THE GLOBAL ECONOMY

Aurora College Economics HSC Study Day, Sydney

Every year there’s some event in the news that’s relevant to your study of the global economy, and this year’s is the continuation of the biggest ever: the pandemic entering its second year. A pandemic is a global event by definition, and this pandemic has had big implications for global economic growth and for the future of the globalisation push. There’s nothing new about epidemics starting in one country then spreading to many other countries. It’s been happening for millennia. Even so, it’s the world’s worst pandemic since the “Spanish” flu epidemic immediately after World War I, and the first where the greater economic integration of the world’s countries – and particularly, the huge number of people at any time flying around the world on jumbo jets – caused the virus to reach all corners of the world in a few weeks rather than years. We’ll discuss aspects of the pandemic before discussing a problem special to our economy: the trade sanctions imposed on us by China.

The pandemic

Most governments have responded to the pandemic by restricting people’s ability to cross their international borders, and our government has imposed more comprehensive restrictions than most, greatly disrupting our airlines, inbound tourism industry and universities’ export earnings from overseas students. Like other governments, ours acted to limit the spread of the virus by locking down much of the economy for some time. This caused the world economy to plunge into a deep recession, which governments sought counter by applying considerable fiscal stimulus. We have been more successful than most at suppressing the virus and so were soon able to lift the lockdown. So, although our coronacession was the deepest recession since World War II, it was also the shortest, with the economy taking only about three quarters to rebound to where it was before virus arrived. The recovery will be much slower in most other countries. In Australia, the main issue is how long it will take to vaccinate enough of our population so we can safely re-open our borders.

The end of hyperglobalisation

The pandemic has greatly disrupted international trade and thus confirmed that the period of “hyperglobalisation” has ended. One measure of the extent of globalisation is the growth in two-way trade between countries (exports plus imports) as a proportion of gross world product (world GDP). Between 1990 and 2008, global trade rose from 39 pc to 61 pc of GWP – the period of rapid globalisation. But the proportion fell after the global financial crisis, and even by 2019 had not regained its peak in 2008. The absolute level of world trade is expected to have fallen 9 pc in 2020.

It’s worth noting that the poor countries did well out of the quarter-century of rapid globalisation. Between 1995 and 2019, real GDP per person in the emerging economies more than doubled, whereas in the advanced economies it grew by only 44 pc (after allowing for differences in purchasing power).

The temptation of returning to protectionism

Much of the strong global economic growth during the period of hyperglobalisation can be attributed to increased trade in goods and services between the developed and developing countries. But it’s likely that, in the period of slower growth that has followed the global financial crisis, some countries have yielded to the temptation to return to protecting their domestic industries against foreign competition, returning to the (failed) strategy of growth through “import replacement” rather than “export-led” growth. Regrettably, this trend is being led by the two biggest developing economies, China and India.

The Economist magazine reports that during the pandemic, countries have passed more than 140 special trade restrictions. Some of these may arise from concerns in the rich countries over the lack of availability of personal protective equipment, or vaccines. Worries about the pandemic’s disruption of global supply chains may be another reason for the return of protectionist attitudes in the advanced economies.

 China’s trade sanctions against Australia

Australia’s deteriorating relations with China – which could have been handled much more skilfully by our own government – have led it to impose a succession of sanctions, including very high tariffs and non-tariff barriers, against our exports of barley, beef, coal, copper, cotton, seafood, sugar, timber and wine. Together, these exports were worth about $25 billion in 2019, or 1.3 pc of our GDP.

This is an unfortunate development. Our government will challenge the legality of some of these measures at the World Trade Organisation. But two points are worth noting. First, any loss of export earnings from China caused by these sanctions has been far more than offset by the exceptionally high prices China is paying for our exports of iron ore. Second, estimates by the Lowe Institute suggest that our exporters of most of those sanctioned products have been able to find other overseas markets for them.

Definition

The OECD defines globalisation as “the economic integration of different countries through growing freedom of movement across national borders of goods, services, capital, ideas and people”.

That’s a good definition, but I like my own: globalisation is the process by which the natural and government-created barriers between national economies are being broken down.

A process

With this definition I’m trying to make a few points. The first is that globalisation is a process, not a set state of being. Because it’s a process, it can go forward – the world can become more globalised – or it can go backwards, as national governments, under pressure from their electorates, seek to stop or even reverse the process of economic integration. This is just what Donald Trump promised to do in the US presidential election in 2016.

Among the advocates of globalisation there has tended to be an assumption that the process of ever greater integration is inevitable and inexorable. That was always a mistaken notion, but this has become more obvious since Brexit and the amazing exploits of Trump. First, the British have voted to reduce their degree of economic integration with the rest of Europe – a decision most outsiders see as involving a significant economic cost to the Brits’ economy. Second, the Trump Administration has withdrawn from the Trans Pacific Partnership, an agreement between the US and 11 other selected countries (including Australia) to reduce barriers to trade between them – although the remaining 11 have finalised the agreement without the US.  Third, the Trump Administration has withdrawn from the Paris global agreement on reducing greenhouse gas emissions. Fourth, Trump has launched a trade war with China. President Biden will re-join the Paris agreement and repair America’s relations with its allies, but continue the contest with China.

Earlier globalisation

The point is that the process of globalisation is and always was reversible. People should know this because this isn’t the first time the process of globalisation has occurred and then been rolled back. The decades leading up to World War I saw reduced barriers and greatly increased flows of goods, funds and people between the old world of Europe and the new world of America, Australia and other countries. But this integration was brought to a halt in 1914 by the onset of a world war. And the period of beggar-thy-neighbour increases in trade protection, to which countries resorted in response to the Great Depression of the early 1930s, greatly increased the barriers between national economies. Indeed, you can see that, in the years after World War II, the many rounds of multilateral tariff reductions brought about under the GATT – the General Agreement on Tariffs and Trade, which has since turned into the World Trade Organisation – were intended to dismantle all the barriers to trade built up in the period between the wars.

The channels of globalisation

The four main economic channels through which the world’s economies have become more integrated are:

1) Trade in goods and services

2) Finance and investment

3) Labour

4) Information, news and ideas.

Trade is probably the channel that gets most attention from the public. Donald Trump’s populist campaigning against globalisation has focus on the belief that America’s greater openness to trade – particularly with developing countries – has caused it to lose many jobs, particularly in manufacturing, as cheaper imports caused many domestic producers to lose sales, or as factories have been moved offshore to countries where wages are lower, without America receiving anything much in return. These sentiments would be shared by many voters for One Nation.

Surprisingly, financial globalisation didn’t get as much blame as it could have for the global financial crisis and the Great Recession it precipitated. But it’s easier for Australians to remember that the global crisis of 2008 was preceded by the Asian financial crisis of 1997-98, indicating that our highly integrated global financial markets are prone to crises – crises which invariably spill over from the “financial economy” of borrowing and lending, saving and investing, to the “real economy” of producing and consuming goods and services. The push by the G20 to strengthen the capital and liquidity requirement imposed on the world’s banks, though the Basel agreements, is intended to make financial markets more stable.

Most countries have not liberalised the flow of labour into their economy in the way they have the other factors of production. Although increasing numbers of people are fleeing their country to escape war, famine and persecution, many choose the country they’d like to arrive at on economic grounds. Many voters object to the inflow of immigrants, whether they be boat people arriving in Australia, Mexicans crossing the border to the US, or Poles taking advantage of the European Union’s single market to look for jobs in Britain. Immigration seems to have been a major motive for some Brits voting in favour of Brexit.

Income distribution and the gains from trade

One of economists’ core beliefs is that there are mutual gains from trade. Provided the exchange of goods is voluntary, each side participates only because it sees some advantage for itself. This is undoubtedly true, but in the era of renewed globalisation we’ve been reminded that, though the gains may be mutual, they are not necessarily equal. Some countries do better than others.

Similarly, the benefits to a particular country from its trade aren’t necessarily equally distributed between the people within that country. When, for example, a country imports more of its manufactured goods because they are cheaper than its locally made goods, all the consumers who buy those goods are better off (including all the working people), but many workers in the domestic manufacturing industry may lose their jobs.

Another factor that has been working in the same direction is digitisation and other technological change which, in its effect on employers’ demand for labour, seems to be “skill-biased” – that is, it tends to increase the value of highly skilled labour, while reducing the value of less-skilled labour. It seems likely that, between them, trade and technological advance have worked to shift the distribution of income in America, Britain and, to a lesser extent, Australia, in favour of high-income families and against many middle and lower-income families.

The unwelcome surprise many politicians and economists have received from the high protest votes for Brexit, Trump and One Nation is causing them to wonder if too little has been done to assist the workers and regions adversely affected to retrain and relocate, and too little to ensure the winners from structural change bear most of the cost of this assistance.

Shares of the World Economy, 2018

GWP Exports Population

China          19   11     19

United States   15   10         4

Euro area (19 countries)   11   26         5

India     8     2       18

Japan     4     4         2

Advanced economies (39) 41   63       14

Developing economies (155) 59   37       86

            100 100     100

Source: IMF WEO statistical appendix; GWP based on purchasing power parity   

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My new hero, Mathias Cormann, now valiant for truth

I find it hugely encouraging. Don’t know if you’ve heard the glad tidings but, on his road to Damascus – or, in this case, Paris – our own Mathias Cormann, former senator and minister for finance, has experienced a miraculous conversion. He’s gone from persecutor of those who care about climate change to being a leader of the cause.

As we said in my Salvo youth, there is much joy in heaven over one sinner that repenteth. I bet Brother Scott’s joy is unconfined.

And it’s clear from Cormann’s first speech as Secretary-General of the revered Organisation for Economic Co-operation and Development that he’s seen the light on a lot more than climate change. Indeed, the new man is exhibiting a distinct air of wokefulness. He’s now valiant for “stronger, cleaner, fairer economic growth”.

Speaking to a meeting of the OECD’s 37 rich and wannabe-rich member-country Council at Ministerial Level last week, Cormann said: “We need to continue to overcome the immediate health challenge, including by pursuing an all-out effort to reach the entire world population with vaccines.

“This is not just an act of benevolence from advanced economies. It is about sustained virus protection for all of us and about giving ourselves the best chance of a sustained recovery.”

Enlightened self-interest. I love it.

Cormann hasn’t changed his tune on chasing down slippery multinational tax avoiders. “It is very important we [the OECD] continue to lead the global fight against tax evasion and multinational tax avoidance and to ensure that digital businesses and all large businesses pay their fair share,” he said.

“We need to complete this work, including by facilitating agreement on an appropriate minimum level of global taxation and by minimising the profit-shifting that has accompanied the digitisation of our globalised economy.” All well and good.

On other matters, where I come from, there was nothing we enjoyed more than hearing some reformed Trophy of Grace testifying to his former wicked ways. As finance minister, Cormann led the Coalition’s repeated cuts to our overseas aid budget which, as a poor country with a big debt, we were told, we could no longer afford.

The reborn Cormann sees it differently. “We [the rich OECD countries] must also continue to strengthen our development co-operation. Low-income countries need our co-operation more than ever – to ensure access to vaccinations, to trade, to financing to help them deal with the climate challenge,” he said.

Cormann, you recall, was one of Tony Abbott’s lieutenants in abolishing Labor’s (already watered-down) minerals resource rent tax and its “price on carbon”.

At the time we were led to believe Julia Gillard’s carbon tax was the reason the retail price of electricity had risen so steeply. Turned out it was just a small part of the story. Prices stayed high.

But, in any case, new insight has come to Cormann in a blinding flash. “Market-based economic principles work,” he now sees. “Global competition at its best is a powerful engine for progress, innovation and an improvement in living standards.”

True, he admits, competition can be uncomfortable. “It can lead to social disruption which, collectively, we need to better manage.” Love that new thought that we ought to do more things “collectively”. Doesn’t quite roll off Cormann’s tongue, but he’s getting there.

“We need to ensure access to high quality education, upskilling and reskilling to ensure everyone can participate and benefit. We need the necessary social supports for those who struggle,” he said.

Amen to that. No hanging the unis out to dry during the pandemic. No spending a decade starving technical education of funds.

On climate change, he tells us that “more and more countries are committing to net-zero emissions as soon as possible and by no later than 2050.

“The challenge is how to turn those commitments into outcomes and to achieve our objective in a ... way that will not leave people behind.”

It’s easy to be cynical. In my youth, working in a big private-sector bureaucracy and watching people fighting their way to the top, I formed the view that many people were happy to adjust their views to fit their new role in the organisation.

When, with much assistance from the Morrison government, Cormann was travelling the world canvassing support for the top OECD job, many environmental groups were loudly opposing his candidacy. They failed to anticipate the fluidity of his views.

In my limited contact with the man, I found this Rocksolid Roarer of the Right friendly to the point of charming. Remembering how successful he was at getting crossbench Senate support for the government’s controversial measures – and at so little cost to the exchequer – I think he has just the right qualities to succeed in bringing the OECD’s divers members to agreement.

And, after all, he wouldn’t be the first person lately to realise that the climate worm has turned and fossil fuel’s days are ending.

Benediction from the Apostle Mathias: “Protecting ourselves from competition and innovation does not stop it from happening elsewhere – it just means that, over time, those who find themselves behind those protective walls fall further and further behind.”

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Morrison needs the guts to save business (and the unions) from folly

Talk about don’t mention the war. The great and good – who miss jetting off overseas several times a year – keep telling us the economy won’t recover until we’ve reopened to the world. Seems they just can’t bring themselves to focus on the obvious: it’s wages, stupid.

It’s self-evident that, ultimately, it would be bad for our economy for us to stay a hermit kingdom. But these worthies are wrong if they imagine that re-opening our borders would immediately strengthen the recovery.

It’s true that our airlines won’t recover until the borders open, and our universities will remain crippled. But because Aussies normally spend far more on touring overseas than foreigners spend touring here, our tourism industry (including every country town) has been doing nicely thank you from the temporary ban on Aussies doing their touring abroad.

Our econocrats have been busy extending the fiscal stimulus to get unemployment down and skill shortages up, in the hope this will bid up wages, and so give the nation’s households more to spend through our businesses.

Trouble is, business has grown used to covering shortages of skilled labour by importing workers on temporary visas, thus avoiding pushing up wage rates (and training costs). Get it? The real reason they want the borders re-opened ASAP is so they can go on playing this game.

But it’s just one of many stratagems our businesses have been using to keep the lid on wages: increased use of part-time and casual employment, labour hire companies, discouragement of collective bargaining and greater use individual contracts, evading labour laws by pretending workers are independent contractors, and even wage theft.

Little wonder “most Australians have not had a meaningful pay rise for almost a decade” and “living standards have stagnated”, as Brendan Coates, of the Grattan Institute, reminds us.

And little wonder the economy’s growth was so weak before the arrival of the pandemic, and threatens to go back to being weak once last year’s massive fiscal stimulus has dissipated.

Market economies are circular – the money goes round and round. And nowhere is this clearer than in the two-sided nature of wages. Wages are both the chief cost faced by most businesses, and the chief source of income for their customers.

See the problem? The more success the nation’s businesses have in keeping the lid on wage costs, the less money the nation’s households have to spend on all the things business wants to sell them.

When the two sides of the wage coin get out of whack, so to speak, business starts strangling the golden goose. Efforts to achieve a healthy rate of economic growth – and rising living standards – won’t be sustained.

This is a form of market failure called a collective action problem. What seems to makes sense for the individual business is contrary to the interests of business as a whole. But no business wants to be the first to stop skimping on wage costs for fear of losing out to its competitors.

The solution to collective action problems is for some authority to come in over the top and impose a solution on all players, thus leaving none at a competitive disadvantage and all of them better off in the end because their customers have more money to spend.

In other words, the only way for us to escape an anaemic, wage-less recovery is for Scott Morrison to intervene in the economy to get wages up.

Since the Fair Work Commission’s annual minimum wage case affects the wages of one worker in four, he should have intervened in the case – as has always been the feds’ right – to encourage the commission to give a generous increase after last year’s miscued pandemic minginess.

He should be trying to set a higher wage “norm” for private sector employers by giving his own federal employees a decent, 3 per cent annual pay rise, and pressuring the premiers – Labor and Liberal – to do likewise.

He should be legislating to protect Australian workers – and his own tax collections - from the ravages of the “gig economy”, which tries to hide its evasion of our labour laws behind its genuine and welcome technological innovation.

And the very least he should be doing is to beef up the Fair Work Ombudsman’s staffing and ability to stamp out wage theft which – purely by mistake, you understand – has become endemic. This outbreak of utterly unAustralian illegal behaviour tells us a lot about the ultimately self-destructive, anti-wage mania that is gripping the nation’s business people.

The obvious problem is that doing anything to increase wage rates is totally foreign to a Liberal politician’s every instinct. The Business Council would be incandescent. Nixon going to China is one thing, but a Liberal putting up wages? Never.

Sorry, but the world turns, and successful leaders must turn with it. We used to have a chronic problem with inflation; now it’s chronic spending weakness. The unions used to have too much power; now they have too little.

Even so, there’s one thing a Liberal Prime Minister could be doing to help without giving offence to Liberal sensibilities. It would actually be a blow against his union and Labor enemies that would do a lot to strengthen the economy’s prospects over the next four years, should he have the strength to put the economy ahead of his own political discomfort.

It would save Australia’s workers from the self-interest of the union elite and the mindless tribalism of Labor (not to mention the bullying of a certain former Labor prime minister), which is happy to give their unions mates what they demand because the Libs want to destroy industry super (which is true, but not a good enough reason to oppose a change that would leave workers and the wider economy better off).

The strange thing about last month’s budget is that, though it sees the econocrats’ wage-lifting strategy getting unemployment down to 4.5 per cent by about the end of 2023, it sees no growth in real wages for the next four years.

In evidence to a Senate committee last week, Treasury secretary Dr Steven Kennedy was obliged to explain this discrepancy. It’s because, starting next month, legislation requires compulsory employer contributions to their workers’ superannuation to be increased by 0.5 percentage points for five Julys in a row, until they reach 12 per cent of wages in July 2025.

Relying on strong empirical evidence, Treasury has assumed that employers will cover 80 per cent of the cost of this impost by raising wages by that much less. The nation’s workers will thus be forced to save rather than spend a significant portion of what would have been their future pay rises.

The nation’s greedy, ticket-clipping super-fund managers play on everyone’s instinctive fear that they aren’t saving nearly enough to provide for a comfortable retirement. It suits the union elite (and their gullible Labor mates) to go along with this deception, even though Grattan’s Coates (and Treasury before him, and the recent Retirement Income Review since him) has demonstrated that, after including a part-pension, most workers will have plenty.

So the Labor tribe wants to force the nation’s employees to live on less during their working lives so they can live like royalty in retirement. Why doesn’t Morrison seek to reverse this Labor-initiated legislation? Because he fears he’d lose votes in the labour movement’s ensuing fear campaign.

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Smaller Government is dogging our efforts to beat the pandemic

It surprises me that, though the nation’s been watching anxiously for more than a year as our politicians struggle with the repeated failures of hotel quarantine and the consequent lockdowns, big and small, and now the delay in rolling out the vaccine, so few of us have managed to join the dots.

Some have been tempted to explain it in terms of Labor getting it wrong and the Libs getting it right – or vice versa – but that doesn’t work. Nor does thinking the states always get it right and the feds get it wrong – or vice versa.

The media love conflict, so we’ve been given an overdose of Labor versus Liberal and premiers versus Morrison & Co. But though we can use this to gratify our tribal allegiances, it doesn’t explain why both parties and both levels of government have had their failures.

No, to me what stands out as the underlying cause of our difficulties – apart from human fallibility – is the way both sides of politics at both levels of government have spent the past few decades following the fashion for Smaller Government.

Both sides of politics have been pursuing the quest for smaller government ever since we let Ronald Reagan convince us that “government is not the solution to our problems; government is the problem”.

The smaller government project has had much success. We’ve privatised almost every formerly federal and state government-owned business. We’ve also managed to “outsource” the delivery of many government services formerly performed by public sector workers.

But the smaller government project has been less successful in reducing government spending. The best the pollies have done is contain the growth in spending by unceasing behind-the-scenes penny-pinching.

And here’s the thing: pandemics and smaller government are a bad fit.

The urgent threat to life and limb presented by a pandemic isn’t something you can leave market forces to fix. The response must come from government, using all the powers we have conferred on it – to lead, spend vast sums and, if necessary, compel our co-operation.

In a pandemic, governments aren’t the problem, they’re the answer. Pretty much the only answer. Only governments can close borders, insist people go into quarantine, order businesses to close and specify the limited circumstances in which we may leave our homes.

Only governments can afford to mobilise the health system, massively assist businesses and workers to keep alive while the economy’s in lockdown, pay for mass testing and tracing, and flash so much money that the world’s drug companies do what seemed impossible and come up with several safe and effective vaccines in just months.

But when you examine the glitches – the repeated failures of hotel quarantine, the need for more lockdowns, the delay in stopping community spread, and now the slowness of the rollout of vaccines – what you see is governments, federal and state, with a now deeply entrenched culture of doing everything on the cheap, of sacrificing quality, not quite able to rise to the occasion.

As we’ve learnt, a pandemic demands quick and effective action. But when you’ve spent years running down the capabilities of the public service – telling bureaucrats you don’t need their advice on policy, just their obedience – quick and effective is what you don’t get.

The feds have lost what little capacity they ever had to deliver programs on the ground. They have primary responsibility for quarantine and vaccination, but must rely on the states for execution. Then, since both sides are obsessed by cost-cutting, they argue about who’ll pay – and end up not spending enough to do the job properly.

It took the feds far too long to realise that hotel quarantine was cheap but leaky. Every leak had the states closing borders against each other. The feds didn’t spend enough securing supplies of vaccines, then took too long to realise a rapid rollout wasn’t possible without help from the states.

Without thinking, Victoria initially staffed its hotel quarantine the usual way, with untrained, low-paid casual staff. It had run down its contact-tracing capacity and took too long to build it up – still without a decent QR code app. NSW let a host of infected people get off a cruise ship and spread the virus all over Australia.

The report of the royal commission laid much of blame for the aged care scandals on the feds’ efforts to limit their spending on aged care. They couldn’t demand providers meet decent standards because they weren’t paying enough to make decent standards possible.

One of the main ways providers make do is by employing too few, unskilled, casual, part-time staff, who often need to do shifts at multiple sites. Do you think this has no connection with the sad truth that the great majority of deaths during Victoria’s second lockdown occurred in aged care?

And now we discover the feds have failed to get the vaccine rollout well advanced even to aged care residents and staff.

Spend enough time denigrating and minimising government and you discover it isn’t working properly when you really need it.

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Top economists think much further ahead than Morrison & Co

If Scott Morrison and Josh Frydenberg are looking for ideas about what more they could be doing to secure our economic future – after all, they’ll be seeking re-election soon enough – they could do worse than study the views of the 56 leading economists asked by the Economic Society of Australia to comment on this month’s budget.

Two points stand out. First, almost all the economists were happy to support the budget’s strategy of applying more fiscal stimulus to get unemployment below 5 per cent. They were pleased to see the government abandon its preoccupation with surpluses and debt.

As Professor Fabrizio Carmignani, of Griffith University, said, “the good thing about this budget is that it was not about repairing the deficit and debt accumulated in 2020”. Professor Sue Richardson, of Flinders University, said: “the debt and deficit mantra was never justified”.

Second, with one notable exception, the economists were critical of the government’s choice of things to spend on. The exception was its big spending on the “care economy” – aged care, childcare, disability care and mental health care – which most respondents welcomed. Indeed, quite a few thought there should have been more of it.

After that, the economists had plenty of constructive criticism of the government’s priorities. For instance, quite a number were happy to see big spending on “infrastructure”, but critical of the government’s narrow conception of what constitutes infrastructure.

Carmignani said: “there is in this budget – as in the past – an almost blind confidence in the power of investment in physical infrastructure to drive future growth and development. In fact, the future prosperity of Australia depends on innovation that requires social rather than physical infrastructures”.

Professor Gigi Foster, of the University of NSW, said: “childcare should be viewed as the social infrastructure that it is, and invested in as such. Instead, when we heard ‘infrastructure’, it was mainly code for transportation”.

So even in the area of physical infrastructure, the budget shows a lack of imagination. Professor Michael Keane, also of the University of NSW, said very little of the infrastructure money was “allocated to such urgent needs as renewable energy, climate change adaptation, environmental sustainability, water resources, etcetera. This shows a real lack of ambition.”

Richardson agrees. “The future is one of zero net greenhouse gas emissions,” she said. “The transformation of the energy, agricultural, transport and manufacturing systems that this requires is enormous, will require unprecedented levels of investment and needs to start now.“

Now that’s interesting. Historically, treasurers and their advisers have regarded the budget as the place for discussion on finances and economics, not the state of the natural environment nor the challenge of climate change.

The economy in one box, the environment in some other box. The natural environment has been seen as of such little relevance to topics such at the budget and the economy that it has barely rated a mention in the five-yearly supposed “intergenerational report”.

But that’s not how our leading economists see it. At least a dozen of them have criticised the budget’s failure to respond to the challenge of climate change. Professor Warwick McKibbin, of the Australian National University, warned that “the world is likely to be taking significant action on climate change which will substantially impact Australia’s fossil fuel exports and the future structure of the Australian economy”.

Another topic barely mentioned in the budget – one of the industries much damaged by the pandemic – was universities. Unsurprisingly, more than a dozen respondents noticed the omission. They’re self-interested, of course, but they make a good case.

Dr Leonora Risse, of RMIT University, said succinctly: “investment in the university sector [is a] generator of productivity-enhancing skills, knowledge and research”. Meanwhile, McKibbin added that “a key ingredient is an investment in human capital”.

But the academics’ concern is wider than their own patch. Risse has called for more attention to the long-running drivers of growth, such as “investment in the workforce capabilities, resourcing, wages and working conditions of high-need, high-growth sectors” such as the care economy.

Dr Michael Keating, a former top econocrat, said restoring past rates of economic growth won’t be possible without addressing the structural problems in the labour market. “This will involve much more investment in education, training and research” but “the extra money in this budget for apprentices and trainees only makes up for past cuts.”

Notice a theme emerging? Budgets should be about investment – spending money now, for payoffs to the economy later – but investment needs to be in people, not just in physical and traditional things such as roads and railways.

It’s easy to accuse academics of pontificating atop their ivory towers, but they seem able see much further into the economy’s future needs than our down-to-earth politicians.

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Reform of “human services” the triumph of hope over experience

Those leftie academics who keep accusing Scott Morrison and his government of being “neo-liberal” aren’t keeping up. This government’s neo-liberal days are long gone. But “micro-economic reform”, on the other hand, is alive and well.

If neo-liberal has any meaning, it’s a belief in free-market capitalism, privatisation and smaller government. It’s a presumption against government intervention in markets.

But that’s just what Morrison keeps doing: intervening to prop up the Portland aluminium smelter, intervening to keep oil refineries open and, of course, spending $600 million-plus to build a government-owned gas-fired power station no one in the industry wants.

By contrast, it’s clear from Treasury secretary Dr Stephen Kennedy’s big speech last week that he’s hot to trot with a new round of economic-rationalist inspired micro reform. The good old days are back.

Kennedy noted that the budget announced “significant additional funding and reforms relating to the provision of mental health, aged care and employment services,” not to mention more money for the national disability insurance scheme.

These sectors are “non-market services” – services that are either provided by the government directly or where the government provides substantial funding. “Lifting the productivity of these sectors can lead to a higher quality and quantity of services, as well as reduce demands on the budget,” he said.

Historically, the care sectors had experienced low productivity growth. In part this reflected the labour intensity of the services delivered (they must be performed by a person, not a machine), and challenges in measuring the quality of outcomes (was it done well or badly?). But there had also been failings in the design of policies and their implementation, Kennedy said.

He noted with approval a speech given in 2019 by the Productivity Commission’s Professor Stephen King, a micro-economist, identifying “human services” as the “next wave of productivity reform”.

“The government clearly has a role to play in incentivising greater productivity in these sectors, and can do so by applying sound economic principles when designing systems for funding and the provision of services, and encouraging innovation among providers to improve the quality and safety of care provided,” he said.

Using the example of aged care, Kennedy outlined four principles for improving the effectiveness (achieving the desired objective) and efficiency (doing so with the least waste of resources) of government services.

First, provide users with more choice. “Informed choice can improve outcomes for users because it enables people to make decisions that best meet their needs and preferences, generates incentives for providers to be more responsive to users’ needs and drives innovation and efficiencies in service delivery,” he said.

“However, to be truly informed, choice must be accompanied by accurate and accessible information about what the user really cares about.”

Giving consumers and their families digestible information on metrics of care . . . allows them to prioritise these metrics in choosing an aged care facility and encourages competition amongst providers on the quality of care they provide, he said.

“But we need to be careful to ensure these metrics are robustly constructed and free of manipulation by providers.”

Second, improve competition. To encourage competition between providers, the government will move from the present system of allocating subsidised places directly to particular providers, to giving the subsidy to the user and allowing them to decide which provider to take it to.

Giving users better information about the quality performance of particular providers should counter the temptation to choose providers of low-cost but low-quality care.

Third, set “efficient prices”. These refer to the size of the per-person subsidy the government pays to private providers. Efficient prices reflect all the costs and “clear the market” (attract just sufficient supply to meet demand). The government will work to set up an independent pricing mechanism.

Fourth, improve accountability and governance. The government has a direct role to play in assuring confidence in the quality, safety and sustainability of the sector, Kennedy said.

Providers will be subject to greater oversight by a new inspector-general of aged care and a beefed-up Aged Care Quality and Safety Commission. “The government requires a well-equipped regulator to undertake surveillance and enforcement of [the new] standards across the sector,” he concludes.

Sorry. It all sounds lovely – especially with the provisos added by Kennedy, who’s more worldly-wise than his Treasury predecessors – but I’m hugely sceptical.

We’ve been watching these attempts at micro-economic reform for decades. They all work the same way: take a public service that’s always been provided by the government, turn it into something that looks like an ordinary market by adding choice, contestability, monetary incentives and a smidgen of regulation, and you won’t believe the difference it makes.

Well, I would believe it’s very different – just not that it’s better. We’ve seen this game played many times and seen many stuff-ups. Using “contestability” to turn a public good into an artificially created market is the econocrats’ version of magical thinking.

They expect to see all the magic of rational self-interest-driven market forces, but don’t expect to see all the real-world complications their beautiful model leaves out: the lack of competition in country towns, the efforts of firms to make their products incomparable, the unequal bargaining power between sellers and buyers, the “transaction costs” that stop a frail, near-death old lady changing providers like you’d change from Woolworths to Coles, the non-monetary motivations, the gaming of metrics and the unintended consequences.

To get technical, the “incomplete contracts” and massive “information asymmetry” between sellers and buyers.

Yet another problem is that these grand designs are implemented not by Treasury economists, but by departmental bureaucrats who are too easily “captured” by well-organised industry lobby groups (who’ll be fighting all that “accountability and governance” every step of the way), and answerable to politicians anxious to look after those industries that give generously to party funds.

To see “human services” as “the next wave of productivity reform” is, to borrow a favourite expression of legendary Treasury boss John Stone, “the triumph of hope over experience”.

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Big spending on aged care not right to fix the problem

Budgets come and, all too soon, budgets go. A big deal in the latest one was the government’s response to the royal commission’s report on the scandal-plagued aged care system. We were told lots of changes will be made, at an extra cost of “$17.7 billion over five years”. Problem solved. Now we can all move on.

Sorry, not so fast. The bright young things of the media may have lost interest, but I’d like a closer look. You can put that down to my advancing years if you wish.

I’m old enough to have stopped deluding myself I won’t be ending up in any aged care home. Both my brother and elder sister are there already. My sister-in-law was too before, as the Salvos say, she was “promoted to Glory”.

I’ve looked at the government’s response and, though it wasn’t nearly as good as it should have been, it’s better than I feared.

To borrow a cliche from the interest groups – who always hope that if they sound grateful, they might get a bit more – it was “a good first step”. But, as Dr Stephen Duckett and Anika Stobart, of the Grattan Institute, put it less diplomatically, “even an investment of this scale does not meet the level of ambition set by the commission”.

Actually, the “$17.7 billion over five years” doesn’t do justice to the government’s willingness to spend. Because its measures are phased in, Grattan calculates their cost builds up to an ongoing $5.5 billion a year. That’s more than half the $10 billion a year the commission estimated the government saved on its aged care spending over the years using annual “efficiency dividends” and rationing.

Grattan groups the many decisions in the budget under four headings. First is a change in the basis on which aged care is delivered. The commission’s report called for the present Aged Care Act, which seeks to maximise the government’s freedom to limit its spending, be replaced by a new act enshrining everyone’s statutory right to decent aged care, according to their needs. As with Medicare, access to aged care proper (as opposed to ordinary living costs) should be “universal”, the commission proposed – free at the point of delivery, because the cost is funded from general taxation.

The government will introduce a new act in 2023 putting consumers at its centre but, Grattan says, with “no clear commitment to the rights of older people or to universal access”.

Many of the those who write to me believe that for-profit providers of aged care put their profits ahead of the quality of care, and fear that extra government spending won’t necessarily go to raising quality.

So, second are steps to improve the governance of providers and make them more accountable. The government will establish an independent inspector-general for aged care, and an independent mechanism for setting prices.

But, Grattan observes, it hasn’t committed to the hard part: changing the present approach to governing the system, which the report found had failed. It’s leaving the federal Department of Health in charge, and reforming rather than replacing the Aged Care Quality and Safety Commission, which is responsible for regulating the system.

Grattan doesn’t say it, but you suspect the bureaucrats have got a bit too close to the providers.

To allow people to be better informed about the quality of a provider’s care, the government will eventually introduce an American-style system of star ratings. Fine – provided it can’t be manipulated.

Third, moves to increase the number and training of staff. The key measure here, following the report’s recommendation, is a requirement that each resident receive three hours and 20 minutes of personal attention a day, including 40 minutes from a registered nurse rather than a care worker.

If properly policed – a big if – this should increase staffing, giving workers more time to help with toileting and feeding, and just to chat with residents, many of whom are lonely.

There’s a shortage of qualified staff, and the government is spending $680 million mainly on a one-off increase in TAFE training for personal carers in the first few years. The report wanted minimum Certificate III training for all personal carers, including mandatory dementia training, but this hasn’t been done.

There’d be fewer shortages of nurses and care workers, and less staff turnover, if award wages were increased, but the government’s done nothing about this.

Finally, funding changes. One of the main ways the government has limited its spending on aged care is by allowing a long waiting list for at-home aged care packages to develop. It’s decided to let through 80,000 more applicants over two years.

But it hasn’t acted on the report’s recommendation that waiting times be limited to 30 days. Rationing will stay.

The report wanted means-tested rental payments in residential care, with “refundable accommodation deposits” phased out, but no change was made.

Adequate reform of the system has a long way to go. Until it gets there, the critics are right to fear it will be only a few years before the system’s back in crisis.

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Key reform needed to fix debt and deficit: ditch stage 3 tax cut

Scott Morrison and Josh Frydenberg won’t admit it. But most economists agree that at the right time, the government should take measures to hasten the budget’s return to balance, even – to use a newly unspeakable word – “surplus”.

Economists may differ on what they consider to be the right time. But, if we’re to avoid repeating the error the major economies made in 2010 by jamming on the fiscal (budgetary) policy brakes well before the recovery was strong enough for the economy to take the contraction in its stride, the right time will be when the economy has returned to full employment, with no spare production capacity.

At that point, the inflation rate’s likely to be back within the Reserve Bank’s 2 to 3 per cent target range, with wage growth of 3 per cent or more. Any further fiscal stimulus from a continuing budget deficit would risk pushing inflation above the target, and could induce a “monetary policy reaction function” where the independent Reserve countered that risk by raising interest rates.

So, better for the government to act before the Reserve acts for it. And if you take the econocrats’ best guess at the level of full employment – when unemployment is down to between 5 and 4.5 per cent – and take the budget’s forecasts at face value (itself a risky thing to do) the right time will be in the middle of 2023.

But the growth in wages and prices has been so weak for so long, that I wouldn’t be acting until it was certain wage and price inflation was taking off.

Even so, since its own forecasts say that point will come towards the end of the next term of government, Morrison and Frydenberg should be readying to give us a clear idea of the steps they’ll take to cut government spending or increase taxes when it becomes necessary.

And, in an ideal world, they would. But, thanks to the bad behaviour of both sides of politics, our world is far from ideal. Former Labor leader Bill Shorten is only the latest to be reminded of the awful, anti-democratic truth that parties which telegraph their punches expose themselves to dishonest scare campaigns.

But that’s just the most obvious reason Morrison and Frydenberg will avoid any discussion of the nasty moves that will be necessary to make the “stance” of fiscal policy less expansionary and, when needed, mildly restrictive, thus slowing the government’s accumulation of debt in the process.

The less obvious reason is that no pollie wants to talk about the policy instrument that’s played a leading part in all previous successful attempts at “fiscal consolidation” and will be needed this time.

It’s what Malcolm Fraser dubbed “the secret tax of inflation”, but the punters call “bracket creep” and economists call “fiscal drag”.

Because our income-tax scales tax income in slices, at progressively higher rates – ranging from zero to 45c in the dollar – but the brackets for the slices are fixed in dollar terms, any and every increase in wages (or other income) increases the proportion of income that’s taxed at the individual’s highest “marginal” tax rate, thus increasing the average rate of tax paid on the whole of their income.

A person’s average tax rate will rise faster if the increase in their income takes them up into a higher-taxed bracket but, because what really matters in increasing their overall average tax rate is the higher proportion of their total income taxed at their highest marginal tax rate, it’s not true that people who aren’t pushed into a higher tax bracket don’t suffer from what we misleadingly label “bracket creep”.

I give you this technical explanation to make two points highly relevant to the prospects of getting the budget deficit down. Both concern the third stage of the government’s tax cuts, already legislated to take effect from July 2024, at a cost of $17 billion a year.

Although this tax cut is, in the words of former Treasury econocrat John Hawkins and others, “extraordinarily highly skewed towards high income earners”, Frydenberg justifies it with the claim that, because it would put everyone earning between $45,000 and $200,000 a year on the same 30 per cent marginal tax rate, it would end bracket creep for 90 per cent of taxpayers.

First, this claim is simply untrue. For Frydenberg to keep repeating it shows he either doesn’t understand how the misnamed bracket creep works, or he’s happy to mislead all those voters who don’t.

What’s true is that the stage three tax cut would greatly diminish the extent to which a given percentage rise in wages leads to a greater percentage increase in income-tax collections, thereby sabotaging the progressive tax system’s effectiveness as the budget’s main “automatic stabiliser”. Its ability to act as a “drag” on private-sector demand when it’s in danger of growing too strongly.

In an ideal world, income-tax brackets would be indexed to consumer prices annually, thus requiring all tax increases to be announced and legislated. But in the real world of cowardly and deceptive politicians – and self-deluding voters – the stage three tax cut is bad policy on three counts.

One, it’s unfair to all taxpayers except the relative handful earning more than $180,000 a year (like me). Two, the biggest tax savings go to the people most likely to save rather than spend them. Three, by knackering the single most important device used to achieve fiscal consolidation, it’d be an act of macro management vandalism.

Think of it: by repealing stage three you improve the budget balance by $17 billion in 1024-25 and all subsequent years. Better than that, you leave intact the only device that works automatically to improve the budget balance year in and year out until you decide to override it.

Without the pollies’ little helper, fiscal consolidation depends on a government that’s still smarting from its voter-repudiated attempt in the 2014 budget, having another go at making big cuts in government spending, and a government that seeks to differentiate itself as the party of low taxes now deciding to put them up.

Good luck with that.

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Treasury boss confident big government debt is manageable

Whether they realise it or not – probably not – the people up in arms about the size of the federal public debt and criticising Scott Morrison and Josh Frydenberg for not doing more to get it down in last week’s budget are saying they should have made the same error the major economies made early in their recovery from the Great Recession.

If you’ve heard Frydenberg saying he won’t “pivot to austerity policies”, you’ve heard him vowing not to make the mistake the Americans, and particularly the Brits and Europeans, made in 2010.

After they’d borrowed heavily in response to the global financial crisis, their recoveries had hardly begun before they looked back at their mountainous debt and panicked, slashing government spending and whacking up taxes.

This policy of “austerity”, as critics dubbed it, proved disastrous. It stunted their recoveries and meant they didn’t reduce their deficits and debts much at all.

This is why, to prevent the budget’s support for the still-recovering private sector falling precipitately over the coming four financial years to June 2025, Morrison and Frydenberg decided to use most, but not all, of an unexpected improvement in forecast budget deficits to increase spending and cut taxes.

Even so, the net debt in June 2024 is now estimated to be $46 billion lower than expected in last October’s budget, as independent economist Saul Eslake has pointed out.

In a speech to the Australian Business Economists this week, Treasury secretary Dr Steven Kennedy defended the government’s two-phase economic strategy.

According to the budget papers, phase one is to promote economic growth through “discretionary fiscal [budgetary] policy and the operation of [the budget’s] automatic stabilisers” so as to “ensure a strong and sustained recovery to drive down the unemployment rate”.

We will remain in the first phase of the strategy “until the recovery is secured” and growth has driven unemployment “down to pre-pandemic levels or lower”.

“Only once the economic recovery is secured will the government transition towards [phase two and] the medium-term objective of stabilising and then reducing debt as a share of gross domestic product,” the budget papers say.

But some economists – the most well-credentialled of whom is former Treasury secretary Dr Ken Henry – are concerned this willingness to live with unusually high levels of deficit and debt for many years, and without mention of any effort to return the budget to surplus – which would reduce the debt in dollar terms, not just relative to GDP - is complacent and risky.

But, with one proviso, Kennedy argues strongly that the presently projected paths of our budget deficit, our debt and the interest bill on the debt aren’t particularly risky.

When I get to that proviso you’ll see that Kennedy and his old boss aren’t so far apart. And remember this: Henry is now free to give the government advice in public, whereas the Westminster system requires Kennedy to give all his frank advice in private, not in speeches to economists.

Starting with the budget deficit, Kennedy says it grew hugely in 2020, partly because the lockdown caused tax collections to collapse and the number of people getting the dole to leap (this being the operation of the budget’s “automatic stabilisers”), but also because of the unprecedented degree of “emergency support” provided to businesses and workers.

The deficit’s expected to peak at $161 billion (equivalent to 7.8 per cent of GDP) in the financial year soon to end, then fall to $57 billion (2.4 per cent of GDP) in 2024-25. This “relatively quick” fall happens mainly because all the emergency support was temporary.

“At this stage, [a hint that policies could change, and probably will] the deficit is expected to persist through the medium term,” Kennedy says, by which he means that, seven years later in 2031-32 (the “medium term”), the projected deficit is still 1.3 per cent.

Budget statement 3 (page 100) shows that’s about the projected size of the“structural” budget deficit – the deficit that’s left after taking account of the cyclical factors affecting the budget – by then.

Kennedy explains this as representing the government’s structural (lasting) increases in spending on what it calls “essential services” – particularly aged care, disability care and the tiny permanent increase in the rate of the dole – in this year’s budget.

Such a structural deficit isn’t huge, but its existence is a tacit admission that, if government spending isn’t going to be cut, taxes should be increased.

Turning to the projected path of the net debt, Kennedy says the budget projections suggest the government is on track to stabilise and begin reducing the debt as a share of GDP in the medium term (the next 10 years), given the present economic outlook “and policy settings” (hint, hint).

The net debt is expected to be 34 per cent of GDP at June 2022, rising to almost 41 per cent at June 2025, before improving to 37 per cent at June 2032. (Eslake reminds us all this is less than half the average for the advanced economies.)

Finally, “debt servicing costs” - fancy talk for the interest payments on the debt. As a proportion of GDP – that is, comparing the interest payments with the size of the nation’s income – net interest payments are projected to “remain low by historical standards at around 1 per cent over the medium term”.

Two eye-opening graphs in Eslake’s first-rate budget analysis show 1 per cent is much lower than we were paying throughout the last quarter of the 20th century (in the late 1980s it was above 2.5 per cent). And, in inflation-adjusted dollars per head of population, it’s much lower than we were paying in both the late ’80s and the late ’90s.

Responding to Henry’s concerns, Kennedy says “there remains fiscal space [room] to respond again with fiscal policy if the need arose”. But here’s the proviso Kennedy adds: “there will come a time where it is prudent to accelerate the rebuilding of our fiscal buffers”.

That’s as frank as Treasury secretaries get in public.

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Don't believe what lightweights tell you about debit and deficit

If you’ve gained the impression that in their pre-election budget Scott Morrison and Josh Frydenberg have gone on a wild, vote-buying cash splash spending spree, leaving us – not to mention our grandchildren – with a string of bigger budget deficits and much increased government debt, you’ve been misled.

Some of it’s simply not true, much of it’s exaggerated and the rest has been misunderstood by people who didn’t do economics at high school. They’re people who are led by their emotions and, when they hear frightening words like “deficit” and “debt”, don’t need to be told we’re all in deep doodoo. They don’t stop to read the details.

Let me give you some of those details, with help from the independent economist Saul Eslake and his first-rate budget analysis.

What would you think if you asked me my salary and I gave you a figure I’d first multiplied by four? You’d think I was big-noting. The politicians do this every budget time to make them sound more generous than they are.

They can do it because the budget shows the cost for the coming financial year, plus “forward estimates” for the following three years. The media go along with it because it quadruples their story’s impressiveness.

They told us the budget involved new spending and tax breaks costing $93 billion “over four years”, when it would have been less misleading to say the new measures will cost the budget about $23 billion a year.

Some have implied the new measures are profligate and motivated by vote-buying. Some measures are, no doubt. But the $3.8 billion a year to fix up our scandal-ridden aged care system? The $2.2 billion a year in increased support for the unemployed? The extra $2 billion a year in infrastructure? The $1.3 billion a year to subsidise apprenticeships? Another $1.3 billion in total to help hard-hit aviation and tourism? An extra $450 million a year on women’s economic security?

The extended tax relief for small business will cost a total of $21 billion in a few years’ time, but then will be clawed back. The “new” tax cut for middle-income earners costing $7.8 billion a year Frydenberg told us about is just a one-year extension of last year’s tax cut.

Doesn’t sound much of a splash to me. The increased subsidy of childcare costs doesn’t start for a year and is about a quarter of what Labor’s promised.

Next, if you’ve gained the impression all this spending will increase the budget deficit and add to the government’s debt, you’ve been misled.

At the time of last year’s delayed budget in October, Eslake points out, the net debt was expected to reach $966 billion by June 2024. In this budget the debt’s now expected to be $46 billion less by then.

How is this possible? It’s possible because the economy has recovered much more strongly than was expected even in October. So tax collections are a lot higher than expected, and dole payments a lot lower.

By design, the government’s new spending takes up most, but not all, of this improvement. The econocrats wouldn’t have thought it smart to withdraw too much of the public sector’s support for the private sector – households and businesses – before the recovery was well established and when unemployment was still so high.

The joke is, the people up in arms about the huge growth in debt are a year late. It was last April when all the damage was done. The pandemic was raging and governments decided to put our heath first and the economy second. They locked down the economy, causing the biggest collapse in the nation’s income since World War II.

But to hold the economy together so it could rebound after the lockdown was lifted, the government spent unprecedented sums on the JobKeeper scheme (that’s $90 billion right there), the JobSeeker supplement and a dozen other temporary programs.

It’s all worked far better than expected, but there’s no denying it’s come at a great cost. Should we have let all those people die of the virus? Should we have let the economy stay flat on its back? The debt panickers weren’t saying that a year ago.

The finances of national governments don’t work the way a family’s do. Eventually, parents die. They know they must have their debts paid off before then.

But though the faces change, governments and the populations they serve never die, they just keep growing. Meaning they – like big businesses – never pay off their debt. It goes down sometimes and up others, but still goes on forever.

What governments do is out-grow their debts, so it shrinks relative to the size of the economy and all the income it generates. That’s how the developed countries got on top of the massive debt they were left with after WWII.

They didn’t pay it back, they outgrew it. And the good news is, interest rates on the public debt are now lower than ever – and won’t be going back up in a hurry.

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