Why surpluses aren't necessarily good, or deficits bad

According to the Essential opinion poll, only 6 per cent of people regard the size of the national surplus as the most important indicator of the state of the economy. I think that’s good news, but I’m not certain because I’m not sure what “the national surplus” is – or what the respondents to the poll took it to mean.

They probably thought it referred to the balance on the federal government’s budget. But the federal budget is not yet back to surplus and, in any case, it can’t be the national surplus because it takes no account of the budgets of the state governments that, with the feds, make up the nation.

Assuming respondents took it to be the federal budget balance, its low score is good news about the public’s economic literacy, but bad news for Scott Morrison and Josh Frydenberg, who are hoping to make a huge political killing when, in September next year, they expect to announce the budget finally is back in surplus.

The pollies are assuming that voters know nothing more about the economy than that anything called a surplus must be a good thing, whereas anything called a deficit must be very bad.

Actually, no economist thinks all surpluses are good and all deficits bad. Sometimes surpluses are good and sometimes they’re bad. Vice-versa with deficits. It depends on the economy’s circumstances at the time.

But the confusion doesn’t end there. There are lots of measures in the economy that can be in deficit or surplus, not just governments’ budgets. When I wrote a column some weeks back foreshadowing that the current account on the nation’s balance of payments would probably swing into surplus for the first time in 44 years, some people assumed I must be referring to the federal budget.

Wrong. The federal budget records the money flowing in and out of the federal government’s coffers – it’s bank account. The “balance of payments” summarises all the money flowing into and out of Australia from overseas – covering exports, imports and payments of interest and dividends in and out (making up the “current account”), and all the corresponding outflows and inflows of the financial payments required (making up the “capital and financial account”).

The trick is that, thanks to double-entry bookkeeping, the balances on the two accounts making up the balance of payments must be equal and opposite. So the longstanding deficit on the current account was always exactly offset by a surplus on the capital account.

And that means the (probably temporary) current account surplus was matched by the capital account swinging from surplus to deficit. Oh no.

Although Australia has been a net importer of (financial) capital almost continuously since the arrival of the First Fleet, for the June quarter we became a net exporter, lending or investing more money in the rest of the world than the rest of the world lent or invested in us.

If you tell the story of this change in plus and minus signs from the current account perspective, it’s mainly that the resources boom has greatly increased our exports, while the slowing in the economy’s growth means our imports of goods and services are also weak.

But there’s also a story to be told about why the capital account has gone from surplus to deficit. As Reserve Bank deputy governor Dr Guy Debelle explained in a speech at the time, the composition of the inflows and outflows of financial capital have changed a lot since 2000.

Since Australia has always been a recipient of foreign investments in our businesses, by June this year, the value of the total stock of that equity investment amounted to a liability to the rest of the world of $1.4 trillion.

But the value of our equity investments in the rest of the world amounted to assets worth $1.5 trillion. So, when it comes to equity investment, the latest figures show we had net assets of $142 billion.

The fact is, the value of our shares in them overtook the value of their shares in us in 2013. That’s a remarkable turnaround from the previous two centuries of being a destination for foreign investment.

Why did it come about? Mainly because of our introduction of compulsory superannuation. Our super funds have invested mainly in local companies, but they’ve also invested a lot in the shares of foreign companies.

For the most part, however, our seemingly endless string of current account deficits has been financed by borrowing from the rest of the world. By June, our debt to foreigners totalled $2.4 trillion. Their debt to us totalled $1.3 trillion, leaving us with net foreign debt of a mere $1.1 trillion.

There was a time when Coalition politicians carried on about that debt – owed more by our banks and businesses, than our governments - rather than the (much smaller) debt of the federal government, only about 55 per cent of which is owed to foreigners.

Why does our huge net foreign debt rarely rate a mention these days? Because it’s always made economic sense for a young country with huge development potential to be an importer of financial capital – it’s part of what’s made us so prosperous.

Because all the debt we owe is denominated in Australian dollars or has been “hedged” back into Aussie dollars – meaning a sudden big fall in our dollar would be a problem for our creditors, not us.

But also because, though our net foreign debt keeps growing in dollar terms, our economy is also growing – and hence, our ability to pay the interest on the debt. That’s a sign that, overall, the money we’ve borrowed has been put to good use.

Adding our net foreign assets to our net foreign debt gives our net foreign liabilities. Measured against the size of the economy (nominal gross domestic product), our net foreign liabilities reached a peak of about 60 per cent in 2009, but have since fallen to about 50 per cent.

Read more >>

Why are the Viking economies so successful? They pull together

I’d like to tell you I’ve been away working hard on a study tour of the Nordic economies – or perhaps tracing the remnant economic impact of the Hanseatic League (look it up) – but the truth is we were too busy enjoying the sights around Scandinavia and the Baltic for me to spend much time reading the books and papers I’d taken along.

But since I always like telling people what I did on my holidays (oh, those fjords and waterfalls we saw while sailing up the coast of Norway to the Arctic Circle!), I’ve been looking up facts and figures in a forthcoming book comparing the main developed countries on many criteria, by my mate Professor Rod Tiffen and others at Sydney University (and me).

But first, the travelogue. Prosperous countries have a lot in common but Scandinavia is different. I have seen the future and, while some might regard it as political correctness gone mad, it looked pretty good to me.

One aspect in which the Nordics (strictly speaking, Finland isn’t Scandinavian because it’s a republic rather than a monarchy and because the Finnish language bears no relation to Danish, Swedish or Norwegian) are way more advanced is the role of women.

All of them have had female prime ministers or presidents, they have loads of female politicians and we were always seeing women out at business functions with their male colleagues.

Governments spend much more on childcare and they’re big on men actually taking paid paternity leave. They have “family zones” in trains and we were struck by how many men we saw by themselves pushing prams.

They’re much more relaxed on sexual matters. These days, any new building in Sweden will have unisex toilets, with rows of cubicles and not a urinal to be seen. Neat way of sidestepping debates about which toilet transgender people should use.

The Nordics are well ahead of us on environmental matters. They’re bicycle crazy (a big health hazard for tourists who don’t know they’re standing in a bike lane) and drive small cars.

They’re obsessed with organic food and even hotel guests are expected to recycle their paper and plastic. One hotel we stayed at in Copenhagen was so concerned to save the planet its policy was to make up the rooms only every fourth day.

The Norwegians have made and, unlike the rest of us, saved their pile by selling oil to the world but you get the feeling it troubles their conscience. So, like the other Nordics, they have ambitious targets to move to renewables and, to that end, are making more use of carbon pricing than most other countries.

The truth is, I’ve long wanted to see Scandinavia for myself. It’s a part of the world that most politicians and economists prefer not to think about. Why not? Because its performance laughs at all they believe about how to run a successful economy.

Everyone in the English-speaking economies knows big government is the enemy of efficiency. The less governments do, the better things go. The lower we can get our taxes, the more we’ll grow.

Just ask Scott Morrison. As he loves to say, no one ever taxed their way to prosperity. What’s he doing to encourage jobs and growth? Cutting taxes, of course. That’s Economics 101 – so obvious it doesn’t need explaining.

Trouble is, the Nordics have some of the highest rates of government spending in the world and pay among the highest levels of taxation, but have hugely successful economies.

The Danes pay 46 per cent of gross domestic product in total taxes, the Finns pay 44 per cent, the Swedes 43 per cent and the Norwegians 38 per cent (compared with our 28 per cent).

Measured by GDP per person, Norway's standard of living is well ahead of America's. Then come the Danes and the Swedes – at around the average for 18 developed democracies (as are we) – with the Finns just beating out the Brits and the French further down the list.

The Nordics are also good at managing their government budgets.

We all know unions are bad for jobs and growth and we’ve succeeded in getting our rate of union membership down to 17 per cent. Funny that, the Nordics still have the highest rates (up around two-thirds). So, do they have lots of strikes? No.

The four Nordics are right at the top when it comes to the smallest gap between rich and poor, with Canada, Australia, Britain and the United States right at the bottom.

Other indicators show that (provided you ignore the long snowy winters) the Nordics enjoy a high quality of life and not just a high material standard of living.

Note this: I’m not claiming that the Scandinavians are more economically successful because of their big government and high taxes. No, I’m saying that, contrary to the unshakable beliefs of many economists and all conservative politicians, there’s little connection between economic success and the size of government.

So how do the Scandis do it? I read this on the wall of an art museum in Aarhus, Denmark: “In a society we are mutually interdependent. Strengthening the spirit of community, we improve society for all of us as a group but we also provide each individual with better opportunities for realising his or her own potential.”

Read more >>

Why we don't get more joy out of our super

When one of our top econocrats gives a speech about behavioural economics, you know we’re making progress. Take the ever-present problem of income in retirement. “BE” explains both why it’s a major area of government intervention in our lives and how that intervention can be made more effective.

One of the greatest limitations of conventional economics – based on the “neo-classical” model, which focuses on how prices are determined by the interaction of supply and demand – is its assumption that people are unfailingly “rational” – calculatingly self-interested – in their response to the prices they face.

Behavioural economics accepts that we’re not the financial automatons the model assumes us to be, and uses insights from the more empirical sciences of psychology and sociology to gain a much more realistic picture of the many non-monetary factors that also affect our behaviour in economic matters.

Behavioural economists draw on the long list of “heuristics” – mental shortcuts or biases in the way we think – developed by cognitive psychologists. In a recent speech, Dr David Gruen, top economics guy in the Department of Prime Minister and Cabinet, outlined the cognitive biases that limit many people’s ability to make adequate provisions for the income they’ll need in retirement.

For more than a century the government has provided the age pension, of course. But in the 1990s people began to worry that it wouldn’t be sufficient to meet the aspirations of the rising generation. So the Keating government introduced compulsory employee superannuation.

In those days before the spread of BE, most economists accepted the imposition of compulsory saving as a correction to the “market failure” of “myopia” – most of us are too short-sighted to save enough towards our retirement.

The BE way of putting it is that we suffer from “present bias” – we overvalue the present relative to the future. Gruen takes the idea further, noting that “while choosing a retirement plan is likely to influence literally decades of our lives, many of us spend little time – sometimes less than an hour – choosing our plan”.

Then there’s “confirmation bias” – we tend to remember events that confirm our existing views, but forget developments that cast doubt on those views. Gruen uses this to explain why many of us spend what little time we have set aside to choose a retirement plan looking for one with an investment strategy that supports our existing investing approach.

And “cognitive overload”. This occurs when people find it too hard to process a mass of information in order to make decisions. In the context of planning for retirement, it leads many of us to stick with choices we have arrived at by default.

“Together, these cognitive biases create a big gap between our intentions and our actions: although people intend to save for their retirement, they often don’t translate that into action. For most people, how much to save, and in what form, are difficult cognitive problems – because of both our limited calculation powers and the apparent enormity of the task,” Gruen says.

When the compulsory super system was first set up, the government adopted the conventional economics view that savers were rational economic agents who knew their own business best. So all it had to do was require the super funds to reveal relevant information about their investment options, and diligent savers would do the rest, ensuring they picked the option that best suited their circumstances.

Yeah sure. At the time of a review of super in 2009, 80 per cent of super fund members were invested in the default fund chosen by their employer. Of that 80 per cent, anecdotal evidence suggested that only about 20 per cent explicitly chose the default option, with the rest making no active choice whatsoever.

“When complicated decisions are required, people often stick with the status quo and take no decision at all. In that case, the default option becomes very important,” Gruen says. (This is actually one of the key “insights” of BE.)

So the review panel recommended creating a default option – called MySuper - with features that would promote the wellbeing of those who didn’t actively choose another option. MySuper funds must be simple and cost-effective, with a diversified portfolio of investment.

Of course, there are remaining challenges in the compulsory super system, which the latest review of retirement incomes, instigated by Treasurer Josh Frydenberg, will consider. Let’s hope it takes full advantage of the behavioural insights available to it.

As Gruen says, BE allows all government policymaking to be improved by starting with a richer understanding of human behaviour and building this into the design of measures.

Read more >>

Governments are learning to nudge us down better paths

The world is a complicated place – partly because humans are complicated animals. One of the many things this means is that when governments try to influence our behaviour, their chances of stuffing up are surprisingly high.

Consider this. Say I’m an investment adviser telling you (or your parents or grandparents) where to invest your retirement savings. I warn you that, should you take my advice, I’ll be paid a commission by the managers of the investments I put you into.

How do you react?

Well, you should react by becoming a lot more cautious about following my advice. It’s clear I have a conflict of interest. Is my advice aimed at doing the best I can for you, or at maximising the commissions I earn?

When governments require investment advisers to disclose any conflict of interest to their clients, that’s how the pollies expect you’ll react. They also expect that this requirement will prompt advisers to eliminate or reduce any conflict so their advice is more likely to be trusted.

But research by Dr Sunita Sah, a psychologist at Cornell University in upstate New York, has found it often doesn’t work like that. Although such disclosures do indeed cause clients to have less trust, they can often lead people to feel social pressure to act on the advice anyway.

Clients may be concerned that refusing to follow the advice would be a signal of their distrust in the adviser, with whom they’ve often formed a personal bond. They may even interpret the disclosure as a request that the advice be taken, as a favour to the adviser who, after all, needs to earn a living like the rest of us.

Sah found that clients given advice they knew to be conflicted were twice as likely to follow that advice as were clients where no disclosure was made.

The lesson is not that we should stop requiring advisers to disclose their conflicts, but that government policymakers need to think carefully about the specific design of their policies.

It turns out you can reduce the undesirable effects of disclosure if they come from a third party – that is, someone other than the adviser. It also helps if clients’ decisions are made in private, or if there’s a cooling-off period before the decision is finalised.

Have you guessed where this is leading? It’s a plug for a relatively new tool that’s been added to the bureaucrats’ policy toolkit – “behavioural insights”.

In a speech he gave in Canada last week, Dr David Gruen, a deputy secretary in our Department of Prime Minister and Cabinet, explained that behavioural insights is an approach to policymaking that draws from psychology, cognitive sciences and economics to better understand human behaviour, help people make good choices more easily, and help improve the effectiveness of public policy interventions.

As the case of conflict-of-interest disclosures illustrates, people’s responses to government policy measures can be surprising. Politicians and bureaucrats need to be more conscious of the insights of behavioural insights when designing policies to fix problems.

And the behavioural insights tool can also be used for real-world testing of how policy measures are working – or not working – in practice.

The first government to establish a behavioural insights team was Britain in 2010, at the initiative of prime minister David Cameron, Gruen says. It’s since become a partly privatised joint venture.

By now, according to the Organisation for Economic Co-operation and Development, there are more than 200 public sector organisations around the world that have applied behavioural insights to their work.

In Australia, the federal government’s behavioural economics team – BETA – was set up to apply behavioural insights to public policy and to build behavioural-insights capability across the public service. It’s at the centre of a network of 10 behavioural insight teams across the federal government and alongside several state government teams.

These teams are also known as “nudge” units because they’re often trying to give individuals a nudge in the direction of making more sensible decisions, while leaving them free to do something else should they choose. You’re not forced, just nudged.

Gruen offered several examples of what the feds have been doing. BERT, the behavioural economics research team in the Department of Health, looked at the ballooning cost of reimbursements to doctors for providing after-hours care.

After-hours care considered urgent was remunerated at about twice the rate of that judged a non-urgent visit. Who judged whether the care was urgent? The doctor.

The department identified the 1200 doctors with the highest urgent after-hours claims, and ran a randomised control trial, sending each of them one of three alternative letters, with the letter a doctor received chosen at random.

One letter compared the doctor’s billing practices with their peers, showing they were claiming the urgent category far more often than others were. This drew on the behavioural insight that individuals are often motivated to change their behaviour when they are out of step with their peers.

The second letter emphasised the consequences of non-compliance, including the penalties and legal action. This letter drew on the behavioural insight that people tend to avoid losses more than they seek the equivalent gains.

The third letter was the control – the standard bureaucratic compliance letter, running to three pages.

All three letters were successful in reducing claims, but the peer-comparison one was far more effective than either the standard compliance letter or the loss-framing letter. The peer-comparison letter reduced claims by 24 per cent.

And it was just a nudge, not a threat of punishment for dishonestly claiming cases to be urgent when they weren’t.

In the six months after the letters were sent, the 1200 high-claiming doctors reduced their claims by more than $11 million (across all three letters), and 18 doctors voluntarily owned up to more than $1 million in previous incorrect claims.

So, as Gruen concludes, a simple and cheap nudge can yield big dividends.

Read more >>

Our leaders slowly come to grips with a different economy

The beginning of economic wisdom is to understand that the advanced economies – including ours – have stopped working the way they used to and won’t be returning to the old normal.

Second in the getting of wisdom is to understand that economists are still debating why the economy is behaving so differently – so poorly - and what we can do about it.

Last week Reserve Bank governor Dr Philip Lowe gave a speech to a conference of central bankers in Wyoming revealing his acceptance that, as he put it, the economic managers are having to “navigate when the stars are shifting”.

And Treasurer Josh Frydenberg gave a speech on Australia’s productivity challenge, which offered the Morrison government’s first acknowledgement that maybe not everything in Australia’s economic garden is rosy.

The shifting “stars” to which Lowe alluded were economists' estimates of the rate of full employment and the equilibrium real interest rate – both of which have moved downwards. He said that economists have become very good at developing explanations for why this has happened.

“Even so, the reality is that our understanding is still far from complete about what constitutes full employment in our economies and how the equilibrium interest rate is going to move in the future,” he said.

He offered two likely explanations for why the stars had moved. First, major changes around the world in the appetite to save and to invest. People were saving more despite low interest rates, and were borrowing less to fund physical investment despite low interest rates.

On the saving side, these changes were linked to demographics (the ageing population), the rise of Asia (which saves a lot) and the legacy of too much borrowing in the past.

On the investment side, the links were to slower productivity improvement and “importantly, increased uncertainty and a lack of confidence about the future”.

The second major change was an increased perception of competition as a result of globalisation and advances in technology. “More competition means less pricing power, for both firms and workers,” he said.

In all this he gave the lie to the latest line that our economy is going fine, it’s just the threat from abroad that’s the problem. Nonsense. Our economy is slowing to a crawl because of weak real wage growth. The external threat just makes it worse.

After giving a learned account of our slower rate of productivity improvement (and acknowledging that it’s happening throughout the developed world), Frydenberg admitted that business investment spending was not as strong as it ought to be.

But then he stepped into the lions’ den. Rather than returning capital to shareholders, business needed to back itself – make its own luck – by using its strong balance sheet (and exceptionally low interest rates) to “invest and grow”.

The fury of the righteous descended upon him, with the business media in full cry. It really is amazing the way business people boast about the centrality of the private sector to the economy and its success, but refuse to accept any responsibility for its outcomes.

Any weaknesses in the economy are solely the government’s fault, and feel free to criticise it uphill and down dale – not to mention using problems in the economy as a pretext for rent-seeking. Don’t even think that the performance of business could be less than blameless. Who do you think invented the term “all care but not responsibility”?

Even so, I fear business is right in protesting that the reason it’s not investing is that, with demand so weak, it can’t see how expanding its production capacity could be profitable.

This problem began long before Trump started playing his crazy trade-war games, but there’s little doubt that the uncertainty he has created is adding to firms’ reluctance to commit to major investment projects. And the more people delay their investment plans until the future is clearer, the greater the risk that conditions deteriorate and the investment never gets done.

Dr Mike Keating, a former top econocrat, argues that productivity improvement is weak because business investment spending is weak. It’s when businesses install the latest and best machines and systems that new technology is diffused through the economy, lifting productivity.

So when weak wage growth leads to weak growth in consumption, you don’t get enough business investment and, hence, slower productivity improvement.

Government intervention to improve workers’ bargaining power may help speed up the flow of income through the system, but Keating believes a lasting improvement will come mainly by making education and training more effective in helping workers adapt to and adopt new technologies.

Read more >>

If you think surpluses are always good, prepare for great news

Don’t look now, but Australians’ economic dealings with the rest of the world have transformed while our attention has been elsewhere. Business economists are predicting that, on Tuesday, we’ll learn that the usual deficit on the current account of the balance of payments has become a surplus.

If so, it will be the first quarterly surplus in 44 years. If not, we’ll come damn close.

You have to be old to appreciate what a remarkable transformation that is. Back in the 1980s we were so worried about the rise in the current account deficit and the foreign debt that it was a regular subject for radio shock jocks’ outrage. They knew nothing about what it meant, but they did know that “deficit” and “debt” were very bad words.

By the 1990s, Professor John Pitchford, of the Australian National University, had convinced the nation’s economists that the rises were a product of the globalisation of financial markets and the move to floating exchange rates, and weren’t a big deal.

By now, economists have become so relaxed about the “balance of payments” that it’s rarely mentioned. So news of the disappearing deficit will be a surprise to many.

To begin at the beginning, the balance of payments is a summary record of all the monetary transactions during a period that have an Australian business, government or individual on one end and a foreign business, government or individual on the other.

The record is divided into two accounts, the current account and the capital and financial account.  The balance on the current account is always exactly offset by the balance on the capital account. If one has a deficit of $X billion, the other must have a surplus of $X billion, so that the balance of (international) payments is in balance at all times.

As a Reserve Bank explainer says, the current account captures the net flow of money resulting from our international trade. The capital account captures the net flows of financial capital needed to make all the exporting, importing and income payments possible. These flows during the period change the amounts of Australia’s stocks of assets and liabilities at the end of the period.

To work out the balance on the current account, first you take the value of all our exports of goods and services and subtract the value of all our imports of goods and services, to get the balance of trade.

Then you take all the interest income and dividends we earnt from our investments in foreign countries and subtract all the interest and dividend payments we make to foreigners who’ve lent us money or invested in our companies.

The result is the “net income deficit” which, after you’ve added it to the trade balance, gives you the balance on the current account. As Michael Blythe, chief economist at the Commonwealth Bank, noted this week, that balance has been a deficit for 133 of the past 159 years.

Why do we almost always run a deficit? Because our land abounds in nature’s gifts, and there’s great opportunity to exploit those gifts and earn wealth for toil. What we’ve always been short of, however, is the financial capital needed to take advantage of all the opportunities.

Moving from poetry to econospeak, for pretty much all of our modern history Australia has been a net importer of (financial) capital, as Reserve deputy Dr Guy Debelle said in a revealing speech this week.

Because we don’t save enough to allow us to fully exploit all our opportunities for economic development, we’ve always drawn on the savings of foreigners – either by borrowing from them or letting them buy into Australian businesses.

Blythe says “the shortfall reflects high investment rather than low saving. By running current account deficits, we have been able to sustain a higher [physical] investment rate than we could fund ourselves. Economic growth rates and living standards have been higher than otherwise as result.”

True. And Debelle agrees, noting that Australia’s rate of saving is on par with many other advanced economies. (So don’t let any silly pollies or shock jocks tell you a current account deficit means we’re “living beyond our means”.)

Be sure you understand this: a current account deficit is fully funded by the corresponding surplus on the capital account, which represents the amount by which we needed to call on the savings of foreigners because the nation’s physical investment in new housing, business plant and structures, and public infrastructure during the period exceeded the nation’s saving (by households, companies and governments) during the period.

But if all that’s true, how come we’re expecting a current account surplus in the June quarter? It’s a combination of long-term changes in the structure of our economy that have been working to reduce the deficit, and temporary factors that may push us over the line.

Debelle says that between the early 1980s and the end of the noughties, the deficit averaged the equivalent of about 4 per cent of gross domestic product. But it’s narrowed since 2015 and is now about 1 per cent of GDP.

Most of this change is explained by the trade balance. It averaged a deficit of about 1.25 per cent of GDP over the three decades to 2015, but since then has moved into surplus. It hit record highs during the three months to June, totalling a surplus of $19.7 billion for the quarter.

The resources boom has hugely increased the quantity of our minerals and energy exports, and there’s been a temporary surge in the price we’re getting for our iron ore. At the same time, the end of the investment phase of the resources boom has greatly reduce our imports of mining and gas equipment.

The rise of China and east Asia also means protracted strong growth in our exports of education and tourism.

At the same time, the net income deficit has widened a little in recent years but, at 3.4 per cent of GDP, is in the middle of its range since the late 1980s.

The marked reduction in the current account deficit overall means that Australia’s stock of net foreign liabilities (debt plus equity in businesses) peaked at 60 per cent of GDP in 2009 and has now declined to 50 per cent. But that’s a story for another day.

Read more >>

Greater social inclusion makes us wealthier, not just happier

If you like made-up, clunky words you could call it the humanisation of economics. And it’s one of the most exciting developments in a field most people don’t consider very exciting. It’s the product of economists’ search for reasons why the economies of the developed world have stopped working as well as they used to.

This week our Reserve Bank governor, Philip Lowe, gave a short but sobering speech at a conference of central bankers in Wyoming exploring the deeper, structural reasons why economies – including ours - aren’t growing as fast as they did, and admitting this wasn’t likely to change any time soon.

A big part of the reason for weaker growth is a slower rate of improvement in the productivity of labour – the use of improved technology to increase the output of goods and services per worker.

Also this week, Treasurer Josh Frydenberg gave a long, carefully researched and highly informative speech about the deterioration in our productivity performance. His one controversial proposition has been monstered by the business media, but the speech was an encouraging sign that the Morrison government may be moving from happy slogans to careful consideration of the problems besetting our economy.

Now to my new word, humanisation. Until the past couple of decades, it was relatively easy to achieve high annual rates of productivity improvement by using bigger and better machines to increase the efficiency of our farms, mines and factories in their production of goods.

These days, goods are produced by machines, helped by humans. Services, on the other hand, are delivered by humans helped by machines. Goods have come to account for an ever-smaller share of the value of economic activity, with services contributing an ever-bigger share.

But installing more productive goods-producing machines is a lot easier than making the human providers of services (ranging from prime ministers to scientists, doctors and teachers on to waiters and cleaners) better at their jobs. This does a lot to explain the slowdown in productivity improvement.

So economists have had to turn their minds to humans, and how you make them more productive. An obvious response is to ensure they’re well educated and trained, equipped with the right skills to take them onwards in an ever-changing economy.

Equally obvious is making sure our workers are in good health – mental as well as physical. These are things we could be doing better than we are.

Less obvious is economists’ relatively recent discovery of the economic importance of “place” – where people live and work. Particularly at a time when knowledge has become a more critical ingredient, big cities have become incubators, bringing together talented workers to promote experimentation and learning, as well as enabling the transfer of knowledge. (Bit surprising in an age where digital connections are ubiquitous.)

Another less-obvious realisation is that, in the services sector, productivity depends on creativity and imagination, which drive innovation. Increasingly the services sector is the home of start-ups aimed at finding innovative ways to deliver new and existing services to larger numbers of customers.

This is very touchy-feely stuff for hard-nosed economists. One of our leading economists, Professor Ian Harper, dean of Melbourne Business School, says creativity and imagination “are generally stimulated by human interaction, social creatures that we are".

“And the more diverse we are when we gather, the more we stimulate, challenge and goad one another to greater heights of imagination and creativity.

“But for diversity to work its magic, there must also be inclusion. No matter how diverse we are, without inclusion we remain separated by physical, social, cultural and emotional barriers, and the creative spark is quenched by sameness and group think,” Harper says.

Enter the SBS network, which has commissioned Deloitte Access Economics to study the economic benefits of improving social inclusion.

By this is meant affording all people the best opportunities to enjoy life and prosper in society. It includes the Indigenous, and almost 7 million immigrants, from 270 ancestries, since 1945. All the women who should have more senior jobs. Almost 50,000 same-sex couples, and one in five people with a physical or mental disability.

About a third of small businesses in Australia, representing 1.4 million employees, are run by migrants to Australia, the great majority of whom didn’t own a business before coming here. And most migrants feel socially included.

Greater social inclusion means people are less likely to experience discrimination in employment, less likely to experience health issues, especially anxiety and depression. By lifting wages and workforce participation in districts of socioeconomic disadvantage, the benefits of economic growth can be shared more evenly across the community.

All this could save the taxpayers money, as well as making businesses more productive – which, by Deloitte’s modelling, could yield an economic dividend of more than $12 billion a year. And that’s not to mention the small matter of allowing the individuals to lead happier, more satisfying lives.

For many years economists believed economic efficiency and fairness to be in conflict. You could make the economy a fairer place only by making it a less-rich place.

That’s the economists’ exciting discovery in recent years: if you play your cards right, you can make the world fairer and a bit richer.

Read more >>

Why government-controlled prices are soaring

As if Scott Morrison didn’t have enough problems on his plate, we learnt last week that government-administered prices are rising much faster than prices charged by the private sector.

Last week my colleague Shane Wright dug out figures from the bowels of the consumer price index showing that, over the almost six years since the election of the Abbott government in September 2013, the prices of all the goods and services in the CPI basket have risen by just 10.4 per cent, whereas the government-administered prices in the basket rose by 26 per cent.

Some of those "administered" prices actually fell and others rose by less than prices overall. But let’s do what everyone does and focus on the really big increases.

Behavioural economics tell us that people’s perceptions of the cost of living are exaggerated by a ubiquitous mental shortcut psychologists call "salience". We tend to remember the things that leapt out at us at the time and forget all the things that didn’t.

So, for instance, we vividly remember the shock we got when we opened our electricity bill and saw how huge it was and how much it had increased.

In round figures, the cost of secondary education rose by 30 per cent over the period, childcare by 27 per cent, postal costs by 27 per cent, hospital and medical services by 36 per cent, council rates by 21 per cent, cigarettes by 109 per cent, gas prices by 16 per cent and electricity by 12 per cent (most of the bigger increase came during the term of the previous Labor government).

Not hard to see that the government has a huge salience problem. Plenty of scope there for the punters to convince themselves the cost of living is soaring.

But what should Morrison do? At a glance, the problem's obvious: government prices rising much faster than market prices say governments are hopelessly wasteful and inefficient. So expose the government to competition and the waste will be competed away, to the benefit of all.

Sorry, the true story’s much more complicated. Indeed, part of the problem is the backfiring of governments’ earlier attempts to make the provision of government services "contestable".

Let’s look deeper. For a start, some of the increase in administered "prices" is actually increases in taxation. The doubling in cigarette prices is the result of the phased massive increase in tobacco excise begun by Malcolm Turnbull.

Local council rates work by applying a certain rate of tax to the unimproved land value of properties. State governments usually cap the extent to which the tax rate can be increased, but the base to which it’s applied soars every time there’s a housing boom.

Postal costs rise because we want to continue being able to post letters to anywhere in Australia at a uniform price, even though we're actually doing it less and less, thus sending economies of scale into reverse. Australia Post would have been privatised long ago if any business thought it could make a profit from the business without scrapping the letter service.

The doubling in the retail prices of the now largely privatised (but still heavily regulated) electricity industry over the past decade is the classic demonstration that attempts to introduce competition to monopoly industries are no simple matter and can easily backfire.

The cost of childcare has been rising over the years because governments have been raising quality standards – staff-child ratios, better educated and paid workers. Is that bad? This formerly community-owned sector has long been open to competition from for-profit providers without this showing any sign of helping to limit price increases.

Even so, childcare is heavily subsidised by the federal government. This government’s more generous subsidy scheme caused the net out-of-pocket cost to parents (which is what the CPI measures) to fall a little last financial year.

The modest suggested fees in government schools wouldn't have risen much over the past six years. If private school fees have risen strongly despite the heavy taxpayer subsidies going to Catholic and independent schools, it’s because the number of parents willing to pay them shows little sign of diminishing. Hardly the government’s problem.

Detailed figures show that the out-of-pocket costs for pharmaceuticals rose by less than 6 per cent (thanks to reforms in the pharmaceutical benefits scheme) and for therapeutic goods fell a few per cent, while for dental services they kept pace with the overall CPI, leaving the out-of-pocket costs of hospital and medical services up by a cool 36 per cent.

That tells you private health insurance is falling apart. Add the continuing problems with needs-based funding of schools, and electricity and gas prices, and the scope for further efficiency improvements in healthcare, and you see the Morrison government has plenty to be going on with.

Read more >>

How strange could money get if the worst came to the worse?

With our official interest rate heading ever closer to zero, there’s much talk that the Reserve Bank may be forced to join other central banks in resorting to “unconventional monetary policy,” including QE – “quantitative easing”. But how likely is this? What might it involve? Are there alternatives? And would it be good or bad?

These questions were debated by Dr Stephen Kirchner, of the United States Studies Centre at Sydney University, Dr Stephen Grenville, a former deputy governor of the Reserve now at the Lowy Institute, and Lyn Cobley, boss of Westpac’s institutional bank, at a meeting of the Australian Business Economists in Sydney this week.

But let’s start with what the Reserve’s governor, Dr Philip Lowe, said on the subject to the House’s economics committee earlier this month.

He said it was possible the official interest rate would end up at zero. Here’s the key quote: “I think it’s unlikely, but it is possible. We are prepared to do unconventional things if the circumstances warranted it.”

The Reserve had been doing a lot of thinking about unconventional policies, so as to be ready if they proved necessary, not because it thought them likely to be needed.

“I hope we can avoid that,” he said. Which I take to mean that, should they prove needed, the economy’s prospects would be much worse than they are now. But also that the Reserve doesn’t fancy having to use unconventional methods.

Conventional monetary policy involves the central bank using its “open market operations” (selling or buying Commonwealth bonds from the banks) to push its official interest rate, and hence the banks’ short-term and variable interest rates, up or down so as to discourage or encourage borrowing and spending (“demand”) in the economy.

Lowe’s list of unconventional measures includes the “negative” interest rates applying in Switzerland, the euro area and Japan (where lenders pay the borrowers tiny interest rates; don’t hold your breath waiting for this one), the central bank lending funds to banks at below-market rates provided they lend them on to businesses, the central bank buying corporate bonds or mortgage-backed securities, or intervening in the foreign exchange market to push the value of its currency down.

But the measure Lowe seemed least uncomfortable with is the central bank buying long-term government securities to try to lower risk-free long-term interest rates. This is similar to conventional policy, just at the long end rather than the short end.

Lowe also said that, if it became necessary to start buying long-term securities, you wouldn’t need to have cut the official interest rate to zero before you started. He implied he might go no lower than 0.5 per cent.

Why stop there? Because by then the banks’ deposit rates would be too low to be cut any further, meaning they couldn’t pass the cut on to their home-loan and business borrowers.

However, he admitted, if things got so bad internationally that all the other central banks had cut their official rates to zero, we might be obliged to follow suit. Another possibility would be if our economic growth slowed even further – say, into the 1 per cent range – though in that case a response would be needed from fiscal policy (the budget) as well as monetary policy.

Turning to this week’s debate, Westpac’s Cobley made it clear the banks would have trouble coping with most of the unconventional measures. Even cutting the official rate any further would hit the banks’ profits (sounds of weeping and breast-beating by the bank customers present).

Kirchner, who is among the minority of economists who believe fiscal policy is ineffective in managing demand, saw no problem with using unconventional measures, which could easily have the same effect as cutting the official rate by a further 2.5 percentage points.

He said the consensus of academic studies was that unconventional measures in the US had been quite effective. Grenville agrees with him that, for the central bank to switch from buying short-term securities to buying long-term securities in no way constitutes “printing money” (even metaphorically).

Grenville disagreed with his claim that unconventional measures don’t promote inequality by helping the rich get richer, however. They lead to higher prices in the markets for shares and property, which help expand the economy through a “wealth effect” – working best for the wealthy.

Except where unconventional measures were used to rescue financial markets that had frozen at the height of the financial crisis, Grenville was unconvinced they achieved much. The academic studies made too little distinction between different episodes.

So he opposes taking interest rates lower and moving on to unconventional measures. Rather, the Reserve should tell the government monetary policy had gone as far as it reasonably could – was already “pedal to the metal” – so now it was over to fiscal policy.

Unconventional measures (I think “quantitative easing” is misleading) would probably achieve lower long-term interest rates, inflate asset prices (particularly shares), encourage financial risk-taking and lower the exchange rate, Grenville said.

None of those things seemed particularly desirable, he said. Lower long-term interest rates wouldn’t help much because, unlike in America, Australian households and businesses borrow at the short end. We’ve had plenty of asset-price inflation already.

A lower dollar helps our exporters, but it’s a “beggar-thy-neighbour” policy (inviting others to do the same to us) and, in any case, the dollar is already low enough to make any viable exporter profitable.

When unconventional measures are discussed, some people think of “helicopter money” – governments distributing cash to ordinary punters, from a metaphorical helicopter. But central bankers insist such a measure is not monetary policy and would have to come from the government as part of fiscal policy.

If the government covered the cost of the cash by borrowing from the public in the usual way, such a stimulus measure would be quite conventional – a la Kevin Rudd’s 2008 “cash splash” into people’s bank accounts.

If the government simply ordered the Reserve to credit people’s bank accounts, that would be “printing money” and highly unconventional. Again, don’t hold your breath.

Read more >>

Recycling is all about being taken for a ride

Another day, another crisis. The crisis in kerbside recycling has been building since China effectively refused to take any more of our rubbish about 18 months ago. Then we sent it to other Asian countries, but now they’re jacking up, too.

The disruption to the local recycling industry has caused one company that accepted recycled material from local councils in Victoria and South Australia to collapse, leaving five big warehouses stuffed with baled paper and plastic that no one wants.

But then Scott Morrison took charge. At a meeting with the premiers, they agreed to establish a timetable to ban the export of waste plastic, paper, glass and tyres. In the meantime, he committed $20 million for “innovative projects to grow our domestic recycling industry”.

Morrison said Australia needed to take responsibility for its own waste, but this moral act should be seen as a money-making opportunity rather than a new economic burden. The changes should “not have to cost us more – in fact, hopefully, it’ll cost us less”.

Minister for Industry Karen Andrews said: “Boosting our onshore recycling industry has the potential to create over three times as many jobs as exporting our plastic waste, ensuring a more sustainable and prosperous future.”

Really? Sounds delusional to me. The truth is that most of what we put out each week is of little value to business – especially after you’ve had to move it, sort it, move it again, clean it up, melt it down or whatever.

It’s not clear that the cost of making our waste attractive to local businesses would be less than they were prepared to pay for it. If not, we’d pay through higher taxes. Of course, governments could compel businesses to use recycled materials, but if this increased their costs we’d pay through higher prices.

This is why, until now, so much of our waste – and that of the Americans, Japanese and Europeans – has been shipped around the world to Asian countries. That’s where wages are low enough to make feasible all the work involved in recovering waste materials.

But even they are now deciding it’s not worth all the air pollution, chemical emissions, discharge of untreated water and damage to workers’ health involved. A fair bit of the plastic can’t be recycled and gets burnt.

So we could spend a lot more than we do at present ensuring that we recycle a high proportion of our own household waste, but before we do we ought to ask ourselves how we’ve come to believe that recycling most of the stuff we discard is absolutely central to our efforts to reduce the damage we’re doing to the natural environment.

Why are we putting recycling on a higher pedestal than reducing carbon emissions? Because it’s easier? We’re learning it’s not as easy as it seems.

If the amount of household waste is such a problem, why are we emphasising recycling rather than reduced packaging? Because governments don’t like telling big business what it can and can’t do?

It amazes me that we’ve put recycling up there with motherhood and never stop to question whether it’s the best use of our time and money in the “environmental space”.

I think recycling involves a high degree of self-delusion (and don’t worry, I’ve been known to completely repack our bin so as to fit more in). It’s more about feeling good than doing good.

We’ve taken to recycling because, with just a small effort on our part, we’re able to convince ourselves we’re doing our bit to save the planet. (I remember shopping at a supermarket in California, with all its indulgences and absurd degree of choice. At the checkout, you were asked whether you wanted your stuff packed in “paper or plastic”. All you had to do was say “paper” and you emerged with a clear conscience.)

With kerbside recycling, it’s out of sight, out of mind. I played my part, what happens after that is up to the government. Turns out, we’ve been sweeping our dust under the carpet and only now are noticing the bulge.

Governments have found it easier to play along with our delusions – see above – than tell us the disillusioning truth. Green groups and ecologists also play along because they think it gives us something to do and keeps us engaged with their issue.

Nobody actually wants the stuff, so the authorities have been shipping it off to Asia on the q.t. Much of the stuff that doesn’t get shipped away ends up in landfill anyway.

What do we imagine recycling achieves? How much further use of fossil fuel, water, chemicals and other damage to the environment is justified to ensure the last bit of paper or bottle cap is recycled?

Recycling’s total effect on the environment is a far more complicated sum than it suits governments and experts to tell us.

For instance, we know how bad single-use plastic bags are. What we’re not told is that, according to a British government study, you have to use a paper bag three times – or a cotton bag 131 times – to be sure that, once the effect of producing the bag is taken into account, you’ve contributed to fewer carbon emissions.

We need to be sure we’re directing our effort and expense towards the most environmentally beneficial ends.

Read more >>

We’re relying on a government that spurns economic advice

I’m starting to wonder if the trouble with our politicians is that they’ve evolved to do politics but not economics, making them unfit to cope with the economic threats we now face.

On the one hand, they’ve been able to leave the management of the economy to the independent Reserve Bank, whose tinkering with interest rates – up a bit, down a bit – has successfully kept the economy growing for 28 years.

On the other hand, the pollies have been locked in a decade of unprecedented political instability where, since the demise of the Howard government in 2007, no prime minister has been safe from attack – from their own side.

In such an environment, with monetary policy (interest rates) so successfully managing the economy, the budget ceases to be “fiscal policy” and becomes just an instrument of politics.

Because you’re eternally looking over your shoulder trying to spot the next colleague holding a dagger behind his back, you use the budget primarily to shore up your support within the party, rewarding the base and punishing its designated enemies.

Be slavish in feeding the 24-hour news cycle. Keep up the pressure for ministers and their departments to provide a continuous flow of minor “announceables”. Remember, any vacuum you leave will be filled by your enemies (external or internal). If you run out announceables, just slag off your (official) opponents.

Of course, if the punters understood what you were up to, they wouldn’t be impressed. So when you’re trying to shore up the support of big business by cutting the rate of company tax, you keep claiming it’s a “plan for jobs and growth”.

When you’re using an income tax tax cut to buy some popularity at the election, you pretend that economic growth is driven by lower taxes.

The worst of it is, since the things your side really cares about – cutting taxes, preserving tax breaks favouring high income-earners, cracking down on the leaners and loafers on social welfare – are economic measures, you convince yourself you’re really into economics.

And running a budget surplus – that’s economic isn’t it? (No, not when your forecasts of a strong economy have proved way too optimistic and you’re counting on a freak improvement in iron ore prices to get you over the line. Then, it becomes an indulgent stretch for political kudos.)

You don’t actually know enough economics to realise economics is about rolling back rent-seeking and increasing the efficiency with which resources are allocated, at the micro level, and managing the economy through the ups and downs of the business cycle, at the macro level. All the rest is politics.

We’ve come to expect that if the person taking the treasurer’s job doesn’t know much about economics, Treasury will give them a crash course and get ’em up to speed. But former senior Treasury officer Paul Tilley’s new book, Changing Fortunes, leads me to think this no longer happens.

These days, treasurers are so preoccupied by the daily battle for political survival they have little time or interest in economics tutorials. Treasury has got out of the habit of giving the treasurer any advice his staff doubts he’d want to hear. Treasury’s job is largely to supply facts and figures when demanded by the treasurer’s staff.

In which case, you have to worry about how much professional rigour goes into producing the budget forecasts. How much they’re designed to avoid giving the treasurer news he doesn’t want to hear.

The Reserve Bank’s latest forecasts for wage growth are laughing at the optimistic forecasts of the budget in April. Where the budget has wages growing by 3.25 per cent a year by June 2021, the Reserve has the growth rate rising only a fraction to 2.4 per cent.

But here’s the surprising thing. Despite the central importance of wages in driving consumer spending and overall economic growth, the Reserve’s year-average forecasts for real GDP differ little from those in the budget.

I find this suspicious. And worrying. If the central bank feels constrained by the forecasts of a Treasury anxious to avoid displeasing its political masters, we’ve got a problem.

Last week, while worries about how much damage Trump’s trade war might do to the world economy were causing share markets to plunge, Treasurer Josh Frydenberg – who was 20 at the time of our last big recession – emerged from his bunker to assure us the government would “take the necessary actions to ensure our economy continues to grow”.

Great. But who’ll be advising him on which actions are necessary? The young punks in his office?

Read more >>

Worried Lowe flouts convention to push for wage rises - now

The most important piece of local economic news this week was no news: the wage price index remained stuck at an annual growth rate of 2.3 per cent for yet another quarter. I’ve said it before but I’ll keep saying it until it’s sunk into the skull of every last politician: we won’t get back to healthy growth in the economy until we get back to healthy growth in wages.

That’s because economies are circular: all of us standing in a circle, buying and selling to everyone else. What’s the main thing people in the circle sell? Their labour. What do they do with the wages they earn? Buy stuff from the rest of the economy.

Business people (and Coalition politicians) are very conscience of the truth that wages are a cost to business. They’ve thus long had the attitude that wages should be kept as low as possible.

But equally, wages are income to wage-earners, and by far the biggest source of income for the nation’s nine million households. So the less wages grow, the less growth there is in the income households use to buy the goods and services produced by the nation’s businesses. Not good.

Get it? In the end, business has as much to lose from weak wage growth as workers do. This is the bit that many businesspeople and politicians don’t get. They’re so used to seeing the economy as my lot versus the other lot, they can’t see that, as the Salvos say, "we’re all in this together".

People – even the media – keep saying wages are flat. That’s not true. What’s true is that, according to the Australian Bureau of Statistics, the rate at which wages are rising has been flat, at 2.3 per cent a year, for the fourth quarter in a row.

In fact, wage growth has been surprisingly low since the end of 2013 – five and a half years ago.

Another point to be clear on is that it’s not low wage growth, as such, that’s the problem. If consumer prices weren’t growing, annual wage growth of 2.3 per cent wouldn’t be bad. It would be fantastic.

So it’s the rate at which wages are growing relative to the growth in consumer prices that matters. Real wages, in other words.

Standard economic theory says that, provided their real growth is no faster than the rate of improvement in the productivity of labour (that is, output per hour worked), wages can grow faster than prices without causing increased inflation.

What’s more, if wage-earners are to get their fair share of the benefit from improved productivity, real wages should be growing in line with the medium-term trend (average) rate of growth in labour productivity, which is about 1.1 per cent a year.

And because wages are the greatest single factor driving household income, household income is the greatest single factor driving consumer spending, and consumer spending accounts for about 60 per cent of gross domestic product, the economy won’t be back to a healthy rate of growth until real wages are back to growing pretty much in line with average productivity improvement.

Which, it turns out, is a bit of a worry. Why? Because it isn’t happening and doesn’t look like happening any time soon.

In the April budget, the government confidently predicted that wage growth would return to something approaching the old normal, accelerating to 2.5 per cent over the year to June this year, then 2.75 per cent by next June, and 3.25 per cent by June the year after.

We learnt this week that, as measured by the wage price index, wages fell short of the first hurdle, coming in at 2.3 per cent rather 2.5 per cent.

Worse, last week we learnt that even the Reserve Bank doesn’t share the government’s optimism.

The Reserve’s revised forecasts now see no advance on 2.3 per cent by June next year, and only the tiniest improvement to 2.4 per cent in two years’ time.

Admittedly, contrary to my contention that we won’t get to decent growth in the economy until we get decent growth in wages, the Reserve is predicting that real GDP will have strengthened to a healthy 2.7 per cent by June next year, and an even healthier 3 per cent by June 2021.

With wage growth forecast to continue weak, the Reserve is expected this improvement to happen with out much help from stronger consumer spending.

So how? Mainly through strong growth in business investment spending, exports and public sector spending on infrastructure.

Consumer spending would be helped a bit by the latest tax cuts and the cuts in interest rates. Other help would come from the falling dollar’s improvement to the price competitiveness of our export and import-competing industries, the brighter outlook for mining investment, and some stabilisation of the housing market.

Maybe. I remain sceptical. And if his behaviour last week is any guide, Reserve governor Dr Philip Lowe is pretty worried about the continuing weakness in wage growth.

It is simply not done for leading econocrats to tell employers they should be paying higher wages. But that’s just what Lowe did in his appearance before the House economics committee.

"At the aggregate [overall] level," he said, "my view is that a further pick-up in wages growth is both affordable and desirable."

Not after we’ve achieved greater productivity improvement, please note, but now. By how much does he think wages should be growing? By about 3 per cent a year, as he’s said on various occasions.

What’s more, federal and state governments – Labor as well as Coalition - should be setting the private sector a better example – or "norm" in Lowe's words – by raising the 2 to 2.5 per cent caps they’ve imposed on their own employees’ wage rises.

Thank goodness somebody’s minding the shop.

Read more >>

We need more helicopter pollies caring for our kids

Sometimes I think that if our politicians spent as much time trying to fix the country as they do playing political games – slagging each other off and finding ways to “wedge” their opponents – we’d be in much better shape.

The world becomes ever more complicated and right now our future is looking, as a pollie might say, “challenging”. Not least among our challenges is ensuring our children have better lives than ours.

So far, you wouldn’t be sure we were making much progress on that project. Leaving aside the way we’ve shifted the tax system in favour of the old at the expense of the young, there’s the less-than-wonderful state of our education and training.

Our schools aren’t winning many prizes on speech day, and though our universities have become much bigger, you wouldn’t be sure all the extra youngsters going in are emerging with valuable degrees. You get the feeling some of them would have been better off going to TAFE.

Speaking of TAFE – sorry, “vocational education and training” - why is it still being treated as the poor relation in the education system? Has it recovered from the disastrous attempt to save money by making vocational training “contestable”?

You may not have noticed but, with Parliament not sitting last week, Scott Morrison and his minister thought they’d better get on with some work in the “education space”.

It was, to be polite, a week of modest accomplishment.

After decades of squeezing the universities – and turning the vice-chancellors into funding-hungry ringmasters who’re no longer sure what the circus is meant to prove – Julia Gillard introduced “demand-driven” funding of undergraduate places.

Predictably, the universities – particularly regional unis - went crazy, cutting entry standards and signing up everyone they could.

Gillard’s view that a much higher proportion of young people should go on to further education was sound, but did that mean everyone was off to uni now?

Enter the Coalition government, which decided demand-driven funding was costing too much. Why not deregulate the setting of uni fees? When that was shot down, it took some years for the government to decide simply to freeze the number of funded places.

Last year it relented, promising to increase places in line with the growth in the working-age population – but on condition of improved performance. Ah yes, performance indicators. That’s what we need.

But which? A committee of five vice-chancellors was commissioned to ponder the question. Last week Education Minister Dan Tehan released their report and accepted their recommendations. From next year the unis will get an extra $80 million, provided they demonstrate success on graduate employment, dropout rates, student satisfaction, and adequate participation rates for Indigenous, low socio-economic status and regional-and-remote students.

I have great sympathy for the government’s desire to stop the vice-chancellors using students as cash cows and get back to their main job of giving our kids a high-quality education.

But I doubt KPIs are the way to do it. Monetary incentives are a poor way to encourage better behaviour, partly because they’re too easily gamed. And nobody knows more about gaming performance indicators than our vice-chancellors, who devote much time to thinking of easy ways to boost their uni’s rank on the various international league tables of universities (because this attracts more overseas students and you can charge ’em more).

Moving on to VET, last week saw the release of a “Vision for Vocational Education and Training” following a meeting of federal and state ministers as part of the Council of Australian Governments.

As a collection of motherhood statements, it’s first rate. A sample: “VET and higher education [unis] are equal and integral parts of a joined-up and accessible post-secondary education system with pathways between VET, higher education and the school system.”

This seems to be an assertion that we already have just the thing we don’t have, but desperately need. How are we to achieve it? Not to worry. The ministers are working on it. (They say that COAG is where good ideas go to die.)

Meanwhile, Andrew Norton, of the Grattan Institute, has used the long-running Longitudinal Survey of Australian Youth to conclude that not too many of the less-academic students going to university – among the 40,000 students a year with ATARs (tertiary admission ranks) of 50 to 70 – would have done better for themselves in VET.

Low-ATAR uni students are more likely to fail subjects and get low marks, and when they graduate are less likely to find professional jobs or earn high salaries.

Less-academic men doing humanities or science degrees might have earned higher lifetime incomes had they done vocational diplomas in construction, engineering or commerce.

But less-academic women often do teaching and nursing degrees. These “deliver good employment outcomes to students across the ATAR range,” Norton says. “These students are unlikely to do better in a vocational education course.”

Hmm. Teaching may be good for less-academic students, but I’m not sure how good less-academic teachers are for teaching.

I think that if universities are willing to admit – and take big fees from – less-able students, they have an obligation to give them more help.

Norton says “a good tertiary education system steers prospective students towards courses that increase their opportunities and minimise their risks. Australia’s post-school system does not always achieve this goal”.

Read more >>

We're edging towards admitting we're in secular stagnation

At least since 2012, Treasury, the Reserve Bank and successive governments have assured us a return to the old normal of strong economic growth, high wages and low unemployment wasn’t far off. But last week big cracks emerged in governor Philip Lowe’s optimistic facade.

In all the years since then, our estimated time of arrival at the promised land has been repeatedly pushed out a year or so. On the face of it, that’s what the Reserve did yet again in its quarterly statement on monetary policy.

Forecast growth in real gross domestic product over the year to December was cut again, to 2.5 per cent (down from a predicted 3.25 per cent last November), but not to worry. By June next year it will have bounced back to trend growth of 2.75 per cent. Happy days.

But that hardly fits with Lowe’s rhetoric during his appearance before the Parliament’s economics committee on Friday. He devoted a surprising amount of time to discussing the Reserve’s possible response in the "unlikely" event that the economy stayed weak.

His own forecasts imply the need for two further rate cuts, taking the official interest rate to just 0.5 per cent.

And if it got to 0.5 per cent, the Reserve would consider some form of "quantitative easing", he said, probably lowering the longer-term risk-free rate of interest by buying government bonds and paying for them simply by crediting the sellers’ accounts at the Reserve (the modern equivalent of "printing money").

What a long way we’ve come from Lowe’s line at the first official rate cut in June. The outlook for the economy was fine, he said then, it was just that the Reserve had redone its sums and realised that, with a bit of extra monetary stimulus, it could get the unemployment rate down to 4.5 per cent without causing any problem with inflation.

Actually, when your look deeper than the latest headline forecast of an early return to trend growth in the economy, you find that, by the end of 2021, wages still wouldn’t be growing any faster than they are now. Happy days?

Larry Summers, eminent academic economist and a former US Treasury secretary, began arguing that the American and other advanced economies were caught in "secular stagnation" – a protracted period of weak growth – in 2013. Since then, many economists have agreed, though they still debate its causes.

So far, however, those naughty, negative SS-words have never crossed the lips of any Treasury or Reserve official, let alone any politician. But on Friday Lowe gave us a detailed account of the phenomenon that’s both the key explanation for, and the main evidence of the existence of, secular stagnation: the amazingly low level of world real interest rates.

"There is a structural thing going on as well, and I think it is really important we understand this. At the moment, right around the world, there is an elevated desire to save and a depressed desire to invest," Lowe said.

"You see a lot of global savings because of demographic factors [population ageing]. There is a lot of saving in Asia [because they don’t have a social security system]. Many people borrowed too much in previous times and now they’re having to repair their balance sheets, so they want to save a bit more [paying off debt is a form of saving].

"There is a lot of desire to save and, right at the moment, not many firms want to invest. The reality we face is that, if a lot of people want to save and not many people want to use those savings to build new [physical] capital, savers are going to get low returns.

"The way the financial system works is that the central banks are the ones who set the interest rates, but we’re really responding to this deep structural shift in the balance between saving and investment right around the world and there’s not much we [central bankers] can do about that."

Just so. Two points. First, the "deep structural shift" began even before the global financial crisis. It’s not just the product of recent worry about a trade war – although that does provide econocrats and politicians with a convenient excuse to shift from their she’ll-be-right rhetoric.

Second, unprecedented low interest rates are a symptom of a deeper problem: aggregate (total) demand is insufficient to take up aggregate supply. That’s why growth is weak and will stay weak until a solution is found.

Where’s the additional demand to come from? Not from lower interest rates, obviously. Which leaves the budget. Now’s the time to rebuild public infrastructure and do other useful things we thought we couldn’t afford.

Anyone who still thinks now’s a good time to run budget surpluses just doesn’t get it. It’s now neither sensible nor possible. Wake up, Josh.

Read more >>

How politics came to trump economics in Canberra

How does the federal government really work? Is it as we were told in Yes, Minister, with the bureaucrats actually in charge, quietly manipulating the politicians? Or are public servants actually the servants of their political masters, as the pollies focus more on getting re-elected than running the country well?

Does Treasury dominate the other departments and the economic advice going to government? Do bureaucrats still give ministers "frank and fearless" advice, or has their role been usurped by the ever-growing army of ministerial staffers, politically aligned think tanks and lobby groups?

In truth, it’s hard for outsiders to be sure. But a new book by a former 30-year senior Treasury officer, Paul Tilley, Changing Fortunes, is surprisingly frank and fearless in spelling out how things work, and how Treasury’s relationship with the elected government has "changed dramatically in recent times".

Last month Scott Morrison said he saw the bureaucrats’ role as implementing the government’s policies. Their advisory role was limited to advising the government of any problems that might arise during that implementation.

Tilley makes it clear this isn’t just what Morrison would like, it’s pretty much what he and his recent predecessors have long had. Treasury gives much information to the treasurer, but avoids giving written policy advice it believes would be unwelcome. What little frank advice is given comes verbally, as part of the private discussion between the treasurer and Treasury secretary.

Tilley says the art of policy advising involves understanding the true nature of the problem, predicting the consequences of policy options and framing effective policy advice.

To be influential, however, policy advisers need to find a balance between having sufficient separation from the raw politics of government to maintain a strong policy framework, on one hand, and having sufficient responsiveness to ministers to be listened to, on the other.

"Treasury’s influence spectrum had ‘frank and fearless advice’ at one end and full ‘responsiveness to government’ at the other," he writes. The trick was the find the right spot in the middle.

But by 2014, under Tony Abbott, "Treasury was now at the full responsiveness-to-government extreme," he writes.

His book is a history of Treasury from its establishment in 1901. "Treasury has long considered itself to be the best economic policy advising agency in Australia.

"Its favoured economic policy framework has for the most part been grounded in neoclassical economics - a belief in the power of markets, and the inherent tendency of supply and demand forces to move towards equilibrium.

"Non-achievement of equilibrium must be caused then, by some market impediment or government interference, and Treasury has seen it as its job to tackle those impediments or that interference.

"If there has been one enduring belief within Treasury – its light on the hill – this is it," he writes.

This is what Tilley means by Treasury’s possession – unlike so many other departments - of a "strong policy framework".

"If there has been a central defining culture in Treasury, it has been around analytical excellence – having the strongest policy framework and the best ideas. If there has been one recurring constraint on Treasury’s policy effectiveness, it has been too narrow in its focus and closed to alternative perspectives," he says.

Tilley’s title, Changing Fortunes, recognises that, over its 118-year life, Treasury’s influence has waxed and waned.

For its first 30 years it was the government’s bookkeeper. It evolved into an economic policy agency only after the Great Depression revealed its inability to provide authoritative advice on economic policy.

The economists arrived from the 1930s, with the advent of Keynesianism. The "golden years" for the economy in the 1950s and ‘60s were also golden for Treasury, which grew in size and status, leading the debate about economic ideas and allowing its influence and strength to give it "a level of arrogance".

This did not sit comfortably with the increasingly assertive governments of the post-Menzies era. Treasury was pushed out into the cold by Gough Whitlam, and kept there by Malcolm Fraser. Treasury’s advice remained frank and fearless, but was considered dogmatic, and often wasn’t listened to. I think this was when our Yes, Minister era ended.

Relations became more constructive when Bob Hawke and Paul Keating arrived, and continued so under John Howard and Peter Costello. "There was a sense of partnership in the Treasury-government relationships, and with the advancement of economic reforms that Treasury advocated it again influenced the policy agenda."

But for the past decade, first under the Rudd-Gillard-Rudd government, then under Abbott-Turnbull-Morrison, the "political chaos" has robbed governments of the sustained political capital needed to pursue difficult reforms. Governments fighting for their political survival have maintained a "relentless push for message over substance".

"In the daily political and media battles of the last decade, Treasury policy advice has not been sought, and at times not very effectively given. In those battles, it has been economic and budget facts and figures, not policy advice, that have been demanded," we’re told.

"The habit has developed of not providing policy advice that ministers don’t agree with. Policy advice on contentious issues now is discussed with ministers’ offices in its preparation and if the office indicates that the minister would not be comfortable with the proposed advice an information brief goes instead.

"The office’s (politically attuned) policy advice can then be provided over the top of the Treasury information brief."

The balance of policy influence has shifted to the political offices and external stakeholder groups, with the public service becoming more information providers and implementers of government decisions, he says.

"The government, therefore, is left without a strong source of genuine policy advice. The consequent lack of a consistent economic narrative over the last decade is plain for all to see."

Read more >>

One day the world's population will start falling

For those who worry about global warming and all the other damage humans are doing to our planet, the latest news on world population growth doesn’t seem good. Fortunately, however, the relationship between population and the environment is paradoxical.

The United Nations Population Division updated its projections in June. From its present 7.7 billion, the world’s population is projected to have grown by 2 billion in 2050. It should reach a peak of nearly 11 billion at about the end of this century, before it starts to fall.

Fortunately, projections are just projections, based on a lot of assumptions that may or may not prove to have been accurate. Some prominent demographers believe the UN’s assumptions are too pessimistic.

It’s a mistake to imagine that controlling world population growth is just a matter of access to effective contraception. Economic development also plays a big part.

It’s the activity of humans that generates greenhouse gas emissions and does other damage to the natural environment, using up non-renewable resources, over-using renewable resources such as fish stocks and forests, damaging soil and waterways, and making species extinct.

So the more people, the more damage. Most human activity is economic – people earning their living. And, the way economies are organised at present, the richer people become, the more damage they do.

But here’s the paradox: the richer people become, the fewer children they have.

As my favourite magazine, The Economist, noted in an article, before the Industrial Revolution the typical woman probably had seven or more children. In 1960, the global fertility rate was six children per woman. Today it’s 2.5.

Within that global average, the fertility rate in rich countries is 1.7 children, below the replacement rate for a stable population of 2.1. In middle-income countries it’s 2.4, not far above replacement. In poor countries, however, it’s 4.9 children.

The first economic factor to reduce family size is urbanisation. When you leave the farm, you don’t need as many kids to help with the work. (Both my parents grew up on farms early last century. Dad was one of 14, and Mum one of eight. Their four children, however, had an average fertility rate of 2.5.)

But perhaps the most important factor is the spread of education, particularly of girls. It’s well established that the more years girls spend at school, the fewer babies they have.

“Education reduces fertility by giving women other options,” The Economist says. “It increases their chances of finding paid work. It reduces their economic dependence on their husbands, making it easier to refuse to have more children even if he wants them.

“It equips them with the mental tools and self-confidence to question traditional norms, such as having as many children as possible. It makes it more likely they will understand, and use, contraception.

“It transforms their ambitions for their own children – and thus the number than they choose to have.”

Worldwide, the proportion of girls completing primary school has risen from 76 per cent in 1997 to 90 per cent today. The proportion completing lower secondary school is nearing 80 per cent.

Fertility rates are low in Europe – particularly in Italy (1.33) – and in Japan (1.37). They’re below replacement rate in New Zealand (1.9), Australia (1.83) and the US (1.78).

But the lowest fertility rates are in emerging Asia: Taiwan (1.15) and South Korea (1.11). In the world’s most populous country, China, it’s 1.69, thanks to the one-child policy. After the relaxation of that policy it rose only briefly. Flats are too small and childcare too limited.

By contrast, India’s rate is 2.24, pretty close to replacement. And it varies greatly from 1.8 in wealthy states such as Maharashtra, to more than 3 in poor states such as Uttar Pradesh. Even so, India's population is expected to overtake China’s in 2027.

Because fertility rates cover the whole child-bearing lives of women, it takes a long time for the population of a country that's a bit below the replacement rate to start falling – assuming they don’t top up with immigration, as we do.

Even so, 27 countries’ populations have fallen since 2010 – sometimes with low fertility rates reinforced by high emigration. Over the next 30 years, 55 countries’ populations are projected to fall – almost half of them by more than 10 per cent. China’s may fall by about 31 million, or 2 per cent.

So what’s the problem? In a word: Africa. Its painfully slow rate of economic development leaves it still with fertility rates of five or six, including big countries such as Nigeria, the Congo, Ethiopia and Tanzania.

The best hope that the world’s population will stop growing sooner than the UN projects is that it has underestimated the rise of girls’ education in Africa (and India and Pakistan).

Of course, economic development is two-edged. It may stop population growth, but it makes everyone else richer and thus makes more demands on the environment.

Just as we can limit climate change without reducing energy use by switching to renewable sources, so we could reorganise the economy in ways that ensured continued economic growth didn’t involve continued destruction of the environment. If we had the will.

Read more >>

Are low interest rates bad? It depends on your perspective

Although media coverage invariably assumes that low interest rates are good news, they’re now so low there’s a backlash, with people pointing to the disadvantages of low rates and getting quite worried.

The fightback is coming at the usual level of complaints from the retired, but also from more sophisticated observers, such as Andrew Ticehurst, of the Nomura banking group, and Dr Stephen Grenville, a former deputy governor of the Reserve Bank.

It’s understandable that the retired and other savers object to the Reserve Bank’s decisions to cut interest rates and are particularly exercised now rates are so close to zero. Doesn’t the Reserve understand we live on our interest income? Of course it does. So why does it persist?

Interest rates are the price borrowers pay lenders (and, ultimately, savers) for the use of their money for a period. Clearly, cutting rates benefits borrowers at the expense of savers. Central banks cut rates to encourage borrowing and spending because they know the expansionary effect on borrowers greatly exceeds the contractionary effect on savers.

They’ll never be dissuaded from this approach. It’s true interest rates are a “blunt instrument”, but they’re pretty much the only instrument central bankers have.

The retired are on much stronger ground when they insist the government continually updates the “deeming rates” it uses to assess the effect of people’s savings on the amount of their part-pension. It’s surprising the grey lobby has taken so long to wake up to this.

The more sophisticated criticism is that, though market economies thrive on risk-taking (and this is one of the mechanisms by which lower rates are expected to stimulate demand), unduly low rates encourage excessive risk-taking.

Businesses are encouraged to become dangerously highly “geared” or “leveraged” (too dependent on borrowed capital rather than share capital) and firms invest in projects that are high-risk or are profitable only if the cost of borrowing is unrealistically low.

In both cases, the seeds of the next bust are being sown. When rates go back up, firms and projects will fall over and there’ll be hell to pay. Very low rates also allow the survival of “zombie” firms – those that have failed and should have died, but are still living – which tie up resources that could be used more efficiently elsewhere.

Running “ultra-loose monetary policy” at a time when demand is weak can do more to cause dangerous bubbles in share, property and other asset markets than to stimulate markets for goods and services.

There’s merit in these arguments – in normal times. But this brings us to the key question of our times: are our present troubles cyclical or structural? Is it just taking frustratingly long for the economy to return to the old normal, healthy rate of growth, or have so many major (but, as yet, not fully understood) changes occurred in the structure of the economy that a “new normal” has arrived, requiring us to get used to a much lower rate of growth, complete with permanently lower inflation and interest rates?

Treasury is sticking firmly to the view that we’ll soon return to the old normal (thus adding weight to the critics’ worries about the bad seeds being sown by protracted low interest rates) and so is the Reserve – except that governor Philip Lowe’s recent exposition of the reasons for persistent low inflation had a bob each way, nominating cyclical (spare capacity) and structural (effects of digitisation and globalisation) factors.

Remember, interest rates come in two parts: the borrower’s compensation to the lender for the loss of their money’s purchasing power while it’s in the borrower’s hands (the expected inflation rate) plus the borrower’s payment to the lender for the use of their money during the loan (the “real” interest rate).

For as long as inflation stays low, nominal interest rates will stay low – without any real loss to savers, even though their susceptibility to “money illusion” (forgetting to allow for inflation) means many don’t realise it.

And here’s something many people haven’t realised: globally, real interest rates have been falling since the 1970s and are still falling. Harvard’s Lawrence Summers finds in a recent paper that real rates have declined by at least 3 percentage points over the past generation.

Put the two parts together and interest rates – both nominal and real – look like staying low for a long time, whether we like it or not. This says many formerly unprofitable investment projects are now profitable, and budget deficits and high public debt are now much less worrying.

The critics imply the Reserve has great freedom to keep the official interest rate high or low. Not really. It can’t defy economic gravity. It’s the Morrison government that could, at the margin, use its budget to reduce the pressure on the Reserve to cut rates further.

Read more >>