It's the budget, not interest rates, that must save the economy

According to a leading American economist, there are two views of the way governments should use their budgets ("fiscal policy") in their efforts to manage the macro economy as it moves through the business cycle: the old view – which is now wrong, wrong, wrong – and the new view, which is now right.

In late 2016, not long before he stepped down as chairman of President Obama’s Council of Economic Advisers and returned to his job as an economics professor at Harvard, Jason Furman gave a speech in which he drew just such a comparison.

I tell you about it now because, with our economy slowing sharply, but the Reserve Bank fast running out of room to cut its official interest rate so as to stimulate demand, it’s suddenly become highly relevant.

Furman says the old view has four key principles. First, "discretionary" fiscal policy (that is, explicit government decisions to change taxes or government spending, as opposed to changes that happen automatically as the economy moves through the ups and downs of the cycle) is inferior to "monetary policy" (changes in interest rates) as a tool for trying to stabilise the economy.

This is because, compared with monetary policy, fiscal policy has longer "lags" (delays) in being put into effect, in having its intended effect on the economy and in being reversed once the need for stimulus has passed. Scott Morrison’s inability to get his tax cut through Parliament by July 1, as he promised he could, is a case in point.

Second, even if governments could get their timing right, stimulating the economy just when it’s needed, not after the need has passed, discretionary fiscal stimulus wouldn’t work.

It could be completely ineffective because, according to a wildly theoretical notion called “Ricardian equivalence”, people understand that a tax cut will eventually have to be paid for with higher taxes, so they save their tax cut rather than spending it, in readiness for that day. Yeah, sure.

Or it could be partially ineffective because the increased government borrowing need to cover the budget deficit would force up interest rates and thus "crowd out" some amount of private sector investment spending.

Third, use of the budget to try to boost demand (spending) in the economy, should be done sparingly, if at all, because the main policy priority should be long-run fiscal balance or, as we call it in Oz, "fiscal sustainability" – making sure we don’t end up with too much public debt.

Now, I should explain that this view is the international conventional wisdom that eventually emerged following the advent of "stagflation" in the early 1970s, and the great battle between Keynesians and "monetarists" that ensued.

But Furman adds a fourth principle to the old view of fiscal policy: policymakers foolish enough to ignore the first three principles should at least make sure that any fiscal stimulus is very short run, so as to support the economy before monetary stimulus fully kicks in, thereby minimising the harm done.

Remind you of anything? The package of budgetary measures – the cash splashes and shovel-ready capital works – designed mainly by Treasury’s Dr Ken Henry after the global financial crisis in 2008 which, in combination with a huge cut in interest rates, succeeded in preventing us being caught up in the Great Recession, was carefully calculated to be "timely, targeted and temporary".

Furman says that, today, the tide of expert opinion is shifting to almost the opposite view on all four points.

That’s because of the prolonged aftermath of the financial crisis, the realisation that the neutral level of interest rates has been declining for decades, the better understanding of economic policy from the past eight years, the new empirical research on the impact of fiscal policy, and the financial markets’ relaxed response to large increases in countries’ public debt relative to gross domestic product.

Furman admits that this "new view" of the role of fiscal policy is essentially the "old old view" dating back to the Keynesian orthodoxy that prevailed between the end of World War II and the mid-1970s.

Furman outlines five principles of the new view of fiscal policy. First, it’s often beneficial for fiscal policy to complement monetary policy.

This is because the use of monetary policy is constrained by interest rates being so close to zero.

This isn’t new: the real interest rate has been trending down in many countries since the 1980s and was already quite low before the financial crisis.

Second, in practice, discretionary fiscal policy can be very effective. Experience since the crisis shows that Keynesian “multipliers” (where stimulus of $1 adds more than that to GDP) are a lot bigger than formerly thought.

And when you apply fiscal stimulus at a time when private demand is weak, there's little risk of inflation, so central banks won’t be tempted to respond by tightening monetary policy and lifting interest rates, thus countering the fiscal stimulus.

Third, governments have more “fiscal space” to run deficits and increase debt than formerly believed. The economic growth that fiscal stimulus causes means nominal GDP may grow as fast or faster than the increase in government debt.

Partly because of reform, the ageing of the population won’t be as big a burden on future budgets as formerly thought.

Fourth, if government spending involves investment in needed infrastructure, skills and research and development, it not only adds to demand in the short term, it adds to the economy’s productivity capacity (supply) in the medium term.

And finally, when countries co-ordinate their fiscal stimulus – as they did in their initial response to the financial crisis - the benefit to the world economy becomes much greater. This is because one country’s “leakage” through greater imports is another country’s “injection” through greater exports, and vice versa.

It seems clear Reserve Bank governor Dr Philip Lowe understands all this.

But whether the present leaders of Treasury, and Treasurer Josh Frydenberg’s private advisers, have kept up with the research I wouldn’t be at all sure.

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For every problem there’s a job, and no shortage of problems

With the economy subsiding in a heap within days of Scott Morrison winning re-election thanks to the Coalition’s superior economic management skills, he and his ministers are being swamped with helpful hints about how they can get things moving again.

The business lobby groups are proffering some novel solutions: what would do the trick is to cut the rate of company tax and reform industrial relations so the unions are no longer running the country and extracting exorbitant pay rises from employers.

But, in doing what they always do, the lobby groups are selling business short. The conclusion I suspect our smarter business people are drawing is that the surprise re-election of a government that isn’t able to agree on many policies means that if they’re waiting for these guys to fix their problems, they’ll be waiting a long time.

We’ve entered the DIY economy: if you’ve got a problem, fix it yourself. Since the government can’t agree that climate change is more than a lip-service problem, the electricity industry will have to find its own solution.

Same goes for our low rate of productivity improvement. The nation’s productivity improves when the nation’s businesses work smarter, not from government planes dropping policy cargo from the sky.

That’s what I like about a new report from Deloitte Access Economics, The Path to Prosperity: Why the future of work is human.

According to its lead author, David Rumbens, “we don’t face a dystopian future of rising unemployment, aimless career paths and empty offices. Yes, technology is driving change in the way we work, and the work we do, but it’s ultimately not a substitute for people.

“Technology is much more about augmentation than automation, and many jobs will change in nature because of automation, rather than disappear altogether. We can use technology to our advantage to create more meaningful and productive jobs, involving more meaningful and well-paid work.”

Rumbens’ boss, Richard Deutsch, says that “for every problem there’s a job, and the world isn’t running out of problems”.

Just so. The report disputes the popular notion that robots will take our jobs. “Technology-driven change is accelerating around the world, yet unemployment is close to record lows, including in Australia,” it says.

“New technologies will have the capacity to automate many tasks, but also create as many jobs as they kill, and employment is growing in roles that are hardest to automate.”

Another mistaken notion is that people will have lots of different jobs over their careers. Despite all the things people who wouldn’t know try to tell you, overall, work is becoming more secure, not less. Australians are staying in their jobs longer than ever.

The gig economy is not taking over, and the proportion of casual jobs isn’t changing, despite what the unions claim. This is not opinion, it’s statistical fact.

Why are jobs becoming more secure rather than less? Because, with more tasks being done by machines, the kinds of skills employers need their workers to possess are changing. And the skills employers increasingly need are in short supply.

When you find people who possess the skills you’re looking for, you don’t make them casuals, you try to keep them. If they left, they’d be hard to replace. That’s particularly true if they’ve acquired those skills on the job – at the boss’s expense.

It shouldn’t surprise you that employers’ demand is shifting from manual skills to cognitive skills – from the hands to the head – and from routine to non-routine jobs. Manual and routine white-collar jobs are most easily done by machines.

What may surprise you is that, as machines get better at doing routine cognitive jobs, employers increasingly require skills of the heart rather than the head – the “soft skills” needed for “interpersonal and creative roles, with uniquely human skills like creativity, customer service, care for others and collaboration, that are hardest of all to mechanise”.

Such heart skills will be needed most in the services sector, where people rather than machines are the key to driving how value is created – government services, construction, health, professional services and education.

So, what must the government be doing to meet this need? The report doesn’t say. Its focus is on what employers – private or public – should be doing.

“With skill requirements changing faster and becoming more job-specific [good point], the future of work will require much more, and much better, on-the-job learning than Australia has today,” it says.

“Business leaders will have to make active choices, and just buying skills won’t be enough, they will have to adopt an investment frame of mind, and train them.

“With investment in on-the-job training cheaper, more relevant and more focused than classroom learning, the future of work will be a combination of learning and work integrated into one. And refreshing the skills of current, experienced workers will be just as critical as producing students and graduates with the skills they need.

“By making workers smarter and better suited to the jobs of the future, and improving the match between what businesses need and what workers have, we will make our workplaces happier and more productive.”

Who’d have thought one of the big four chartered accounting firms could talk so much sense?

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ABBA was right: Rockonomics shows the winner takes it all

Why do we live in the era of superstars – whether people or businesses? Why is there such a thing as winner-take-all markets? Why do the top 1 per cent of households get an ever-bigger slice of the pie?

Short answer: because the digital revolution is disrupting far more of the economy than we realise.

It’s explained in the new book, Rockonomics: What the music industry can teach us about economics and life, by Alan Krueger, and summarised in his article in the New York Times, from which I’ll quote. Krueger, an economics professor at Princeton University, died in March at the age of 58.

Krueger says the first economist to explain the growing income gap between superstar businessmen and everyone else was the great English economist Alfred Marshall, in the late 1800s.

Marshall argued that a remarkable development in communications technology, the undersea telegraph, allowed top entrepreneurs “to apply their constructive or speculative genius to undertakings vaster, and extending over a wider area, than ever before”.

Ironically, Marshall used the music profession as his counterexample. Because the number of people who could be reached by a human voice was so limited, it was unlikely that any singer could better the £10,000 that the great soprano Elizabeth Billington was said to have earnt in a season.

What the superstar businessmen had, but Billington and her rivals lacked, was the ability to scale up at no prohibitive cost. Of course, Krueger notes, the other thing you need to become a superstar is what economists call “imperfect substitutes”. In English, you must have your own unique style and skills.

Today, of course, music is a most extreme and obvious example of superstars and winner-take-all markets. Why? Because technological advance has provided the economies of scale lacking in Marshall’s day.

Start with amplification of the human voice and then musical instruments. Then, the advent of enhanced recording technology. Finally, the internet and digital streaming of individual tracks anywhere in the world.

“Scale magnifies the effect of small, often imperceptible differences in talent. With the ability of scale, the rewards at the top can be much greater for someone who is slightly more talented than his or her next-best competitor, because the most talented person’s genius can reach a much greater audience or market, in turn generating much greater revenue and profit,” Krueger says.

Album sales and digital streaming clearly reflect the superstar phenomenon, he says. In 2017, the top 0.1 per cent of artists accounted for more than half of all album sales. Song streams and downloads are similarly lopsided.

But a strange thing has happened. Because digital recording has made it so easy to copy and share recordings, the revenue earned by artists and record labels has collapsed. These days, musicians make most of their income from live performances – from nobodies playing in pubs to superstars touring the world’s major venues.

Krueger says that, in 2017, the top 1 per cent of artists increased their proportion of total concert revenue to 60 per cent, compared with 26 per cent in 1982.

Another funny thing: it's now so cheap and easy to record your performance and get it onto the internet, where it’s available to the whole world, that anyone can do it. But does that make you famous? No way. The amount of music available on the net is so vast that the chances of your genius being discovered are tiny.

If you’re already famous, it’s easy to become more so. We hear of some unknown’s YouTube video getting a million clicks, but these are the exceptions. And if that happens it does so because something about the video is exceptional, and because a cascading network of people hear about it and recommend it to their friends. Do you make any money out of it? Probably not.

What happens is not a normal, “bell-shaped” distribution of listens – or dollars – but a “power-law” distribution in which a small number of people get huge scores, which quickly fall off until you get to everyone else getting next to nothing.

In 2016, Krueger says, the most popular artist, Drake, was streamed 6.1 billion times, followed by Rihanna (3.3 billion streams), Twenty One Pilots (2.7 billion) and The Weeknd (2.6 billion). Move down just 100 places and you get to Los Tigres del Norte (0.5 billion).

See how quickly it falls away? That’s a power-law distribution. So is the “80/20 rule”.

Krueger says that the whole United States economy has moved in the direction of a superstar, winner-take-all market. Since 1980, more than 100 per cent of the total growth in income has gone to the top 10 per cent of households, with two-thirds of that going to the top 1 per cent, while the share of the remaining 90 per cent has shrunk.

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Election hype about strong growth now back to grim reality

The grim news this week is that the weakening in the economy continued for the third quarter in row, with economic activity needing to be propped up by government spending.

The Australian Bureau of Statistics’ “national accounts” showed real gross domestic product – the nation’s production of market goods and services – grew by just 0.3 per cent in the September quarter of last year, 0.2 per cent in the December quarter and now 0.4 per cent in the March quarter of this year, cutting the annual rate of growth down to 1.8 per cent.

That compares with official estimates of our “potential” or possible growth rate of 2.75 per cent a year. It laughs at Treasurer Josh Frydenberg’s claim in the April budget – and Scott Morrison’s claim in the election campaign - to have returned the economy to “strong growth”, which will roll on for a decade without missing a beat.

It suggests Frydenberg’s boast of having achieved budget surpluses in the coming four financial years – and Labor’s boast that its surpluses would be bigger – are little more than wishful thinking, manufactured by a politicised Treasury.

The future may turn out to be golden but, even if it does, the econocrats have no way of knowing that in advance – they’re just guessing - and the road between now and then looks pretty rocky.

Why is the immediate outlook for the economy so weak and uncertain? Not primarily because of any great threat from abroad – though a flare-up in Donald Trump’s trade war with China could certainly make things worse – but primarily because of one big and well-known problem inside our economy: five years of weak growth in wages.

When you examine the national accounts, that’s what you find. Over the nine months to March, the income Australia’s households received from wages grew by 3.5 per cent, before adjusting for inflation.

That wasn’t because of strong growth in wage rates, but because more people had jobs. Weakness in other forms of household income meant that total household income grew by just 2.4 per cent.

But households’ payments of income tax grew by 4.5 per cent, thanks mainly to bracket creep. This helped cut the growth in household disposable income to 2 per cent. Even so, households’ spending on consumer goods and services grew by 2.2 per cent – meaning they had to reduce their rate of saving.

Actually, the last big fall in households’ rate of saving occurred in the September quarter. Since then, households have tightened their belts, cutting the growth in their consumer spending so as to raise their rate of saving from 2.5 per cent of their disposable income to 2.8 per cent.

Reverting to “real” (inflation-adjusted) figures, this explains why consumer spending has grown by only about 0.3 per cent a quarter since June, reducing its growth over the year to March to an anaemic 1.8 per cent.

The bureau noted that the weakness in consumer spending was greatest in discretionary spending categories, including on recreation, cafes and restaurants, and clothing and footwear – a further sign that households are feeling the pinch.

Since consumer spending accounts for almost 60 per cent of GDP, that’s all the explanation you need as to why the economy’s now so weak. But there are other factors contributing.

One is the end of the housing boom. Home-building’s contribution to growth peaked in the September quarter, with building activity falling by 2.9 per cent and 2.5 per cent in the following two quarters. It will keep falling for some time yet.

And business investment is also weak. While non-mining investment grew by 2 per cent in the quarter, mining investment fell a further 1.8 per cent. Overall, business investment was up 0.6 per cent in the quarter, but down 1.3 per cent over the year to March.

External demand is helping, however. With the volume of exports growing, while the volume of imports was “flat to down” - another sign of weak domestic demand - “net exports” (exports minus imports) are contributing to growth.

Even so, total private sector demand (spending) has actually fallen for the second quarter in a row. So, apart from the contribution from net exports, any growth is coming from public sector demand.

It grew by 0.7 per cent in the quarter to be 5.5 per cent higher over the year. This reflects the rollout of the National Disability Insurance Scheme and state spending on infrastructure. It means government spending contributed half the growth in GDP during the quarter and more than 70 per cent of total GDP growth over the year to March.

Note, it’s not a bad thing for government spending to be contributing to growth. That’s exactly what it should be doing when private demand is weak. No, the concern is not that public spending is strong, it’s that private spending is so weak.

Dividing GDP by the population shows that GDP per person fell fractionally for another quarter, and grew by a mere 0.1 per cent over the year to March.

This tells us not that the economy is on the edge of recession – how could GDP contract when a growing population is making it ever bigger? – but that, as Jo Masters of Ernst & Young has said, “growth is being driven by population growth alone, and not increased participation or productivity”.

The economy’s getting bigger, but it’s not leaving us any better off.

Speaking of productivity, the productivity of labour deteriorated by 0.5 per cent in the March quarter and by 1 per cent over the year.

Is this a terrible thing? Well, before you slit your wrists, remember that when employment is growing a lot faster than the growth in the economy would lead you to expect, a fall in GDP per worker (or, in this case, per hour worked) is just what the laws of arithmetic would lead you to expect.

Surprisingly strong growth in employment – most of it full-time – doesn’t sound like a bad thing to me. It’s just hard to see how it can last much longer.

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Interest rate cuts may not do much to counter slowdown

This won’t be the only cut in interest rates we see in coming months – which may be good news for people with mortgages, but it’s a bad sign for the economy in which we live and work.

The Reserve Bank is cutting rates because the economy’s growth has slowed sharply, with weak consumer spending and early signs that unemployment is rising.

In such circumstances, cutting interest rates to encourage greater borrowing and spending is the only thing it can do to try to push things along.

Whether we see just one more 0.25 percentage-point cut in a month or two’s time, or whether there will be more after that depends on just how slowly the economy is growing. The Reserve – and the rest of us - will get a much better idea of that on Wednesday morning, when the Australian Bureau of Statistics publishes the quarterly “national accounts”, showing by how much real gross domestic product grew during the first three months of this year.

If you’re thinking that cutting interest rates by a mere 0.25 per cent isn’t likely to make much difference, you’re right. That’s why we can be sure there’ll be at least one more cut.

While it’s true that, with the official interest rate now at a new record low of 1.25 per cent, the Reserve has limited scope for further cuts, don’t expect it to follow the advice from some chief executives that it should refrain from responding to further evidence of weakness in the economy with further cuts so that, once the economy’s reached the point of being really, really weak, the Reserve will still have something left to use to give it life support.

Let’s hope these executives are better at running their own businesses than they are at offering the econocrats helpful hints on how they should be doing their job.

No, we can be confident that, until it believes the economy is picking up, the Reserve will keep doing the only thing it can to help – cutting rates further.

Should this mean the official rate gets to zero, Scott Morrison and his government will then have no choice but finally to respond to governor Dr Philip Lowe’s repeated requests – repeated again only two weeks ago – that they put less emphasis on returning the budget to surplus and more on helping to keep the economy growing, by spending more on needed (note that word) infrastructure and doing it soon, not sometime in the next decade.

Morrison got himself re-elected by claiming to be much better at running the economy than his political opponents. In the next three years we’ll all see just how good he is. Boasting about budget surpluses while unemployment rises is unlikely to impress.

But back to the efficacy of interest rate cuts. Even if we get several more of them, the economy’s circumstances are such that this wouldn’t offer it a huge stimulus.

One part of this is that while interest rates are an expense to borrowers, they are income to lenders, so that a rate cut reduces the spending power of the retired and others. This is always true, but it’s equally true that borrowers outnumber lenders, so the net effect of a rate cut is to increase spending.

In principle, the mortgage payments of households with home loans will now be a little lower, leaving them with more to spend on other things. In practice, many people leave their payments unchanged so they’re repaying the mortgage a little faster.

In principle, lower mortgage rates allow people to borrow more. And moving houses almost always involves increased spending on consumer durables - new lounge suites and the like. In practice, Australian households are already so heavily indebted that few are likely to be tempted to borrow more.

In principle, lower interest rates should also encourage businesses to borrow more to expand their businesses. In practice, what’s constraining businesses from borrowing more is poor trading prospects, not the (already-low) cost of borrowing.

In principle, lower rates are good news for the property market. But the Reserve wouldn’t be cutting rates if it thought the property boom might take off again. Combined with the removal of Labor’s threat to negative gearing, the likely result is a slower rate of fall in house prices, or maybe a floor for them to bump along for a few years. The home building industry won’t return to growth for some years yet.

The rate cuts should, however, cause our dollar to be lower, which may not please people planning overseas holidays, but will give a boost to our export and import-competing industries.

Putting it all together, even if we get a few more rate cuts that isn’t likely to give the economy a huge boost. Which means it’s unlikely to do much to fix the underlying source of the economy’s weakness: very small increases in wages.

The Fair Work Commission’s decision to raise all award minimum wage rates by 3 per cent will help about 2.2 million workers, but few of the remaining 10.6 million are likely to do as well.

Morrison’s promised $1080 boost to tax refund cheques, coming sometime after taxpayers have submitted their annual returns from the end of this month, will provide a temporary fillip, but it's a poor substitute for stronger growth and the improved productivity it helps to bring.

I have a feeling Morrison and his merry ministers will really be earning their money over the next three years.

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How to dud manufacturing: be the world’s biggest gas exporter

Did you know Australia has now overtaken Qatar to be the largest exporter of natural gas in the world? But, thanks to private profiteering and government bungling, this seeming triumph comes at the risk of further diminishing manufacturing industry in NSW and Victoria.

It’s yet another example of naive economic reformers stuffing things up because real-world markets don’t work the way they do in textbooks.

Last week Dow Chemical announced it would close its Melbourne manufacturing plant due, in part, to high gas prices. This came after RemaPak, a Sydney-based producer of polystyrene coffee cups, and Claypave, a Queensland-based brick and paving manufacturer, went belly-up citing rising gas prices as an important contributing factor.

“Many other manufacturers are close to making critical decisions on their future operations,” according to Australian Competition and Consumer Commission boss Rod Sims. “If wholesale gas prices do not [come down], it is just a matter of time before they follow Dow, RemaPak and Claypave.”

When expected world liquefied natural gas prices rose last year, Australian gas suppliers were quick to raise their prices to local manufacturers, which use much gas in their production processes.

But expected world prices have fallen significantly over the past six months. Have the three suppliers dominating our east coast market cut their prices with the same alacrity? No. Most commercial and industrial users will pay more than $9 a gigajoule for gas this year, with some paying more than $11.

Why haven’t suppliers cut their prices? Because their pricing power means they don’t have to if they don’t want to. Why would they want to? Only because the government threatens them with something worse if they rip too much off their customers.

This was the big stick the softly spoken Sims was carrying last week as he urged them to do the right thing.

Is this the best way to regulate a market? No, but once you’ve stuffed it up you have little choice. The stuff-up evolved over some years, under federal governments of both colours and, predictably, with a lack of federal-state co-ordination.

It began in the resources boom, when Labor’s Martin Ferguson approved the construction of no less than three gas liquefaction plants near Gladstone in Queensland. That was one plant too many.

The companies secured the cost of building their plants by writing future contracts to export LNG to foreign customers. The first two companies secured the supply of sufficient gas from local sources, but the third had to scramble for what it needed to meet its sales contracts.

They expected far more gas to be available than transpired because they failed to anticipate the NSW and Victorian governments’ moratoriums on fracking for unconventional gas from coal seams.

Until the construction of the liquefaction plants – which enabled gas to be shipped overseas – the east coast gas market was cut off from the world market. This meant its prices were much lower than world prices.

The federal government knew that allowing the plants to be built meant opening the east coast market to the (much bigger) world market, forcing local prices up to the “export-parity price” or LNG “netback” price.

But, as Sims noted in a speech last week, the east coast was "just about the only region in the world that allowed unrestricted exports”. By contrast, when our west coast gas market was opened up, the West Australian government insisted on reserving sufficient gas to meet the needs of local users at local prices.

So, the east coast market opening was textbook pure (and much to the liking of the gas companies). Trouble was, the market worked nothing like the textbook promised. Lack of competition meant prices shot up to way above the export price.

The gas producers were able to overcharge the big industrial users, the three big gas retailers – AGL, EnergyAustralia and Origin – charged the smaller industrial users even more, and the pipeline owners whacked up their prices, too. Retailers’ prices peaked at $22 a gigajoule.

The threat to manufacturing was so great that Malcolm Turnbull eventually stepped in. Arming himself with the “Australian gas domestic security mechanism” (permitting him to set up a domestic reservation scheme), he forced the LNG producers to agree to offer domestic users sufficient gas on reasonable terms.

Now, however, prices have drifted back above export-parity. And the Australian Energy Market Operator is warning that gas shortages in NSW and Victoria could arise as soon as 2024 in the absence of major pipeline upgrades to allow more gas to flow from Queensland, or new sources of supply emerging.

This uncertainty adds to the risk of manufacturers giving up the struggle. The easiest and best solution would be for the Victorian government to lift its restrictions on development of – would you believe – conventional gas deposits.

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As you were: getting back to budget surplus no longer urgent

Sometimes, changes in fashion are shocking. In economics, the fashion leaders are top American economists. Their latest fashion call is highly relevant to Australia’s circumstances, but will shock a lot of people: stop worrying so much about debt and deficit.

Among the various big-name economists advocating this change of view, the one who made the biggest splash was Professor Olivier Blanchard, of the Massachusetts Institute of Technology, in his presidential lecture for the American Economic Association early this year.

Blanchard was formerly chief economist at the International Monetary Fund, and had a big influence on the advanced economies’ response to the global financial crisis. He offered a simpler version of his lecture in a paper for the Peterson Institute for International Economics in Washington.

When governments spend more than they raise in taxes, they cover their deficit by borrowing via the sale of government bonds. If you run deficits for many years, you rack up much debt.

So the conventional wisdom – which we heard from both sides in the election campaign – has long been that, as soon as the economy has recovered from its downturn, governments should raise more in taxes than they spend, so as to run an annual budget surplus. They use the surplus to buy back some of the bonds the government has issued, and thus reduce its debt.

Why do most people – and many economists still - think this is the right thing to do? Because when you borrow money you have to pay interest. The more you borrow, the more interest. And the only way to stop having to pay interest is to repay the debt.

Blanchard calls this the “fiscal [or budgetary] cost”. In the end, interest payments and repayments of principal have to be covered by the higher taxes extracted from people, which may discourage them from working or distort their behaviour in other ways.

But Blanchard realised there may be no fiscal cost because interest rates are so low – especially for governments, whose debt is regarded as risk-free (or “safe” as he calls it). Governments are almost always able to repay their debts because, unlike the rest of us, they can get the money they need by increasing taxes. Or they could simply print more money.

Safe interest rates in the rich economies – including Australia – are so low that, after you allow for inflation, the “real” interest rate may be close to zero, or even negative. If they’re zero they’re costing the government nothing.

If they’re negative, the lender is actually paying the government to borrow from them (once you remember that, because of inflation, the lender will be repaid in dollars with less purchasing power that the dollars originally borrowed).

But that’s not all. A government’s revenue-raising capacity tends to grow in line with the size of the economy – nominal gross domestic product. And nominal GDP almost always grows faster than the nominal safe interest rate.

If so, the government can go on, year after year, paying the interest on its debt and continuing to run a budget deficit - provided it isn’t too big – without its debt growing relative to the size of the economy.

Now, you may object that interest rates are so low at present only because it’s taking so long for the world economy to recover from the global financial crisis and the Great Recession.

But if interest rates are higher in the future, that will be because there’s stronger demand to borrow relative to the supply of funds available, and this, in turn, should mean the economy is also growing at a faster rate.

In any case, Blanchard and others have shown that nominal GDP growth has been higher than the safe interest rate for decades.

So, unless budget deficits are very high, the value of the debt should decline over time as a percentage of GDP. This, in fact, is the way all countries got on top of the massive debts they incurred during World War II.

The second conventional reason for worrying about government debt is the cost to the economy, which Blanchard calls the “welfare cost”. When governments borrow to fund their deficit spending, they compete with private sector borrowers, driving up the interest rates firms have to pay and so “crowding out” some business borrowers.

This causes firms’ investment in renewing or expanding their businesses to be lower than otherwise which, in turn, leads to less economic growth and job creation than otherwise.

(That’s the standard argument, used since Milton Friedman’s day. It’s still relevant to an economy as huge as America but, in an economy as small as ours, it stopped applying after we floated the dollar and our financial markets became integrated with the global market. In Australia, if crowding out happens, it does so via the inflow of borrowed foreign capital causing our exchange rate to be higher than otherwise and thus making our export and import-competing industries less price competitive.)

But Blanchard argues that, in fact, the welfare cost of high government debt is probably small. If the average rate of return on business investment projects is higher than the rate of growth in nominal GDP, this implies there is a cost to the welfare of people in the economy.

On the other hand, if the safe interest rate is lower than the rate of growth in nominal GDP, this implies a welfare benefit from the government debt. Putting the two together implies that the welfare cost, if any, wouldn’t be great.

Blanchard is quick to warn, however, that these arguments don’t “add up to a licence to issue infinite amounts of [government] debt”. Debt and deficit make sense when government spending is countering the weakness in private sector spending. When this fiscal stimulus succeeds in restoring strong growth in private sector spending, governments should pull back to avoid excessive inflation pressure.

And, to be on the safe side, government borrowing should be used mainly to support investment in needed infrastructure, education and healthcare, so it’s adding to the economy’s productive capacity, not just to consumption.

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FISCAL POLICY AND THE BUDGET

UBS HSC Economics Day, Sydney, Thursday, May 30, 2019

I want to start by congratulating you – you’ve picked a really interesting year to be studying economics. Strange things are happening in the economy – it’s not working the way it used to before the global financial crisis. The managers of the macro economy have gone for years predicting things will soon be back to normal, but it hasn’t happened yet and, just last week, the governor of the Reserve Bank, Dr Philip Lowe, made it clear the RBA would begin cutting interest rates next Tuesday. So, though I will be talking about the budget last month and fiscal policy, I’ll do so in the broader context of the use of economic policies to manage the economy and deal in particular with the economic issues of growth, unemployment and inflation.

Our economy – and, as it happened, the global economy – slowed sharply in the second half of last year, growing by just 2.3 pc over the course of 2018, a lot slower than our estimated “potential” (or “trend”) rate of growth of 2¾ pc. So we’ve had seven years of weak growth in real GDP, in productivity improvement and in real wages, with inflation stuck below the target range of 2 to 3 pc on average. And although employment has grown a lot more strongly than all that would lead you to expect, the unemployment rate was stuck at 5 pc for six months, and now may be starting to rise, and under-employment with it.

Trouble is, the government and Treasury don’t seem to have got the message. When the Treasurer, Josh Frydenberg, unveiled his first budget on April 2, effectively the start of the election campaign, he repeated essentially the same forecast Treasury had been making for the previous seven years, that the economy, wages and inflation would soon return to the old normal: 2¾ pc economic growth, 2½ pc inflation, wage growth of 3¼ pc and unemployment of 5 pc. This optimistic forecast – particularly of an early return to strong growth in real wages – is hard to reconcile with recent deterioration in economic indicators I’ve just mentioned, and the RBA’s sharp downward revisions to its own forecasts and its decision that it must start cutting interest rates again to stop the economy slowing even further.

Now let’s look at the secondary arm of macroeconomic management – fiscal policy. But, since the main policy arm - monetary policy – has so far been the main arm used to achieve internal balance (ie low inflation and low unemployment), we need to say a little about monetary policy, since it’s been the main arm responding to this story of so-far disappointingly weak growth in wages and GDP.

Recent developments in monetary policy

Because of the six consecutive years of below-trend growth since 2011-12, the Reserve Bank cut its cash rate from 4.25 pc to 1.5 pc between the end of 2011 and August 2016. For more than 2½ years after that, it left the rate unchanged – a record period of stability. It’s not hard to see why it left the official interest rate so low for so long: the inflation rate has been below its target range; wage growth has been weak, suggesting no likelihood of rising inflation pressure; the economy has yet to accelerate and has plenty of unused production capacity, and the rate of unemployment shows little sign of falling below its estimated NAIRU of 5 pc. But now, after many months of saying the next move in interest rates would be up, the recent bad results on growth and inflation – a fall in the inflation rate to just 1.3 pc – the RBA is starting to cut the cash rate, so as to increase the monetary stimulus being applied to the economy.

Fiscal policy “framework”

Fiscal policy - the manipulation of government spending and taxation in the budget - is conducted according to the Morrison government’s medium-term fiscal strategy: “to achieve budget surpluses, on average, over the course of the economic cycle”. This means the primary role of discretionary fiscal policy is to achieve “fiscal sustainability” - that is, to ensure we don’t build up an unsustainable level of public debt. However, the strategy leaves room for the budget’s automatic stabilisers to be unrestrained in assisting monetary policy in pursuing internal balance. It also leaves room for discretionary fiscal policy to be used to stimulate the economy and thus help monetary policy manage demand.

Recent developments in fiscal policy

Until recently, 2017-18, the Coalition government (and the Labor government before it) had seen the growth in the economy being repeatedly less than forecast, meaning the government has made slow progress in returning the budget to surplus and halting the rise in its net debt. Even so, it has focused on the medium-term objective of fiscal sustainability, not the secondary objective of helping monetary policy to get the economy growing faster. The long period of policy stimulus has come almost wholly from lower official interest rates.

In the year to June 30, 2018, however, the underlying cash budget deficit proved a lot smaller than expected - thanks mainly to an improvement in export commodity prices and higher company tax collections for other reasons. The improvement in export prices continued in bolster company tax collections in the financial year just ending, 2018-19, producing another big fall in the budget deficit. How can the budget be improving rapidly when economic growth has been weak? Because of the unexpected improvement in the terms of trade and thus mining company profits and tax payments.

In this year’s budget Mr Frydenberg is forecasting a return to a modest budget surplus of $7 billion (0.4 pc of GDP) in 2019-20, with the surplus continuing to grow in future years.

This forecast improvement in the budget balance means that, when expressed as a proportion of GDP, the federal government’s net debt is now expected to peak at 19 pc in June 2019, and then fall back to zero by June 2030. Again, it will be a great thing if it happens. It also means the budget balance is expected to continue improving despite the budget’s centrepiece, a doubling of last year’s plan for tax cuts in three stages (July 2018, July 2022 and July 2024) over seven years, with a cumulative cost to the budget of a remarkable $300 billion over 10 years. This is possible because of plan’s slow start.

Judged the RBA’s way, by its “fiscal impact” (the expected direction and size of the change in the overall budget balance), the “stance of fiscal policy” adopted in the budget is mildly contractionary. However, judged the Keynesian way (which focuses on the expected direction and size of the change in just the structural or discretionary component of the budget balance) the stance is mildly stimulatory, thanks to the doubled immediate first stage of the tax cuts.

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Our new economic worry: Reserve Bank running out of bullets

Scott Morrison got the government re-elected on the back of a budget built on an illusion: that the economy was growing strongly and would go on doing so for a decade. The illusion allowed Morrison to boast about getting the budget back into surplus and keeping it there, despite promising the most expensive tax cuts we’ve seen.

The illusion began falling apart even while the election campaign progressed. The Reserve Bank board responded to the deterioration in the economic outlook at its meeting 11 days before the election.

It’s now clear to me that it decided to bolster the economy by lowering interest rates, but not to start cutting until its next meeting, which would be after the election – next Tuesday.

If that wasn’t bad enough for Morrison, with all his skiting about returning the budget to surplus he may have painted himself – and the economy – into a corner.

In a speech last week, Reserve Bank governor Dr Philip Lowe made it clear that cutting interest rates might not be enough to keep the economy growing. He asked for his economic lever, “monetary policy” (interest rates), to be assisted by the government’s economic lever, “fiscal policy” (the budget).

He specifically mentioned the need to increase government spending on infrastructure projects, but he could have added a “cash splash” similar to those Kevin Rudd used to fend off recession after the global financial crisis in 2008.

See the problem? Any major slowdown in the economy would reduce tax collections and increase government spending on unemployment benefits, either stopping the budget returning to surplus or soon putting it back into deficit.

That happens automatically, whether the government likes it or not. That’s before any explicit government decisions to increase infrastructure spending, or splash cash or cut taxes, also worsened the budget balance.

And consider this. The Reserve’s official interest rate is already at a record low of 1.5 per cent. Its practice is to cut the official rate in steps of 0.25 percentage points. That means it’s got only six shots left in its locker before it hits what pompous economists call the “zero lower bound”.

What happens if all the shots have been fired, but they’re not enough to keep the economy growing? The budget – increased government spending or tax cuts – is all that’s left.

The economics of this is simple, clear and conventional behaviour in a downturn. All that’s different is that rates are so close to zero. For Morrison, however, the politics would involve a huge climb-down and about-face.

My colleague Latika Bourke has reported Liberal Party federal director Andrew Hirst saying that, according to the party’s private polling, the Coalition experienced a critical “reset” with April’s budget. The government’s commitment to get the budget back to surplus cut through with voters and provided a sustained bounce in the Coalition’s primary vote.

The promised budget surplus also sent a message to voters that the Coalition could manage the economy, Bourke reported.

Oh dear. Bit early to be counting your chickens.

The first blow during the election campaign to the government’s confident budget forecasts of continuing strong growth came with news that the overall cost of the basket of goods and services measured by the consumer price index did not change during the March quarter, cutting the annual inflation rate to 1.3 per cent, even further below the Reserve’s target of 2 to 3 per cent on average.

Such weak growth in prices is a sign of weak demand in the economy.

The second blow was that, rather than increasing as the budget forecast it would, the annual rise in the wage price index remained stuck at 2.3 per cent for the third quarter in a row. The budget has wages rising by 2.75 per cent by next June, by 3.25 per cent a year later and 3.5 per cent a year after that.

As Lowe never tires of explaining, it’s the weak growth in wages that does most to explain the weakening growth in consumer spending and, hence, the economy overall. Labor had plans to increase wages; Morrison’s plan is “be patient”.

The third blow to the budget’s overoptimism was that, after being stuck at 5 per cent for six months, in April the rate of unemployment worsened to 5.2 per cent. The rate of under-employment jumped to 8.5 per cent.

Why didn’t Labor make more of these signs of weakening economic growth during the campaign? It had no desire to cast doubt on the veracity of the government’s budget forecasts because, just as they provided the basis for the government’s big tax cuts, they were also the basis for Labor’s tax and spending plans.

Labor was intent on proving that its budget surpluses over the next four years would be bigger than the government’s – $17 billion bigger, to be precise.

Think of it: an election campaign fought over which side was better at getting the budget back to surplus, just as a slowing economy and the limits to interest-rate cutting mean that, at best, any return to surplus is likely to be temporary.

Morrison’s $1080 tax refund cheques in a few months will help bolster consumer spending, but they’re a poor substitute for decent annual pay rises.

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Without decent policies, Labor would get fewer votes, not more

The main reason so many voters have given up on politics and politicians is their belief that modern pollies care more about advancing their careers than advancing the wellbeing of the nation.

So, were Labor to decide that it lost the election – which dodgy polling encouraged it and everyone else to believe it was sure to win - because it made itself a "big target" by having lots of policies to fix things, rather than "small target" with few policies of any consequence, it would risk confirming voters’ suspicions that it cared more about getting back to power than improving voters’ lives.

Not a great way to garner votes. Particularly because, for reasons I’ll get to, the small-target strategy works better for the party of the business establishment and the status quo than for the party representing those who think the status quo needs reforming.

When you decide that having too many policies was the main reason you lost, it’s only human nature to flip to the opposite extreme of having none. Human, but not smart.

Economics teaches that success in life comes from seeking out the best “trade-off” between conflicting but equally desirable objectives. It involves using your brain to nut out the best answer, not turning it off.

As political scientist Rod Tiffen has reminded us, the no-brain response after elections is that “everything the winning party did is treated as a stroke of genius, and all the loser’s moves were foolish”.

If Labor wants to draw the right conclusions about the various reasons for its failure it will need to put a lot more mental effort into answering the eternal policy question: “what works and what doesn’t?”.

One obvious possibility is that Labor lost partly because it “did a Hillary Clinton,” focusing on the well-educated, socially progressive (and often public-sector employed) section of the party’s base and forgetting about the less educated, less progressive section in outer suburbs and the regions.

Labor’s had the tricky job of straddling these two, very different parts of its heartland for decades. When John Howard perfected the technique of “wedging” your political opponent, the original application involved driving a wedge between the well-educated and the blue-collar parts of Labor’s base. The classic case is the treatment of asylum seekers.

The no-brain response would be for Labor to “go back to” its blue-collar base. Labor can’t win without both ends. But it certainly needs to put a lot more effort into satisfying both ends. What can it do to help the regions than isn’t too blatantly wasteful? How can it look after victims of the inevitable shift from fossil fuels to renewable energy?

With every summer getting hotter, it’s not surprising the Greens had a good election. And the best explanation for the swing to Labor or independents in many well-heeled Liberal electorates is Liberal voters’ growing recognition that we need a government that’s genuine about combating global warming.

It’s quite possible this is of less concern to the blue-collar end of Labor’s heartland, particularly if it can be (falsely) convinced the immediate cost to household budgets would be high. But for Labor to tone-down its climate policy would risk it getting an even lower primary vote as more of its progressive base shifted to the Greens and, in the case of the Senate, didn’t flow back.

Labor needs reminding that life wasn’t meant to be easy for reformist parties. The party of the business establishment and the status quo always starts with a built-in advantage. They’re the people who surely must be better at running the economy and who stand for minimal change – the thing we all fear.

That’s why the Libs can get elected with no policy other than blocking the rise of all those Labor trouble-makers, and why Labor gets elected only by making the case for change. Why vote for a Labor status quo when you can vote for the original and best?

One of the Libs’ most effective lines was “Labor can’t manage money so they’ll come after yours.” Labor’s eternal vulnerability on the money question is why it would be folly for it to lay most of the blame for its failure at the feet of its one money man who does command the respect of econocrats, economists and business people, Chris Bowen. All the people who wanted to win votes by promising to spend big on education and health, scapegoating the poor blighter who had to find ways to pay for it all.

Similarly, when Labor relegates to a junior role a highly regarded former economics professor, Andrew Leigh, simply because he’s not a member of any faction, it reinforces voters’ suspicion that Labor members put their own careers ahead of the country’s good governance.

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Why did Labor lose? Not because of its tough tax plans

It’s been a week since the election so, naturally, by now a great many of the people who work in the House with the Flag on Top – politicians, staffers, journalists – know exactly why Labor lost and the Coalition won: those hugely controversial dividend franking credits.

There were other reasons, of course, but franking credits is the big one. How do I know they know? Because this is what happens after every election.

The denizens of the House take only a few days to decide on the single most important factor driving the result. Surprisingly, each side of politics – the winners and the losers – almost invariably comes to the same conclusion.

And once they have, the concrete around the notion sets quickly and what started as a theory becomes received wisdom, something any fool knows and part of the building’s corporate memory.

Months later, political scientists will come up with different, much more “evidence-based” explanations, but by then it will be too late. No one listens to them because the die has been cast.

Which is why it may already be too late for research by Dr Richard Denniss and others at the Australia Institute to debunk the quite misguided notion that it was all the people who’d be hurt by the franking credits policy voting against an evil-intentioned Labor Party.

When you see Denniss’ quite startling findings it should also disabuse you of the notion that, particularly in a country as big and varied as ours, a party’s loss of an election could ever be, as the academics say, “mono-causal” rather than “multi-factorial”.

Labor’s performance was disappointing (for its supporters, anyway), not disastrous. The composition of the House of Reps has changed surprisingly little. So it may surprise you, but shouldn’t, that as well as there being lots of electorates that swung to the Coalition (measured on a two-party-preferred basis), there were also lots of electorates than swung to Labor.

Get this: the seats that swung to the Coalition were mainly those whose voters had low incomes, whereas the seats that swung to Labor tended to be those whose voters had high incomes.

Among the seats with the 10 biggest swings to Labor were five from Victoria, three from NSW and one each from WA and the ACT. The swings varied from 3.7 per cent to 6.6 per cent.

In all but two of those seats, they had at least twice the proportion of high income-earners (people in the top 20 per cent) than the national average. Under the Coalition’s three-stage tax plan, voters in the same eight electorates are estimated to get tax cuts in 2024 varying from 49 per cent more to double the national average.

Across Australia, the average value of franking credits per taxpayer is $695 a year. In those eight electorates (five of which are held by the Coalition), the average value ranges from $1213 to $2578 a year.

Now let’s look at the 10 electorates with the biggest swings to the Coalition – six in Queensland and four in NSW. The swings varied from 6 per cent to 11.3 per cent. All of the seats had less than the national average of people with high incomes. And for all but one of them, the average tax cut in 2024 will be below the national average.

How much do they get in franking credits? All 10 seats get less than the $695-a-year national average. Between 83 per cent and 16 per cent of the average, to be precise.

Looking more generally, electorates with more people on low and middle incomes tended to swing to the Coalition, whereas electorates with more people on high incomes tended to swing to Labor.

Next, since it’s the (well-off) retired who would have been hit by the plan to end refunds of unused franking credits, the researchers looked at the voting trend for electorates with a high share of voters over 65.

They found only a very slight tendency for such electorates to move their votes to the Coalition.

So, what should we make of all this? Well, for a start, the figures allow us to rule out some possibilities, but leave others open.

They seem to refute the contention that many well-off retirees (or even prospective well-off retirees) moved their votes away from Labor because they were deeply opposed to the planned changes to franking credits.

They leave open the possibility than many less well-off voters moved their vote away from Labor because they disapproved of the way well-off retirees were to be treated. If so, they were being very magnanimous towards people better off than themselves.

Possible, but not likely. It’s easier to believe they (or, at least, some of them) were renters voting against Labor in response to the real estate agents’ scare campaign claiming Labor’s plan to limit negative gearing would force up rents.

Turning to the higher-income electorates, there’s little sign of many people moving their votes away from Labor because of their opposition to its franking credit plan – or to its move against negative gearing, for that matter.

According to Denniss, it looks like renters voted to help their landlords keep their tax lurks, whereas the landlords voted for Labor’s offer of free childcare and the restoration of penalty rates for their tenants.

Well, maybe. What can be said with more confidence is that it’s hard to see much sign of an outbreak of class warfare.

Moving on from Labor’s controversial tax changes, the success or near success of independents running in Liberal seats such as Warringah and Wentworth in prosperous parts of Sydney, and Indi in rural Victoria, makes it easier to believe the swing to Labor in so many high-income electorates was motivated by a concern that Australia needed a more convincing policy to combat climate change.

As for the swing against Labor in many low-to-middle electorates in Queensland and NSW, my guess is they felt Labor was neglecting their worries about jobs and the cost of living.

It’s never as simple as many workers in Parliament House convince themselves.

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Now the pilot's back, economy flying on a wing and a prayer

It’s always nice for the country to be led by someone who’s obviously got God on his side. When he prays for a miracle, he gets it. And the challenges facing the economy are such that Scott Morrison may need all the divine assistance he can summon.

The Coalition – and their dispirited opponents - should remember the fate of the last chap who won an unwinnable federal election: Paul Keating in 1993. By the time the next election arrived, voters were, in Queensland Labor premier Wayne Goss’s words, “sitting on their verandas with baseball bats”.

The Liberals shouldn’t forget the miraculous nature of their win. After their years of infighting and indiscipline they richly deserved to be thrown out, but were saved by Morrison’s superior campaigning skills and his success in convincing people with nothing to fear from restrictions on franking credits and negative gearing that they should be fearful (not sure what God thought about that).

This was not a historic vindication, just a reprieve. Carry on the way you have been, and your fate will only have been delayed.

And remember: Keating’s reprieve came as part of the 25 years Australians spent trembling at the thought of a tax on services as well as goods. “If you don’t understand it,” Keating told the punters, “don’t vote for it.”

We’ve now had such a tax for almost 20 years. And would you believe? Turned out the GST was no biggie. What brave souls we are.

Come July, we’ll have gone an amazing 28 years without a severe recession. Starting to sound ominous.

Look around the world – trade war between America and China, China’s faltering economic miracle, America’s boom that must bust, Japan and Europe with chronically weak economies and Brexit Britain about to shoot its economy in both feet – and it’s not hard to think you see our next recession in the offing.

Certainly, it has to come some time. But I don’t see one as imminent. What many don’t realise is we have enough troubles of our own, without help from abroad.

Ever since the global financial crisis in 2008-09, and more so since the busting of our mining construction boom in 2013, our economy has been acting strangely, behaving in ways it used not to.

If Morrison and his Treasurer, Josh Frydenberg, understand the way it hasn’t been back to business as usual, they’ve shown little sign of it.

If they haven’t yet got the message – perhaps because a politicised Treasury hasn’t been game to give them news they won’t like – enlightenment, in the form of being hit on the head by the bureau of statistics, may not be far off.

Ever since Treasury’s optimistic forecasts encouraged Labor’s Wayne Swan to claim to be delivering four budget surpluses in a row – a claim Frydenberg repeated in the April budget – the econocrats have just shifted forward another year their unwavering conviction that everything will soon be back to the old normal.

It hasn’t happened throughout the Coalition’s two terms. The economy’s just kept grinding along in second gear, failing to reach the cruising speed the econocrats profess to see coming.

It hasn’t happened because the economy’s productivity – output per unit of input - hasn’t improved as fast as it used to, and what little improvement we’ve had hasn’t flowed on to wages. It’s because wages haven’t grown faster than prices, as we’ve come to expect, that so many people are complaining about the cost of living.

What has concealed the truth from us is our rapid, immigration-fuelled population growth. The other rich countries’ populations haven’t been growing nearly as fast. This has given us a bigger economy, but not a richer one.

Of late we have had a partial – and probably temporary – rebound in the prices we get for our mineral exports. Combined with years of bracket creep, the boost to mining company profits (and their tax payments) has finally made Frydenberg’s budget look a lot healthier than the economy does.

Weak growth in real wages (plus continuing bracket creep) mean weak growth in the disposable income of Australia’s households. Which, in turn, means weak growth in the economy’s mainstay, consumer spending.

All this became unmissable when the economy slowed to a crawl in the second half of last year. Predictably, the April budget took this to be little more than a blip on the onward and upward trajectory.

But all the economic indicators we’ve seen since the budget – weak inflation, no improvement in wage growth – suggest the weakness is continuing.

Another respect in which the economy has been behaving strangely is that employment – particularly full-time jobs - has been growing much more strongly than the modest growth in the economy would lead us to expect.

It’s this that Morrison and Frydenberg trumpeted during the election campaign as proof positive of their superior management of the economy. Fine. But the rate of growth in employment is slowing and the rate of unemployment, having fallen slowly to 5 per cent, seems now to be going up, not down.

With the election out of the way, the Reserve Bank won’t wait long before it cuts interest rates to try to give the economy a boost. The $1080-a-pop tax refund cheques after June 30 will also help, provided Morrison can get them through Parliament in time. More earnest prayer required, I think.

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Morrison's miracle election may turn out to be the easy bit

The great risk from Scott Morrison’s miraculous victory is that it will lead politicians on both sides to draw conclusions that worsen our politics and our policies. Bill Shorten offered us a chance to change the government and change the nation, and was answered with a firm No Thanks.

It’s a great win for the Coalition, but a loss for economic policy. The voters’ "revealed preference" is for more personality, less debate of the tough choices we must make to secure our future in a threatening world.

The first lesson the pollies will learn is that disunity doesn’t have to be death. Almost six years of fighting like Kilkenny cats can be forgotten during the eternity of a five-week election campaign, provided you put all the focus on the latest guy, and his predecessors are kept hidden.

The second lesson the pollies will learn is that the only safe strategy for oppositions is to make themselves a "small target", with only a few, popular policies, so all the focus is on the failings of the government.

Whatever policy changes you may be thinking of making, keep your intentions to yourself and don’t, whatever you do, seek a mandate for change.

Almost 28 years of continuous growth have rendered Australians a timorous nation. No national emergency, no need for change. As Kevin Rudd was the last Labor leader to understand, what voters crave is change without change. Promise it. (Since such a thing is impossible, deliver something else. Expect a backlash.)

Politicians have understood all this since Dr John Hewson (his PhD said: "knows more about economics than politics") used Fightback – "the longest suicide note in history" – to lose the unlosable election in 1993.

Labor forgot this because it wanted to be seen as less negative and destructive than Tony Abbott, and because, knowing Shorten lacked charisma, it decided policy substance was the best substitute. As it turned out, wrong.

In this era of unreal reality game shows, and multitudes of disillusioned, disengaged voters, the most successful politicians are those best at show biz. Morrison may not be the lovable larrikin Bob Hawke was, but he comes a lot closer than Hawke’s union mate did.

Morrison spent five weeks performing for the cameras to the exclusion of all others, and the electorate warmed to what it saw. Perhaps what Labor needs is a casting director.

The third lesson the pollies will learn is that the eternal reality of conflict between the classes must always remain covert. Any overt attack on privilege does more to fire up the defences of the well-off than to whet the appetites of those missing out.

In this country, the only envy that works is the downward variety. Envy the jobless for being able to eat without working, or the Indigenous for the extra help they get? Sure.

This government has spent its time beating up on boat people, public servants and those on welfare and, in the process, has gained more votes than it’s lost.

The well-off may have benefited from a lot more good luck (as I have) than it suits them to admit, but they are adept at convincing the punters than an attack on my five dollars is an attack on your five cents.

Labor fashioned a policy to pay for more of the spending on health and education voters genuinely want by reducing the tax breaks of the top 10 per cent (including the top 10 per cent of retirees), but almost every oldie was convinced they’d be a victim.

Same with the way the nation’s real estate agents put the frighteners on their tenants over negative gearing.

Highlight the conflict between the generations and you’re smacked by the demographic reality that voters get older every year, and the over-65s far outnumber the young.

In this election it was the Morrison government that made itself a small target so all the focus would be on Labor’s perceived policy losers.

Believing he had nothing to lose, Morrison staked everything on offering the world’s most expensive tax cuts.

But did he lie awake in the early hours of Sunday morning wondering how on earth he’d pay for them without the budget heading back into deficit? About the hugely optimistic forecasts of the economy’s early return to strong growth used to bolster his economic record? About the requirement that there be zero real growth in government spending per person over the next four years?

Morrison has no policy to control electricity prices, no convincing policy on climate change, no policy to halt the rising cost of health insurance, no policy response to any downturn in the economy, no solution to “cost of living pressures” and no plan to increase wages except yet more waiting.

The day may come when he decides winning the election was the easy bit.

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Where’s the money coming from? Ask me after the election

A key issue in this campaign has been whether government should be bigger or smaller. But that’s not the way either side has wanted to frame it. As usual, both sides prefer to be seen as offering more government spending and tax cuts and a return to big budget surpluses. In election campaigns, the rules of arithmetic are flexible.

A twist this time is that Scott Morrison is using his promised super-mega $300-billion tax cuts to support his claim that the Libs are always the lower-taxing party, whereas Labor is invariably the party of higher taxes.

But such massive tax cuts surely require big cuts in government spending? Oh, gosh no. Where did you get that idea? As he and Treasurer Josh Frydenberg have repeatedly said, they’re willing to "guarantee the essential services that Australians need and deserve".

For their part, Bill Shorten and Chris Bowen are promising to reverse a lot of the government’s previous alleged spending cuts in health and education, while more than matching the first stage of the government’s tax cuts and achieving bigger budget surpluses than it would. They would square this circle by "paying for our commitments by closing loopholes for the top end of town".

Only this week did Labor produce its detailed costings and figurings. We’ll come to that.

Apart from this week’s last-minute additions, all the government’s costings and figurings were outlined in the April budget, of course, and confirmed a few days later in the pre-election update.

Actually, this government has a rather chequered history on the unmentionable subject of whether government should be bigger or smaller. The obvious advantage of a bigger government is that it provides more of the services we love, and doesn’t skimp on their quality. The obvious advantage of a smaller government is less tax to pay.

When Tony Abbott came to government in 2013 determined to end debt and deficit ASAP, he pledged to do so solely by cutting government spending and avoiding any tax increases (apart from his temporary budget repair levy on high income-earners).

Trouble is, voters were so appalled by the sweeping cuts to health and education he proposed that his government’s standing in the opinion polls plunged, never to recover. The Senate blocked many of his cuts.

The episode revealed what economists call the "revealed preference" of voters (not what they say, but what they do). They may like tax cuts and hate the idea of new or increased taxes, what they really don’t want is smaller government.

In subsequent budgets, the Coalition pretty much abandoned the notion of cutting its way back to surplus (apart, of course, for its regular cuts in things most voters didn’t worry about – public servant numbers and payments to people on welfare).

It tried to limit the growth in government spending by following a rule that any new spending proposals had to be offset by equivalent cuts. Apart from that, it sat back and waited for "bracket creep" to raise tax collections to the point where the deficit disappeared.

Except for Malcolm Turnbull’s first budget, in 2016. Here he proposed to phase in a cut to the rate of company tax, and covered part of its cost by pinching Labor’s plan for huge increases in the tax on tobacco, and doing his own versions of Labor’s plans to tax multinational companies and reduce superannuation tax concessions.

In the end, most of the plan to cut company tax was abandoned, but the tax raising measures stayed – a point to remember when Morrison and Frydenberg try to give you the impression it’s only Labor that increases taxes or cuts back tax concessions (or increases taxes via bracket creep).

When Danielle Wood, of the Grattan Institute, looked more closely at Frydenberg’s budget, she found the government had fiddled the figures to exaggerate the extent to which it had limited the growth in government spending so far, and now was claiming to be able to limit its average real growth to just 1.3 per cent a year over the next four years – something no government has ever come close to achieving.

The ageing of the population and the huge demands this will make on the budget make it even harder to credit.

Now Dr Peter Davidson, principal adviser to the Australian Council of Social Service, has taken Grattan’s work and dug even deeper. He finds that, after you allow for expected population growth, real spending growth per person would be zero.

We’re told that, still in real terms, spending on tertiary education is expected to fall by 0.6 per cent each year, while spending on dental health, and on family payments, are each expected to fall by 0.7 per cent.

Spending on employment services is expected to fall by 2.5 per cent a year and on social housing by 2.7 per cent.

You may believe that would happen should the Coalition be re-elected, but I don’t. It’s possible Morrison has a dastardly secret plan to "do another Abbott" after the election, but it’s much easier to believe the government was just fudging the figures to make it seem it could afford big tax cuts as well as achieve big surpluses.

Meanwhile, Labor’s costings reveal that "closing loopholes for the top end of town" is a misleading way to describe its various cutbacks of tax breaks affecting high-income earners and plan to restore the Coalition’s budget repair levy for another five years.

But the costings are just that – costings of individual promises. Nowhere are we told what the various tax-raising measures add up to, nor what the various spending measures add up to.

We are, however, told that the former would exceed the latter by $17 billion over the next four years. Oh, well that’s OK then.

Bit too tricky for my liking. When it comes to the size of government, neither side wants to spell it out truthfully before the election. Thanks, guys.

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A politician always wins, but this time the choice really matters

If you judged it by the way Labor's been so quick to match the Coalition’s backdated doubling to $1000-a-year of its tax cut for middle income-earners (good idea) and now the Coalition’s plan to help first-home buyers (con job), you’d be justified in thinking that, despite all their furious arguing with each other, there’s little to choose from between the two sides. For once, however, such a conclusion would be dead wrong.

Not for many moons have voters faced such a clear-cut choice between Labor and Liberal.

It’s true that, if you judge the pollies by the way they behave, they’re just as bad as each other. Both sides refuse to answer the question, never say yes or no when they could dissemble, keep saying tricky things calculated to mislead, claim to “feel your pain” when they don’t, keep badmouthing each other and answering a question about their policies by attacking their opponents’ policies, and make promises they’re not sure they can keep.

And – one we’ll need to watch out for if Labor wins – claim to be much more high-principled than the government while they’re in opposition, but then do just the same when they’re in government, justifying it by saying they’re no worse than the last lot.

All true. But where the two sides are very different is in the policies they’re offering. And, although the more unpopular of those policies may or may not make it through the Senate, this is one time I’m inclined to agree with Paul Keating when he repeats his saying that “when you change the government, you change the country”.

Since it’s true that governments lose elections far more often than oppositions win them, the standard practice is for oppositions to make themselves a “small target” – to promise little of substance – so all the focus is on the many things the government has stuffed up.

Not this time. This time it’s the government making itself a small target – running on its economic record, with few policy promises bar its $300-billion tax plan – while Labor has so many controversial policies to go with its popular ones the Libs have been spoilt for choice.

Only the naive believe the battle between the classes ever ended, but in this election it’s more in-your-face than any time since the days of Labor’s Arthur Calwell. The Libs say Labor wants to increase taxes rather than cut them, but it would be more accurate to say it wants to make the well-off (including the well-off retired) pay more tax, while using the proceeds to increase government spending on health, education, childcare and much else, with what’s left over used to repay some of the government’s debt.

Labor plans to abolish tax refunds of unused dividend franking credits for those not on the pension, wind back negative gearing and the capital gains tax discount, reduce superannuation tax concessions, tax family trusts and restore for four years the 2¢-in-the-dollar budget repair levy on income above $180,000 a year, not to mention cancel the second and third stages of the Libs’ tax cuts.

In other words, Bill Shorten and Chris Bowen plan to use both sides of the budget to affect the biggest redistribution of income from high income-earners to low and middle income-earners we’ve seen in ages.

By contrast, the Libs are fighting tooth and nail to protect the tax breaks favouring property investors, self-funded retirees, high-income superannuation savers and business people who’ve gone for years using family trusts to reduce the tax they pay – most of which concessions were introduced by the Howard government.

As well, the Libs’ seven-year, three-stage, super-mega tax plan would favour high income-earners – individuals earning more than $100,000 and, particularly, $200,000 a year – to a degree more generous/blatant than I can remember.

The first stage, which is limited largely to middle income-earners, would give them an immediate cut in their average tax rate of no more than about 1¢ in every dollar they earn. That’s pretty much it for low and middle income-earners.

High income-earners have to wait for stage two (July 2022) and stage three (July 2024) before they get much. But then the heavens would open. Cuts in average tax rates would range from 1.5¢ in every dollar for those on $110,000 to 4.5¢ in the dollar for me and my mates on $200,000 and above.

Next, more than ever before, this election sees Labor going for the young vote (negative gearing, better childcare, preschool and universities) while the Libs defend actual and prospective self-funded retirees.

Except for Scott Morrison’s last-minute, few-details first home loan deposit scheme (which Labor matched within an hour or two). It sounds better than is, mainly because access to it would be limited. Further falls in house prices would do far more to help – but no pollie wants to say that.

Then there’s the minor matter of the adequacy of our contribution to the Paris Agreement’s effort to limit global warming. Here, too, the choice is wide, ranging from the Coalition (just pretending) to Labor (real but inadequate) to the Greens (full blast).

All that remains is a threshold question: will your choice be aimed at benefiting yourself and your family, or the wider community and “those less fortunate than ourselves”?

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Let's stop pretending the old normal is just around the corner

Just as a new chief executive makes sure their first act is to clear out all the stuff-ups left by their predecessor, so a new federal government needs to release its econocrats from the ever-more dubious proposition that nothing in the economy has changed and we’ll soon be back to the old normal.

That’s the old normal of productivity improving by 1.5 per cent a year, the economy growing by 2.75 per cent and wages growing more than 1 per cent faster than the 2.5 per cent inflation rate, with unemployment of 5 per cent and a fat budget surplus rapidly returning the government’s net debt to zero.

That’s the happy fantasy the econocrats have been predicting every year since 2012, the year they helped former treasurer Wayne Swan delude himself he was “delivering” four budget surpluses in a row.

It’s the same fantasy guiding the forecasts in this year’s budget and allowing Treasurer Josh Frydenberg to repeat Swan’s prediction.

A new government would do well to start by freeing itself from the purgatory of endlessly under-achieved forecasts. A re-elected government, of course, would find it much harder to free itself from addiction to the happy pills.

A now highly politicised Treasury seems to have had little trouble keeping this dubious faith that nothing fundamental in the economy has changed and that, every year the return to the old normal fails to happen – we’re up to seven and counting – makes this year’s forecast all the more likely to be the lucky winner.

No, it’s the Reserve Bank and its governor, Dr Philip Lowe, that’s had trouble reconciling the she’ll-be-right forecasting methodology with the daily reality of economic indicators that didn’t get the memo. Unlike Treasury, Lowe has to do it in public – and update his forecasts every quarter, not just twice a year.

The Reserve may be independent when it comes to making decisions about interest rates – though, as we saw last week, not still so independent it’s game to risk pricking the political happy bubble by cutting rates during an election campaign – but it has never allowed itself to be independent of Treasury’s forecasts.

Being bureaucrats, the Reserve’s bosses live in fear of ignorant journalists writing stories about Treasury and the Reserve being at loggerheads. So they never allow their forecasts to be more than a quarter of a percentage point at variance with Treasury’s.

Their bureaucratic minds also mean they prefer to initiate rate changes in February, May, August or on Melbourne Cup day, so their move can be justified in the quarterly statement on monetary policy published the following Friday.

All this does much to explain the contortions Lowe put himself through last week. Everything the Reserve said about the immediate outlook for the economy implied it should have begun cutting last week.

It slashed its forecasts for consumer spending, inflation and GDP for the rest of this calendar year, which of itself was enough to justify an immediate cut. Last Tuesday it told us enigmatically it “will be paying close attention to developments in the labour market”, but three days later forecast that unemployment would be unchanged at 5 per cent for the next two years.

What Lowe hasn’t explained is that the only thing in the labour market that would stop him cutting rates in the next few months is if unemployment were to fall. That’s because the one respect in which he’s broken free of the Treasury orthodoxy is his acknowledgement, before a parliamentary committee, that the best estimate of full employment (the “non-accelerating-inflation rate of unemployment”) has dropped from about 5 per cent to about 4.5 per cent. If you’re not heading down to 4.5 per cent, why aren’t you cutting?

Trouble is, if full employment is 4.5 not Treasury’s 5, that means our “potential” growth rate is likely to be below Treasury’s 2.75 per cent (including its assumption of 1.5 per cent annual improvement in productivity). And, if that’s so, then our “output gap” will be less than the 1.25 percentage points that Treasury uses to justify its projection that the economy will grow for five years in a row at 3 per cent, before dropping back to 2.75 per cent a year.

The trick to Treasury’s forecasting is that, though it always cuts its immediate forecasts to accommodate the latest disappointment in the actual data, its mechanical projections assume “reversion to the mean”, so its later forecasts have to rise to meet the start of the we’re-back-to-normal projections. But it’s always the old mean we'll be reverting to, not any new one.

Now get this: measured on a consistent “year-average” basis, the Reserve’s latest “slashed” forecasts differ in no significant way from those Treasury put in this year's budget. When it comes to forecasting, the Reserve is slave to a politicised Treasury.

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