Fear is driving good economic policy out of the political market

When it comes to politicians, some are good shots and some are cheap shots. These days, the successful politicians – you wouldn’t call them leaders – have relied heavily on cheap shots. The cheapest being to spread fear.

The simple truth is that humans have evolved to continually check their environment for threats. Those who weren’t so obsessively cautious died from some misadventure before they’d managed to have kids.

One way of defining civilisation is that it’s the quest to remove all threats to life and limb. This is the largest role performed by government and the main thing our taxes pay for.

The welfare state – including universal health care and social security payments – is about removing the threat of people dying because they’re too old or sick or disabled to work, or just can’t find a job. The welfare state is a giant risk-sharing system, a massive insurance scheme.

But though our lives have become infinitely less risky – one reason we live much longer than our great grandparents - we go on scanning our environment for threats. Which is good news for the news media - and the reason most of the news they choose to tell us is about bad things – and for less-scrupulous politicians.

Politicians have long known how easy it is to play on our fears to their own advantage. In our more racist past, the “Yellow Peril” was a frequent issue in election campaigns. Scott Morrison’s AUKUS nuclear subs deal led pollster Peter Lewis to wonder whether Morrison would consider “tapping the Coalition’s longstanding brand advantage on national security for a fear campaign about China’s rising influence”.

As the independent economist Saul Eslake rarely loses an opportunity to remind us, in recent years it has suited politicians to greatly exaggerate the risk we face from terrorists. Both sides have been happy to play to our fears that all those people arriving in leaky boats would take our jobs and clog our highways.

But issues of economic management are far from immune to the fear treatment.

Since politics has become so professionalised – a career path you start on after university, rather than a contribution you make after succeeding in some other field – politicians are people who worry more about what they have to do or say to attain and retain power than about why they need power to fix all the things they believe need fixing.

The more we’ve come to distrust our politicians – all politicians – the more they’ve realised the only thing they can say that we’ll believe is how bad their opponents are. Ask a minister how the government’s policy would work and the answer you get is disparagement of the opposition’s policy.

Invariably, any plan to tackle pressing economic problems, or just make the economy work better, has pros and cons, winners and losers. Bingo. A pollie with a plan is a pollie fighting a scare campaign.

One man with a massive plan was economist-turned-pollie Dr John Hewson. He lost the unlosable election in 1993. Another man with a plan was Bill Shorten. He had to fight scare campaigns on every front.

This was partly the Liberals’ retaliation for the success of Labor’s under-the-radar social media Mediscare in the 2016 election. Guess what? The coming federal election will be the battle of the scare campaigns, with as few substantive policies as possible.

Gresham’s Law says bad money drives out good. A new law says scare campaigns drive out policy reform. Or maybe B-grade pollies drive out A-grade. When it comes to standards of political behaviour, it’s always a race to the bottom.

One price we pay for this is that it encourages pollies to take no thought for the morrow. “I’ll just get re-elected and cope with whatever problems arise, if any do.” It raises muddling through to bipartisan policy.

Another price is that we go through the ritual of electing governments with little knowledge of what they secretly hope to do – or may have to get on with if circumstances force their hand. Why risk outlining your intentions when it’s safer to make up stories about your opponents’ evil intent.

But not to worry. An ever-helpful media will spend most of the election campaign pressing them to bind their hands by “ruling out” this and ruling out that. Thanks, guys, that’ll really help.

Since the rise of Tony Abbott, the Coalition has benefited greatly from scare campaigns about the cost of acting to reduce carbon emissions.

But pressure from G7 leaders, international financial markets, sensible Liberal voters threatening to elect independents, and now even the Business Council, may force Morrison to campaign on the claim that moving from fossil fuel to renewable energy could do wonders for the economy.

It’s true – but who’ll believe him?

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Cheapest, easiest way to reach net zero is to put a price on carbon

If Scott Morrison fails to front for the Glasgow climate conference at the end of the month, his preference to stay home while we’re dismantling the lockdown will be only one reason. The other’s that the conference isn’t looking like it’ll be a roaring success.

You wouldn’t know it from all Morrison’s agonising over signing up to net zero carbon emissions by 2050, but it’s the easy bit. The hard part about Glasgow is the expectation you’ll make an improved commitment on how much you’ll have done to reduce carbon emissions by 2030.

Unlike us, most of the big players have already put their revised commitments on the table. That’s the problem with Glasgow. So far, those commitments add up to much less than needed to hold the global average temperature rise to the “well under 2 degrees” agreed on at Paris in 2015, let alone the 1.5 degrees the poorer countries demand.

As many of us now realise, we wouldn’t be trembling in our boots over the enormity of getting our emissions down to net zero by 2050 – and making big strides long before then – had we not abolished after only two years the perfectly good carbon pricing scheme the Gillard government introduced in 2012.

By 2014, people had realised the carbon tax accounted for only a little of the huge increase in electricity prices we experienced, and that the Coalition’s talk of $100 legs of lamb was just a fairy story.

Of course, the carbon price would be higher by now, and we’d have had to extend it beyond electricity and gas to all other sources of emissions.

The series of studies the Grattan Institute’s Tony Wood is doing on how we can reduce emissions in other parts of the economy – transport, manufacturing, agriculture – shows that without the help of a carbon price it’s much harder going.

And it strikes me that insufficient reliance on a carbon price may explain much of the trouble the other parties to the Paris Agreement are having in making adequate progress. Indeed, it could be we won’t make it to net zero without the biggest emitters making greater use of emissions pricing.

In a recent paper, Ian Parry, of the International Monetary Fund, says more than 60 carbon tax or emissions trading schemes have been introduced at sub-national, national or multi-country levels. In recent months, China and Germany have launched major initiatives, the carbon price in the European Union has risen above €50 ($80) a tonne of carbon dioxide, and Canada announced its price would rise to the equivalent of $185 a tonne by 2030.

Even so, only about a fifth of all global emissions are covered by pricing schemes, and the global average price is only about $4 a tonne. Parry says that’s a far cry from the global price of about $US75 (more than $100) a tonne needed to reduce emissions sufficiently to keep global warming below 2 degrees.

Does $100 a tonne sound expensive? It is in the sense that the price increase built into the prices of emissions-intensive goods and services needs to be big enough to produce sufficient change in the behaviour of consumers and businesses.

But it’s cheap when you realise that the purpose of a carbon tax (or, equivalently, the proceeds from the government auctioning emissions permits to businesses who need them) is not to raise additional revenue but to change behaviour.

So the proceeds can be used to make equivalent reductions in other taxes, especially income tax. Thus people pay more for some of the goods and services they buy, but pay less income tax. People on welfare benefits have them indexed to cover their higher living costs.

As we discovered in 2012, introducing a carbon tax or emissions trading scheme (ours was the former that, after a few years, would become the latter) is a relatively simple business. You don’t tax emissions directly, but use scientific estimates of the average amount of carbon dioxide the production and use of that class of product emits.

But almost all economists recommend using a carbon price to decarbonise the economy also because they think it’s the policy instrument likely to achieve the objective with the least disruption to the economy and least loss of growth in the production of goods and services.

That’s what economists really mean when they say a carbon price is the cheapest way to get to net zero. They know that sufficiently large changes in relative prices will change people’s use of fossil fuels.

Get this: a carbon tax is a tax the government actually wants people to find ways to avoid having to pay. It’s intended to discourage people from using fossil fuels. How? By using electricity, gas and petrol less wastefully.

By switching to renewable energy (which is untaxed) because it’s relatively cheaper. By making sure that the next car or appliance or production machine people buy is more energy-efficient than the last. By increasing the monetary incentive for businesses to come up with less-polluting ways of doing things and inventing less-polluting machines.

To save face, Morrison has set his face against using the price mechanism to save the planet. But economic reality – or pressure from other, more sensible countries, or even voters – may yet change his tune.

One worry about putting a price on carbon is whether it would put our exporters at a disadvantage. A new and opposite worry is whether countries that have one when we don’t will protect their industries by slapping a “carbon tariff” on our exporters.

But the International Monetary Fund has come up with a solution to these worries that would also allow every country to use carbon pricing to make greater progress towards net zero. It proposes that the G20 countries (including us) phase in a uniform carbon minimum or “floor price” of $US75 a tonne of CO2 by 2030. Smart idea.

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Farmers have most to lose - or gain - from climate change

Doesn’t it strike you as strange that the born-again Scott Morrison – by now, presumably, deeply ashamed of his public fondling of a lump of coal during his unregenerate days – is being held back from signing up to the target of net zero carbon emissions by that fierce defender of farmers and rural Australia, the National Party?

Farmers are, if you’ll forgive the expression, at the coal face of the damage climate change is doing and will keep doing to Australia. They’ll also be among the chief beneficiaries of successful international action to stop further increase in global warming.

By now there’d be few farmers who didn’t understand that. Certainly, all the main farming lobby groups, from the National Farmers Federation down, have endorsed the net zero target and want to get on with it.

So what’s the National Party’s problem? Just that it sees itself as champion of two regional industries, agriculture and mining. Trouble is, the miners have always seen their interests as lying in fending off action to reduce the use of fossil fuels for as long as possible.

The Nats’ allegiance to mining gets stronger as you move north, and reaches its peak in Queensland. And it’s not hard to guess which of the two industries has the deeper pockets when it comes to generous support for the party cause.

But not to worry. The Nats’ method of operation within the Coalition has long been to blackmail the Libs into shifting more money from the city to the bush. It doesn’t have to be well spent as long as there’s more of it. And all the nudging and winking coming from the chief national Nat, Barnaby Joyce, suggest the Nats (or most of them) will surrender their principled position as long as the price is right.

One part of the price could be to exempt agriculture from any effort to reduce its own emissions. But a recent report from the Grattan Institute says that would be a mistake for two reasons. Agriculture accounts for 15 per cent of our total emissions, so we won’t make it to net zero if it isn’t pulling its weight like other industries.

But also, now the big countries are serious about climate change and are requiring their own industries to shape up, they’ll be using a carbon tariff to punish exporters from those countries that aren’t doing likewise. Any excuse to protect their own farmers from our more-efficient operators would not go unused.

So let’s start at the beginning. Farmers are disproportionately affected by climate change, including by higher temperatures, changing rainfall patterns and increasing drought, bushfires and floods.

As Grattan’s James Ha reminds us, federal government research says changes in rainfall have cut farm profits by 23 per cent compared to what could have been achieved in pre-2000 conditions.

Cropping farmers have done worst, but if global warming reaches 3 degrees, livestock in northern Australia are expected to suffer heat stress almost daily. As the climate continues to change, the value of some farming land may fall considerably and some properties may become increasingly expensive to insure.

Agriculture’s emissions of greenhouse gases have fallen somewhat in recent years, but this is a result of the drought. As herd size is rebuilt, emissions will increase – until the next big drought.

About three-quarters of agriculture’s emissions come from cattle and sheep. Most of this is our 24 million cattle and 64 million sheep burping methane (which causes a lot more warming than carbon dioxide), and then the nitrous oxide (also worse than CO2) that comes from their poo.

Then come emissions from the use of diesel to fuel most farm equipment, emissions from the use of chemical fertilisers and lime, and emissions from plant matter left after harvest.

All this makes farm emissions difficult to reduce. There are vaccines and dietary supplements to reduce methane belching, but they are not yet well developed and are hard to use on wide-ranging animals.

Farm equipment has not yet been adapted to use electric motors. Even so, there are practices that could be changed to manage farms more efficiently and with fewer emissions.

State agriculture departments have spent much over many years teaching farmers how to bring their practices up to date, and they need to spend a lot more teaching farmers how to adapt to climate change and reduce emissions.

Similarly, the CSIRO has spent taxpayers’ money on advancing farm technology over many decades. We should be investing in technological solutions to limit methane emissions. Where farmers need to buy expensive new equipment, the government could help them with “income-contingent” loans similar to HECS loans to uni students.

Farmers will gain directly from emission-reducing practices that also increase their productivity. They’ll be enormously better off from whatever the global effort does to limit further warming.

And, remembering the “net” in net zero, they’ll benefit greatly from doing things that allow them to sell “carbon credits” to firms in other industries – so long as it’s not just another National Party boondoggle.

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The economy can self-correct, but only up to a point

As you’ve no doubt noticed, the crippling lockdowns in Sydney and Melbourne turn out to have one important side-benefit: NSW and Victoria have the highest rates of vaccination, which offers those states a path out of lockdown.

By contrast, the other states – which sensibly closed their borders to people coming from the two highly infected states – have the advantage of not needing to lock down, but the disadvantage of low rates of vaccination.

The two states that built the highest walls against the coronavirus - Queensland and Western Australia – have the lowest vaccination rates. (Which suggests they may not be feeling quite so superior once the lockdowns end and the virus’s chances of penetrating their borders are greatly increased.)

You don’t need me to tell you the two sides of the coin are connected. The incentive to get vaccinated has been greatest in the most infected states and least in the least infected states.

What you may need me to tell you is that this offsetting outcome is just what an economist is trained to expect. One of the most important and useful insights of economics is that market economies possess an inbuilt self-correction mechanism, a negative feedback loop.

Positive feedback causes a variable that’s going up to keep going up and a variable that’s going down to keep going down, whereas negative feedback causes a variable that’s going up to start going down, and a variable that’s going down to start going up.

Don’t take this the wrong way, but economists love negative feedback. Why? Because it returns a market and, by extension, the whole economy, to “equilibrium”.

Equilibrium means a state where everything’s in balance and thus at rest. There is – until the next “shock” to the system comes a long - no pressure for things to change.

What is it that always pushes markets back to equilibrium? “Market forces”.

This refers to the interaction between the demand from consumers for some product on one side and the willingness to supply that product on the other. What brings demand and supply into balance is the “price mechanism” – the price keeps changing until demand and supply are equal and the price is stable.

Say there’s some shock that causes the quantity demanded to exceed the supply available. This will cause the market price to rise, and the rise will send a “price signal” to both buyers and sellers.

The signal to buyers is: buy less. Be less wasteful in your use of the product, or look for similar products that are cheaper. The signal to sellers is the reverse: sell more. Now the product has become more profitable, produce more of it.

So, the price mechanism has caused a fall in the demand for the product and a rise in its supply. This will push the price back down until demand and supply are equal again. The market will have “cleared,” leaving nothing unsold, and the price will be back to about where it was before the shock. Equilibrium will have been restored.

Simple, eh? Neat, eh? And that’s a big part of the reason the economists’ way of thinking about how markets and market-based economies work hasn’t changed much in 150 years.

You see, too, why economists believe that prices – particularly changes in them – are the great incentive for people to change their behaviour. You want to decarbonise the economy? Put a price on carbon emissions.

Another instance of the equilibrating effect of prices is the existence of “arbitrage”, particularly in the markets for shares and other securities. Any difference in the price of the same security in different markets won’t last because the actions of people seeking to profit by buying in the cheaper market and then selling in the dearer market will soon eliminate the discrepancy. Economists call this “the law of one price”.

Putting all this another way, economists have long understood that markets and market economies are, in the modern idiom, “interactive”. Any new action always leads to a reaction, as the people affected change their behaviour to cope with the new development.

This understanding is why economists don’t worry about some developments as much as normal people do. Normal people say: look what’s just happened - it’s terrible. Economists say: yes, but then what happens? They call this the “second-round effect” and their model is supposed to predict what it will be.

For example, economists have never been impressed by all those reports warning that, by 2030, there’ll be a massive national shortage of teachers/nurses/other skilled occupation as all the baby boomers retire. No, there won’t. Why not? Because employers will take evasive action and other employees will take advantage of the opportunities presented.

But the notion of equilibrium can be taken too far. The doctrine of “laissez-faire” (leave it alone) – which lurks just below the surface of what lefty academics call neo-liberalism, but I prefer to call market fundamentalism – says that, since market economies have an inherent ability to return themselves to equilibrium after any shock, government intervention to correct the problem will only make things worse.

This is the old case of taking an element of truth and raising it to the status of a magic answer. The economists’ theory of how markets work is grossly oversimplified. In the real world there are lots of problems that can’t be solved just by leaving it to market forces.

Wait for market forces to stop global warming, and you’ll wait forever, decimating the economy in the process.

Or cases where waiting for the market to solve the problem would take too long or extract an unacceptable price in human suffering. Do nothing about the pandemic and waiting for all of us to get the virus and thus achieve herd immunity would cost too many lives.

The econometric models that economists use to forecast the macroeconomy or predict the effects of some policy proposal rely heavily on the assumption that, over the (unspecified) long term, the economy always returns to where it would otherwise have been. Yeah, sure.

The opposing theory to certain return to equilibrium – which comes from the physical sciences - is “path dependence”. That where you end up after equilibrium is disturbed depends on what else happens to the economy while it’s supposed to be on its way back to where it was. It could be knocked off course and never return to the previous path it was following.

The notion of equilibrium contains a lot of truth. Trouble is, so does the notion of path dependence. As always, the whole truth is somewhere in the middle.

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Economists need updating on what makes humans tick

At the heart of the weaknesses of economics – its frequently wrong predictions and the bad advice its high priests often give governments – is its primitive understanding – its “model” - of how and why humans behave the way they do.

It’s taking economists far too long to realise that to understand how the economy works you’ve got to start by understanding how the people who make up the economy work. The model economists started with in the second half of the 19th century and haven’t really moved on from is the mere assumption that businesses, workers and consumers always behave “rationally” – with carefully considered self-interest.

In the 150 years since economists decided their stick-figure assumptions were a sufficient foundation on which to build their model of economic behaviour, the other social sciences – psychology, sociology, anthropology – have made much progress in understanding human behaviour and motivations.

So, just this once, let’s set aside “Homo economicus” and see what wisdom the more social social scientists have to impart.

In his book, Moral Tribes, the Harvard moral psychologist Joshua Greene lays out a view of human behaviour that accounts for most of the things missing from economics. He starts with the proposition that the way humans behave is heavily influenced by the way we have evolved.

As one of the founders of behavioural economics, the psychologist Daniel Kahneman, explained in Thinking, Fast and Slow, humans are good at thinking rationally, but it takes time and (literally) requires energy, so we’ve evolved to make most of our everyday decisions instantly and instinctively – without conscious thinking.

Our feelings and emotions can’t be dismissed because their role is to do most of our thinking for us. To motivate our instinctive reactions.

Humans have spent all but the past 10,000 years or so in roaming bands of hunters and gatherers. So it’s no surprise we still think like members of a tribe. We feel an affinity with those in our tribe, but not with people in other tribes.

As tribal animals, we care deeply about our relations with those around us, the other members of our tribe. It’s being in the tribe that protects us from harm and provides us with food, friends and someone to mate with. So we have to keep in with the tribe; make sure we’re not kicked out.

This is where moral attitudes come from. Morality is about how we treat others. Greene says “morality is a set of psychological adaptations that allow otherwise selfish individuals to reap the benefits of co-operation”.

You can get competition within tribes, but mainly they’re about co-operation for mutual benefit. We co-operate to organise enough food and shelter, but also for the group’s protection against its enemies, animal or human.

As tribe members, the moral issue we face is “me versus us”. We’ve evolved to remember to suppress unbridled self-interest and treat others well. Thus we’re good at co-operating in shared objectives, and our moral standards involve punishing others who fail to co-operate.

This co-operation does much to explain our success in becoming the dominant species and in radically transforming the world to make ourselves more comfortable. Greene says we’ve defeated most of our natural enemies. We’ve outsmarted most of our predators, from lions to bacteria.

But note this: our ability to co-operate as a tribe has evolved into a weapon to use in competing with other tribes. And, though our evolutionary instincts may not have changed a lot since we ceased being roaming hunters, our success has greatly changed the circumstances in which we live.

Though we live in countries with populations of many millions, we still have moral instincts that evolved to help us solve the problem of me versus us, not the problem of us versus them.

In one sense, we no longer live in small tribes that don’t have much contact with other tribes, but only sometimes do we see ourselves as living in, say, one big Australian tribe. We tend to see ourselves as members of many tribes, according to our differing characteristics: not just the party we vote for, but the part of the country we live in, our ethnic origin, our religion, our occupation, social class, education and much else.

Our tribal instincts keep most of us believing and behaving the way our tribe thinks we should. But the moral intuition of particular tribes has evolved in differing directions. What I see as the moral – or fair – thing to do, may be quite different to how you and your tribe see it.

Most countries used to be fairly homogeneous, with most people in the country adhering to the same religious views, particularly about issues such as abortion, same-sex marriage and assisted death.

These days, many people have abandoned traditional religious views, though many haven’t. And much moving between countries means most countries have many people from differing religious traditions.

This leaves us with moral tribes that can’t agree on what’s right or wrong. This applies not just to sexual morality, but to whether I think it’s “fair” for me to pay more tax to support you when (I tell myself) you wouldn’t need my support if you’d worked as hard as I have to get what I’ve got.

Because our two-speed brains are adept at finding fancy rationalisations for “values” that are really just instinctive desires, we argue about our sacred Right to this or that treatment – which the other tribe counters with its own sacred (but conflicting) Right.

And, Greene says, even when we think we’re being fair, we unconsciously favour the version of fairness most congenial to our tribe.

He offers no magic answers to these widespread problems caused by modern tribalism. But he does say that, with a better understanding of why these tribal disputes arise, we all ought to be a lot less self-righteous about the moral correctness of our position and more willing to find compromises all of us can live with.

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We won’t be paying back government debt, but we WILL be paying

If you’re one of the many who worry about how we’ll pay off the massive debt the Morrison government has incurred during the pandemic, the Parliamentary Budget Office has reassuring news.

The budget office – which is responsible to the whole Parliament and so is independent of the elected government – has prepared its own projections of the budget deficit and debt over the decade to 2032.

It’s also assessed our “fiscal sustainability” over the 40 years to 2061, testing the budget against 27 different best, worst and middle scenarios with differing assumptions about economic growth, the level of interest rates on government debt and the size of our budget deficit or surplus.

It finds that the federal government’s debt is projected to keep growing until it reaches a peak equivalent to about 50 per cent of gross domestic product in 2029. After that it’s projected to keep growing in dollar terms, but at a slower rate than the economy is growing, so that it slowly declines relative to the size of the economy, to reach 28 per cent of GDP in 2061 in the middle scenario.

We don’t pay off any debt unless we get the budget back into annual surplus. But this happens only in the best-case scenario, where the debt is completely repaid by 2058. Don’t hold your breath.

So the budget office’s reassuring news is not that we’ll be able to repay the debt – it’s unlikely we will – but that it accepts Scott Morrison’s assurances we don’t have to repay it to keep out of trouble. That, unless our leaders go crazy, we can outgrow the debt and that the interest bill isn’t likely to become a significant burden on taxpayers even though the debt remains unpaid.

These are not controversial propositions among economists. If you find them hard to believe then – forgive me – but you don’t understand public finances as well as you should. It’s a mistake to think that a national government of 25 million people has to live by the same rules as your household.

Households must pay off their debts before they’re too old to work, but governments go on forever and always have most of their population working and paying taxes. Their populations keep growing and getting a bit richer every year, so they can keep rolling over their debts.

They can do what no household can do: pay their bills not by working but by imposing taxes on other households. So stop thinking governments have to pay off their debts the way you and I do.

And stop thinking our kids will be lumbered with massive government debts; they won’t be. Indeed, it won’t be government debt our kids and grandkids will hold against us, it’s our generation’s failure to act early enough to stop global warming.

But that’s not to say government debt doesn’t matter or that it comes without a price tag. In its projections over the next decade and its scenarios over the next 40 years, the budget office assumes that the “shocks” causing ups and downs in the economy in the future will be no worse than those we’ve experienced over the past 30 years or so. Maybe; maybe not. As well, it assumes that present and future governments will be no more reckless spenders than governments have been over past decades.

It judges that our deficit and debt position will be sustainable over the next 40 years – will cause no need for “major remedial policy action” (no horror budgets) – “provided fiscal strategy is prudent”. We can continue to run budget deficits provided they’re “modest”.

We’ll need “a measured pace of fiscal consolidation”. Translation: if governments stop trying to keep deficits low, all bets are off. So governments will need to avoid wasteful spending. And they’ll need to ensure tax collections are sufficient to cover most of any growth in government spending.

It’s here I think the budget office’s projections of an ever-diminishing budget deficit out to 2032 are hard to believe. They’re based on assumptions that government spending grows no faster than the economy grows, but tax collections grow a lot faster than the economy.

How? By letting bracket creep rip. The tax cuts we’ve been promised for 2024 will be limited to high-income earners, and will be the last we see for the decade.

That’s not hard to believe. What’s hard is believing governments can keep the lid on government spending for another decade. We know we’ll be spending hugely more on nuclear subs and other defence equipment, on aged care and on the National Disability Insurance Scheme.

So how is government spending supposed to grow only modestly? Because spending on social welfare – age pension, family tax benefits, disability support pension, JobSeeker and sole parent payment – will fall as a share of GDP.

Get it? The only way we’ll keep on top of our debt and deficit is by driving the disadvantaged further into poverty. If we’re not that heartless, we’ll be paying a lot more tax – whatever we’re promised at the election.

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Budget wisdom: keep options open and don't cry over sunk costs

The nation’s economists are realising that what we need is not smaller government but better government – government that delivers value for money. That means stopping the waste of taxpayers’ money. But identifying genuine waste is harder than you may think.

As former top econocrat Dr Mike Keating has argued in a revealing article on the Pearls and Irritations website, the Coalition preaches that smaller government is best, but has failed to deliver it. Even before the pandemic, federal government spending had risen as a percentage of gross domestic product.

Why? Because as it realised after the debacle of its first budget in 2014, the government lacks the voters’ support for big cuts in major spending programs. So it’s been reduced to cutting a narrow range of spending that lacks public support and, otherwise, just trying to keep a lid on other spending.

As economics professors Richard Holden and Steven Hamilton have argued, this penny-pinching has led to many “false economies” – cost cuts that end up costing you more than you’ve saved.

The prevalence of false economy shows that avoiding waste is trickier than many suppose. Take the decision to dump our $90 billion contract for French submarines in favour of US or British nuclear subs as part of the new AUKUS security pact.

This involves walking away from initial payments to the French of, reportedly, $2 billion. Is this a huge waste of taxpayers’ money?

Well, yes and no. We’ve had a lot of second thoughts about the contract since the Turnbull government decided on it. It’s been plagued by disputes, delays and massive cost blowouts. If Scott Morrison is right in believing the move to nuclear subs and a stronger alliance with the Brits and Americans offers us markedly better security arrangements for the future then, no, writing off $2 billion isn’t a waste of money.

Of course, if you want to say the original decision to accept the French proposal was a mistake and a waste of money, you can. But you’ll be relying on the wisdom of hindsight – on you knowing today what Malcolm Turnbull & Co couldn’t have known with any certainty in 2016.

The wisdom economists have to tell us is that past decisions to spend money are “sunk costs”. Whether they turned out to be good decisions or bad, they can’t be undone. So we should ignore them when making decisions today about what we think may happen in the future.

Today, all that matters is deciding what’s the best thing to do to improve our future prospects. If, for reasons of face, we stick with a bad deal rather than moving to a better one, we’re throwing good money after bad. And that would be a waste.

But Holden and Hamilton point to another case where deciding what is or isn’t waste is tricky. Last year, various pharmaceutical companies and university groups around the world were rushing to develop effective vaccines against the coronavirus. At the time, governments couldn’t know which projects would make it through all the trials.

They had to make deals then that would allow them to vaccinate their populations as effectively and rapidly as possible once it was known which potential vaccines had survived the testing.

But Morrison decided to save money by signing up for just two of the possible vaccines: AstraZeneca and one that scientists at Queensland University were working on.

Holden believes Morrison put our money on just those two because they could be manufactured locally, as “a back-door industry policy”. This goal seemed to overshadow the primary goal of ensuring that, whichever vaccines lasted the distance, we’d have all the vaccine we needed ASAP.

But Morrison got caught. The Queensland candidate fell over and AstraZeneca was tripped up by the ill-considered announcements of ATAGI, the Australian Technical Advisory Group on Immunisation.

Holden and Hamilton’s point is that Morrison’s decision to bet on only two of the horses in the vaccine race was false economy, caused by his failure to understand the wisdom of “option value”.

As sharemarket players know, an option is a financial derivative that gives the buyer the right – but not the obligation — to buy (or to sell) the relevant shares at a stated price within a specified period. You have to pay a modest fee for an option contract, but it keeps your options open and minimises the risk of being caught out. It’s a kind of insurance policy.

Morrison should have used the equivalent of options to back every horse in the vaccine race. The cost of buying all those options would have been more than covered by the saving we’d have made by being able to get everyone vaccinated early and thus reduce the massive cost of the present extended lockdowns. False economy strikes again.

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OECD boffins find a new and better reason to increase the GST

Ask almost any bunch of economists what big reforms to the economy we need and their list will start with tax reform and probably not get much further. Ask a bunch of big-business people what we need and their list will linger lovingly on tax reform.

You can see this in the Organisation for Economic Co-operation and Development’s latest report card on our economy, the first since 2018. To be fair, the rich-nations club’s list of important reforms included much more than tax. But tax was front and centre of news reports in the financial press.

In particular, it seized on the outfit’s recommendation that we either increase the rate of the goods and services tax, or broaden the range of goods and services to which it applies, and use the proceeds to cut the rates of income tax. Good one! Yay! Let’s do it!

But hang on. Haven’t we heard this tune before? Yes, we’ve been hearing it for years. And haven’t both sides of politics made it clear it’s not on their list of promised reforms?

Yes, they have. But federal politics has degenerated to the point where both sides have not one controversial reform on their to-do list. That’s what inspiring, ambitious leaders our politicians have become. But all the more reason the rest of us should be writing our to-do lists for them. Let ’em know there’s work they should be doing.

Starting with the economists, their obsession with taxation comes from their favourite, “neo-classical” model of how our market economy works. In every market you have a contest between demand on one side and supply on the other.

What brings the two sides into balance is the “price mechanism”. The price of the item in question goes up or down until demand and supply are equal. This is why, if economists wore T-shirts, they’d say Prices Make the World Go Round.

To a neo-classical economist, prices are the great source of incentive, the great motivator. And, to them, a tax is just another price. So governments’ control of what’s taxed and at what rate gives them huge power to change the behaviour of producers and consumers in ways that make the economy work better – or worse.

Well, yes, there’s some truth in that. But maybe not as much of it as the economists’ grossly oversimplified model of the economy leads them to believe.

As for big-business people, their obsession with taxation, and income tax in particular, comes because they pay so much of it. Almost all their proposals, invariably marketed as great for “the economy,” involve them paying less and everyone else paying more.

It’s notable, however, that whereas business people see the greater revenue from an increased GST being used to cut income tax rates on higher incomes, the OECD boffins see it being used to cut the tax on low and middle incomes.

Why? Because income tax is the tax system’s main “progressive” tax – that is, as incomes rise from the bottom to the top, the rate of tax people are required to pay gets progressively higher, whereas “indirect” taxes such as the GST are “regressive” – they take a higher proportion of lower incomes than higher incomes.

So, the organisation’s boffins argue, the fairness of the tax system overall could be preserved by giving proportionately higher cuts to low and middle income-earners than to higher income-earners. Not what the Business Council had in mind.

The boffins advance their usual argument for changing the “mix” of federal taxes, raising a higher proportion from the GST and a lower proportion from personal income tax. Relative to the organisation’s other member-countries, they say, we are much less reliant on taxes on goods and services.

This is true. What’s not true – provided you compare apples with apples – is that we rely far more heavily on income tax collections than the others do.

No, the real standard argument for reducing income tax’s share is that the high “marginal” tax rates imposed on the last part of high income-earners’ incomes discourage them from working and innovating as much as they otherwise would.

The mainly older and more powerful men paying the top tax rate (as I do) have no trouble believing this to be true, as neo-classical theory says (sort of). Trouble is, there’s little empirical evidence that the theory accurately describes the real world.

Indeed, the empirical evidence says it’s mainly “secondary earners” – such as mothers deciding whether it’s worth moving from part-time to full-time work – who are discouraged from doing more paid work. The well-paid old men have never worried much about them.

So the conventional arguments for changing the tax mix aren’t very convincing. But the boffins have come up with a new and more convincing reason to increase our reliance on the GST: to ensure the total tax system remains able to raise all the revenue we’ll need to cover the ever-growing demand for government spending, particularly on health, ageing and education.

They point out that, left unchanged, our reliance on the GST will decline in coming decades (because it doesn’t tax the fastest growing classes of consumer spending), whereas reliance on income tax will increase (because of unreturned bracket creep).

But, as well as adding to government spending on the age pension, health care and aged care, the ageing of the population – read the retirement of the baby boomers – means more of the population (even people like me, who’ll be very comfortably off) will be paying little income tax. That’s mainly because income from superannuation is hardly taxed.

This will mean much pressure for those people still working to make up the shortfall by paying higher rates of income tax – far higher rates than retired people with the same income are paying.

Unless, of course, we extract more from the comfortably retired by at least requiring them to pay higher GST as they spend their largely untaxed public and private pensions.

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Timing the economy to fit a pandemic election is a tricky business

So, with Scott Morrison pulling the new AUKUS pact out of his hat, will we be off to a khaki election? It would hardly be the first election conservative governments have won by promising to save us from the threat to our north.

But that’s why I doubt it. For an issue to dominate an election campaign, it has to be in contention. National security is an issue that always favours the conservatives, so Labor won’t be offering any objection to AUKUS or nuclear subs.

Similarly, an issue that should figure large in the campaign is whether the Coalition is too conflicted over climate change to be worthy of re-election. But that issue naturally favours Labor, so Morrison won’t want to take up that fight.

Which leaves? The economy, stupid. Until the end of June, the economy was looking in great shape, better than it had been even before the pandemic. But the arrival of the Delta variant means that, right now, more than half the national economy is back in lockdown, and looking mighty sick.

Does it surprise you that Morrison’s so keen to see the south-eastern mainland states out of lockdown and the others opening their borders, and is pressing the premiers accordingly? He desperately needs the economy back looking trim and terrific by March – May at the latest.

Add to this the business community’s pressure to get back to business – “don’t bother me with all the COVID details” – and the public’s impatience to get life back to normal. Sydneysiders have had enough of lockdowns; Melburnians have had more than enough – something even “Dictator” Dan Andrews can see.

So Gladys Berejiklian and Andrews have added their separate modelling by the Burnet Institute to Morrison’s National Plan modelling by the Doherty Institute – not to mention the independent modelling by the Kirby Institute – and announced their “road maps” for opening up their economies progressively once vaccination rates have reached 70 per cent and 80 per cent of the eligible population, expected in mid-to-late October and early November.

NSW is projected to be only about a week ahead of Victoria, and the gap between 70 and 80 per cent only about two weeks.

Everyone’s so pleased to be getting on with it that we risk losing sight of the high risks the two premiers are running. If all goes to plan, we’ll be back to a new (still-masked) normal by early next year, and the economy will be humming in time for a March election.

But models, based on a host of unmentioned explicit and implicit assumptions, inevitably give politicians and punters a false sense of certainty. No model can accurately predict something as mercurial as human behaviour. And, as we’ve learnt, a new coronavirus knows nothing of models and is a law unto itself.

The risk Andrews and Berejiklian face is that so many unvaccinated people contract the virus that our hospital system is overwhelmed, with people dying because they were turned away, leading to a number of deaths the public finds unacceptable. Whether they press on or turn back, the premiers would be in deep trouble.

The first risk comes from an ambulance and hospital system that, 18 months after the crisis began, is already at full stretch. The premiers tell us our wonderful health workers are coping; the message from ambos, doctors and nurses on the ground says they’re close to collapse.

The next risk comes from the inconvenient truth that our vaccination targets of 70 and 80 per cent of people 16 and older turn out to be just 56 and 64 per cent of the full population. That’s a huge proportion of unvaccinated friends and relations.

Remember, too, that these are statewide averages. They conceal less-vaccinated pockets of particularly vulnerable groups – the disabled, the Indigenous, for instance – and a city-country gap that leaves many rural towns hugely exposed, together with their limited hospital capacity.

Even the decision to move as soon as the 70 and 80 per cent targets are reached, rather than wait another fortnight for vaccines to become fully effective, carries a risk of higher infection.

Both the Burnet and revised Doherty modelling say starting to open up at 70 per cent rather than 80 per cent is likely to involve significantly higher infections, hospitalisations and deaths. Why take that risk just to avoid waiting another fortnight or so?

Morrison’s national plan called for all states to open up together once all had reached the 70 and 80 per cent targets, but now NSW and Victoria are going first. This increases the risk that, despite the other states’ closed borders, the virus will spread to them – where the lesser threat of catching the virus has caused vaccination rates to be much lower.

The risk for Berejiklian and Andrews is that they could be moving the Delta outbreak from the city to the country. The risk for Morrison is that, by pressing those two to open up early, he could be moving the outbreak from one half of the economy to the other.

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Smaller Government turns out to be penny wise, pound foolish

Our problems responding to the pandemic are just the latest, most acute demonstration of the failure of the decades-long pursuit of Smaller Government. It was intended to leave us better off by rooting out waste and inefficiency, so we’d get government services of unchanged – maybe better – quality at less cost to taxpayers.

You’d have to say the project has limited the rise in government spending – after allowing for inflation and population growth – despite politicians on both sides being willing to increase the services provided. The Libs on defence and security; Labor on the Gonski school education funding reforms and the National Disability Insurance Scheme.

There’s little reason to believe we’ve seen much improvement in the efficiency with which government services have been delivered. Rather, there are numerous examples of reductions in the quality of services and a decline in the policy capability of public service – evident in the need to bring in military generals and the small fortune being spent on management consultants from the big four accounting firms.

This failure isn’t surprising when you remember the Smaller Government project is based on prejudice rather than evidence – the public sector is always inefficient; the private sector is always efficient – and on using the crudest measures to achieve greater efficiency.

For economists, the private good/public bad mentality is implicit in the neo-classical model of how the economy works. For business people and politicians, it comes from tribalism: the private good guys versus the public bad guys.

The Smaller Government push has been hijacked by conservative politicians wanting to transfer taxpayers’ money, workers and (they hope) votes from the public Labor column to the private Liberal column.

To the nation’s business people, privatisation spells access to the state’s monopoly pricing powers. Outsourcing gives them easier access to the vast profit-making opportunities of that Aladdin’s cave that is the government’s coffers.

Leaving aside this hijacking of the Smaller Government push for PPP – party-political purposes – it’s done more harm than good for two reasons: because of the failure to think through the objects of the exercise and because of the crude methods used to limit government spending.

One reason government spending has continued to grow is that governments have continued to promise voters new and better services. This is no bad thing, and is inevitable as we get richer and our wants shift from more goods (which are usually best produced by the private sector) to more services, many of which – such as education and healthcare, childcare, disability care and aged care – are better funded (and often, provided) by the public sector.

Once you accept that, in terms of government spending, literally Smaller Government is never going to happen, you realise the object of the exercise should be not smaller government, but better government: government that achieves its objectives efficiently and effectively. Government that gives value for money.

A big part of the problem is that, within the bureaucracy, the Smaller Government push has been led by the accountants in the Finance Department, with little thought applied by the economists in Treasury.

Lacking an appreciation of the broader economic issues involved in government budgeting, Finance has taken a Good Housekeeping approach: a tidy budget is a balanced budget. It’s been a short-sighted, budget-to-budget affair: “next month’s budget’s deficit is looking on the high side, so what quick cuts can we make to stop it looking so bad?”

This mentality is what breeds the crudeness of the measures used to limit spending – notably, the annual “efficiency dividend”, which each year imposes an arbitrary, top-down percentage cut in the total administrative costs of a department or agency. “We have no idea where the waste is, but there must be plenty of it, so you find it.”

After a couple of decades of saying “there must be plenty of waste” every year, the waste is long gone. Departments are left to find their own cuts, and what they cut is anything that won’t bring howls of protest from the lobbyists representing the powerful industries the department is supposed to be regulating in the public interest.

You end up cutting things where the true cost won’t be apparent until sometime in the future – such as the people doing the department’s policy development, the preparations you’re making for a pandemic that may never happen, and anything that involves cost now in return for cost-savings later.

This, however, is just the opposite to what you should be doing to make government better – more cost-effective. You should be seeking out, initiating and protecting spending that’s an investment in future cost-saving.

What we’ve ended up with isn’t Smaller Government, it’s just penny-pinching. It’s being penny wise and pound foolish.

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When judging recessions, depth matters more than length

With the publication this week of the latest “national accounts”, our situation is now clear: we’re not in recession, yet we are – but, in a sense, not really.

Confused? It’s simple when you know. One thing we do know is that the economy – as measured by real gross domestic product – will have contracted significantly in the present quarter, covering the three months to the end of September.

At this stage, the smart money is predicting a contraction – a fall in the production and purchase of goods and services – of “two-point-something” per cent, although there are business economists who think the fall could be as much as 4 per cent.

Recessions are periods when people cut their spending sharply, causing businesses to cut their production of goods and services and lay off workers. It’s mainly because so many people lose their jobs that recessions are something to be feared. But also, a lot of businesses go broke.

This means no one should need economists to tell them if we are or aren’t in recession. If you can’t tell it from all the newly closed shops as you walk down the main street, you should know from what’s happening to the employment of yourself, your family and friends. Failing that, you should know it from all the gloomy stories you see and hear on the media.

Have you heard, by chance, that NSW, Victoria and now Canberra are back in lockdown, leaving some workers with no work to do, and the rest of us unable to spend nearly as much as usual because we’re confined to our homes? You have? Then you know we’re in recession.

When the first, national lockdown began in late March last year, real GDP contracted by 7 per cent in the June quarter. That was the deepest recession we’ve had since the Great Depression of the 1930s.

But it was also the shortest recession we’ve had because, once the lockdown was lifted, the economy – both consumer spending and employment - immediately began bouncing back. As the Australian Bureau of Statistics revealed this week, the bounce-back continued in the June quarter of this year, which saw real GDP growing by a strong 0.7 per cent, leaving the level of GDP up 1.6 per cent on its pre-pandemic level.

All clear so far? The confusion arises only in the minds of those people silly enough to let the media convince them that, despite all the walking and looking and quacking they see before their eyes, a recession’s not a recession unless you have two consecutive quarters of contraction in GDP.

The size of the contraction is of no consequence, apparently, nor would be two or more quarters of contraction that weren’t consecutive. This is nonsense.

As my colleague Jessica Irvine has explained, this “rule” is repeated ad nauseam by the media, but has no status in economics. It’s a crude rule of thumb that’s frequently misleading. It’s in no way the “official” definition of recession.

But the consecutive-quarter rule is so deeply ingrained that it causes needless debate and uncertainty. Some business economists convinced themselves that this week’s figure for growth in the June quarter could be a small negative.

Oh, gosh! Since we know the present quarter will be a negative, that means we could be in another recession. Quick, get out the R-word posters.

But no. June quarter growth proved stronger than expected. Treasurer Josh Frydenberg couldn’t resist the temptation to declare there’d been no “double-dip recession”. Thank God!

But wait. The lockdowns could easily continue beyond the end of this month and into the December quarter. So we could have a second negative quarter on the way. Quick, bring back the posters and start writing the double-dip speech.

Sorry, this is not only silly, it’s got the arithmetic wrong. When the economy goes from growth to lockdown, you get a negative. But when, in the follow quarter, the economy merely stays in lockdown you get zero growth, not another fall.

The present lockdowns apply to a bit over half the economy. So, if the other half continues to grow, we will get a positive change in GDP during the quarter.

What’s more, if the lockdowns end sometime before the end of December, we’ll get a bounce-back in growth in that half of the economy, as everyone rushes out to start buying the things they were prevented from buying during the lockdown.

That’s what happened last time the lockdown ended; it’s safe to happen this time too. So it’s hard to see how we could get a second quarter of “negative growth” in the three months to New Year’s Eve.

We’ll learn what the figure was in early March, in good time for the federal election. Stand by for Frydenberg’s triumphant declaration that we’ve avoided a double-dip recession for a second time. He’ll turn the media’s consecutive-quarters bulldust back on them, and spin a story of great success.

But this will literally be non-sense. He’ll take a contraction in the September quarter of, say, 2 to 4 per cent – as big as the contractions that caused the recessions of the mid-1970s, the early 1980s and the early 1990s – and pretend it doesn’t count, simply because that massive contraction was concentrated in one quarter rather than spread over two.

He’ll con us into accepting that the depth of a slump doesn’t matter, just its length. More nonsense.

But there remains a respect in which, like the first dip, the second isn’t really a recession. What we had last year and are in the middle of right now aren’t recessions in the normal sense.

They’re artificial recessions deliberately brought about by governments to minimise the loss of life from the pandemic. They thus involve a degree of monetary assistance to workers and businesses unknown to normal recessions. This means they don’t take years to go away, but disappear in six months or so because of the speed with which the economy bounces back when the lockdown ends.

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If you want to shop in competitive markets, you’ll have to fight for it

The lockdown is dragging on so long and its end point is so uncertain that it’s easy to become anxious and despondent. That’s especially true of the young, who’ve had less experience of bad episodes eventually passing. The rest of us know they will, however long it takes. But it may help if we switch the focus to what we’ll do to make the world a better place once things return to normal.

One conclusion the young are justified in reaching is that the world is run by well-off older men (present company excepted) intent on making the world better for themselves, even if that comes at the expense of others.

A question for the coming federal election is which side is more likely to restrain the rich and powerful rather than help them in their quest.

It’s true that people near the very top have continued doing better, while the rest of us have had very modest pay rises. In healthy market economies, vigorous competition and continuous investment in better machines increases the productivity of workers, which is reflected in higher real wages.

There’s been very little of that over the past decade and one reason for this seems to be a decline in competition between the few big businesses that dominate so many of our markets.

When companies get bigger by taking over their competitors, this gives them more power to increase their prices and profits (and executive salaries) without them becoming more efficient or paying their workers more.

The list of Australian markets dominated by a few large firms is long, including banking, supermarkets, insurance, electricity and gas retailing, domestic air travel, pathology testing, mobile phones and internet service providers, not to mention internet search and social media platforms.

It may surprise you that, contrary to what happens in other advanced economies, companies seeking to merge don’t need permission from the ACCC, the Australian Competition and Consumer Commission.

Many choose to consult the commission, but if they press on with a merger the ACCC thinks will increase their “market power”, its only recourse is to take them to the Federal Court and convince it that the merger would “substantially lessen competition” in the future.

This isn’t easy. The executives generally assure the judges that something so dastardly has never crossed their mind, and their assurances are believed. The last seven times the commission has sought to get mergers blocked, it has failed.

It’s not the court’s job to come back a few years later and see if those assurances were honoured by the rich and powerful men whose evidence the judges found it so easy to believe.

So, in a speech last week, commission chair Rod Sims sought to start a public debate on “market concentration” and proposed that the proponents of mergers be legally required to notify the commission of their intentions, then wait for the deal to be assessed and cleared before proceeding. The proponents could appeal in court against any decision they didn’t like.

Sims says competitive markets work much better for consumers, and increase innovation and productivity.

“While the available evidence is not definitive, it appears that market power [to raise prices] is increasing in Australia. This trend has also been observed in many advanced economies, including by the International Monetary Fund,” he says.

“Without action, market power in Australia will become further entrenched; and will certainly not reduce.”

Market power is hurting Australians in many ways, he says. Consumers are paying more than they should for a wide range of goods and services.

It’s also “squeezing the incomes of farmers. For example, chicken growers and dairy farmers have little option but to sell their produce to large buyers with substantial bargaining power.” Farmers purchase many of their supplies from only a few big sellers.

“Many small businesses and farmers are largely reliant on Coles and Woolworths to access grocery shoppers ... This power imbalance places small businesses and farmers in precarious positions with consequent damage to our economy.

“In digital markets, we are exchanging access to our personal data and attention for so-called ‘free’ services, but have little choice, knowledge or control over how our data is being used.”

Now, if you’re sitting down, I’ll tell you something that will amaze. Jennifer Westacott, chief executive of the Business Council of Australia, can’t see what the fuss is about. She fears the proposed changes would be “another blow to investment”. (By which I assume she means businesses “investing” in the takeover of other businesses.)

As for Treasurer Josh Frydenberg, he has no enthusiasm for Sims’ reforms. He says the lockdown means we need to encourage business and growth, not throw up regulatory barriers. (I suspect we’ll be hearing a lot more of that convenient argument between now and the election.)

Do you see why Sims wants to start a public debate? If this issue is left for the Treasurer and the big-business lobby to sort out behind closed doors, nothing will change.

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Smaller Government push explains much of our pandemic fumbling

It’s right for our elected leaders to be held responsible for the failures that have led to the loss of lives and livelihoods in our struggle against the coronavirus. But let’s not fail to see the systemic failures that have led our governments – federal and state; Liberal and Labor – to fall short.

If you’re not looking for it – or don’t want to find it – it’s easy to overlook the inconvenient truth that decades of pursuit of Smaller Government have contributed greatly to the difficulty we’ve had controlling the spread of the virus and hastening the rollout of the vaccine.

Earlier this month, two economics professors, Steven Hamilton and Richard Holden, used two articles in the Australian Financial Review to lay much of the blame for delay in the rollout and in rapid COVID testing at the feet of the “medical regulatory complex”.

They criticised our TGA - Therapeutic Goods Administration – for being “persistently behind the curve – lagging months behind foreign regulators” in approving the various vaccines. The medicos should hardly need economists to remind them of the point they themselves dinned into the rest of us: the spread of pandemics is exponential, so a delay of just six weeks really matters.

So, if medical bureaucracies overseas can approve new drugs with expedition, why can’t we? And they can approve in-home rapid tests, but we can’t?

Because our standards are so much higher than theirs? Doubt it. More likely because we weren’t trying hard enough. Maybe the TGA was short-staffed or the government hadn’t approved enough overtime. As for the reservations about rapid testing, you wonder if it wasn’t a case of doctors trying to make work for doctors, not nurses or pharmacists.

Then there was all the chopping and changing over who should get the AstraZenica vaccine by ATAGI – the Australian Technical Advisory Group. It was narrow, inappropriate advice that failed to take account all the relevant considerations and did much damage to the rollout.

Maybe the government asked the wrong bunch of specialists, or gave them the wrong terms of reference. I’ve seen it suggested that a more appropriate committee had been abolished in cost-cutting by the Abbott government.

The Morrison government’s delay in acquiring sufficient vaccines seems to have arisen from a desire to limit the cost of the exercise, combined with an ill-fated preference for having the vaccine manufactured locally.

Much of our difficulty preventing leakages from hotel quarantine has arisen from cost saving: using ill-suited empty hotels would be much cheaper than purpose-building out-of-town cabin-style facilities, especially when you remember we won’t get another pandemic for decades. Maybe.

Similarly, outsourcing quarantine security to private contractors using casual, low-paid and untrained workers, who probably work at several facilities to make ends meet, saves money. The same way we use outsourcing to cut the cost (and quality) of so many public services these days.

At state level, stockpiles of personal protective equipment recommended by a committee charged with getting us ready for a pandemic were cut as a cost-cutting measure.

Wherever responsibility is shared between federal and state – which is most areas - you get cost-cutting, cost-shifting, game-playing and duck-shoving. The feds had huge success at shifting the blame for Victoria’s second lockdown to Dictator Dan, even though the great majority of deaths occurred in federally regulated aged-care homes.

As the royal commission found, the unending string of scandals in aged care arises from decades of trying to hold down the cost of care to the federal government. Knowing they’re not spending enough to fund decent care, the feds don’t dare to properly regulate the sector’s mainly for-profit providers.

But, since businesses are entitled to a reasonable return on their capital, turning the sector over to private providers adds another layer of cost. There’s little reason to hope their profit margins are covered by their greater efficiency in running institutions. They make room for their profit by cutting other costs.

Cost cutting is just one aspect in which the Smaller Government push has hindered our efforts to respond to the pandemic. Another is the longstanding rundown in the capability of the public service, especially its ability to give policy advice.

Who needs advice from public servants when, if the minister doesn’t know what to do, the politically ambitious young punks in the minister’s office will have plenty of ideas? Failing that, you can always commission a report from one of the big four accounting firms which, you can be sure, will tell you only what you want to hear. I doubt the health departments are immune from these weaknesses.

Of course, our pandemic problems are just the latest, most acute demonstration of the failure of the Smaller Government project, but that wider story’s a topic for another day.

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Morrison's surprise investment in a better class of economic debate

When he was appointed chair of the Productivity Commission, Michael Brennan looked to be just another political appointment by a government that disrespected the public service and was busily installing its own men – and I do mean men – to plum jobs and key positions.

Three years later it’s clear that, whatever Scott Morrison’s motives in insisting he be appointed, Brennan is his own man, with his own inquiring and “well-furnished” mind. His disposition is conservative and he’s expert in the neo-classical orthodoxy of economics.

He’s what Treasury-types used to call an “economic rationalist”. But Brennan is no narrow-minded dogmatist who, having discovered the truth, sees no need to look further. He’s learnt from behavioural economics and is interested even in “evolutionary economics”.

Brennan’s appointment to head the Productivity Commission coincided with the early departure of John Fraser as secretary to the Treasury and then-treasurer Morrison’s decision to replace Fraser with the chief of staff in his own office, Philip Gaetjens.

Fraser, you recall, had been hand-picked for Treasury secretary by Tony Abbott, after his first act as prime minister had been to sack the existing secretary, Dr Martin Parkinson, and several other top econocrats.

The fact that Brennan had previously worked for Liberal ministers, federal and state, and had once run for Liberal preselection, framed his appointment as political. What this misses, however, is that Brennan is his father’s son.

Geoff Brennan, an economics professor at the Australian National University, won an international reputation for his contribution to the theory of public choice. All professors have sharp minds; Brennan’s is sharper than most.

In all its previous incarnations, going back to the pre-Whitlam Tariff Board, the Productivity Commission has been a bastion of economic orthodoxy. Its influence on elite thinking played a big part in the transformation of the economy under Hawke and Keating.

It’s usually been led by neo-classical, rationalist warriors. Brennan fits the bill, but he’s far more open-minded, widely read and persuasive than his predecessors.

In a speech last week, Brennan noted that the commission will soon release research on working from home: what it might mean for cities, for our work health and safety regime, the workplace relations system; what it might mean for productivity.

“We analyse these things from an economic perspective,” he explained, “and our starting point is a fairly conventional neo-classical framework.

“The conventional economic framework is useful because it helps us think through the forces acting on wages, rents, productivity and – importantly – overall wellbeing. But I do think that to really understand the path of digital technology and its economic impact you really need to combine those traditional neo-classical insights with the insights gleaned from a more evolutionary approach.”

Eh? What?

“The evolutionary approach to economics – of which [Professor] Jason Potts [of RMIT University] is a leading practitioner – eschews that narrow profit maximising assumption in favour of the more realistic view that firms face uncertainty – both about the state of things and the future – and do their best to navigate their way through the fog.

“The evolutionary approach stresses the importance of variety – the idea that different firms make different bets based on their subjective hypotheses about what will work; with these experiments submitted to the test of the market and society.

“It stresses that variety can foster novelty. It is not an aberration, but that it’s actually fundamentally important – particularly in the early stages of a new technology.”

None of Brennan’s predecessors at the commission would ever have said anything like that. Recognise that the neo-classical model is just one way of trying to understand how the economy works, and that there are other, quite different ways of analysing economic activity that could add to our understanding of how it ticks? Never.

In an earlier speech, Brennan gave a warning about the relaxed approach of some to the massive build up in deficit and debt since the pandemic. All his predecessors would have shared that concern. But they would never have expressed the warning in such a well-reasoned way.

The new conventional wisdom among economists (to which I subscribe) is that high public debt doesn’t necessarily have to be paid back. It will decline in relative terms – relative to the size of the economy, gross domestic product – so long as nominal GDP grows at a faster rate than the rate of interest on the public debt – and, of course, so long as you’re not adding to the debt.

Brennan’s warning: “The risk in the public debate is that this insight – that GDP growth tends to exceed interest rates – is taken to imply something altogether different and much bigger: that debt and deficit no longer matter at all.

“That we can afford the next and the next ‘one-off’ rise in debt on the grounds that growth rates will continue to outpace bond yields . . .”

Brennan outlines various reasons for not being seduced by this life-was-meant-to-easy view, but focuses on the micro-economic case for caution. He notes, as economists do, that hidden behind the amounts of mere money being spent is the use of “real resources” in the economy. We can print as much money as we want, but what can’t be produced from thin air are the land and raw materials, capital equipment and labour that money is used to buy.

And there are physical limits on the extent to which real resources – as opposed to money – can be borrowed from the future. Real resources bought by the government are no longer available to be used by business for investment and innovation.

True. Good point. Surprise, surprise there’s no free lunch. But this tells me we should be trying a lot harder to ensure the money governments spend isn’t spent wastefully. We should spend on things governments are prepared to ask taxpayers to pay for.

What doesn’t follow is neo-classical economics’ implicit assumption that spending decisions made by the private sector are always superior to the things governments spend on.

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Working from home would be back to the future

By now it seems cut and dried. The pandemic has taught us to love the benefits of working from home and stopped bosses fearing it, so we’ll keep doing it once the virus has receded and the kids are back at school. Well, maybe, maybe not. Any lasting change in the way we work is likely to be evolutionary rather than revolutionary.

Productivity Commission boss Michael Brennan and his troops have been giving the matter much thought and, as he revealed in a speech last week, such a radical change in the way we work would be produced by the interaction of various conflicting but powerful forces.

After all, it would be a return to the way we worked 300 years ago before the Industrial Revolution. Then, most people worked from home as farmers, weavers and blacksmiths and other skilled artisans. And, don’t forget, by today’s standards we were extremely poor.

What’s made us so much more prosperous? Advances in technology. But technology is the product of human invention. That invention could have pushed our lives in other directions.

What underlying force pushed us in the direction it did? As the Productivity Commission boss was too subtle to say, our pursuit of improved productivity.

Productivity isn’t producing more, it’s producing more with less. In particular, producing more of the goods and services we love to consume using less labour. Why among the three “factors of production” – land and its raw materials, capital equipment and labour – is it labour we’ve always sought to minimise?

Because we run the economy to benefit ourselves, and it’s humans who do the labour. We’ve reduced physical labour, but now automation allows us to reduce routine mental labour.

(While we’re on the subject, note this. Many people think automation destroys jobs. But in 250 years of installing ever-better “labour-saving technology” we’ve managed to increase unemployment only to 6 per cent or so. That’s because automation doesn’t destroy jobs, it changes and moves them. From the production of physical goods to the delivery of human services. In the process, it’s made us hugely better off.)

It was the Industrial Revolution that increasingly drove us to the centralised workplace. Initially, the factory and the mine, then the office.

The move to most people working in a central location was driven by economic forces. Businesses saw the benefits – to them and their customers – of combining labour with large and expensive machinery, powered by a single source. Initially, steam.

“The factory provided a means for bosses to co-ordinate activity in real time, supervise workers and it also provided an efficient way to share knowledge – as did the office,” Brennan says.

So the central workplace reduced the cost of combining labour and capital, but did so by imposing transport costs – mainly on workers who had to get themselves from home to the central location and back.

For most of the 20th century, however, it got ever-cheaper to move people around, via steam, electricity, the internal-combustion engine and the aeroplane. So advances in transport technology reinforced the role of the central workplace.

For about the past 30 years, however, the cost of moving people around has stopped falling. “We seem to have hit physical limits on speed; and congestion has meant that today it takes longer to move around our cities than was the case a few decades ago,” Brennan says.

This, of course, is why we fancy the idea of continuing to work from home. It’s only advances in computing and telecommunications technology that have made this possible. The cost of moving information has plummeted, while the cost of moving workers – in time and discomfort – has gone up.

So, could it be that modern communications technology is set to drive us back to our homes?

Perhaps. But remember this. While the tiny proportion of people working from home has hardly budged over the past two decades, our capital city CBDs have become more significant as centres of economic activity and as engines of productivity improvement.

Here’s the catch. At the same time as information technology was improving, and the cost of communicating over distance was falling, the nature of work was changing. As machines have replaced routine tasks, modern jobs have come to require more open-ended decision-making, critical thinking and adaptability.

Experts think these quintessentially human skills are best developed and honed through face-to-face interactions, such as the serendipitous encounter or the tacit knowledge we absorb through observing those around us.

Get it? That many of us have come to prefer working from home (I’ve been doing it since 1990) is just one factor that happens to be pulling us in the direction of home. Other factors will keep pulling us into the office. Expect a lot of businesses experimenting with different mixes of the two.

Economic history suggests that what evolves will be the combination that maximises our productivity. Not just because bosses want to make bigger profits, but also because most people like a rising standard of living.

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How Morrison can get going towards net zero - if he wants to

Scott Morrison seems keen to keep his job as Prime Minister, but not so keen to do the job PMs are paid to do: make tough decisions in the nation’s interests. So it’s up to the rest of us to step into the breach. And when it comes to the decision Morrison fears most – getting to net zero emissions by 2050 – no one’s keener to help out than Tony Wood and his team at the Grattan Institute.

Wood begins where everyone with any sense begins: by noting that the best way to reduce emissions at minimum cost to the economy - and all the people in it - would be to introduce a single, economy-wide price on carbon emissions.

But the temptation to win elections with populist bulldust about “a big new tax on everything” proved too great and so, with that off the table, we must find other, more interventionist, sector-by-sector ways to skin the cat (many of them requiring additional government spending, which will have to be paid for somehow).

The basic strategy for reducing our emissions is clear: move from fossil fuels to renewable ways of producing electricity (plus the use of batteries to store it), then meet all other energy needs with electricity. In practice, it’s more complicated, of course.

Official projections foresee emissions from electricity falling substantially over his decade, while the next four largest sources of emissions either grow or, at best, plateau. Grattan is producing a series of five reports proposing relatively easy and obvious ways of achieving early reductions in emissions in each sector.

Its thinking is to get early progress because, even if we were to reach net zero emissions just before 2050, that wouldn’t be sufficient to stop the increase in the global average temperature being a lot greater than 1.5 degrees – which is about as much as we can take without major social and economic disruption, not to mention personal discomfort.

If we take as many easy shots as we can now, that buys more time for technological advances to help us with the harder stuff. Getting some momentum going should help build public acceptance of the need for more, as well as giving business a clearer picture of where we’re heading and the risks it runs if it ploughs on regardless.

In any case, the latest report of the UN’s Intergovernmental Panel on Climate Change isn’t likely to be the last telling us temperatures are rising faster than earlier thought. It wouldn’t be surprising to see the 2050 deadline brought forward.

Wood’s first report in Grattan’s five-part series covered the transport sector. It proposed measures to achieve an early move to electric cars, while we wait for hydrogen technology to help with heavier transport.

Wood’s second report, on the industrial sector, was released on Sunday. This covers emissions arising from the production of coal, oil and gas – as opposed to their customers’ use of their products – emissions from the mining and processing of other minerals and metals, and emissions from processing in manufacturing.

As well as burning fossil fuels to help extract fossil fuels, coal, oil and gas production involves “fugitive” emissions of greenhouse gases during the extraction process.

The sector’s emissions have increased significantly since our base year, 2005, mainly because of our foolish decision to permit three different companies to build huge liquefaction plants on an island off the coast of Queensland and turn us into one of the world’s largest exporters of liquid natural gas. Liquefaction, it turns out, involves massive emissions.

The entire industrial sector accounts for almost a third of our total emissions, which are projected to be little changed over the decade. The good news is that 80 per cent of its emissions come from just 187 large facilities. Most of these are subject to the federal government’s existing “safeguards mechanism”, which sets a baseline – or maximum - for each facility’s emissions.

So Wood’s chief proposal is for this mechanism to be modified and extended. Existing facilities should be required to use technologies now available to gradually reduce their emissions. New facilities should be required to meet benchmarks substantially lower than existing ones.

“From now on,” Wood says, “every decision to renew, refurbish or rebuild an industrial asset potentially locks in emissions for the coming decades. Getting these decisions right will be critical for reaching net zero.”

Of course, when it comes to the many facilities producing fossil fuels for export, their future prospects will be affected more by other countries’ climate-change policies than by ours. Good luck finding customers for fossil fuels as the reality of global warming catches up with them as well as us.

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Global warming is too 'wicked' to just muddle our way through

It’s probably always true that democracies take too long to accept the need to act decisively to avert foreseeable problems. We never do it well, but always manage to muddle through. We wait until the problem’s reached crisis point. Everyone’s panicking, and thus willing to accept the tough remedies needed. But I fear climate change is too “wicked” a problem to be solved this usual way.

An extra problem for Australia is that we have a government rendered impotent by its internal divisions. The good news – of sorts – is that when the captain of the ship goes AWOL, the crew take over. The premiers – Liberal and Labor – are stepping in to fill the gap. And business can see the writing on the wall and is taking evasive action.

It’s obvious the world is moving to renewable energy and, before long, oil, gas and coal will become “stranded assets” selling a product for which demand can only decline. Here and overseas, banks are worrying about the security of their loans to fossil-fuel businesses, pension funds and investment managers are worrying about their members’ distaste for investing in polluting businesses, and energy businesses such as AGL and now BHP are dividing themselves into good bank and bad bank, so to speak.

Much of the wake-up call to finance and business is coming from financial regulators. Our Australian Prudential Regulatory Authority (APRA) has initiated a climate vulnerability assessment for banks, encompassing scenarios up to 3 degrees of average global warming, and has issued draft guidance for companies to stress test their own finances against scenarios of up to 4 degrees warming.

But in the report, Degrees of Risk, released this week by the Breakthrough – National Centre for Climate Restoration, and written by David Spratt and Ian Dunlop, the authors warn that if by these actions the climate-risk regulators imply warming of 3 to 4 degrees is manageable, or could be adapted to, APRA risks doing more harm than good.

Why? Because with warming of that extent, it’s doubtful we’d still have any banks. The authors say scientists consider 4 degrees of warming to be an existential threat, incompatible with the maintenance of human civilisation. And 3 degrees would be catastrophic, perhaps leading to outright chaos in the relations between nations.

If warming was anything like that bad, applying “stress tests” and doing “scenario planning” would be largely irrelevant.

The authors quote one professor saying that a 4-degree future is “incompatible with an organised global community, is likely to be beyond ‘adaptation’, is devastating to the majority of ecosystems and has a high probability of not being stable”.

Another prof says “it’s difficult to see how we could accommodate 8 billion people or maybe even half that . . . it will be a turbulent, conflict-ridden world”.

Among other impacts, the authors say, 4 degrees would in the long run melt both polar ice caps, with a sea-level rise of about 70 metres. Even 3 degrees would be catastrophic and make some nations, and regions, unliveable.

The authors say most people don’t understand what “global mean [average] warming” implies. As a general rule, global average warming of 4 degrees – covering land and ocean – is consistent with 6 degrees over land (that is, warming over the ocean would be a lot lower, bringing the average down) and with average warming of 8 degrees over land in the mid-latitudes.

That, in turn, risks an average warming of 10 degrees in summer. Or perhaps 12 degrees during heatwaves. All this is packed inside a tolerable-sounding global annual average warming of 4 degrees.

The authors say that Western Sydney has already reached heatwaves of 48 degrees. Add 12 degrees to that and you get summer heatwaves of 60 degrees. Phew.

Now, remember that psychologists and communications experts have been warning climate change campaigners that, if they make their message too frightening, the reaction of many people won’t be to rush out and join Extinction Rebellion, but to close their ears and do nothing.

Remember, too, that the modelling and projections of the climate scientists are far from certain sure and, as with the virus modelling of the epidemiologists, are based on assumptions that keep changing as our understanding of the phenomenon improves.

For these reasons, the UN’s Intergovernmental Panel on Climate Change has long erred on the side of understatement. But the risk with all this is that sensible people with the best intentions – such as regulators of the financial system – don’t realise how bad things could get.

The authors of Degrees of Risk say the science of climate change is inherently complex because it describes the dynamics of a multi-dimensional, “non-linear” system, involving many sub-systems and networks of adverse “cascade effects”.

“Some responses to increasing levels of greenhouse gases are relatively linear and able to be projected well by climate models” but other responses are “non-linear, characterised by sudden changes, rather than smooth progress, which take the system from one discrete state to another, possibly with system cascades” where one change touches off a chain of changes.

“Factors contributing to this non-linearity include the existence of tipping points – polar ice sheets [melting], for example – where a threshold exists beyond which large, system-level change will be initiated, and positive feedbacks [that is, self-reinforcing loops] drive further change.

“In a period of rapid warming, most major tipping points, once crossed, are irreversible on human time frames”.

The authors’ message to regulators of the financial system is that the risk to banks and businesses at degrees of warming of anything like 3 or 4 degrees are huge, but so uncertain as to be unmeasurable. We need to act on the precautionary principle of significantly reducing emissions now, so we never get to find out how bad it could be.

The more prosaic message I draw is that we mustn’t kid ourselves that climate change is just another problem with unpopular solutions that we’ll muddle through as we always do.

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It's the rich wot get to complain and the poor wot get infected

If you’re anything like me, you’re getting mighty tired of lockdowns. I miss being able get out of the house whenever I choose, I miss going to restaurants and – my favourite vice – going to movies. That bad, huh? You’re right, I don’t have much to complain about. I don’t envy those having to school their kids while working at home – although I do miss seeing my grandkids in the flesh.

If you think I need reminding of how easy I’m doing it compared with a lot of others, you’re probably right. But I suspect that’s true of many of us, even those of us doing it just a tiny bit tougher than me.

Apart from those with kids to mind, the first hardship dividing line is between those of us easily able to work from home and those not. This probably means those still on their usual pay and those reliant on some kind of government support.

Even those unable to work from home but “fortunate” to work in an essential industry probably pay the price of running a much higher risk of getting the virus. And that without anyone doing enough to help them get jabbed.

Another divide would be between those in secure employment, with proper annual and sick leave entitlements, and the third of workers in “precarious” employment, most of whom are casuals rather than in the “gig economy”.

Having so many workers without entitlement to sick leave has been a burden for those involved and for the rest of us, namely an increased risk of being infected by someone who, needing the money, keeps working when they shouldn’t.

But though the dividing lines are different in a pandemic, the greatest divide of all is unchanged. As the old song says, it’s the same the whole world over, it’s the rich wot gets the pleasure, it’s the poor wot gets the blame.

Any amount of research confirms what the medicos call “the social gradient” – the well-off tend to be in much better health than those near the bottom. They’re less likely to be overweight (I must be an exception) and less likely to smoke.

The Mitchell Institute at Victoria University has just issued the second edition of its “health tracker by socio-economic status”. It finds that the 10 million Australians living in the 40 per cent of communities with lower and lowest socio-economic status have much higher rates of preventable cardio-vascular diseases, cancer, diabetes or chronic respiratory diseases than others in the population.

Why then should we be surprised to learn that, though Sydney’s outbreak of the Delta variant seems to have started in the better-off eastern suburbs, it soon migrated to the outer south west, where it finds a lot more business?

Last week the welfare peak body, the Australian Council of Social Service, issued a joint research report on Work, Income and Health Inequality, with academics at the University of NSW.

ACOSS boss Dr Cassandra Goldie says “the pandemic has exposed the stark inequalities that impact our health across the country. People on the lowest incomes, and with insecure work and housing, have been at greatest risk throughout the COVID crisis. Now, they are the same people who are at risk of missing out in the vaccine rollout”.

Then there’s the question of trust. Social trust works through social norms of behaviour, such as willingness to co-operate with strangers and willingness to follow government rules. As in other rich countries, our trust in governments has declined over the years. Last year it seemed to lift, as many of us believed we could trust our leaders – particularly the premiers – to save us from the pandemic.

Whether that confidence survives this year’s missteps we’ll have to see. But the economic historian Dr Tony Ward, of Melbourne University, reminds us of a significant finding in this year’s World Happiness Report: in general, the higher a country’s level of social trust, the lower its COVID-19 death rate.

Stay with me. An experiment by the American behavioural economist Alain Cohn and colleagues in Switzerland involved “losing” 17,000 wallets in 355 cities across 40 countries and seeing how many of them were returned to their supposed owners.

The rate of wallet return was about 80 per cent in the Scandinavian countries and New Zealand, just under 70 per cent in Australia, less than 60 per cent in the US and less than 30 per cent in Mexico.

Ward did his own study and found that two-thirds of the difference between countries could be explained by their degree of inequality of income. The greater the inequality, the less trust. When he added survey data on people’s perceptions of corruption, his apparent ability to explain the differences in trust rose from 68 per cent to 82 per cent.

Premier Gladys Berejiklian and her minions tell us the virus is raging in certain “LGAs of concern” because people aren’t doing as they’ve been asked. Maybe their lack of co-operation reflects a lack of trust in the benevolence of those higher up the income ladder. Inequality doesn’t come problem-free.

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