a lot lower that our estimated "potential" (medium-term average) rate of growth of 2¾ per cent.

It's true, however, that we've been growing at below our non-inflationary potential rate for so many years we've acquired such a lot of spare production capacity (including unemployed and under-employed workers) – such a big "output gap", in econospeak - that we could and should be growing a fair bit faster than that medium-term speed limit of 2¾ per cent, until the spare capacity's used up.

Another indication things aren't a bad as they've been painted is Reserve Bank governor Dr Philip Lowe's statement that this week's figures give him no reason to revise down the Reserve's forecast that growth will strengthen to 3 per cent this year and next.

Why so confident? Because when you look into the detail of this week's results, you see more signs of strength than weakness. (From here on I'll switch to quoting the unsmoothed figures favoured by those who prefer the exciting confusion of noise to the boring wisdom of signal.)

First point is that "domestic demand" (gross national expenditure) grew over the year at the healthy rate of 3 per cent, meaning it was a fall in "net external demand" (exports minus imports) that caused growth in aggregate (domestic plus external) demand to be only 2.4 per cent.

The fall in the volume of "net exports" (exports minus imports) was caused mainly by a fall in exports, but there's little reason to believe this was due to anything other than temporary factors.

Turning to the biggest components of domestic demand, we've been worried that consumer spending wasn't growing strongly because of the lack of growth in real wages. But this week's figures show consumer spending growing by 1 per cent during the quarter and a healthy 2.9 per cent over the year.

Quarterly growth of 1 per cent won't be sustained, but an upward revision to the previous quarter's growth adds to confidence that household consumption is stronger than we'd believed.

All the increased employment is boosting household income, even if real wage growth isn't.

Business investment in new equipment and structures fell by 1 per cent in the quarter, but this was explained by another fall in mining investment (which falls are close to ending) concealing stronger than expected growth in non-mining investment (as estimated by Treasury) of 2.1 per cent in the quarter and 12.4 per cent over the year.

As Paul Bloxham, of the HSBC bank, summarises, "the key drivers of domestic demand – household consumption and non-mining business investment – were strong, and should drive a lift in overall growth in 2018".

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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.

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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.

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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".

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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  

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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.

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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.

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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.

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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.

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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.

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