Evil Lord Keynes flies to rescue of disbelieving Liberals

When we entered lockdown in March this year, many people (including me) pooh-poohed Scott Morrison’s assurance that the economy would “snap back” once the lockdown was lifted. Turned out he was more right than wrong. Question is, why?

Two reasons. But first let’s recap the facts. About 85 per cent of the jobs lost in April and May had been recovered by November, with more likely this month. It’s a similar story when you look at the rebound in total hours worked per month (thereby taking account of underemployment).

In consequence, the rate of unemployment is expected to peak at 7.5 per cent – way lower than the plateaus of 10 per cent after the recession of the early 1980s and 11 per cent after the recession of the early 1990s. And the new peak is expected in the next three months.

At this stage, the unemployment rate is expected to be back down to where it was before the recession in four years. If you think that’s a terribly long time, it is. But it’s a lot better than the six years it took in the ’80s, and the 10 years in the ’90s.

We’ve spent most of this year telling ourselves we’re in the worst recession since World War II. Turns out that’s true only in the recession’s depth. Never before has real gross domestic product contracted by anything like as much as 7 per cent – and in just one quarter, to boot.

But one lesson we’ve learnt this year is that, with recessions, what matters most is not depth, but duration. Normally, of course, the greater depth would add to the duration. But this is anything but a normal recession. And, in this case, it’s the other way round: the greater depth has been associated with shorter duration.

Of course, the expectation that this recession will take just four years to get unemployment back to where it was is just a forecast. It may well be wrong. But what we do have in the can is that, just six months after 870,000 people lost their jobs, 85 per cent of them were back in work. Amazing.

So why has the economy snapped back in a way few thought possible? First, because this debt-and-deficit obsessed government, which would never even utter the swearword “Keynes” - whom the Brits raised to the peerage for his troubles - swallowed its misconceptions and responded to the lockdown with massive fiscal (budgetary) stimulus.

The multi-year direct fiscal stimulus of $257 billion (plus more in the budget update) is equivalent to 13 per cent of GDP in 2019-20. This compares with $72 billion fiscal stimulus (6 per cent of GDP) applied in response to the global financial crisis – most of which the Liberals bitterly opposed.

Some see Morrison’s about-face on the question of fiscal stimulus as a sign of his barefaced pragmatism and lack of commitment to principle. Not quite. A better “learning” from this development is that conservative parties can afford the luxury of smaller-government-motivated opposition to using budgets (rather than interest rates) to revive economies only while in opposition, never when in government.

At the heart of Morrison’s massive stimulus were two new, hugely influential, hugely expensive and hugely Keynesian temporary “automatic budgetary stabilisers” - the JobKeeper wage subsidy and the supplement to JobSeeker unemployment benefits.

But the second reason the rebound is stronger than expected is that, while acknowledging the coronacession’s uniqueness, economists (and I) have been too prone to using past, more conventional recessions as the “anchor” for their predictions about how the coronacession will proceed.

We’ve forgotten that, whereas our past recessions were caused by the overuse of high interest rates to slowly kill off a boom in demand over a year or more, the coronacession is a supply shock – where the government suddenly orders businesses (from overseas airlines to the local caff) to cease trading immediately and until further notice, and orders all households to leave their homes as little as possible.

It’s this unprecedented supply-side element that means economists should never have used past ordinary demand-side recessions as their anchor for predicting the coronacession’s length and severity.

Whereas normal recessions are economies doing what comes naturally after the authorities hit the brakes too hard, the coronacession is an unnatural act, something that happened instantly after the flick of a government switch.

Morrison believed that, as soon as the government decided to flick the switch back to on, the economy would snap back to where it was. Thanks to his massive fiscal stimulus and other measures – which were specifically designed to stop the economy from unwinding while it was in limbo – his expectation was 85 per cent right.

But there’s a further “learning” to be had from all this. In a normal recession, a recovery is just a recovery. Once it’s started, we can expect it to continue until the job’s done, unless the government does something silly.

But this coronacession is one of a kind. What we’ve had so far is not the start of a normal recovery, but a rebound following the flick of the lockdown switch back to “on”. It has a bit further to run, with the leap in the household saving rate showing that a fair bit of the lockdown’s stimulus is yet to be spent.

Sometime next year, however, the stimulus will stop stimulating demand. Only then will we know whether the rebound has turned into a normal recovery. With wage growth still so weak, I’m not confident it will.

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Working from home takes us back to the future

If there’s one good thing to come from this horrible year, surely it’s the breakthrough on WFH – working from home. This wonderful new idea – made possible only by the wonders of the internet – may have come by force, but for many of us it may be here to stay.

If so, it will require a lot of changes around the place, and not just in the attitudes and practices of bosses and workers. With a marked decline in commuting – surely the greatest benefit from the revolution – transport planning authorities will have to rethink their plans for more expressways and metro transport systems.

If we’re talking about fewer people coming into the central business district and more staying at home in the suburbs, over time this will mean a big shift in the relative prices of real estate. For both businesses and families, CBD land prices and rents will decline relative to prices and rents in the suburbs.

In big cities like Melbourne and Sydney, as so many jobs have moved from the suburbs to office towers in the CBD and nearby areas, the dominant trend in real estate has gone from position, position, position to proximity, proximity, proximity. Everyone would prefer to live closer to the centre.

If you measure the rise in house prices over the years, you find the closer homes are to the GPO, the more they’ve risen, with prices in outer suburbs having risen least.

But if WFH becomes lasting and widespread, that decades-long trend could be reversed. If you don’t have to spend so much time commuting, why not live further out, where bigger and better homes are more affordable and there’s more open space?

Maybe apartment living will become less attractive compared to living in a detached house with a garden, with a corresponding shift in relative prices. And if we’re going to be working at home as a regular thing, maybe we need an extra bedroom to use as a study.

It’s interesting to contemplate. But before we get too carried away, let’s remember one thing: in human history, there’s nothing new about working from home. Indeed, when you think about it you realise humans have spent far more centuries working at home than not.

We’ve been working from home – not having a factory or office to go to – since we were hunters and gatherers. That was all the millennia before the beginning of farming about 10,000 years ago.

In all the years before the start of the Industrial Revolution in Britain in the 1760s, most people earned their living from farming, and farming was done next to – and sometimes inside – the hovels of peasant workers or, in less feudal times, the homesteads of farmers.

You know that in Europe and other cold climes, families lived with their farm animals during winter. Much work would have been done in nearby sheds.

In the Middle Ages, most tradespeople worked at home. Blacksmiths, carpenters, leather workers, bakers, seamstresses, shoemakers, potters, weavers and ale brewers made their goods in their homes and sold them from their homes.

This was work suitable for women as well as men, and it could be combined with childcare and other, income-earning farm work.

In the early days of capitalism, from the 1600s to until well into the Industrial Revolution, much use was made of the “putting-out” system, as The Economist magazine describes in a recent issue.

“Workers would collect raw materials, and sometimes equipment, from a central depot. They would return home and make the goods for a few days, before giving back the finished articles and getting paid,” it says.

“Workers were independent contractors: they were paid by the piece, not by the hour, and they had little if any guarantee of work week to week.”

Is this ringing any bells?

Being economists, the magazine notes that when Adam Smith wrote The Wealth of Nations, in 1776, it was perfectly common to work from home. Smith famously described the operation of the division of labour in pin-making – not in a dark satanic mill but a “small manufactory” of perhaps 10 people, which could well have been attached to someone’s house.

Eventually, however, the putting-out system gave way to full-on manufacturing in factories – despite the resistance of the machine-smashing Luddites who preferred the old ways.

The move to factories was an inevitable consequence of the development of bigger and better machines in the unending pursuit of economies of scale. Workers moved from the farm to the factory and then, as technological advance continued, from highly automated factories to city offices and, eventually, sitting at a desk staring at a screen.

It’s economic development and the pursuit of ever-greater material prosperity that opened the geographic divide between home and work. Which is not to say that further technological change – including the advent of Slack and Zoom – can’t make it possible to bring them back together for many, though obviously not all, workers. Provided, of course, that’s what workers and, more significantly, bosses see as being to their advantage.

Here, too, it’s worth remembering a bit of history. The Economist notes that, according to some economic historians, workers were exploited under the putting-out system. Those who owned the machines and raw materials enjoyed enormous power over those whose labour they used.

It was difficult for workers spread across the countryside to team up against the bosses and their take-it-or-leave-it offers. Crammed into a big factory, however, workers could more easily join together to ask for higher wages. Trade unions started to grow from the 1850s onwards.

Happy speculation aside, there’s no certainty how much working from home will take on. If it does, there’s a risk that will be because bosses see it as a new way to cut costs. That really would be turning the clock back.

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Experts work overtime to take the fun out of Christmas

Feeling bad about the way the pandemic is disrupting your Christmas arrangements? Cheer up, I have good news – of a sort. Keep reading and I’ll convince you Christmas has become so “problematic” you’re probably better off not bothering this year.

A bad-to-non-existent festive season is the perfect way to top off this horrible year, leaving us confident 2021 couldn’t possibly be worse. After this, it’s all upside.

With nowhere to go and nothing better to do, I’ve been searching the internet for ways of improving on the Joy of Christmas. Having consulted the earnest academic experts, I’ve realised Christmas is a minefield of impossible dreams, dashed expectations, overspending, overindulgence and waste, all of it threatened by the risk of a family fight.

And that’s before you remember the damage to the planet – the minimisation of which so many academics seem to see as the whole point of Christmas. (I warned you they were earnest.)

But first, a consumer warning: none of the facts and figures the academics toss around so confidently comes with a money-back guarantee. Read them, be impressed, do not commit to memory.

I must start by acknowledging the seminal contribution of economists to the Yuletide Killjoy movement. One economist who shall remain nameless made his name with a journal article and then book titled The Deadweight Loss of Christmas.

His point was that, in the frequent cases where the gifter of a gift paid more for it than the giftee valued it, the difference was a “deadweight loss” – money spent that yielded no benefit to either party.

His solution was that if you must keep giving presents, stick to cash. Great. Remember, the goal of all Christmas advice is to be admonitory rather than helpful. I’m smart; you're not so.

But the purveyors of the dismal science have no monopoly over the academy’s efforts to increase the dismality of Christmas. The charge is now being led by, of all people, the marketing experts, themselves led by Dr Adrian Camilleri of the University of Technology Sydney, and Professor Gary Mortimer of the Queensland University of Technology.

Camilleri’s research into the psychology of gift-giving finds there are two potentially conflicting goals. First is to make the recipient happy, which mostly depends on whether the gift is something they want.

Second is to strengthen the relationship between giver and recipient. This is achieved by giving a thoughtful and memorable gift – one that shows the giver really knows the recipient. “Usually this means figuring out what someone wants without directly asking,” Camilleri says.

See the problem? Asking them what they want is the way to achieve high marks on desirability, but yields a fail on communicating thoughtfulness.

But now we step up the analysis (stop me if I’m going too fast). Camilleri sets up a matrix, showing the four quadrants made when you account for degrees of thoughtfulness and then degrees of desirability.

In the top left-hand quadrant – unthoughtful and undesired – would be a gift of, say, a pair of socks. The top right-hand quadrant – unthoughtful and desired – would be, say, a gift of money. In the bottom left-hand quadrant – undesired but thoughtful – would be a present you’d never imagined getting, but quite liked. In the bottom right-hand box is a gift that’s both desired and thoughtful.

See how high are the chances of giving a present that misses the mark? “This is why buying a gift can be so anxiety-inducing,” he says. “There is a ‘social risk’ involved.”

But isn’t it the thought that counts? Not as much as you think. Research shows gift-givers tend to overestimate how well unsolicited gifts will be received. Research also shows people tend to overestimate their ability to discern what a recipient will like.

As well, gift-givers tend to overestimate the extent to which more expensive gifts will be received as being more thoughtful. Turns out recipients appreciate expensive and inexpensive gifts similarly.

And they actually feel closer to those who give convenient gifts such as a gift certificate for a nearby, ordinary restaurant, rather than a distant, flash restaurant.

Mortimer and colleagues warn against the evil of giving for giving’s sake. They report that $400 million unwanted presents were given in Christmas 2018, comprising about 10 million items, many of which probably went to landfill. Topping the unwanted list were (in order) novelty items, candles, pamper products, pyjamas or slippers and underwear or socks.

“The shopping frenzy is not good for the planet. It generates a mountain of waste, including plastics, decorations, wrapping paper and party paraphernalia only used once. It also involves thousands of air and road miles to transport goods, which creates up to 650kg of carbon dioxide per person," we're told.

Which brings us to overeating. Under the heading of “How not to give the gift of food guilt this holiday season”, Dr Kelly McGonigal, a psychologist at California’s Stanford University, asks: “Are you overloading your loved ones with indulgent treats they’ll regret?”

I tell you, we’re much better out of the whole thing.

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Year of wonders: Coronacession not as bad as feared

This year has been one steep learning curve for the nation’s medicos, economists and politicians. And you can bet there’ll be more “learnings” to learn in 2021.

Just as the epidemiologists learnt that the virus they assumed in their initial worst-case modelling of the effects of the pandemic wasn’t the virus we got, economists have learnt as they continually revised down their dire forecasts of the economic damage the pandemic and its lockdown would cause.

It reminds me of the “anchor and adjust” heuristic – mental shortcut – that behavioural economists have borrowed from the psychologists. Not only do humans not know what the future holds, they’re surprisingly bad at estimating the size of things.

They frequently estimate the absolute size of something by thinking of something else of known size – the anchor – and then asking themselves by how much the unknown thing is likely to be bigger or smaller than that known thing.

(Trick is, we often fail to ensure the anchor we use for comparison is relevant to the unknown thing. Experiments have shown that psychologists can influence the answers subjects give to a question such as “how many African countries are members of the United Nations?” by first putting some completely unrelated number into the subjects’ minds.)

The econocrats have been furiously anchoring-and-adjusting the likely depth and length of the coronacession all year.

Their initial forecasts of the size of the contraction in gross domestic product and rise in unemployment – which were anchored on the epidemiologists’ original modelling results – soon proved way too high. (Treasury’s first estimate of the cost of the JobKeeper wage subsidy scheme was way too high for the same reason.)

When Prime Minister Scott Morrison started assuring us the economy would “snap back” once the lockdown was over, many people (including me) expressed scepticism.

An economy couldn’t simply “hibernate” the way bears can. Businesses would collapse, some jobs would be lost permanently, and business and consumer confidence would take a lasting hit. There’d be some kind of bounce-back, but it would be way smaller and slower than Morrison was implying.

Wrong. The first reason we overestimated the hit from the pandemic was our much-greater-than-expected success in suppressing the virus. Early expectations were for total hours worked to fall by 20 per cent and the rate of unemployment to rise to 10 per cent.

Morrison’s impressive handling of the pandemic – being so quick to close Australia’s borders, acting on the medicos’ advice, setting up the national cabinet, conjuring up personal protective equipment, and encouraging the states to build up their testing and tracing capability – gets much of the credit for this part of our overestimation.

But the main reason things haven’t turned out as badly as feared is that the economy has rebounded much more in line with Morrison’s assurance than with the doubters’ fears. Victoria’s second wave made this harder for some to see, but last week’s labour force figures for November make it very clear.

Total employment fell by 870,000 between March and May, but by November it had increased by 730,000, an 84 per cent recovery. Victoria accounted for most of the jobs growth in November and now has pretty much caught up with the other states – the more remarkable because its lockdown was so much longer and painful.

Admittedly, more than all the missing 140,000 jobs are full-time, suggesting that some formerly full-time jobs may have become part-time.

By the time of the delayed budget 10 weeks ago, the forecast peak in the unemployment rate had been cut to 8 per cent, but in last week’s budget update it was cut to 7.5 per cent by the first quarter of next year.

If this is achieved it will show that the coronacession isn’t nearly as severe as the recession of the early 1990s – in which unemployment reached a plateau rather than a peak of 11 per cent – or the recession of the early 1980s, with its plateau of 10 per cent.

Similarly, Treasurer Josh Frydenberg now expects the unemployment rate to return to its pre-pandemic level (of 5 per cent or so) in about four years, in contrast to the six years it took following the 1980s recession and the 10 years it took following the ‘90s recession.

Question is, why has the rebound been so much stronger than even the government’s forecasts predicted? Two reasons – but I’ll save them for next Monday.

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Job insecurity is about shifting risks, not being flexible

One thing we’ve learnt from the pandemic is that, for those who rely on evidence rather than anecdotes, what we believe to be The Truth keeps changing as we learn more. Take the way the medicos changed their tune on mask-wearing as more evidence came in.

It’s the same with the truth about job insecurity. The unions have gone for years claiming that work has become less secure, and in recent years the rise of the “gig economy” – where people get bits of paid work via a digital platform such as Uber or Deliveroo – means many people have found that claim a lot easier to believe.

But the training of economists says you should base conclusions about the economy on statistical evidence, not anecdotes or even personal experience. And the trouble is, a quick look at the Australian Bureau of Statistics’ figures for the labour force shows little sign of growing job insecurity.

The bureau doesn’t measure insecurity as such. Nor, since there’s no legal definition yet, does it even measure casual employment directly. But, since casual workers aren’t paid annual and sick leave, the bureau’s figures for those workers who say they aren’t eligible for paid leave are taken to be a measure of casual employment.

By this measure, although casual employment grew strongly to about a quarter of all workers in the 20 years to the turn of the century, that’s hardly changed in the 20 years since then. So where is all the growing insecurity?

Of course, since the big companies running the gig platforms on the internet have gone to great lengths to ensure the people getting work from them aren’t classed as their employees, they aren’t included among the casual employees.

No, they’d be counted as “self-employed”. But the figures show no great change in the proportion of workers who are self-employed over the past 20 years.

So where’s all this growing job insecurity we hear about? Short answer: buried much deeper in the figures.

Before we get to that, one thing we can say with confidence, however, is that though the gig economy is highly visible and gets much publicity in the media, it isn’t all that big relative to a labour force of more than 13 million people.

And, contrary to what some young people who spend too much time on their phones imagine, it’s highly unlikely that most work is in the process of moving to some internet platform. No, the issue of insecure employment is much bigger and wider than what happens to the gig economy.

One labour market expert who’s been working to explain why job insecurity is real despite its seeming absence from the stats is Professor David Peetz, of Griffith University.

In a piece he wrote for my second-favourite website, the universities’ The Conversation, in 2018, Peetz argued that the real causes of job insecurity aren’t the type of contract people are on – casual or permanent – but the way businesses are being structured these days.

These new organisational structures are designed to minimise costs, transfer risk from corporations to employees, and shift power away from employees, Peetz says.

Another part of his explanation is that the statisticians’ nationwide totals conceal changes in some industries but not others. (Other academics, from Curtin University, have used their own index of precarious employment to show that insecure employment is above average in the accommodation and food services, agriculture, and arts and recreation industries, but below average in the utilities, financial services, and public administration industries.)

Peetz says that “large corporations want to minimise their costs and risks, avoid accountability when things go wrong, and ensure products have the features they want.”

One instance of changing organisational arrangements is the dramatic increase in franchised businesses – where what looks like the local branch of some national chain is actually owned by a local small business person.

“The franchisee bears responsibility for scandals such as underpaying workers,” he says.

“Other corporations call in labour hire companies to take on responsibility for their workers. This cuts costs and transfers risk down the chain – which means jobs are more insecure.

“Most people working for franchises, spin-off companies, subsidiaries and labour hire firms are still employees. It’s more efficient for capital to control workers through the employment relationship than to pay them piece rates as contractors. That would run the risk of worker desertion or of shortcuts affecting quality.” (One powerful reason most of us won’t end up in the gig economy.)

In research published this month, Peetz drills into previously unpublished statistics from the bureau on casual workers to discover more of the elusive truth about “precarity” (my nomination for ugliest new word of the year).

He found that about a third of workers classed as “casual” because of their lack of leave entitlements worked full-time hours. More than half had the same working hours from week to week. More than half could not choose the days on which they worked.

Almost 60 per cent had been with their employer for more than a year, and about 80 per cent expected to be with the same employer in a year’s time.

Does any of that fit your mental image of what it means to be a casual worker? Get this: Peetz found that as few as 6 per cent of those we class as “casuals” work varying hours or are on standby, have been with their employer for a short time, and expect to be there for a short time.

Note that employers can usually dispense with the services of casual employees without giving them any notice, nor any redundancy payout.

“Overall,” Peetz concludes, “what I’ve found suggests the ‘casual’ employment relationship is not about doing work for which employers need flexibility. It’s not about workers doing things that need doing at varying times for short periods.

“The flexibility is really in employers’ ability to hire and fire, thereby increasing their power. For many casual employees there’s no real flexibility, only permanent insecurity.”

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Mistreating workers isn’t a smart path to prosperity

Sometimes I think that, when it comes to industrial relations, we’ve gone from one extreme to the other. We used to be pushed around – and frequently inconvenienced – by overly powerful unions, but now the employers are on top and want it all their own way.

We’ve gone from often inflexible and unreasonable unions to “workplace flexibility” that’s all about making life easier – and more hugely remunerated – for bosses, while making work unpleasant and unrewarding – emotionally and monetarily – for far too many of our workers.

I guess what it proves is that when one side or the other acquires too much power, the temptation to abuse it is irresistible.

The push to “reform” Australia’s highly centralised wage fixing began with the Hawke-Keating government and its accord with the union movement. It was taken a lot further – and became a lot more overtly anti-union – under the Howard government.

At the time, many of these “reforms” seemed sensible. What we didn’t realise then was the way globalisation (“Why don’t I move my factory to Asia where wages are lower?”) and the digital revolution (“Why employ a worker when you can farm stuff out to some unknown slave on the internet?”) would undercut the unions without any help from reforming legislators.

The result is, unions are now a shadow of their former selves, clinging to their role in industry super funds to keep themselves relevant. The proportion of workers who belong to unions has gone from half to 15 per cent and falling.

On the other hand, one unintended consequence of the now-ended era of neoliberalism has been to convince our manager class they have a divine right to be given whatever they think necessary to their greater success.

Which brings us to the latest batch of “reforms” being proposed by Scott Morrison and his Attorney-General, the misleadingly advertised Christian Porter, of Robodebt fame. With Parliament now off on Christmas holidays, the much-debated bill has gone to a parliamentary committee, and won’t resurface until March.

If you listen to some people, the proposed reforms are nothing more than an employers’ wish list. Fortunately, they’re not that bad. With one notable exception, the changes are the product of Porter’s extensive joint discussions with the unions and employer groups.

No Liberal government is capable of doing other than making changes that lean in favour of the employers, but the measures are the result of those discussions – so no surprise to the unions – and include some wins for the union side.

The big, undiscussed surprise is the plan to suspend – temporarily, of course; take my word for it – the requirement that enterprise agreements leave workers “better off overall” despite any reduction in particular benefits.

The unions aren’t buying that one. But, in any case, Porter has already signalled his willingness to drop it. This is no WorkChoices 2.0. The Libs are still smarting over the real WorkChoices’ role in the Howard government’s defeat in 2007. Whatever else he may be, Morrison is no crazy brave when it comes to pushing through controversial economic reforms.

No, the other changes are more modest and less objectionable. One is to include in the legislation the first-ever (weak) definition of what it means to be a “casual”. Another is a sunset provision to kill off enterprise agreements that are decades old and out of date.

Truth is, the changes we need to our labour laws are much more sweeping. Although you need to dig deep into the official statistics to find evidence, the unions and labour economists are right to say we have a growing problem with precarious employment, of which the “gig economy” is just the tip.

Outfits such as Uber are a strange combination of highly beneficial innovation (a more efficient way of bringing riders and drivers together) and an arrogant attempt to sidestep the labour laws that give much-needed protection to employees (and the taxman).

Then there’s the proliferation of franchising and labour hire companies. And the epidemic of wage theft – prompted by business people’s belief that, whatever some law may say, as God’s gift to the economy they are protected from prosecution.

I think we’re getting muddled between means and ends. The business proposition is: if only you’ll let me give my workers a hard time, my business will be more successful and everyone will benefit. If only you’ll accept an insecure job with hours that change from one week to the next according to my needs, the economy will be much better off.

But if you take the workers and their dependents out of the economy, you don’t have much left. People rightly crave job security. Make their working lives a misery and a pay rise is poor consolation. (And right now, of course, we can’t afford the pay rise either.)

We’re getting the cart before the horse, turning the people who are supposed to be the chief beneficiaries of a good economy into the people who, we’re told, must suffer to bring the good economy about. That’s what needs reform.

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Start of the end for ratings agencies' dubious influence

Walt Secord, Labor’s Treasury spokesman in NSW, and Michael O’Brien, Liberal Opposition Leader in Victoria, should be condemned for their attempts to score cheap political points when Standard & Poor’s downgraded its AAA credit ratings of both state governments last week. Fortunately, the politicians’ unprincipled carping fell flat.

Both men wanted to have their cake and eat it. Neither was prepared to criticise their government’s big spending to alleviate the state’s pandemic-driven high unemployment – nor admit that, had their party been in power, it would have done the same – but both wanted to portray the consequent downgrade as proof positive of their political opponents’ financial incompetence.

But the deeper truth is that the financial markets and economists have stopped caring about the august pronouncements of the three big American ratings agencies.

Their decline has three causes. First was their loss of credibility following their role in the global financial crisis of 2008. Not only did these supposed paragons of financial precaution fail to foresee the looming collapse, but they actually contributed to it by selling triple-A ratings to the promoters of private-sector securities subsequently discovered to be “toxic debt”.

Just as the scandal surrounding the collapse of Enron in 2001 led to the demise of its auditor, Arthur Andersen, formerly the big public accounting firm with its nose highest in the air, so the financial crisis showed the world that when one for-profit business is paid to report on the affairs of another for-profit business, only an innocent would expect the audit or prospectus report or modelling exercise or credit rating to be genuinely independent.

The second development contributing to the decline of the ratings agencies is the emergence of what the Americans call "secular stagnation" and others call being caught in a "low-growth trap" – where aggregate demand can’t keep up with aggregate supply, and the supply of "loanable funds" exceeds the demand for borrowed funds.

Two side effects of this long-term structural shift of particular relevance to the credit-rating industry are the fall of inflation rates to negligible levels, and the fall of the global real "neutral" official interest rate to a level somewhere near zero.

Especially with the rich world’s central banks – these days, including our Reserve Bank – so heavily into "quantitative easing" (that is, buying government bonds so as to force down their interest-rate "yields"), all this means super-low interest rates, increased private investor demand for government bonds (because there's so little else to invest in), and central banks doing all they can to stop the interest rates on government bonds (including state government bonds) from being driven up by investors.

Third, it’s hard to see how a national government with a floating currency, which borrows only in that currency, could ever default on its debt. (Nor is it easy to see our federal government standing by while one of our state governments defaults on its debt.)

Now do you see why – at least as applies to government securities – events have overtaken the ratings agencies? They’re doing a job that no longer needs to be done, and making assessments of the supposed risk of default on state government bonds that won’t be defaulted on.

This is why our top econocrats have stopped caring about the actions of the rating agencies.

Reserve Bank deputy governor Dr Guy Debelle said recently: "There is the possibility of a ratings downgrade from higher debt, but that really only has a political dimension not a financial dimension, as government bond rates would likely be little changed.

"In any case, a ratings agency should not be the determinant of [budgetary] policy. Fiscal policy should be set to be the most beneficial for the Australian economy and people."

Treasury Secretary Dr Steven Kennedy said recently: "I don’t think there is any significant implications for Australia from a ratings agency downgrade. It is an important tick of confidence to have the rating agencies’ assessment … but frankly the actual impact on the economy I think would be negligible."

Reserve Bank governor Dr Philip Lowe said in August: "I think preserving the credit ratings is not particularly important; what’s important is that we use the public balance sheet in a time of crisis to create jobs for people."

And more recently: "A downgrade of credit ratings doesn’t concern me. The AAA credit rating had more political symbolism than economic importance."

Just so. Although the ratings agencies have lost their economic credibility and usefulness, state governments remained fearful of the fuss their political opponents would make over a downgrade. But their opponents’ failure to gain traction last week spells the beginning of the end for the agencies’ unhealthy influence over government spending and borrowing.

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Productivity is magical, but don't forget the side effects

Something we’ve had to relearn in this annus horribilis is that the state governments still play a big part in the daily working of the economy. Another thing we’ve realised is that the Productivity Commission is so important that some of the states are setting up their own versions.

When you put the word “productivity” into the name of a government agency, you guarantee it will spend a lot of its time explaining what productivity is – a lot of people think it’s a high-sounding word for production; others that it means we need to work harder – and why it’s the closest economics comes to magic.

Earlier this year the NSW Productivity Commission issued a green paper that began with the best sales job for the concept I’ve seen. Its title said it all: Productivity drives prosperity.

Its simple definition of productivity is that it “measures how well we do with what we have. Productivity is the most important tool we have for improving our economic [I’d prefer to say our material] wellbeing,” it says.

“Our productivity grows as we learn how to produce more and better goods and services using less effort and resources. It is the main driver of improvements in welfare and overall [material] living standards.

“From decade to decade, productivity growth arguably matters more than any other number in an economy . . . Growth in productivity is the very essence of economic progress. It has given us the rich-world living standards we so enjoy.”

Productivity improvement itself is driven by increases in our stock of knowledge and expertise (or “human capital stock”) and by investment in physical capital (“physical capital stock”).

But by far the biggest long-term driver of productivity is the stock of advances known as “technological innovation” – a term that covers everything from new medicines to industrial machinery to global positioning systems.

Technology’s contribution to overall productivity growth has been estimated at 80 per cent, the paper says.

“Our future prosperity depends upon how well we do at growing more productive – how smart we are in organising ourselves, investing in people and technology, getting more out of both our physical and human potential.”

The (real) Productivity Commission has pointed out that on average it takes five days for an Australian worker to produce what a US worker can produce in four. (That’s not necessarily because the Yanks work harder than we do, but because they have fancier equipment to work with, and better organised offices and factories – not to mention greater economies of scale.)

The paper notes that productivity improvement hinges on people’s ability to change. “Unwelcome as it has been, the COVID-19 episode has shown that when we need to, we can change more rapidly than we thought. There is no reason we can’t do the same to achieve greater productivity and raise our future incomes.”

Technological innovation is the process of creating something valuable through a new idea. You may think that new technology destroys jobs – as the move to renewable energy is threatening the prospects of jobs in coal mining – but, if you take a wider view, you see that it actually moves jobs from one part of the economy to another and, because this makes our production more valuable, increases our real income and spending and so ends up increasing total employment.

“All through history,” the report adds, “[technological innovation] has been a huge source of new jobs, from medical technology to web design to solar panel installation. And as these new roles are created and filled, they in turn create new spending power that boosts demand for everything from buildings to home-delivered food.

But the thing I liked best about the NSW Productivity Commission’s sales pitch was the examples it quoted of how technology-driven productivity has improved our living standards.

Take, medicine. “The French king Louis XV was perhaps the world’s richest human being in 1774 – yet the healthcare of the day could not save him from smallpox. Today’s healthcare saves us from far worse conditions every day at affordable cost.”

Or farming. “In 1789, former burglar James Ruse produced [Australia’s] first successful grain harvest on a 12-hectare farm at Rose Hill. Today, the average NSW broadacre property is 2700 hectares and produced far more on every hectare, often with no more people.”

Or (pre-pandemic) travel. About “67 years after the invention of powered flight, in 1970, a Sydney-to-London return flight cost $4600, equivalent to more than $50,000 in today’s terms. Today, we can purchase that flight for less than $1400 – less than one-30th of its 1970 price.”

Or communications. “Australia’s first hand-held mobile call was made at the Sydney Opera House in February 1987 on a brick-like device costing $4000 ($10,000 in today’s terms). Today we can buy a new smartphone for just $150, and it has capabilities barely dreamt of a third of a century ago.”

There are just two points I need add. The first is that there’s a reason we’re getting so many glowing testimonials to the great benefits of productivity improvement: for the past decade, neither we nor the other rich countries have been seeing nearly as much improvement as we’ve been used to.

Second, economists, econocrats and business people have been used to talking about the economy in isolation from the natural environment in which it exists and upon which it depends, and defining “economic wellbeing” as though it’s unaffected by all the damage our economic activity does to the environment.

As each month passes, this not-my-department categorisation of “the economy” is becoming increasingly incongruous, misleading and “what planet are you guys living on?”.

What’s more, the growing evidence that all this year’s “social distancing” is having significant adverse effects on people’s mental health is a reminder we should stop assuming that ever-faster and more complicated economic life is causing no “negative externalities” for our mental wellbeing.

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We're having trouble learning to live without inflation

When I became an economic journalist in the early 1970s, the big economic problem was high and rising inflation. The rate of increase in consumer prices briefly touched 17 per cent a year under the Whitlam government, and averaged about 10 per cent a year throughout the decade.

It never crossed my mind then that one day the rise in prices would slow to a trickle – they rose by 0.7 per cent over the year to September – and I certainly never imagined that, if it ever did happen, people would have so much trouble living in a largely inflation-free world.

What? Why would anyone ever object to prices rising at a snail’s pace? Well, of course, no one does. Nor do you see many borrowers objecting to a fall in interest rates.

For savers, however, it’s a different story. Last month, when Reserve Bank governor Dr Philip Lowe announced what’s likely to be the last of many cuts in the official interest rate – it’s a bit hard to go lower than 0.1 per cent – there were bitter complaints from the retired.

“How do you expect us to live when you keep cutting the interest we get on our investments? How long are you going to keep screwing us down like this? When will you take the pressure off and start putting rates back up where they should be?”

Short answer to that last question: unless you’re only newly retired, probably not in your lifetime.

There’s something I need to explain. People like me may have given you the impression that our Reserve Bank moves interest rates up and down as it sees fit, cutting rates when the economy’s weak and it wants to encourage people to borrow and spend, or raising rates when the economy’s “overheating” and it wants to discourage borrowing and spending.

That’s true, but it’s not the whole truth. The deeper truth is that interest rates are closely related to the inflation rate. That’s because much of the rate of interest lenders require borrowers to pay them represents the compensation the lender needs to be paid just for the loss of purchasing power their money will suffer before it’s repaid.

(And when I talk about the lender, I mean the ultimate lender – ordinary savers – not the bank, which is just an intermediary standing between the ultimate lender and the ultimate borrower, probably someone with a home loan.)

So when the expected inflation rate is high, interest rates are high; when the expected inflation rate is low, so are interest rates. The other component of the interest payment lenders receive – the “real” interest rate – represents the actual fee the borrower pays for the temporary use of the lender’s money.

It’s only this much smaller real interest rate that the Reserve Bank is free to adjust up and down. So the main reason interest rates are so low and getting lower is that the inflation rate is low and getting lower.

And that’s not because of the pandemic and the recession it induced, so it won’t be going away when the economy recovers. It’s because, after rising steadily for about 30 years after World War II, the inflation rate in Australia – and all other advanced economies – has spent the past 30 years steadily going back down.

So inflation has gone away as a problem – leaving unemployment and underemployment as our dominant worry – and, as far as anyone can tell, it won’t be coming back for a long, long time.

If so, interest rates will be staying low, and it’s pointless to rail against the Reserve Bank. Rather, people reliant on their retirement savings will just have to adjust to a changed world.

If they want the safety of a bank term deposit, they’ll have to accept the tiny interest payment that goes with it. If that’s not enough, they’ll have to accept the greater risk and volatility that goes with share and other investments.

But let’s not exaggerate their predicament. If interest rates are low because inflation is low, that means their cost of living is low.

Indeed, the Australian Bureau of Statistics’ living cost index designed to measure the special circumstances of self-funded retirees shows their cost of living rose by just 0.7 per cent over the year to September.

Many self-described self-funded retirees take the view that their annual earnings from their superannuation should be sufficient for them to live on, thus leaving what they regard as the “principal” to cover future contingencies or be left to their children.

But, particularly for super payouts large enough to put retirees beyond being eligible for the age pension, it’s wrong to think of that payout as consisting of all your contributions (principal) plus interest. Well over half that sum consists not of your hard-earned, but of the government’s munificence in granting you 30 or 40 years of compounded tax concessions on both your contributions and your annual earnings.

Its generosity was intended to leave you with a sum sufficient to let you live comfortably in retirement, not to set up your kids’ inheritance. Trying to live without dipping into your payout isn’t a sign you’re doing it tough, it’s a lifestyle choice.

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The secret sauce is missing from our recovery recipe

According to Reserve Bank deputy governor Dr Guy Debelle, a big lesson from the global financial crisis was “be careful of removing the stimulus too early”. Good point, and one that could yet bring Scott Morrison and his nascent economic recovery unstuck. But there’s something that’s even more likely to be his – and our – undoing.

Debelle was referring to the way the British and other Europeans, having borrowed heavily to bail out their banks and stimulate a recovery in the real economy, took fright at their mountain of debt and, before the recovery had got established, undercut it by slashing government spending. The consequences – contributing to more than a decade of weak growth - are hardly to be recommended.

The Yanks have been doing something similar this time round, with the Republican-controlled Senate agreeing to a huge initial stimulus package but, with the nation caught in a ferocious second round of the pandemic, having so far steadfastly refused a second package.

It almost seems a design flaw of conservative governments always to be tempted to pull the plug too early.

So premature withdrawal of stimulus is certainly a significant risk to the strength of our recovery. But I doubt it’s the biggest one. We should be giving much more thought than we have been to the sources of growth that will keep the economy heading onward and upward once the stimulus peters out.

The basic idea of managing the macro economy is that, when it’s flat, you use budgetary and interest-rate stimulus to give it a kick start, but then all the usual, natural drivers of growth take over.

Such as? We can talk about population growth, but it could well take more than a year or two to return to its accustomed annual rate of 1.5 per cent. And, in any case, it does far less to increase gross domestic product per person than it suits its promoters to admit.

We can talk about business investment spending but, though it does add to demand for goods and services, it’s essentially derived demand. That is, it doesn’t spring up spontaneously so much as grow in response to the growth in consumers’ demand for the goods and services businesses produce.

This being so, the government’s various tax incentives intended to get businesses investing in advance of the surge in consumer demand are unlikely to get far.

Up to 60 per cent of aggregate demand comes from household consumption. But the strong growth in consumer spending in the September quarter – with more to come this quarter – isn’t a sign that healthy growth in consumption has resumed. It’s just the semi-automatic rebound in spending following the lifting of the lockdown.

The leap in the household saving rate to a remarkable 18.9 per cent of disposable income is some combination of greater “precautionary” saving – “Who knows whether I’ll yet lose my job?” – and pent-up demand caused by the lockdown.

As things return to something reminiscent of normal, we can expect people to run down this excess saving to keep their spending returning to normal despite higher unemployment and widespread wage freezes.

But this is a once-only catch-up, spread over several quarters, not a return to on-going healthy real growth in consumer spending. For this, the occasional tax cut can help – though not by much if its prime beneficiaries are the top 20 per cent of income-earners, as scheduled for July 2024 – but there’s simply no substitute for healthy real growth in the dominant source household income: wages.

Real wage growth is the secret sauce missing from the hoped-for recovery. The Reserve Bank’s latest forecasts are for real wage growth of a mere 0.25 percentage points in each of calendar 2020, 2021 and 2022.

The econocrats don’t want to dampen spirits by admitting what they surely know: that without decent growth in real wages there’s little hope of a sustained recovery. Reserve governor Dr Philip Lowe’s recent remarks say we’re unlikely to see much growth in real wages until a rate of unemployment down to 4.5 per cent means employers must bid up wages in their competition to attract all the skilled labour they need.

This implies that, even if we were to achieve healthy rates of improvement in the productivity of labour – a big if – it’s no longer certain that organised labour retains the bargaining power to ensure ordinary households get their fair share of the spoils; that real wages still grow in line with productivity.

The government and its advisers ought to be grappling with the question of how we can get real wages up – but I doubt that’s what we’ll see this week when it reveals its plans for yet more “reform” of industrial relations.

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Economy's rebound goes well, but now for the hard part

Does the economy’s strong growth last quarter mean the recession is over? Only to those silly enough to believe in "technical" recessions. Since few economists are that silly, it’s probably more accurate to call it a "journalists’ recession". Makes for great headlines; doesn’t make sense.

It’s probably true – though not guaranteed - we’ll suffer no more quarters where the economy gets smaller rather than bigger. But people fear recessions not because they deliver growth rates with a minus sign in front of them, but because they destroy businesses and jobs.

You’ll know from walking down the main street that some businesses have closed and not been replaced. You’ll probably also know of family or friends who’ve lost their jobs or now aren’t getting as much casual work as they need and were used to.

By any sensible measure, this recession won’t be over until the rates of unemployment and underemployment are at least back down to where they were at the end of last year, before the virus struck. And Reserve Bank governor Dr Philip Lowe said this week that wasn’t likely for more than two years.

On a brighter note, the increase of 3.3 per cent in real gross domestic product during the September quarter, revealed by the Australian Bureau of Statistics in this week’s "national accounts", does mean the recovery from recession is off to a good start.

So far, however, what we’ve had is not so much a recovery as a rebound. Remember, this unique recession was caused not by an economic threat, as normal, but by a health threat.

The contraction in GDP of a record 7 per cent in the June quarter was caused primarily by a sudden collapse in consumer spending of 12.5 per cent. Why? Because, to halt the spread of the virus, governments ordered many retail businesses and venues to close, employees to work from home if possible, and everyone to stay in their homes and leave them as little as possible.

As a result, people who’d kept their jobs had plenty of money to spend, but greatly reduced opportunity to spend it. Even people who’d lost their jobs had their income protected by the JobKeeper wage subsidy scheme and the temporary supplement to the JobSeeker unemployment benefit.

Turns out that, despite the loss of jobs, those two big support measures actually caused a jump in the disposable incomes of the nation’s households in the June quarter. But, since it was impossible to keep spending, the proportion of households’ income that was saved rather than spent leapt from 7.6 per cent to 22.1 per cent.

The worst-hit parts of the economy were hotels, cafes and restaurants, recreation and culture, and transport (public transport, motoring, domestic and overseas air travel).

But this initial lockdown lasted only about six weeks before it was gradually lifted in all states bar Victoria. In consequence, consumer spending jumped by 7.9 per cent in the September quarter, more than enough to account for the 3.3 per cent jump in overall GDP.

Guess what? The strongest categories of increased spending were hotels, cafes and restaurants, recreation and culture, and transport services. Spending on healthcare rebounded as deferred elective surgery and visits to GPs resumed.

The quarter saw the rate of household saving fall only to 18.9 per cent – meaning people still have plenty of money to spend in coming quarters, even if pay rises will be very thin on the ground. And, since Victoria makes up a quarter of the national economy, its delayed removal of the lockdown ensures the rebound will continue in the present, December quarter.

See the point I’m making? When the greatest part of the collapse in economic activity was caused by a government-ordered lockdown, it’s not surprising most of that activity quickly returns as the lockdown is unwound.

But this is just a rebound to something not quite normal, not a conventional recovery as the usual drivers of economic growth recover and resume their upward impetus.

Thanks to the massive support from JobKeeper and JobSeeker, the rebound is the easy, almost automatic bit. But even the rebound is far from complete. The lockdown will leave plenty of lasting damage to businesses and careers – and the psychological and physical recovery is much harder matter to get moving.

Treasurer Josh Frydenberg boasts that, of the 1.3 million Australians who either lost their jobs or saw their working hours reduced to zero at the start of the pandemic, 80 per cent are now back at work.

Which is great news. But 80 per cent is still a long way short of 100 per cent. And even when 100 per cent is finally attained, that only gets us back to square one. It doesn’t provide additional jobs for those young people who’ll be needing employment in coming years.

Note, too, that most of the rebound in employment has been in part-time jobs. So far, less than 40 per cent of the 360,000 full-time jobs lost between March and June this year have returned.

In March, the rate of unemployment was 5.2 per cent; now it’s 7 per cent. The rate of underemployment was 8.8 per cent; now it’s 10.4 per cent.

And, returning to this week’s figures for GDP in the September quarter, once you look past the rebound in consumer spending, you don’t see much strength in the rest of the economy. Output in mining fell by 1.7 per cent, while production in agriculture was down 0.6 per cent.

One bright spot was home building, which ended a run of eight quarters of decline to grow by 0.6 per cent. Many new building approvals say this growth will continue.

But non-mining business investment in new equipment, buildings and structures incurred its sixth consecutive quarterly fall, with subdued investment intentions suggesting the government’s investment incentives will have limited success.

Little wonder the Reserve’s Lowe has warned the recovery will be "uneven, bumpy and drawn out". Don’t pop the champagne just yet.

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Super risk: be poorer today so you can live it up tomorrow

For a columnist, the trouble with taking leave is that something really interesting or important is likely to happen while you’re away from the keyboard. It’s now more than a week since the Treasurer Josh Frydenberg released the long-awaited review of retirement income by former Treasury heavy Mike Callaghan. But not to worry. I suspect we’ll still be furiously debating the report’s findings come the next election.

For most people, superannuation is an incomprehensible subject they prefer not to think about – just as they’ve never really understood the “dividend franking credits” that figured so prominently in last year’s election.

As a former accountant, however, I’ve always been fascinated by the ins and outs of super. And being a boring accountant has an odd benefit: paying attention to super all these years has left me with hugely more than I'm likely to need for a comfortable retirement.

Scott Morrison has been dreading the release of this report because he knew it would incite his hard-line backbenchers to demand that he cancel the long-legislated increase in employers’ compulsory contributions to their workers’ super from 9.5 per cent of wages to 12 per cent by 2025.

He knew Labor would oppose this every step of the way, there’d be a huge fight to get it through the Senate and, even if he succeeded, his opponents would take the issue to the election as proof he was so down on workers’ wages he was willing to destroy their chances of a decent retirement.

Truth is, super has been an unending source of conflict between Labor and the Liberals since the present compulsory-contribution scheme was implemented by Paul Keating and the unions’ Bill Kelty in the early 1990s.

Labor sees it as one of the great social reforms of the Hawke-Keating government. But the Libs opposed it from the beginning. They claimed this was because of their philosophical objection to compulsory saving, but it’s easy to see their real objection was partisan.

Compulsory super was introduced in a way that ensured some of the super contributions were managed by non-profit “industry” super funds, rather than the usual for-profit funds set up by banks and insurance companies.

In principle, these new industry funds would be run by equal numbers of trustees from the unions and the employer groups. In practice, the unions have dominated. The ACTU will tell you union officials are required to pay their directors’ fees into union coffers. Some doubt that always happens.

The Libs always saw the industry funds – which have consistently outperformed the for-profit “retail” super funds – as an incursion into Liberal-owned territory. The nation’s share capital should be controlled by Liberal supporters, not unionists. And what’s to stop a little of the billions going into industry funds from trickling down into Labor campaign funding?

Throughout his time in office, John Howard was always coming up with ways to clip the wings of the hated industry funds – with little success.

So there’s nothing any Liberal government can do on super that doesn’t cause the unions and Labor to smell a conspiracy. If the Libs want to cancel any further increase in the rate of employers’ compulsory contributions, their only conceivable motive must be to cripple the industry funds.

Just one problem with this theory. A survey in August of 44 leading economists by the Economic Society found that two-thirds of them wanted the increases deferred or abandoned. This isn’t surprising. As far back as 2010, the Henry tax review found that a higher contribution rate wasn’t needed to ensure people retired with adequate incomes, when there was so much fat in the fees the fund managers were charging.

The findings of the Callaghan review also cast doubt on the need for an increased rate of contributions. So why do the experts disagree with the supposed champions of the workers?

Two main reasons. First, because of convincing empirical evidence that, over time, about 80 per cent of the cost of increased rates of contribution by employers is passed on to their workers in the form of pay rises that are lower than otherwise.

So employer contributions are no free gift. They involve forcing workers to spend less and save more today, so they can have more to spend in retirement. But for many middle-income workers, the more super savings they amass, the more their entitlement to a full age pension is reduced.

Second, in its long-running campaign to persuade governments to force workers to hand over more of their wages to super funds, the fee-hungry superannuation industry has played on people’s instinctive fears they aren’t saving enough.

But careful calculations by the Callaghan review – coming on top of those by the independent Grattan Institute – have found that, on the present contribution rate, most workers will retire with disposable incomes at least equal to the widely accepted benchmark of 65 to 75 per cent of their pre-retirement disposable income.

If so, why deny yourself more than you need to in your working years, so you can have more than you need in retirement?

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THE POST-COVID ECONOMY: How our economy has changed

Talk to virtual Comview conference

I want to talk to you about how the Australian economy has changed as a result of the pandemic, including a once-in-30-year change in the macro-economic policy mix, and consider how the economy can recover from this unique recession.

You don’t need me to tell you that the coronavirus is the greatest threat to the health of Australians and the entire world since the “Spanish” flu pandemic a century ago. Nor that the recession this pandemic has precipitated is the greatest blow to our economy, and the world economy, since the Great Depression of the 1930s. What I may need me to remind you of is that, despite Victoria’s second wave, Australia has so far had more success in suppressing the virus than almost all the other advanced economies, and this should mean we suffer less economic damage than they do. It’s also true that our major trading partners – China, Japan and South Korea – have also done well in controlling the virus, which is another good sign for our recovery relative to the other rich countries. However, the pandemic is far from over and we don’t know when that will be. We could still suffer setbacks, and it’s hard to see a full return to business and consumer confidence until it’s clear the pandemic is over. With the rich countries likely to grab the vaccine before the poor countries get it, it seems likely that international travel will be the last thing to return to something like we were used to.

Why this recession is unlike previous recessions

Usually, recessions occur not simply because the economy runs out of puff, but because an inflationary boom prompts the macro authorities to apply the interest-rate brakes, but they hit it too hard and the boom turns to bust. The mood of optimism flips to pessimism, and greed turns to fear. This time, however, there was no boom and no inflation. The economy had not properly recovered from the global financial crisis more than a decade earlier, it was growing slowly and the mood was already sombre.

This time, the recession was driven by governments’ attempts to limit the spread of the virus by closing our borders, shutting down a large part of the economy and requiring people to leave their homes as little as possible. This means the contraction in demand came suddenly and completely, rather taking months to decline, as it usually does. Note, however, that had the government not ordered a lock down, economic activity would have fallen anyway as people tried to avoid being infected.

But the fact that it was the government’s own actions in ordering the lockdown meant that its fiscal policy and monetary policy response to the recession was faster and larger, particularly its two big measures, the JobKeeper wage subsidy scheme and the temporary supplement to JobSeeker unemployment benefits. JobKeeper’s objective was to maintain the link between employers and their workers even if the lockdown left them with little work to do, so that once the lockdown ended, normal trading could resume. Together with other measures, another goal was to help protect the cash flow of firms during the lockdown. At one point 3.5 million workers were benefiting from JobKeeper, who otherwise would have been unemployed. With the lockdown having soon been lifted in all states bar Victoria, it’s now clear that much of the collapse in employment and hours worked in April has now been reversed, with Victoria now following. So there has been a significant bounce-back, with much of the 7 per cent decline in real GDP during the June quarter reversed in the two following quarters. Even so, the bounce-back has been far from complete. And although the collapse of many businesses has been avoided, many failures haven’t been.

How the coronacession has changed the economy

In a recent speech, Reserve Bank governor Dr Philip Lowe listed five respects in which the pandemic is leaving its mark on the economy. The first is on the labour market. The rate of unemployment is expected to peak at about 8 per cent by the end of the year, with the rate of under-employment even higher. Unemployment will then decline only slowly and still be above 6 per cent by the end of 2022, the year after next. This suggests wage growth will continue weak.

Second, weak population growth. Restriction of international travel and migration, and a lower birth rate, mean the population is expected to grow by just 0.2 per cent in the present financial year, the lowest since 1916, and be weak the following year. This compares with growth averaging 1.5 per cent a year over the past two decades. Even when eventually international travel resumes, it’s not clear that our rate of immigration will return to what it was. And, even if it does, it seems unlikely that the two or three years of lost population growth will be made up. Australia has had one of the fastest rates of population growth among the advanced economies, with higher rates of economic growth to match. This may not continue, although it may not mean lower rates of economic growth per person. If so, we’ll have a smaller housing industry and less need for investment in new infrastructure.

Third, a changed property market. The market is being hit by a range of conflicting factors: a recession; lower population growth; record low interest rates; government incentives to support residential construction; and changes to the way that people work, shop and live. Rents for CBD retail properties have fallen, as have vacancy rates for office blocks. Residential property prices have fallen in Sydney and Melbourne, particularly for apartments.

Fourth, attitudes to risk. Businesses and households seem to have become more averse to the risks involved in decisions to borrow and spend, despite the fall in interest rates. This is understandable when there is so much uncertainty about what the future holds but, as Lowe reminds us, economic growth depends on business people and consumers being willing to take calculated risks to advance their prosperity. Lowe worries greater risk aversion may add to the signs that the economy has become less “dynamic” – slower to change over time. These signs include low numbers of new firms, less switching between jobs, slower adoption of new technology, and fewer workers moving from low to high productivity firms.

Fifth, digitisation. It seems clear that the pandemic and the lockdown has hastened the adoption of digital technology. Doctors’ longstanding resistance to telehealth and electronic prescriptions has broken down. Many firms have used technology to allow their staff to work from home, and much of this may continue after the pandemic is past, with big implications for time spent commuting, CBD retailing and transport infrastructure needs. Online meeting technology has reduced the need for travel. There has been huge growth in online retailing, which is unlikely to be reversed. Electronic transactions have greatly reduced cash transactions.

The changed macro management policy mix

For the first 30 years following World War II, the main policy instrument used to stabilise demand as the economy moved through the business cycle was fiscal policy, with monetary policy playing a subsidiary, supporting role. That changed in the late 1970s when the advanced economies acquired a serious problem with high and rising inflation, and “stagflation” destroyed confidence in the simple Phillips curve trade-off between inflation and unemployment. The conventional wisdom became that monetary policy, conducted by an independent central bank, should be the main instrument used for stabilising demand, with fiscal policy playing the subsidiary role.

But roughly 30 years later, the coronacession has a seen a reversion to fiscal policy playing the dominant role in short-term stabilisation, leaving monetary policy as a back-up. Ostensibly, this is because the need for stimulus was so great and because, with interest rates already so low, monetary policy was left with little room to move. In the recession of the early 1990s, for instance, the official interest rate was cut by more than 10 percentage points. In the response to the global financial crisis of 2008-09, the rate was cut by more than 4 percentage points. In the response to the coronacession, the RBA has been able to cut by less than 1 percentage point before taking the cash rate virtually to zero, at 0.1 per cent. Since March the RBA has also resorted to “quantitative easing” – buying second-hard government bonds from the banks and paying for them merely by crediting amounts to the banks’ exchange-settlement accounts with the RBA – but how much this does to stimulate demand for goods and services (as opposed to demand for assets such has houses and shares) is open to doubt. By contrast, the federal budget has provided a total of $257 billion in direct stimulus over serval years, equivalent to 13 per cent of nominal GDP in 2019-20. (This compares with stimulus in response to the GFC of 6 per cent of GDP in 2008-09.)

Behind these immediate reasons for fiscal policy resuming the leading role, however, are deeper, structural factors. As Treasury Secretary Dr Steven Kennedy has observed, there has been “a fundamental shift in the macroeconomic underpinnings of the global and domestic economies, the cause of which is still not fully understood”. This is a reference to the “secular stagnation” or “low-growth trap” I discussed at last year’s Comview. Your modern, independent central bank – and the policy mix that gave top billing to monetary policy – was designed to cope with the problem of high and rising inflation. But, as former Reserve governor Ian Macfarlane has explained, inflation in the advanced economies has been falling for the past 30 years and is now below central bank targets. Low inflation means low nominal interest rates, of course. And, as Treasury’s Kennedy has reminded us, the global real interest rate, similar to the neutral interest rate – the real official rate that’s neither expansionary nor contractionary – has been falling steadily for the past 40 years. This has been due to structural developments that drive up savings (the supply of “loanable funds”) relative to the willingness of households and firms to borrow and invest (the demand for loanable funds), he says. This “is likely due to some combination of population ageing, the productivity slowdown and lower preferences for risk among investors,” he says.

All this says that fiscal policy’s return to primacy over monetary policy is not just a temporary development, but the culmination of structural forces building up over decades, suggesting this will be a lasting change. It may be many years before inflation returns as a problem.

Fiscal policy and monetary policy: pros and cons

Monetary policy’s great advantage is that it can be changed so quickly and easily, by a decision of the RBA board (this covers the decision lag and implementation lag), whereas fiscal policy changes involve possibly protracted development of measures and consideration by cabinet (the decision lag), and then often delays before the measures can be put into effect (the implementation lag). But, once implemented, monetary policy changes probably take longer to have their full effect on the economy (the impact lag) than does fiscal policy.

But fiscal policy measures – whether on the tax or spending sides of the budget - can be targeted to fixing particular problems, whereas monetary policy is a “blunt instrument” or one-trick pony: it uses interest rates to encourage or discourage borrowing and spending. Fiscal policy includes the budget’s automatic stabilisers (to which, Kennedy has argued, JobKeeper and the JobSeeker supplement, being open-ended, were temporary additions).

Economists at the IMF and elsewhere argue that fiscal policy multipliers are higher than earlier believed. This is partly because leakages to imports are less significant when all major governments are stimulating simultaneously in response to the same global shock (such as the GFC or a pandemic). But it’s also because the effect of fiscal stimulus isn’t reduced by the “monetary policy reaction function” – the decisions of independent central banks to raise interest rates because they fear the fiscal stimulus will add to inflation pressure.

Finally, and as I said in last year’s talk, monetary policy’s “comparative advantage relative to fiscal policy is controlling inflation, not stimulating demand when the economy is again caught in a liquidity trap”. Because we are likely still to be caught in a low-growth trap even when the pandemic is a receding memory, l have no trouble believing the econocrats’ repeated warnings that the road to recovery will be long and bumpy.

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Reserve Bank suffering relevance deprivation syndrome

I’m sorry to say it, and it’s certainly not the done thing to say, but the Reserve Bank looks to me like that emperor with a serious wardrobe deficiency.

Apart from the nation’s allegedly “self-funded” retirees – whose angry letters to Reserve governor Dr Philip Lowe must by now be absolutely blistering – no one wants to question last week’s decision to make what must surely be the smallest-ever cut in the official interest rate, and engage in a bit more of what central bankers prefer to call “quantitative easing” or “balance-sheet expansion” rather than use those verboten words Printing Money.

I guess there’s no reason any borrower would object to paying lower interest rates, no matter how microscopic the reduction. Nor are the nation’s treasuries and governments likely to object to having their own interest bills cut a fraction.

As for the experts in the financial markets, their vested interest lies in having the central bank stay as busy as possible, organising events where they can lay bets. An inactive Reserve is a central bank that’s not helping them justify their lucrative but unproductive existence. “Negative interest rates? Might be a fun day out. Bring it on.”

But I’ve heard from a lot of retired central bankers who disapprove of the Reserve’s scraping of the barrel. And last week Dr Mike Keating, a former top econocrat, also questioned the wisdom of keeping on keeping on.

Some other people have seen the Reserve’s decision to, in Lowe’s words, “do what we reasonably can, with the tools that we have, to support the recovery” as a sign it judged last month’s budget not to have done enough.

Maybe, but I doubt its motives are so noble. Alternatively, Lowe’s reference to “doing what we can” with “the tools we have” could be taken as a tacit admission that his tools can’t do much.

As Treasury Secretary Dr Steven Kennedy made clear last week, monetary policy’s “scope . . . to provide sufficient stimulus is limited and has necessitated the large levels of fiscal support”. His speech was devoted to making sure his financial-markets audience – and the rest of us – understood that the headquarters of short-term management of the macro economy has now shifted from Martin Place, Sydney to Parkes Place, Canberra.

No, I think what we’re seeing is our most well-resourced economic regulator (well-resourced because it prints its own banknotes) desperately trying to look busy and relevant because it’s lost its main reason for existence, but can’t be shut down or even sent on “furlough” – the latest euphemism for being put on unpaid leave, in the hope the need for your services will return.

No country could leave itself bereft of a central bank. The Reserve can’t be shut down because one of its infrequent but vital roles is to flood the financial markets with liquidity whenever they become dysfunctional (as happened in the global financial crisis and, in a smaller way, in the early days of the pandemic).

But the fact remains that the Reserve’s primary function – the short-term stabilisation of demand - has gone away and isn’t likely to come back in my lifetime (another 20 years, max). That is, its problem is structural (long-lasting) not cyclical (temporary).

Your modern, independent central bank was designed to respond to the problem of high and rising inflation. And during the 1980s (and, in Australia, 1990s) its ability to do so was clearly demonstrated.

But, as former Reserve governor Ian Macfarlane has reminded us, inflation rates in the advanced economies have been falling for the past 30 years, and now seem entrenched below the central banks’ targets. And, as Treasury’s Kennedy reminded us last week, the global (real) neutral interest rate has been falling for 40 years.

Central banks need independence of the politicians so they can raise interest rates to fight inflation. They don’t need it to lower rates. But with inflation having gone away as a problem, it’s now 10 years since the Reserve last raised rates (and even that proved unnecessary and had to be unwound).

When nominal interest rates were high, cutting rates in big licks did seem effective in helping revive growth and employment. But with interest rates now so low and getting lower in the 12 years of weak Australian and advanced-country growth since the financial crisis, there’s little reason to believe cutting rates is effective in reducing unemployment and underemployment.

Last week Lowe insisted that an official interest rate down at 0.1 per cent does not mean the Reserve has “run out of firepower” – by which he meant that there’s still plenty of money he can print.

True. But, as Reserve assistant governor Dr Chris Kent has explained, the dominant purpose of the money-printing is to lower “risk-free” (government bond) interest rates further out along the maturity curve beyond the official overnight cash rate.

And this doesn’t provide a reason to believe slightly lower interest rates will induce households and firms to borrow and spend in a way that fractionally higher rates didn’t. Whatever people’s reasons for not spending, the high cost of borrowing isn’t one of them.

The old jibe that cutting interest rates to induce growth is like “pushing on a string” for once seems apposite.

Remembering the retired Reserve bankers’ point that it chose to limit its intervention in financial markets to short-term and variable interest rates for good reason – to limit monetary policy’s distortion of private sector choices - one thing we can be more confident of is that printing money and cutting rates when few people want to borrow for consumption or real investment will be effective in inflating bubbles in the prices of assets such as houses and shares.

How this would leave the unemployed better off is hard to see. Risking our heavily indebted household sector becoming more so doesn’t seem a great idea.

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Treasury chief warns big changes are on the way

When finally the pandemic has become just a bad memory, we’ll see it has left big changes in the way the macro economy is managed and the way we work and spend. Whether that leaves us better or worse off we’ve yet to discover.

That’s the conclusion I draw from Treasury Secretary Dr Steven Kennedy’s (online) post-budget speech to the Australian Business Economists on Thursday, the restoration of a tradition going back to the 1990s.

Kennedy observes that, although “fiscal policy” (changes in government spending and taxing) has always responded to large shocks such as recessions, for the past 30 years the accepted wisdom in advanced economies has been that the preferred tool for stabilising the ups and downs in demand is “monetary policy” (changes in interest rates by the central bank), leaving fiscal policy to focus on structural and sustainability (levels of public debt) issues.

This mix of policy roles was preferred because central banks could make timely decisions, using an appropriately nimble instrument – the official interest rate. Interest rates, it was considered, could help manage demand without having much effect on the allocation of resources (the shape of the economy) in the long-run, Kennedy says.

In previous downturns, monetary policy played a major part in helping to get the economy moving. In response to the 1990s recession, Kennedy reminds us, the Reserve Bank cut the official interest rate by more than 10 percentage points. In response to the global financial crisis of 2008-09, it cut rates by more than 4 percentage points.

By now, however, the Reserve has run out of room. In its response to the coronacession, it cut the rate by 0.5 percentage points to 0.25 per cent. This week it squeezed out another cut of 0.15 percentage points and went further in “unconventional” monetary policy measures. That is, printing money.

Why so little room? Interest rates are down to unprecedented lows partly because, as I wrote last week, the rate of inflation has been falling for the past 30 years.

But Kennedy explains the other reason: the “natural” or “neutral” interest rate has been “steadily falling globally over the past 40 years”. The neutral interest rate is the real official rate when monetary policy is neither expansionary nor contractionary.

(Note that word “real”. Conceptually, nominal interest rates have two parts: the bit that’s just the lenders’ compensation for expected inflation, and the “real” bit that’s the lenders’ reward for giving borrowers the temporary use of their money.)

“The declining neutral rate is due to [global] structural developments that drive up savings relative to the willingness of households and firms to borrow and invest,” Kennedy says.

“While the academic research is not settled on the relative importance of different structural drivers, it is likely due to some combination of population ageing, the productivity slowdown and lower preferences for risk among investors,” he says.

Because this is a “structural” (long-term) rather than “cyclical” (short-term) development, “a number of central banks have suggested that interest rates will not rise for many years”.

Kennedy says the size and speed of the shock from the pandemic necessitated a large fiscal (budgetary) response. This would have been true even if a large response from conventional monetary policy had been available – which it no longer was.

Monetary policy is a one-trick pony. It can make it cheaper or dearer to borrow, and that’s it. As we saw with the early measures – particularly the JobKeeper wage subsidy and the temporary supplement to the JobSeeker dole payment – fiscal policy can be targeted to problem areas. “Monetary policy cannot replace incomes or tie workers to jobs,” he says.

So the move from monetary policy to the primacy of fiscal policy is not only unavoidable, it has advantages.

Since the onset of the pandemic, the federal government has provided $257 billion in direct economic support over several years, which is equivalent to 13 per cent of last financial year’s nominal gross domestic product. That compares with the $72 billion the feds provided in economic stimulus during the global financial crisis, or 6 per cent of GDP in 2008-09.

Kennedy notes that fiscal policy is about stabilising the economy’s rate of growth over the short term; it can’t increase economic growth over the medium to long-term. According to neo-classical theory, that’s determined by the Three Ps – growth in population, participation in the labour force, and productivity.

But whereas over the 10 years to 2004-05 our rate of improvement in “multi-factor” productivity averaged 1.4 per cent a year, over the five years prior to the pandemic it averaged half that, 0.7 per cent.

There are many suggested causes for this slowdown (which can also be observed in the rest of the rich world). Treasury research has highlighted signs of reduced “dynamism” (ability to change over time), such as low rates of new firms starting up, fewer workers switching jobs, slower adoption of the latest technology, and fewer workers moving from low-productivity to high-productivity firms.

Kennedy says it’s not clear how the pandemic will affect Australia’s long-run rate of improvement in productivity. But it has the potential to cause some large structural changes in the economy. We’ve seen the way it has forced businesses to innovate.

“Necessity is a great ramrod for breaking down the barriers to technological adoption,” he says.

Remote working is one example. In September, almost a third of workers worked from home most days. If this continues it could have “significant implications for transport infrastructure planning and for the functioning of CBDs”.

An official survey in September found that 36 per cent of businesses had changed the way products or services were provided to customers. The ability to pivot displayed by many firms indicates potential for innovation and adaptation.

On the other hand, there’s a risk that closures among smaller firms will lead to even more market concentration and slower productivity growth. Let’s hope not.

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