Boards and managers responsible for reducing banks' value

Too few of us realise it, but we should thank God (and my new best friend, Peter Costello) for our independent central bank. Prime ministers and treasurers seem to say little that’s not point scoring, and Treasury is now highly politicised, but we can always rely on Reserve Bank governors to be frank about what’s happening in the economy and what should be happening.

Last week the latest of our straight-shooting governors, Dr Philip Lowe, offered his conclusions on the shocking revelations of the banking royal commission. His wise words are worth recounting at length, to be sure you don’t miss them.

As Lowe reminds us, finance is all about trust. The first line of the voluntary “banking and finance oath” (which more bankers should now be taking) says “trust is the foundation of my profession”.

Australian banks have a strong record of being worthy of the trust that is placed in them to repay deposits, but in other areas trust has been strained.

The royal commission has highlighted three issues where work is needed to restore the public’s trust. First, Lowe says, “the inadequate way in which banks have dealt with conflict of interest issues”.

Second, “the way that poorly designed incentive systems can distort behaviour – promoting a sales culture at the expense of a service culture, and promoting the short term at the expense of the long term”.

Third, “the fact that the consequences for not doing the right thing have, in some cases, been too light”.

Central to fixing these breaches of trust is creating a strong culture of service within our financial institutions, Lowe says. This starts with correcting the system of internal reward established by the board and management.

“The vast bulk of the people who work for Australia’s financial institutions do want to do the right thing, and they do want to serve their customers as best they can. But, like everybody else, they respond to the incentives they face.

“If they are rewarded on sales or short-term objectives, it should not come as a great surprise that that’s what they prioritise.”

In the minds of economists, incentives can be negative (sticks) as well as positive (carrots). “One of the things that influences incentives is the consequences and penalties that apply when something goes wrong.

“Strong penalties can play an important role in incentivising good behaviour, and this is an area we should be looking it.”

But it’s worth distinguishing between the penalties that apply for poor conduct and those that apply for granting loans that can’t be repaid, Lowe says. “On conduct issues, we should set our expectations and standards high, and if they are not met the penalties should be firm.”

With bank lending, however, it’s trickier. “Even when banks lend responsibly, a percentage of borrowers will end up in financial strife and be unable to meet their obligations.

“We need banks to be prepared to make loans in the full expectation that some borrowers will not be able to pay them back."

Get this: “Banks need to take risk and manage that risk well. If they become afraid to lend simply because of the consequences of making a loan that goes bad, our economy will suffer.”

So it does seem true that Lowe fears the banks will overreact to the punishment and tighter regulation imposed on them following the royal commission’s findings, and that this could lead to them crimping economic growth.

(Just how concerned Lowe is about this is something the media can only speculate about. Top econocrats will always be sotto voce, for fear a loud shout of warning may be self-fulfilling. The media trumpet dire predictions because they don’t imagine anyone will take them seriously.)

Back on the public’s trust, having clear lines of accountability can help. But “we should not lose sight of the fact that it is the banks’ boards and management that are ultimately responsible for the choices that banks make. Creating the right culture is a core responsibility of boards and management.”

One thing that would help, Lowe says, “is for financial institutions to a have a long-term focus and reflect that in their internal incentives. Managing to short-term targets might boost the share price for a while, but this short-termism can weaken the long-term franchise value of the bank.

“I would argue that the franchise value is more likely to be maximised if our financial institutions have a long-term perspective, treat their customers well, reward loyalty rather than take advantage of it, and invest in systems and technology that deliver world-class financial services . . .

“Doing this would not only be good for bank shareholders, but also for the broader community.” Well said.

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How about a Robin Hood carbon tax to combat climate change?

What does a public-spirited citizen do when a government makes a solemn commitment to do something important, but simply can’t come up with a policy measure to keep that commitment? Why, they come up with their own suggestion to fill the vacuum.

If you haven’t guessed, the government in question is Scott Morrison’s. The solemn commitment is our Paris agreement to cut our greenhouse gas emissions by 26 or 28 per cent from 2005 levels by 2030.

As part of his overthrow, the government backbench refused to accept former prime minister Malcolm Turnbull’s NEG – national energy guarantee – policy. But Morrison hasn’t been able to come up with a policy measure to take its place.

The public-spirited citizen – or citizens – are Richard Holden, an economics professor at the University of NSW, and Rosalind Dixon, a professor of law at the same uni (who just happen to be married).

This week the pair launched a proposal for an “Australian climate dividend plan” as part of the uni’s “grand challenge on inequality”.

The plan is for a carbon tax, levied at the rate of $50 per tonne of carbon dioxide emissions, not just from electricity generation, but also from transport fuels, direct combustion, fugitive emissions and industrial production processes.

The pair estimate the tax would raise net revenue of about $21 billion a year – and would, of course, raise the retail prices of electricity, gas, petrol, diesel, cement and various other products subject to the tax.

Not likely to be politically popular? Here’s the trick: the $21 billion would be returned to every Australian citizen of voting age, in the form of a tax-free “dividend” payment of about $1300 per person per year.

Because the amount of tax a person paid would vary with the amount of their consumption of taxable items (which, in turn, would vary roughly in line with the size of their incomes), but everyone’s dividend would be a flat $1300 a year, this would produce net winners and net losers.

Holden and Dixon estimate the average household would be a net $585 a year better off. The poorest 25 per cent of households would be better off by more than double that. The net losers would be people whose high spending on taxed items put them on incomes way above average.

Get it? The tax would be highly “progressive”, taking from the rich and giving to the poor. There need be no concern that low-income families would be adversely affected by the new tax. (This, BTW, is how the plan fits the “grand challenge on inequality”.)

And don’t forget this. Pollution taxes such as a tax on carbon are intended to encourage people to avoid paying them. How? By using or doing less of the undesirable thing that’s being taxed.

There are many ways a family could reduce the carbon tax it pays. Avoid wasting electricity and gas. When replacing household appliances, make the next one more energy efficient. Make your next car more fuel efficient.

And here’s an idea: why not generate your own power by putting solar panels on the roof? The higher cost of electricity from the grid would mean the investment paid for itself all the quicker.

In other words, an individual family could increase its net saving by paying less tax but still getting its $1300 annual dividend.

Of course, if too many people did that, the total amount of tax collected would be a lot lower and so the amount of the dividend would need to be reduced.

And, indeed, since the object of the exercise is to significantly reduce our carbon emissions, the tax’s ideal is that next to no one ends up paying it. The more successful the tax, the less it collects. If so, the dividend would start high, but gradually fall to zero.

Since the higher prices of the taxed products they produced would discourage their customers from buying as much, the carbon tax would also create an incentive for the affected businesses to find ways of reducing the emissions caused by those products.

Innovations that made this possible would be very valuable. One obvious way for electricity retailers to reduce the tax on their product (and hence, its price) would be to buy more renewable energy (whose generation involves few emissions) and less coal-fired energy (whose generation involves heavy emissions).

Underlying the economists’ preoccupation with “putting a price on carbon (dioxide)” is their concern that the greenhouse gases emitted by use of fossil fuels impose a cost on society - global warming – that isn’t reflected in the prices charged by producers of emission-intensive products and paid by their customers.

This means that, left to their own devices, the price mechanism and market forces will do nothing to discourage private sellers and buyers of these products from imposing the “social” cost of global warming on all of us.

In other words, emissions and other forms of pollution are outside the economy’s system of private prices. That’s why economists call them “externalities”. Because they’re a cost to society, they’re a “negative” externality. (An example of a “positive externality” is the small benefit to the rest of us when little Janey takes herself off to uni to get an education, which she does purely for her own (private) benefit.)

In econospeak, the point of “putting a price on carbon” is to “internalise the externality”. To get it into the prices charged and paid by private sellers and buyers. Why? To give them a monetary incentive to find ways to reduce the social cost their polluting activity is imposing on us.

In the absence of a carbon price, polluting coal-fired electricity has an undesirable price advantage over non-polluting renewables electricity. This is the economic justification for government subsidy schemes for renewables electricity and household solar power systems.

But Holden and Dixon remind us that, if we introduced their Robin Hood carbon tax, those subsidies would no longer be needed, saving governments (and often, other power users) about $2.5 billion a year.

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ALIGNING INSTITUTIONAL INCENTIVES WITH GOOD SOCIAL OUTCOMES

Talk to University of Sydney Association of Professors Symposium, Friday, November 23, 2018

The other day I noticed a tweet that was in the form of an incomplete statement, to be finished by the hearer: At the end of this course, students will be able to . . . The tweet suggested Socrates’ ending would be “know that they know nothing”. The education administrator’s response would be “I’m sorry, but that is not a measurable learning outcome”.

I want to give you an economic journalist’s perspective on the symposium’s question of What should Universities be? Economic journalists take a great interest in budgets, particularly the federal budget. Politicians are eternally conscious of the public’s unending demand for more government spending on 101 worthy projects, but – at least in the politicians’ belief - the public’s steadfast reluctance to pay the higher taxes needed to fund that higher spending.

By the late 1980s, the Hawke-Keating government realised that free university education – which had failed to achieve its goal of significantly increasing the proportion of students from low-income homes – could no longer be afforded, particularly because it involved taxpayers who had not benefited from higher education contributing to the education of students from better-off families gaining, at no tuition cost, an education that brought them significant private benefit in the form of higher lifetime incomes. In what I regard as one of the most important applications of applied micro economics in our times, Professor Bruce Chapman, of the ANU, invented what is properly know as the income-contingent loan, but we remember as HECS, an ingenious way of requiring students to contribute part of the cost of their education, without discouraging students from poor families from going to uni. The introduction of HECS and the advent of full-fee paying international students were the first steps in reducing the burden of universities on the federal budget. The Howard government greatly increased HECS and universities greatly increased their reliance on revenue from international students, with the government taking every opportunity to reduce its share of the cost of a growing local student population. Unis were freed to set their own fees for post-graduate degrees and diplomas, and have turned this into a “nice little earner”. If you remember, at one stage the Howard government even allowed unis to charge a full fee to local undergraduate students whose marks fell not too far short of the cut-offs applying to Commonwealth-supported places, until the incoming Rudd government put a stop to the practice.

The one development which didn’t fit the feds’ trend of expanding the universities’ revenue-raising capacity as a way of reducing their own contribution was Julia Gillard’s decision to relinquish the feds’ control over the number of funded undergraduate places for local students and allow them to be “demand driven”. This was part of a plan to greatly increase the proportion of school-leavers going on to higher education. To universities that had been under so much pressure to generate their own funding, this was like the opening of a great safety valve. The following years saw a huge increase in the number of undergrad places. My guess is that it was the second-tier and regional unis that did most to increase their numbers. When the demand for places had exceeded the government-limited supply of places, universities had used high ATAR cut-offs to select the brightest available students. Admittedly, when a policy decision is made that a higher proportion of each cohort should receive a university education, a reduction in entry standards is inevitable. But the abandon with which some universities dreamt up reasons for admitting students with limited qualifications has been, to coin a phrase, unedifying. It didn’t disguise the unseemly rush for money from the government’s open coffers.

What followed with the election of the Abbott government was, with hindsight, eminently predictable. The increased cost to the feds of demand-driven places was unsustainable, and the only answer was to reduce the proportion of feds’ contribution to undergrad places, while allowing the universities to cover this loss by deregulating fees. To me, it was impossible to not to see where this move was intended to take us: as unis progressively increased their fees, the feds would progressively reduce their contribution to teaching costs until the cost of university teaching was completely off the federal budget, leaving only the cost of the HECS loan scheme and the cost of research funding. As the Group of Eight used their pricing power to really ramp up their fees, changing students a premium for their greater social status and more centrally located and better-appointed campuses, and using that premium to subsidise their research effort, it might be possible for the feds even to cap their contribution to research costs. The more the sandstone unis ramped up their fees, the more scope they would create for second-string unis to raise their fees, even if to a much lesser extent. The claim that market forces would prevent unis from abusing their pricing power was naive economics. The existence of HECS meant the price students were paying was government-subsided and of uncertain size over the distant future. Universities of lesser reputation or regional location would be unlikely to compete by charging a lower price than other second-string universities because the difficulty of knowing the quality of their degrees before actually undertaking them meant students would use price as an indicator of quality. Thankfully, fee deregulation was blocked by the Senate. The Coalition government has since tried to make savings in other ways, finally succeeding in abandoning the demand-driven system and capping the number of Commonwealth-supported places. I’m not sorry to see an end to the demand-driven approach. It created the perverse incentive of encouraging unis to get more funding by further lowering their entry standards.

What this story amounts to is that, for the past 30 years, successive federal governments have worked to get university funding off the federal budget. Although it’s possible to point to snippets of economic fundamentalist thinking – eg competition between universities would prevent them from abusing their right to set their own fees – there’s been no government report that has recommended such a policy and I don’t believe it’s the result of some grand “neoliberal” conspiracy. Rather it’s been an undeclared, unplanned, backdoor privatisation of the universities. I believe it’s happening in an ad hoc way as Treasury and Finance have looked at each year’s budget and tried to find ways of reducing the deficit by saving money here and saving a bit more there.

Because it’s not genuine privatisation – because universities remain government-owned agencies, subject to quite a high degree of regulation by the federal Department of Education and Training; because university education is in no meaningful way a market in which profit-making universities compete against one or two formerly government-owned unis – this backdoor privatisation has left universities rudderless, with no boss to report to, no simple objective of maximising profits, no one telling them what their objectives should be. University leaders have found themselves overwhelmingly preoccupied with a task their academic careers have not prepared them for and for which there’s no precedent to follow: raising sufficient revenue to fund their ever-growing establishments. Little way of knowing how to find the best trade-off between the funding imperative and the maintenance of traditional standards of teaching and research, let alone such airy-fairy notions as the pursuit of knowledge just for its own sake.

Little wonder then that so much of universities’ present performance is open to criticism.  My greatest fear is that a university degree is not as valuable, not as rigorous, not as life-changing and life-preparing as it used to be. That gaining a university degree has become more like being processed through a sausage factory, with ever declining staff-student ratios, with lecturers who have far less personal interaction with their students, lecturers who are rewarded for gaining research funding by being give money to pay some part-timer to take their place in lectures (another perverse incentive), with videoed lectures placed on websites so that students don’t have to physically turn up, with assignments and exams that are easier to pass, with essay assignments that aren’t marked with comments as conscientiously as they should be, with informal quotas on how few students may be failed and informal rules on how vigorously widespread plagiarism should be detected and punished.

I worry that the period of demand-driven open slather, combined with overly ambitious parents and universities’ eternal quest for more funding, has led to too many not-particularly-academically-inclined young people going to uni when they would have been better served going to TAFE.

I worry that, heightened by the Howard government’s perverse attack on compulsory student unionism, universities have become places you visit between your employment obligations, not places you hang around most days, debating incessantly with your friends.

I worry that too many international students are paying big bucks for degrees than haven’t taught them as much as they should have. Like many others, I worry that universities have become too dependent on revenue from international students, particularly from China. In the longer term, this revenue source will diminish as Asian countries get more universities of their own. In the short term, unis could be hard hit by a sudden deterioration in relations between Australia and China.

I worry that universities have become bad employers, mistreating young people seeking an academic career by keep them on successive short-term contracts when they should be given permanency. I worry about professors who take advantage of their young helpers’ job insecurity.

I worry that in their newfound search for a lodestar, universities have settled on key performance indicators, debatable measures of academic effort and excellence and, above all, international university rankings, most of which value research excellence more highly than teaching excellence. The trouble with relying on such “metrics” is that they too often create perverse incentives, and are too easily gamed, not just by staff but by university leaderships themselves. I accept the value of the universities’ contribution through research. But research effort whose primary objective is to gain promotion, or to get the university a higher league-table ranking, may not be research that’s worth taxpayers paying for.

So, what can be done to better align institutional incentives with good social outcomes? One good outcome is students who’ve been taught to think critically, whose outlooks and values have been broadened beyond those they got from their families, and who have been left with inquiring minds and a love of learning. Another good outcome is research motivated by a genuine spirit of inquiry, rather than as a means to the end of promotion or higher ranking on league tables. Yet another good outcome is vice-chancellors unafraid to proclaim to the world that a primary objective of their university is knowledge for its own sake. Vice-chancellors willing to argue that humans have always been an inquisitive animal, and that the richer we become the more we can afford to indulge – yes, indulge - our curiosity. That learning is an end in itself, not just a means to better jobs and higher incomes.

How can we better align incentives with good social outcomes? For a small start, politicians should stop encouraging the unhealthy obsession with league tables by boasting about well we’re doing. I believe it is reasonable to require students to bear part of the cost of their tuition (at present, about half), particularly because of use of HECS-style concessional arrangements for repayment. But I don’t believe it’s reasonable to require students, rather than taxpayers, to contribute to the cost of university research. The Productivity Commission has already pointed out that students whose course puts them in the top tier for HECS payments – such as law and business students – are being required to make such contributions. The Productivity Commission has also pointed out that the universities’ preoccupation with international league tables is also motivated, at least in part, by a desire to attract more international students and be able to charge them higher fees. This is not healthy.

The logical implication of all I’ve said is that federal governments should abandon and reverse their covert ambition to get universities off their budget. Government’s should bear more of the cost of universities, and be braver in asking voters to pay higher taxes as a consequence. Politicians would be assisted in this if there was greater confidence by voters that youngsters going to university were being well taught. Inevitably, any significant increase in public funding is likely to come with strings attached. At least in principle, I’m not sure it would be a bad thing for universities to have their owner and paymaster give them a clearer indication of what the community requires universities to be. In practice, however, greater central regulation may not be as sensibly done as we would like.

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Why Morrison has changed his tune on immigration

Wow. And you thought the punters had no political power. Scott Morrison’s change of tune on population growth – following on the heels of NSW Premier Gladys Berejiklian – will please a lot of ordinary voters and enrage big business.

Be clear on this: almost to a man or woman, the nation’s business people, economists, Coalition politicians and Labor politicians have long believed in high rates of immigration, going back to the days of “populate or perish”.

They still do. They’ll have one dismissive, contemptuous word for the Liberal Party’s seeming backflip – “populism”.

By contrast, the public has long had reservations about immigration, going back to Chinese joining the gold rush and, as the movie Ladies in Black reminds us, to post-war resentment of “reffos” (not to mention dagoes and wogs).

It’s quite possible Gladys had a word in the ear of Scott, but I have no doubt both are reacting to results from their party’s private polling and focus groups. (If so, Labor politicians would be getting a similar message.)

That would explain their changed thinking on the topic. Their sudden sensitivity to popular opinion may be explained also by the proximity of elections in Victoria, NSW and federally.

Morrison is nothing if not direct. He’s left no doubt that this is a Sydney and Melbourne special. In the reduction in the size of the annual national permanent migration program he says he expects to emerge from the review, NSW and Victoria may wish to have fewer migrants, while other states may wish to have more.

Whether such picking-and-choosing is practically possible will be a matter for the experts to debate. Sydney and Melbourne are natural entry points of migrants. They have more jobs going, and immigrants are more likely to have relatives, friends and communities already established there. The two big cities’ businesses are likely to want to sponsor more skilled workers.

Before we leave elections, a cautionary tale from the 2010 federal election. Early that year, Kevin Rudd brought forward the next Intergenerational Report, showing the population was projected to reach 36 million by 2050. Rudd proudly proclaimed himself a Big Australia man – which, among other benefits, would give Australia (and him) more clout at international forums.

Then came the backlash. By the time of the election in July, both Julia Gillard and Tony Abbott were loudly proclaiming their opposition to Big Australia.

But here’s the point: after Gillard’s election in 2010 and Abbott’s in 2013, nothing was heard again about the evils of Big Australia. Immigration continued on its merry way.

If the public has always had reservations about immigration, what’s brought matters to a head?

Again, Morrison is direct. Though population growth has played a key role in our economic success, he says, “I also know that Australians in our biggest cities are concerned about population. They are saying: enough, enough, enough.

“The roads are clogged, the buses and trains are full. The schools are taking no more enrolments. I hear what you are saying. I hear you loud and clear.”

So, in a word, resentment over congestion has brought simmering disapproval to a rolling boil.
But I suspect there’s a further factor.

Because the establishment’s enthusiasm for high immigration has always been at odds with the public’s instincts, there was for many years a tacit agreement between both sides of politics not to wake up the question of immigration.

Want to know why this nation of immigrants has never had a formally established population policy? That’s why. (I know because once, during the Fraser government’s time, I wrote in my naivety that we needed a great big debate about immigration and population. The immigration minister immediately slapped me down, almost accusing me of racism.)

That bipartisanship has broken down as politicians realised there were cheap votes to be had by echoing the public’s objection to “too many Asians”. When asylum seekers started arriving by boat, it was on for young and old between the parties.

John Howard allowed very high levels of immigration during his almost 12 years in office – the population was growing by 2 per cent a year at the end of his reign – but the public’s disapproval never boiled over.

Why not? Perhaps because traffic congestion wasn’t as bad as it is today. But my theory is that, while coping with the genuine problem of boat people, Howard also used them to draw the public’s attention away from high levels of conventional immigration. Sometimes you even hear political candidates claiming its boat people who are clogging the roads.

But now there are no boat people arriving – not, we belatedly discover, because none are setting out, but because of our navy’s success in turning them back – this diversionary tactic is no longer available. The voters’ ire turns back to ordinary immigrants.

But what of the much-touted economic benefits of immigration? Business people want a bigger population because having more people to sell to is the easiest way to increase their profits. But that doesn’t necessarily leave you and me better off.

The traditional fear that immigrants take our jobs is wrong – they add about as much to the demand for labour as to its supply.

Immigration does slow down the ageing of our population, but most of the other efforts to show how much benefit it brings the rest of us rest on economic modelling exercises using convenient assumptions. I hae ma doots.

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Benefits from big data at risk from untrustworthy politicians

The digital revolution holds the potential to use mere “data” to improve the budget and the economy, and hence our businesses and our lives. But you have to wonder whether our politicians are up to the challenge.

In a speech last week, the Australian Statistician, boss of the Australian Bureau of Statistics, David Kalisch, said the new statistical frontier is “data integration” – you take two or more separate sets of statistics and put them together in ways that reveal new information. Things you didn’t know about how bits of the world work.

This is just exploring the huge, still largely untapped potential of computers to manipulate a lot of figures and produce useful information about what’s going on in this field or that. But it also involves new statistical techniques for combining data in ways that make sense and don’t mislead.

(This, BTW, raises a bugbear of mine. Digitisation, which allows us to measure any number of aspects of a company’s performance cheaply and easily, has given rise to the enthusiasm for “metrics”. But bosses who allow their metrics to be chosen and presented by people who know a lot about IT but nothing about the science of statistics, or who draw conclusions from those metrics without any knowledge of stats, are asking to be led up the garden path. They never know when the metric is answering a different question to what they imagine.)

Kalisch says data integration is already delivering new insights, such as improved estimates of Indigenous life expectancy, understanding outcomes for successive cohorts of migrants, and the importance of small to medium enterprises for job creation (not as outstanding as the propaganda would lead you to expect).

There’s much more of that kind of thing we could do. But Kalisch points also to the considerable untapped potential to use data integration to assess the performance of government policies and programs, and thus to target budget funding to programs assessed as more likely to be effective.

Kalisch says “Australia does not have a strong tradition of rigorously evaluating outcomes of government programs and policies”. That’s putting it politely. The Americans do (because Congress insists on it) and so do many other countries – even those backward and poverty-stricken Kiwis do.

Why don’t we? Because too many ministers and department heads fear the embarrassment if rigorous assessment showed a program was a waste of money, as many would. And also because Treasury and Finance don’t bother pushing it – perhaps because program evaluation costs money upfront, and only saves money down the track.

But that’s only one reason we risk failing to exploit all the benefits of big data analysis. The biggest is the very real probability bully-boy politicians and over-zealous agency heads try to ram through data aggregation schemes over the worries of people concerned about breaches of their privacy.

Consider the hash they’re making of My Health Record where, among other things, the instigators are relying more on slick ads than honest explanation. Consider the long running attempt by the masterful Alan Tudge, the department and the Centrelink PR man to deny there was any problem with robodebt, until the full extent of the fiasco – and the hurt it caused many innocent victims – could no longer be concealed.

Then consider the way Tudge used the shield of Parliament to reveal very private information about a woman who'd had the temerity to criticise him. And he escaped uncensured.

Such episodes, and many years of spin doctor-led politicians playing the true-but-misleading game, have hugely reduced the public’s trust in politicians and their happy assurances that nothing could possibly go wrong.

We stand on the cusp of reaping huge benefits from data analysis, or stuffing it up so badly the electorate punishes any government that touches it.

Part of this is the risk that government penny-pinching doesn’t give the data gatherers enough funding to install adequate privacy safeguards, or enough resources to respond honestly and adequately to the public’s questioning.

But that’s just part of a bigger money question: data integration isn’t particularly dear relative to the benefits of greater understanding, better public policy and more effective government spending it offers, but that doesn’t mean the pollies have the sense to cough up.

Operational funding of our bureau of statistics has been cut by 30 per cent in real terms over the past decade, by governments of both colours.

An independent benchmarking exercise in 2016 found that our bureau’s funding was about half the funding provided to Statistics Canada for roughly equivalent work. Even New Zealand’s official statistician got more than ours did. Smart thinking.

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How the banks lost our trust - and how they can get it back

Where to now for the big four banks, AMP and some other big businesses? They’ve abused the trust of their customers and the public, and it will be a long time before any side of politics wants to be seen as going easy on them.

Of course, the banking royal commission isn’t over. We’ve yet to see what punishments it recommends be imposed and what tightening of regulation, and then what the next government decides to do in response.

But if the nation’s chief executives have any gumption, they won’t wait for all that before turning their minds to why their customers’ trust was lost, and how they can go about getting it back.

This week the Academy of the Social Sciences in Australia held a symposium in Canberra on regenerating integrity and trust in Australian institutions. Professor Leon Mann, a psychologist from the University of Melbourne, and Associate Professor Nicole Gillespie, a management expert from the business school at the University of Queensland, spoke about trust from a business perspective.

Gillespie drew on a major study she conducted with three other academics, Designing Trustworthy Organisations, published by the MIT Sloan Management Review.

Although companies that suffer a loss of trust often blame “rogue employees” or “a few bad apples,” Gillespie and her colleagues’ research shows that major violations of trust are almost never the result of rogue actors.

Rather, they are predictable in organisations that allow dysfunctional, conflicting or incongruent elements of their system to take root. It’s the barrel that’s rotten.

Often the incongruence that led to the loss of trust was the development of a company strategy that favoured the interests of one stakeholder group while betraying those of others.

“This problem has often been defined as letting shareholder profits take precedence over core responsibilities to other stakeholders (such as employees, customers, suppliers or communities),” the study says.

And it’s not just favouring one stakeholder over the others, it’s doing so at the expense of the others, and even causing harm to them.

Bang on. How did those guys know about our banks?

They note that a US Senate committee investigating the global financial crisis was very critical of Goldman Sachs, whose stated values of client focus and integrity were at times overshadowed by a less formal culture that emphasised getting deals done with less than full disclosure (to the mugs on the other end of the deal).

Good point. Trustworthiness has to be embedded into every aspect of the business’s strategy, structure, processes and systems. But there are formal ideals and rules, and then there’s always an informal culture. The two must be “congruent” – they must fit together.

When the rules say one thing, but the pressure from your supervisor says something different, most employees soon realise what the boss, and the boss’s bosses, really want.

“Our research suggests that the key differentiator between companies that violate trust and those that sustain it is integrity and consistency within and across the organisation,” the study says.

So how can a company that’s lost its customers’ trust get it back? The good news is that when years of untrustworthy behaviour reach crisis point, this can create the impetus to really turn things around.

You need to start with a credible, rigorous and independent investigation of the weaknesses in the system that caused the problem.

“Companies are often so concerned with appearance and damage control that they are unwilling to engage in the degree of examination required to root out the entrenched causes of trust violations,” the study says.

For instance, BP allowed its Texas refinery explosion in 2005 to be followed by the oil spill in the Gulf of Mexico in 2010. News Corp had an employee jailed for phone hacking in 2007, but endured another phone-hacking scandal in 2011.

Next, since trust failures are typically systemic, the organisational reforms need to be systemic as well. Structures, systems and processes should be the first point of intervention because they’re relatively easy to design and change.

However, such interventions by themselves are unlikely to produce sustainable change. “The more difficult challenges involve making changes to the organisation’s culture, strategy and leadership and management practice.

“Indeed, adding training in ethical conduct probably won’t affect organisational behaviour in any meaningful way if supervisors, workplace norms and performance management objectives continue to encourage questionable activities,” the study says.

Finally, evaluation. Even when a trust crisis recedes, old habits have a way of returning. Reforms must be evaluated to ensure they are working as intended, and any shortfalls are addressed.

“Because it takes time to change systems and deep change is hard to realise, in some respects the most important part of trust repair is the ongoing assessment, learning and course correction required to build authentic, sustained trustworthiness.”

Wow. How easily Australia’s story fits into the academics’ generalised framework.

I think the main reason our banks ran off the rails is that they got locked into an utterly inward-looking game in which each of the four players competed to see who could raise their profits the most.

To this end, they gave their senior people incentive schemes and their junior people key performance indicators aimed solely at increasing profits. The targets set were so demanding they implicitly encouraged staff to ignore the company’s stated values and bend rules that stood in the way of achieving the target and pleasing the boss.

Bosses can’t have failed to notice the questionable practices this gave rise to, but they looked the other way for fear of falling back in the profits comp.

They attempted to justify this by claiming company law required them to put shareholders’ interests first. They failed to mention that, by exploiting and using up the trust of their customers, they were putting shareholders’ short-term interests ahead of their long-term interests – a short-sightedness company law never required of them.

The price bank shareholders are paying for the mistreatment of bank customers is now apparent.

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The price we pay for funding schools based on religion

You can tell we’ve had generational change among our federal leaders when the latest prime minister through the revolving door knows to pronounce the “d” in congratulations. No doubt he’ll have many impordant things to say to us.

So far, the message seems to be that he’s just an ordinary, fair dinkum, baseball cap-wearing, pie-eating, beer-swilling kinda guy. Egalitarianism is back and Jack is as good as his prime minister.

Or maybe not. A great disappointment with the Coalition government is the failure of its attempt to have a second run at the Gonski reforms proposing needs-based, sector-blind funding of schools.

Gonski was our chance to do something other countries did decades ago: remove sectarianism from federal and state funding of schools. To stop determining how much government funding a child receives according to the religious affiliation (or lack of it) of the school attended. Need should be the only criterion, regardless of religion.

Julia Gillard threw a lot of taxpayers’ money at the reform to avoid conflict with non-government schools, but couldn’t pull it off. She ended up doing side deals with the Catholic schools and other groups.

Malcolm Turnbull’s reworking of Gonski seemed to be more principled, but the Catholic hierarchy kept the pressure up – we want to share the money our way, not your way – and the government buckled. The Catholics got their special deal and the (mainly Protestant) independent schools got something similar to stop them kicking up.

What a country we live in. We can happily agree to same-sex marriage, but when Catholics put the frighteners on, politicians on both sides get weak-kneed.

Some relevant information has just arrived from Paris. A report from the Organisation for Economic Co-operation and Development has used its PISA worldwide testing of 15-year-olds on maths, reading and science to assess progress on Equity in Education.

Prime ministers love boasting about our economy’s high standing in the world, so how about this: Australia now has the equal-fourth most socially stratified education system among the OECD’s 35 member-countries.

Only Mexico, Hungary and Chile can claim to have a more social class-segregated school system than ours. For a country that still likes to think of itself as class-free, that’s quite an achievement.

The report classifies students according to their parents’ socio-economic status, taking account of economic, social and cultural factors. Socio-economically disadvantaged students are those in the bottom 25 per cent of students in their country. Socio-economically advantaged students are those in the top 25 per cent.

Similarly, socio-economically disadvantaged schools are those in the bottom 25 per cent of the distribution of schools, based on the average status of their students.

If all schools perfectly reflected the socio-economic composition of the total population, each school would have 25 per cent of students in the disadvantaged category, 25 per cent in the advantaged category and the rest in between.

Of course, no country’s schools are anything like that lacking in social stratification. In Australia, however, the proportion of disadvantaged students attending disadvantaged schools is not 25 per cent, but double that: 51 per cent.

By contrast, the proportion of disadvantaged students attending advantaged schools is not 25 per cent, but 4.6 per cent.

The report also measures the change in the proportion of disadvantaged kids in disadvantaged schools between 2006 and 2015.

On average, it fell a fraction, with 22 countries improving and 13 getting worse. Another international distinction for Morrison to boast about: we won silver with a worsening of 5.2 percentage points. Only the Czechs did worse.

But why does it matter if our schools become more socio-economically stratified?

It matters because, on average, disadvantaged students attending disadvantaged schools don’t do as well as they would if they attended advantaged schools.

Such students face a double disadvantage: one coming from their parents’ circumstances and another from the less conducive learning environment at school.

Trevor Cobbold, of Save Our Schools, says information published by the OECD in June shows disadvantaged schools (95 per cent of which happen to be public schools) have more students per teacher, more teacher shortages, more teacher absenteeism and more poorly qualified teachers.

It matters because it helps show the price we’re paying for decades of funding schools on the basis of religion rather than need. The Kiwis stopped doing that ages ago, and they have the fourth lowest proportion of disadvantaged students at disadvantaged schools.

It matters if you don’t want what we’ve got: a yawning gap between our strongest students and our weakest.

It matters because it has broader implications for society. “Social segregation in schools breeds social intolerance in communities and workplaces and undermines social understanding and cohesion,” Cobbold says.

“Schools segregated by class make it more difficult for children to develop a real understanding of people of different backgrounds and to break down barriers of social intolerance.”

And then we wonder why politics is getting more polarised.

Of course, many factors besides schools are contributing to the growing social stratification of our cities. But schools are something we can influence by adopting better policies.

And if you believe in equality of opportunity, the first thing you fix is schooling. As the OECD says, “children from poor families often have just one chance in life, and that is a good school that gives them an opportunity to develop their potential.

“Those who miss that boat rarely catch up.”

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HOW ECONOMICS DEALS WITH INTEGRITY, CORRUPTION AND TRUST AND CONTRIBUTES TO IMPROVING THEM

ASSA Symposium on Trust in Australian Institutions, Canberra, Tuesday, November 13, 2018

I’m not at all sure I’m the right person to be speaking on behalf of economists on the question integrity, corruption and trust. My accustomed role is to provide outsiders with a critique of economics and economists, whereas academic economists tend to be quite defensive. So I can’t promise you that most economists would agree with all I say.

The plain truth is that, historically, trust has not been an issue of central concern to economists. Their workhorse model of markets takes for granted a high level of trust between buyers and sellers, producers and consumers. Only as economists have become aware that levels of trust seem less than they were have they become more conscious of the economic value of trust and trustworthiness to the smooth functioning of the economy or, to put it the other way, of the greater costs that are incurred when, for example, it can’t be taken for granted that everyone walking away from an airport luggage carousel actually owns the bags they’re carrying. At the macro level, economists have found some evidence of correlation between high levels of trust, or low levels of corruption, and higher rates of economic growth. Over the past 20 years or so a small number of economists – prominent among whom is Luigi Zingales of the Booth School of Business in the University of Chicago – have been studying trust but, on my reading, their findings are still at an early stage. The field of public choice theory, earlier led by James Buchanan and Gordon Tullock, and the associated literature on rent-seeking, has done much to explain the incentives that create risks of corruption among politicians and senior bureaucrats, and institutional corruption, including regulatory capture.

But now I want to turn from academia to the contribution of economic practitioners, particularly econocrats. The OECD has established Trustlab, to collect and improve measures of trust, so as to understand what drives it and how policymakers can attempt to restore it. So far it has data from seven countries measuring interpersonal trust, trust in immigrants and people from another religion, as well as trust in institutions such as parliament, government, the judicial system, the police, the media and financial institutions. It finds levels of trust in other people and in government rise with levels of education and income. Perceptions of high-level government corruption and government reliability and responsiveness are the strongest determinant of trust.

The Productivity Commission’s report, Shifting the Dial, noted survey evidence that the majority of Australians do not have trust or confidence in government, and that the degree of trust has fallen significantly. A recent speech by the chairman of the ACCC, Rod Sims, acknowledged a significant amount of law-breaking by companies. 

But now let me give you my own views. I believe that much of our loss of trust in governments, the banks and business is justified, because there has been a deterioration in the vigilance of regulators and the behaviour of businesses. Some part of this may be explained by failures in the experiment with the deregulation of many industries which, it was expected, would lead to increased economic efficiency – to the benefit of customers - without any change in standards of honest dealing with customers. Unfortunately, heightened competition in markets may sometimes lead to a race to the bottom, in which firms feel under pressure to adopt the questionable practices of their rivals, or are reluctant to be the first to give up such practices for fear of losing business to less scrupulous rivals. Regulatory bodies were quietly encouraged to be more conciliatory and less aggressive. Often their funding was cut. It may be no coincidence that the surprising number of allegations of “wage theft” in recent years came after the reduction of unions’ right of entry to the workplace, including their right to check wage records to ensure industrial awards were being adhered to.

It’s predictable for a decline in the public’s trust in firms to treat their customers fairly to be followed by demands for greater government regulation of business behaviour. I have sympathy for such calls, but economists know that using regulation to achieved improved behaviour can easily involve unintended adverse consequences, which add more to costs than they do to improve outcomes. In his interim report, the banking royal commissioner noted that most of the misconduct he had uncovered was already unlawful, suggesting that a raft of new laws was not needed. Rather, he implied, a better approach would be for regulatory bodies to enforce the existing laws with greater diligence. This might well involve them being given greater funding to do so.

There is an amoral calculation in economics which says that a “rational” decision on whether to break a law involves weighing the expected benefit from doing so against the expected cost of doing so, which is the amount of the penalty multiplied by the probability of being caught. Since the probability of apprehension is usually low, penalties need to be high – much higher than at present - for the deterrent to be effective. Sometimes economists, who are used to reducing everything to monetary calculations, forget that penalties involving a jail term, however short, may be a far more effective deterrent.

At this stage in the discussion business people retort that you can’t legislate to make people honest. This is only half true. If you make the expected penalty high enough, you will induce businesses to change their behaviour. And behavioural economists have learnt from social psychology that if you can bring about a change in people’s behaviour, they will seek to reduce their cognitive dissonance by changing their beliefs to fit with their new behaviour. This tells me it is possible to change group norms of acceptable behaviour – what today is called “business culture” – for the better. Were that to happen, it’s reasonable to hope that the public’s trust in our economic institutions could eventually return.

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The G20 is a talkfest we need to keep talking

If it’s 10 years since the global financial crisis, it must be 10 years since the elevation of the Group of 20 to the status of a “leaders’ summit” – the next of which will be in Buenos Aires in two weeks’ time.

You could say the decision to supplant the G7 with the G20 as the premier forum for global economic co-operation is the one good thing to come out of the financial crisis.

The G7, like the various international bodies set up after World War II, is too Western and Eurocentric, being limited to rich North America, Europe and Japan.

The G20, by contrast, adds in the developing countries and all parts of the globe, encompassing the G7, all five permanent members of the UN Security Council and all five emerging-economy BRICS – Brazil, Russia, India, China and South Africa.

And did I mention it gives Australia a seat at the top table for the first time?

While the G7 accounts for only about 30 per cent of the world economy (measured according to purchasing-power parity), which is projected to have fallen below a quarter by 2040, the G20 accounts for almost 85 per cent of the world economy, which should still be about that in 2040.

The G20 also accounts for 84 per cent of global investment and 63 per cent of the world’s population.

The rich and poor worlds could have spent years arguing over the formation and composition of such a group, but in the heat of the financial crisis, no one doubted that a representative but not unwieldy whole-world body was needed to quickly achieve a co-ordinated response to the threat of a global depression.

The avoidance of such a calamity is all the proof anyone should need that the G20 has justified its existence.

At the time of the crisis, the G20 achieved co-ordinated discretionary fiscal (budgetary) stimulus averaging more than 2 per cent of world GDP in both 2009 and 2010.

It tripled the International Monetary Fund’s lending capacity and facilitated an increase in lending from multilateral development banks of $US 235 billion, at a time when private sector sources of finance were scarce.

Later, it established the Financial Stability Board to tighten up regulation of the world's financial institutions, including banks judged too big to fail.

It’s also working with the OECD to reduce tax avoidance by multinationals, through its BEPS project – base erosion and profit shifting – and having more success than many imagined it could.

But if you want to argue that, in the years since then, the G20 has done a lot of meeting, talking and passing of resolutions without achieving all that much, you wouldn’t be wrong.

You would, however, have missed the point. Do you imagine this was the last economic crisis the world’s leaders will have to cope with? Or that the next crisis is sure to be decades away?

As Scott Morrison’s G20 “sherpa” (every leader ascending summits needs the assistance of a personal sherpa), Dr David Gruen, said in a recent speech, the G20 is best thought of as an institution that comes into its own when it’s most needed - “more a ‘rough weather’ friend than a ‘fair weather' friend".

It is, he says, like a global fire department. It may sit around for days not doing much, but as soon as the need arises it rushes off to put out the conflagration.

What gives the G20 its fire power is its status as a “leaders’ summit” – all G20 leaders attend summit meetings, almost without exception. And when they attend, they talk to each other, just as Donald Trump and Xi Jinping are scheduled to have a meeting on the sidelines at the summit in Argentina, no doubt to chat about their little trade war.

Let me ask you, which would you prefer – world leaders who knew each other and talked regularly, or leaders who didn’t?

The more meeting and chatting they do, the safer the rest of us are.

Gruen reminds us it was the legendary American economist Thomas Schelling who realised international conflicts can arise simply because one side can't understand what’s eating the other side. That messages sent in public may differ from messages sent in private.

A book Schelling wrote led to the installation of the hotline between the White House and the Kremlin. The annual G20 summits are a big step up from that. Nor does it hurt to have the countries’ finance ministers and central bankers meeting regularly.

With Trump’s America behaving so crazily, picking fights with its allies and major trading partners and threatening the rules-based international order the Americans laboured so long to build, we need the G20 to hang together and keep our leaders talking to each other more than ever.

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Services are taking over the economy – despite the politicians

One test of whether our political leaders are looking to the economy’s future or clinging to its past is whether they show an understanding that most of our future lies in the services economy.

Whether they hanker for an economy where most people earn their living by growing things, digging things out of the ground or making things.

Probably only the dearly departed Malcolm Turnbull passes this test, with his early enthusiasm for innovation and agility. Kevin Rudd said he didn’t want to be the leader of a country that didn’t make things. Scott Morrison took a lump of coal into the Parliament to show where his allegiances lay.

But as the Organisation for Economic Co-operation and Development reminds us in its latest report, the shift from producing goods to performing services is fundamental to the process of economic development.

Every country’s economy starts on the economic development journey with most people working on the land, and others in mines. That’s where we were in the 19th century. About a hundred years ago, the great migration from the country began, with more and more people moving to the city to work in factories.

By 1971, employment in manufacturing had reached 1.4 million workers. Manufacturing’s share of total employment in Australia reached 25.5 per cent a little earlier in 1966.

But from that period on, employment in manufacturing began to decline, both in absolute numbers and as a share of the total.

It – and employment in the other goods industries: agriculture and mining – declined as a share of the total simply because employment in the services sector grew much faster.

So, for at least for the past 50 years, it’s services that have been going up while goods industries have been going down. That’s true whether you look at shares of total employment or shares of total production (gross domestic product).

When you turn to the absolute numbers of workers, they’ve been declining in agriculture for more than a century. Today, just 325,000 people work on the land.

In manufacturing, they’ve been falling since 1971, to be down to 980,000 today.

Mining employment got a fillip from the resources boom, but even its job numbers have resumed their decline since 2013, and are now down to 245,000 – or just 2 per cent of our total employment of 12.6 million.

There’s nothing peculiarly Australian about this move from farming to manufacturing to services. You can see just the same progression in other rich economies and in “emerging” (that is, rapidly developing) economies.

It’s been unfolding before our eyes in China since it began opening its economy to the world in the late 1970s. It was all the people leaving its farms to work in city factories that, a few years ago, took the proportion of the world’s population living in urban areas to more than half.

Returning to Oz, don’t get me wrong. Some of us will always be working in the goods part of the economy. That’s particularly true of Australia because, though we’ve never been great shakes at manufacturing, we have had, and will continue to have, a comparative advantage in agriculture and mining, relative to other countries.

Note this: though the number of people working in the three parts of the goods sector has been falling, that doesn’t mean we’re growing less food or digging fewer minerals. Our annual production of food and minerals and energy is greater than ever. Even in manufacturing, our annual production has been falling only since 2008.

How can production go up while employment goes down? Easy. Increased productivity of labour caused by automation – technological advance. The use of more and better machines has made farming, mining and manufacturing more “capital-intensive” and so less “labour-intensive”.

That’s the thing about the goods side of the economy: it’s relatively easy to use machines to replace men (and women). And this isn’t bad, it’s good – for two reasons. First, it’s helped make goods cheaper, thus making us more prosperous.

Second, it’s much harder to use machines to replace workers delivering services. Robots will change this to an extent, but by not nearly as much as the alarmists claim.

And it’s not hard to think of more services we’d like other people to do for us. That’s why total employment is higher than it’s ever been. And why further growth in services’ share of total employment and production is inevitable and inexorable.

Where will the new jobs be coming from? That's where.

The OECD report tells us that, in 2014, the goods sector’s share of production was down to 17 per cent (agriculture 3 per cent, mining 6 per cent, manufacturing 8 per cent), with the services sector’s share up to 83 per cent – about average for the OECD.

Within services, the biggest industries are: business services, 14 per cent of GDP; wholesale and retail trade, 10 per cent; financial services, 9 per cent; construction, 8 per cent; health and aged care, 7 per cent; education 5 per cent and defence and public administration, 5 per cent.

A favourite argument the goods industries use to exaggerate their importance to the economy is to point to their higher share of exports (a widget sold to a foreigner is more virtuous than one sold to a local, they claim).

A third of all our agricultural production is exported. For manufacturing it’s more than a quarter (bet you didn’t know that) and for mining it’s more than 90 per cent. For services it’s a mere 11 per cent.

This means that, as usually measured, agriculture contributes 8 per cent of total exports; mining, 40 per cent, manufacturing 26 per cent, and services, 26 per cent.

Education of overseas students is now our third biggest export, after iron ore and coal. Tourism is the other big one.

But the OECD points out that the goods we export have inputs of services embedded within them. Allow for this and agriculture’s share of total export “value-added” drops to 5 per cent, mining’s to 30 per cent and manufacturing’s to 13 per cent, while services’ share rises to an amazing 52 per cent.

Services are taking over the economy. Live with it.

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