Can the critics prove higher profit margins are fuelling inflation?

There’s a big risk we’ll fail to learn a vital lesson from our worst inflation outbreak in decades. If inflation is such a scourge that we must pay a terrible price to get it back under control, why do we do so little to stop big companies from acquiring the power to raise their prices by more than needed to cover their rising costs?

Economists are far more comfortable thinking about inflation at the top, macro level than the bottom, micro level. At the top, inflation is caused by aggregate (total) demand for goods and services growing faster that aggregate supply – the economy’s ability to produce those goods and services.

We know from Reserve Bank figuring that more than half the price rise we’ve seen has come from temporary disruptions to the supply of production inputs, caused by the pandemic and the Ukraine war.

But, the Reserve insists, prices have also risen because demand’s been stronger than it should have been. Why? Because in our efforts to hold the economy together during the pandemic, we applied far more economic stimulus than was needed.

Economists – even those who stuffed up the stimulus – are comfortable with this explanation because it puts the blame on government. The model of the economy they carry in their heads tells them the market usually works fine, whereas it’s government intervention in the market that usually causes the problems.

So, you can see why economists were so discombobulated when one of the world’s top macroeconomists, Olivier Blanchard, tweeted about “a point which is often lost in discussions of inflation”. “Inflation,” he wrote, “is fundamentally the outcome of the distributional conflict between firms, workers and taxpayers.”

He’s saying economists need to look at the more fundamental, bottom-up factors driving inflation. Is worsening inflation caused by workers and their unions successfully demanding real wage rises higher than the increasing productivity of their labour justifies?

Or is the strength of competition insufficient to do what the mental model promises: prevent firms from raising their prices beyond what’s needed to cover their higher costs (including a “normal” return – profit – on the capital invested by their owners)?

The strange fact is that economists and econocrats have a long history of lecturing workers and unions on the need for wage restraint. Reserve Bank governor Dr Philip Lowe has been saying workers must be “flexible” and accept wage rises far less than the rise in consumer prices. That is, take a big pay cut in real terms.

But economists are infinitely more reticent in urging businesses to go easy with their price rises. I suspect this is partly because of the biases hidden in their mental model, but mainly because they know their employer, or the big-business lobby, or its media cheer squad, or all the business people on the Reserve’s board, would tear into them for daring to say such a thing.

Similarly, economists have insisted the Australian Bureau of Statistics publish any number of different measures of wage growth, but few measures of profit growth.

Last month, Dr Jim Stanford, of the Australia Institute, sought to even things up a bit by publishing figures that broke the inflation rate up into the bit caused by rising wages and the bit caused by rising profits.

He found that “excess corporate profits account for 69 per cent of additional inflation beyond the Reserve Bank’s target”, whereas rising labour costs per unit of production (that is, after adjusting for the productivity of labour) account for just 18 per cent.

What? Huh? Never seen an exercise like that before. How’d he cook that up? The business lobby went on the attack and the business press consulted a few economists who lazily dismissed it as nonsense.

But though it’s unfamiliar, it’s not as weird as you may think. Stanford was copying the method used by some crowd called the European Central Bank. What would they know?

Well, OK. But how can you take the rise in the prices of products over a period and “decompose” it (break it down) into the bit caused by rising wage costs and the bit caused by rising profits?

By taking advantage of the fact that, every time we measure the growth in gross domestic product in the “national accounts”, we measure it three different ways.

First, the growth in the nation’s expenditure on goods and services. Second, the growth in the nation’s income from wages, profits and other odds and sods. Third, the growth in the production of goods or services by each of our 19 different private and public sector industries.

In principle, each way you measure it gives you the same figure for GDP. Then you use a “deflator” to divide the growth in nominal GDP between the bit caused by higher prices and the bit caused by higher quantities – the “real” bit.

So, it’s quite legitimate to take this measure of inflation and break it up between higher wages and higher profits (leaving the bit caused by changes in taxes and subsidies).

Actually, the stats bureau’s been doing this exercise for wages (“nominal unit labour costs”) for decades, but not doing it for profits (because no one’s been keen to know the results).

Note that the “GDP deflator” is a quite different measure of inflation to the one we usually focus on: the index of consumer prices.

Note, too, that the Ukraine war has caused a huge jump in the profits of our energy producers. This windfall hasn’t been caused by businesses sneaking up their profit margins (“mark-ups”, as economists say). But the growth in mining industry profits accounts for only about half the rise in total profits over the three years to December 2022.

I’m not comfortable relying on a think tank for these figures. But if the economists who champion big business don’t like it, they should take this exercise seriously and join the debate. The government should ask the stats bureau to finish doing the numbers itself.

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Relax, student loans show there's fate worse than debt

If you believe what you see in the media, our youth are groaning under the weight of debt they’ve acquired under the Higher Education Loan Program (HELP), alias the Higher Education Contribution Scheme. But I don’t believe every sob story I hear. Soft heart, hard head is my motto.

The latest is an ABC report claiming HELP debt has helped entrench women’s economic disadvantage. And the Futurity Investment Group’s latest University Debt Report, released on Wednesday, claims to reveal “the long-term financial and social burden the cost of a university education is having”.

As I’ve written recently, Baby Boomers are leaving a terrible legacy for the rising generation: climate change, unaffordable homeownership, precarious employment and tax breaks reserved for the old.

I suppose that, to many youths, adding a HELP debt to all that seems like adding insult to injury. But really, compared with that catalogue, student debt is well down the list.

According to the ABC’s report, women say they are frustrated by the HELP debt system and feel disadvantaged. It claims graduates today “often look like” a woman who, having had her children and approaching her 40s, retrained as a teacher.

Seven years later and working part-time, she’s frustrated because, despite paying back $6000 on her debt, she’s only $2000 ahead of where she started. Another woman fears she’ll end up living in her car.

The report says women hold the majority of all student debt, and claims “researchers say the student debt system has exacerbated structural financial inequities between men and women”.

This is a reference to a paper by Mark Warburton of the University of Melbourne. But his message is actually more nuanced, saying student debt has “become unfair for women, but there is a way to fix this”.

Considering that more girls than boys go on to uni, it’s no surprise that women hold the majority of student debt – even if, on average, men’s debts are greater than women’s.

Women take longer to repay their debt, but this is actually a feature of the scheme that adds to its fairness.

According to the Futurity Investment Group’s survey of about 1000 people who attended uni, student debt is pretty much the source of all social evil.

We’re told that three in five respondents say their student debt has affected their ability to buy a home. One in three say it has had a “moderate to very large” effect on their ability to start a family. A slightly smaller proportion say it’s affected their ability to get married. (Maybe they mean afford a big-budget wedding.)

A bit under a third of respondents say it’s had a “moderate to very large” effect on their ability to change jobs.

Sorry, but my bulldust detector is pinging like crazy. I just don’t believe it. I’m always sceptical of the results of small-sample surveys sponsored by vested interests, with the results just happening to endorse the outfit’s sales pitch.

Speaking of which, the Futurity Investment Group sells a range of “education bonds” which “allow parents and grandparents to tax-effectively save and invest to accumulate the funding to support their family’s life-long education objectives”.

I suspect that a lot of the resentment of HELP debt stems from a self-serving belief that university education should be free, as it was for a relatively brief period under the Whitlam government.

But that was when less than the top 10 per cent of school-leavers went on to uni. Today it’s 40 per cent. And, as Warburton reminds us, the student loan system was introduced in 1989 so taxpayers could afford to offer higher education to many more young people.

The scheme was carefully designed – by Professor Bruce Chapman, of the Australian National University – to allow universities to charge tuition fees without that discouraging bright kids from poor families from seeking to better themselves.

To this end, the government would lend people the fee-money up front, which they’d have to start repaying only once they were earning the average wage. If you lost your job, the repayments would stop until you got back on your feet.

The government would index your outstanding debt to the inflation rate but, unlike every commercial loan you’ll ever get, it won’t charge you a “real” interest rate of several percentage points on top of the inflation rate.

This is why it’s a good thing, not a bad thing, that women (and men) working only part-time are given longer to repay. A commercial bank wouldn’t do you the favour. And since the whole basis of the scheme is that if you can’t afford to repay the loan, you don’t have to, people need to learn not to worry about student debt the way you should about normal debt. It’s a very different animal.

Even so, in recent years the Coalition tightened up the repayment arrangements in ways that make the scheme less fair, particularly for those working part-time. But, as Warburton says, Labor can fix this.

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RBA inquiry should propose something much better

The inquiry into the Reserve Bank, due to report this month, will be disappointing if it does no more than suggest modest improvements in the way it does its job. The question it should answer is: should we give so much responsibility to an institution with such a limited instrument – interest rates – and with such a narrow focus?

In Reserve Bank governor Dr Philip Lowe’s lengthy appearance before the House of Representatives Economics Committee last month, he spent much of his time reminding critics that he only has one tool, so he can’t do anything to resolve the problems they were complaining about.

He’s right. But if the problems are real, and he can’t do anything about them, why should the central bank be the top dog when it comes to managing the economy, and Treasury’s job be limited to worrying about debt and deficit?

Shouldn’t the greatest responsibility go to an institution with more instruments, and ones capable of doing more tricks?

By the way, if you’re wondering why I’ve had so much to say recently about the limitations of monetary policy and the questionable convention of making it dominant in the management of the macroeconomy, it’s because it’s the obvious thing to do while we’re holding an inquiry into Reserve Bank’s performance.

Frenchman Olivier Blanchard, one of the world’s top macroeconomists, recently caused a storm when he tweeted about “a point which is often lost in discussions of inflation and central bank policy”.

“Inflation,” he wrote, “is fundamentally the outcome of the distributional conflict between firms, workers and taxpayers. It stops only when the various players are forced to accept the outcome.”

Oh, people cried, that can’t be right. Inflation is caused when the demand for goods and services exceeds the supply of them.

In truth, both propositions are correct. At the top level, inflation is simply about the imbalance between demand and supply. At a deeper level, however, “distributional conflict” between capital and labour can be the cause of that imbalance.

Businesses add to inflation when they seek to increase their profit margins. Workers and their unions add to inflation when they seek to increase their real wages by more than the productivity of labour justifies.

But this way of thinking is disconcerting to central bankers because – though there may well be a way of reducing inflation pressure by reducing the conflict between labour and capital – there’s nothing the Reserve can do about it directly.

Central banks’ interest-rate instrument can fix the problem only indirectly and brutally: by weakening demand (spending) until the warring parties are forced to suspend hostilities. So distributional conflict is the first thing monetary policy (the manipulation of interest rates) can’t really fix.

Then there’s inflation caused by other supply constraints, such as the pandemic or wars. Again, monetary policy can’t fix the constraint, just bash down demand to fit.

The next things monetary policy doesn’t do are fairness and effectiveness. When we’re trying to reduce inflation by reducing people’s ability to consume goods and services, it would be nice to do so with a tool that shared the burden widely and reasonably evenly.

A temporary increase in income tax or GST would do that, but increasing interest rates concentrates the burden on people with big mortgages. This concentration means the increase has to be that much greater to achieve the desired slowing in total consumer spending.

A further dimension of monetary policy’s unfairness is the way it mucks around with the income of savers. Their interest income suddenly dives when the Reserve decides it needs to encourage people to borrow and spend.

In theory, this is made up for when the Reserve decides to discourage people from borrowing and spending, as now. In practice, however, the banks drag their feet in passing higher interest rates on to their depositors. But it’s rare for the Reserve even to chivvy the banks for their tardiness.

Governments need to be free to encourage or discourage consumers from spending. But where’s the justification for doing this by riding on the backs of young people saving for a home and old people depending on interest income to live on?

The next thing monetary policy doesn’t do is competition. What’s supposed to keep prices no higher than they absolutely need to be is the strength of competition between businesses. You’d think this would be a matter of great interest to the Reserve, especially since there are signs that businesses increasing their “markups” are part of the present high inflation.

But only rarely does the Reserve mention the possibility, and only in passing. It gives no support to the Australian Competition and Consumer Commission’s efforts to limit big firms’ pricing power.

The final thing monetary policy doesn’t do is housing. The Reserve is right to insist that its increases in interest rates aren’t the main reason homes have become so hard to afford.

The real reason is the failure of governments to increase the supply of homes in the places people want to live – close to the centre of the city, where the jobs are – exacerbated by their failure to provide decent public transport to outer suburbs.

But the ups and downs of mortgage interest rates must surely be making affordability worse. To this, Lowe’s reply is that, sorry, he’s got a job to do and only one instrument to do it with, so he can’t be worried about the collateral damage he’s doing to would-be young home buyers.

Well, he can’t be worried, but his political masters can. And if they’re not game to fix the fundamental factors driving up house prices, they should be willing to create an instrument for the short-term management of demand that doesn’t cause as many adverse side effects as using interest rates does.

The one big thing going for monetary policy as a way of keeping the economy on track is that the Reserve’s independence of the elected government allows it to put the economy’s needs ahead of the government’s need to sync the economy with the next election.

But, as various respected economists have pointed out, there’s no reason the government can’t design a fiscal instrument, giving another body the ability to raise or lower it within a specified range, and making that body independent, too.

It’s the Reserve Bank inquiry’s job to give the government some advice on why and how it should make a change for the better.

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Now the hard part for the RBA: when to stop braking

In economics, almost everything that happens has both an upside and a downside. The bad news this week is that the economy’s growth is slowing rapidly. The good news – particularly for people with mortgages and people hoping to keep their job for the next year or two – is that the slowdown is happening by design, as the Reserve Bank struggles to slow inflation, and this sign that its efforts are working may lead it to go easier on its intended further rises in interest rates.

But though it’s now clear the economy has begun a sharp slowdown, what’s not yet clear is whether the slowdown will keep going until it turns into a recession, with sharply rising unemployment.

As the Commonwealth Bank’s Gareth Aird has said, since the Reserve Bank board’s meeting early last month, when it suddenly signalled more rate rises to come, all the numbers we’ve seen – on economic growth, wages, employment, unemployment and the consumer price index – have all come in weaker than the money market was expecting.

What’s more, he says, only part of the Reserve’s 3.25 percentage-point rate increase so far had hit the cash flow of households with mortgages by the end of last year.

“There is a key risk now that the Reserve Bank will continue to tighten policy into an economy that is already showing sufficient signs of softening,” Aird said.

That’s no certainty, just a big risk of overdoing it. So while everyone’s making the Reserve’s governor, Dr Philip Lowe, Public Enemy No. 1, let me say that the strongest emotion I have about him is: I’m glad it’s you having to make the call, not me.

Don’t let all the jargon, statistics and mathematical models fool you. At times like this, managing the economy involves highly subjective judgments – having a good “feel” for what’s actually happening in the economy and about to happen. And it always helps to be lucky.

This week, the Australian Bureau of Statistics’ “national accounts” for the three months to the end of December showed real gross domestic product – the economy’s production of goods and services – growing by 0.5 per cent during the quarter, and by 2.7 per cent over the calendar year.

If you think 2.7 per cent doesn’t sound too bad, you’re right. But look at the run of quarterly growth: 0.9 per cent in the June quarter of last year, then 0.7 per cent, and now 0.5 per cent. See any pattern?

Let’s take a closer look at what produced that 0.5 per cent. For a start, the public sector’s spending on consumption (mainly the wage costs of public sector workers) and capital works made a negative contribution to real GDP growth during the quarter, thanks to a fall in spending on new infrastructure.

Home building activity fell by 0.9 per cent because a fall in renovations more than countered a rise in new home building.

Business investment spending fell by 1.4 per cent, pulled down by reduced non-residential construction and engineering construction. A slower rate of growth in business inventories subtracted 0.5 percentage points from overall growth in GDP.

So, what was left to make a positive contribution to growth in the quarter? Well, the volume (quantity) of our exports contributed 0.2 percentage points. Mining was up and so were our “exports” of services to visiting tourists and overseas students.

But get this: a 4.3 per cent fall in the volume of our imports of goods and services made a positive contribution to overall growth of 0.9 percentage points.

Huh? That’s because our imports make a negative contribution to GDP, since we didn’t make them. (And, in case you’ve forgotten, two negatives make a positive – a negative contribution was reduced.)

So, the amazing news is that the main thing causing the economy to grow in the December quarter was a big fall in imports – which is just what you’d expect to see in an economy in which spending was slowing.

I’ve left the most important to last: what happened to consumer spending by the nation’s 10 million-odd households? It’s the most important because it accounts for about half of total spending, because it’s consumer spending that the Reserve Bank most wants to slow – and also because the economy exists to serve the needs of people, almost all of whom live in households.

So, what happened? Consumer spending grew by a super-weak 0.3 per cent, despite growing by 1 per cent in the previous quarter. But what happened to households and their income that prompted them to slow their spending to a trickle?

Household disposable income – which is income from wages and all other sources, less interest paid and income tax paid by households – fell 0.7 per cent, despite a solid 2.1 per cent increase in wage income – which reflected pay rises, higher employment, higher hours worked, bonuses and retention payments.

But that was more than countered by higher income tax payments (as wages rose, with some workers pushed into higher tax brackets) and, of course, higher interest payments.

All that’s before you allow for inflation. Real household disposable income fell by 2.4 per cent in the quarter – the fifth consecutive quarterly decline.

That’s mainly because consumer prices have been rising a lot faster than wages. So, falling real wages are a big reason real household disposable income has been falling, not just rising interest rates.

Real disposable income has now fallen by 5.4 per cent since its peak in September quarter, 2021.

But hang on. If real income fell in the latest quarter, how were households able to increase their consumption spending, even by as little as 0.3 per cent? They cut the proportion of household income they saved rather than spent from 7.1 per cent to an unusually low 4.5 per cent.

If I were running the Reserve, I wouldn’t be too worried about strong consumer spending stopping inflation from coming down.

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Don't waste sympathy on self-funded retirees ... like me

You probably haven’t noticed, but I never write about self-funded retirees without adding a pejorative adjective – “so-called” or, better, “self-proclaimed”. As worthy causes go, they’re at the top of their own list, but not high on mine.

One day, a reader took me to task: “Why are you so down on self-funded retirees, Ross, when from what I can see, you’ll be one yourself when you retire?”

Ahem, ah, yes, well... Some explaining to do. If self-funded means you’re so well-off you couldn’t possibly meet the means test to be eligible for the age pension then, yes, I’ll be self-funded. One thing I don’t have to look forward to is waiting on the phone for hours for help from those lovely souls at Centrelink.

In my experience, no one ever tells you they’re self-funded without expecting you to give them a medal. While other people have led spendthrift lives and now expect the taxpayer to support them in old age, I worked hard and saved my pennies, and now I’m getting nothing from the government.

What a good citizen I am. If only other people could be as self-sacrificing as I am. And, by the way, while we’re talking money, since it’s a bit of a struggle without the pension, I was wondering if the government could manage to give me a little something by way of appreciation. Say, a special tax offset for seniors, or easier access to a healthcare card?

What gets me about all this is that it’s just the wrong way round. It’s not the supposedly self-funded who are doing the taxpayer a favour, it’s the pensioners who retire without much in the way of super.

Why’s that? Because so much of any superannuation balance comes not from what you saved, but from the accumulated tax breaks you were given. I guess what many people don’t realise is that you get compound interest not just on what you contributed, but also on the concessions you received, year after year.

Many people retire with quite modest superannuation payouts, which do little to reduce their eligibility for the age pension. According to the Association of Superannuation Funds of Australia, the median balance for people aged 60 to 64 is less than $360,000 for men and less than $290,000 for women.

But people who retire with a super balance big enough to extinguish all or most of their pension eligibility will be getting far more help from the government than someone on the full pension. So, for such people to think of themselves as “self-funded” is delusional.

Consider these figures from Brendan Coates of the Grattan Institute. In 2019-20, the average tax break on earnings received by people with at least $1.6 million in super totalled about $60,000 a year. This was nearly three times the value of the single pension.

It’s not well understood that, whereas the age pension costs the government about $55 billion a year, the annual cost of superannuation tax concessions is almost as large – $52 billion. At the rate we’re going, it won’t be many more years before the super concessions exceed the cost of the pension.

Now perhaps, you understand why, at a time when so many demands are being made on the budget, Prime Minister Anthony Albanese and Treasurer Jim Chalmers have decided to make the super tax breaks less generous for the 0.5 per cent of people with a super balance exceeding $3 million.

According to Coates’ calculations, this will free up about $1 billion a year for use in more deserving causes – decent aged care, for instance. Think about it. Balances of more than $3 million – I couldn’t spend that much money before I died if I tried. Especially because, the older you get, the less inclined you are to do things that cost a lot of money. You could be living it up at the George V Hotel in Paris, but you don’t feel like it.

According to Coates, nearly 90 per cent of the tax breaks go to the wealthiest 20 per cent of retirees. So, the critics are right to describe super as it presently stands as a taxpayer-funded inheritance scheme for wealthy Australians.

It’s only natural for people to aspire to leave their offspring well provided for. What’s not natural is for you to expect other, less fortunate taxpayers to contribute to your kids’ greater comfort.

The trouble with super is that it’s arse-about. The people who have the highest incomes, and thus the greatest ability to save, are given the greatest assistance, while the people with the least ability to save are given little or no help.

Oh, perhaps I should have mentioned it. If these appalling Labor people go ahead with lopping the tall poppies of superannuation, they’ll be aiming their scythe directly at me. Please write to the treasurer and say how terribly unfair this would be.

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The rich world should think twice about 'central bankism'

For the best part of 30 years, the governments of the advanced countries have outsourced the management of their economies to independent central banks. For many of those years, this change looked to have been a smart one. Now, not so much.

If the central banks’ efforts to get on top of the huge and quite unexpected surge in inflation that followed the pandemic go too far, and the rich countries end up in a severe recession, the inevitable search for someone to blame will lead straight to the door of the central bank.

After all, it was the central bank that, ignoring all the cries of pain, insisted on raising interest rates as far and fast as it did. And, as would by then be obvious, it misjudged and went too far.

It ignored the first rule for econocrats using a policy tool notorious for its “long and variable lags”: if you keep tightening until you’re sure you’ve got inflation beat, you’re sure to have gone too far.

You kept telling us it wasn’t your intention to cause a recession, but we got one anyway. So, were you lying to us, or just incompetent?

That’s my first point: if we do end up in recession, the independent central banks will get the blame, and there’ll be a posse of angry voters around the world demanding they be stripped of their independence.

But even if – as we hope - the worst doesn’t come to the worst, there’ll still be a strong case for our politicians to ask the obvious question: surely there must be a better way to run a railroad?

The rich world moved to central bank independence in the 1990s for strictly pragmatic reasons: because governments couldn’t be trusted to move the interest rate lever up and down to fit the economic cycle, not the political cycle.

Fine. But this is a democracy. How come a bunch of unelected bureaucrats have been given so much power? The fact is, independent central banking’s legitimacy comes solely because a duly elected government saw fit to grant it that freedom, and the present government hasn’t seen fit to take it away. Yet.

The trick is, if a central bank really stuffs up, voters will be furious, and they’ll turn on the only people they can turn on: the government of the day. You may think that, should a government of one colour be tossed out because of the central bank’s almighty stuff-up, the incoming government of the other colour would be mighty pleased with the central bank.

No way. What it would think is: if those bastards could do it to the others, they could just as easily do it to us. The new government’s first act would be to clip the central bankers’ wings.

The broader point is that independent central banking was not ordained by God. It’s just a policy choice we made at a time when it seemed like a good idea. When circumstances change, and we realise it wasn’t such a good idea, we’ll be perfectly equipped and entitled to change to a different policy arrangement we hope will work better.

Of course, moving away from economic management by interest-rate manipulation wouldn’t please everyone. It wouldn’t please academic economists who’d devoted their lives to the study of monetary economics (and right now, are hoping for a well-paid spot on the Reserve Bank board).

Nor would it suit the industry that, over the past 30 years, has grown up on the pavement outside the central bank’s building, so to speak. All the money market dealers who make their living betting on whether the central bank will change rates this month and by how much. Nor the economists who write the professional punters’ tip sheets.

And it’s a safe bet it wouldn’t suit the big banks, who’d much prefer the economy to be run by their mates down the road in Martin Place, rather than all those unknown bureaucrats and politicians in Canberra.

When you let one institution run the economy day to day for so long, it starts to get proprietorial. It’s in change of the economy and, when problems arise, it must be the outfit that takes charge and does what’s necessary to fix things.

There’s never a time when you admit that some other institution – the government and its Treasury advisers, for instance – should take the running because their instrument, the budget, is more multifaceted and suited to the problem than is your one-trick-pony instrument, interest rates.

And you do this even when the official interest rate is not far above zero. You tell everyone who thinks you’re out of ammo and should leave the running to Treasury and fiscal policy, they’re wrong, and resort to quantitative easing and other “unconventional measures”.

I reckon a big part of the reason what we thought was a problem of holding the economy together while we dealt with the pandemic turned into the worst inflationary episode in 30 years was the uncalled-for intervention of central banks, pushing themselves to the front of the fiscal parade.

And this from the institution that’s spend decades telling us it knows more about inflation than everyone else, cares more about inflation than anything else, and accepts ultimate responsibility to protect us from the supreme evil of inflation.

Today’s conventional wisdom says the present inflation surge was caused by big pandemic and war-caused supply shortages coming at a time when demand had been overstimulated. But a big part of that overstimulation occurred because central banks insisted on coming in over the top of those who were better equipped to respond to the pandemic and, indeed, were responsible for ordering and policing the lockdowns: the federal and state governments.

In Australia, nowhere was this overkill more apparent than in housing. While both federal and state governments were instituting temporary incentives to encourage home building, the central bank was not only slashing the official interest rate to near zero, it was lending to the banks at a hugely concessional rate, and buying second-hand government bonds, so the banks could offer home buyers two and three-year fixed-interest loans.

Throw in a temporary, pandemic-caused shortage of imported building materials, and you have much of our inflation surge being explained by an astonishing 27 per cent leap in the cost of a newly built home.

Why wasn’t there any co-ordination between the three arms of government that caused this avoidable inflationary disaster? Because the central bank is independent. It acts on its own volition.

But also because, when your only tool is a one-trick pony, you end up wearing blinkers. When you can only join the game by putting rates up or putting them down, you just can’t afford to worry about anyone who may be sideswiped in the process.

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How about sharing the economic pain arround?

If you don’t like what’s happening to interest rates, remember that although the managers of the economy have to do something to reduce inflation, it’s not a case of what former British prime minister Maggie Thatcher called TINA – there is no alternative.

As Reserve Bank governor Dr Philip Lowe acknowledged during his appearance before the House of Representatives Standing Committee on Economics last week, there are other ways of stabilising the strength of demand (spending) and avoiding either high inflation or high unemployment, which are worth considering for next time.

So, relying primarily on “monetary policy” – manipulating interest rates – is just a policy choice we and the other advanced economies made in the late 1970s and early 1980s, after the arrival of “stagflation” – high unemployment and high inflation at the same time – caused economists to lose faith in the old way of smoothing demand, which was to rely primarily on “fiscal policy” – manipulation of taxation and government spending in the budget.

The economic managers have a choice between those two “instruments” or tools with which smooth demand. The different policy tools have differing sets of strengths and weaknesses.

Whereas back then we were very aware of the weaknesses of fiscal policy, today we’re aware of the weaknesses of monetary policy, particularly the way it puts a lot more pain on people with home loans than on the rest of us. How’s that fair?

Lowe says the conventional wisdom is to use monetary policy for “cyclical” (short-term) problems and fiscal policy for “structural” (lasting) problems, such as limiting government debt.

But it’s time to review what economists call “the assignment of instruments” – which tool is better for which job. The more so because the government has commissioned a review of the Reserve Bank’s performance for the first time since we moved to monetary policy dominance.

It’s worth remembering that the change of regime was made at a time when Thatcher and other rich-country leaders were under the influence of the US economist Milton Friedman and his “monetarism”, which held that inflation was “always and everywhere a monetary phenomenon” and could be controlled by limiting the growth in the supply of money.

It took some years of failure before governments and central banks realised both ideas were wrong. They switched back to the older and less exciting notion that increasing interest rates, by reducing demand, would eventually reduce inflation. There was no magic, painless way to do it.

Macroeconomists long ago recognised that using policy tools to manage demand was subject to three significant delays (“lags”). First there’s the “recognition lag” – the time it takes the econocrats and their bosses to realise there’s a problem and decide to act.

Then there’s the “implementation lag” – the delay while the policy change is put into effect. Lowe described the cumbersome process of cabinet deciding what changes to make to what taxes or spending programs. Then getting them passed by both houses, then waiting a few weeks or months for the bureaucrats to get organised before start day.

He compared this unfavourably with monetary policy’s super-short implementation delay: the Reserve Bank board meets every month and decides what change to make to the official interest rate, which takes immediate effect.

He’s right. While the two policy tools would have the same recognition lag, monetary policy wins hands down on implementation lag.

But on the third delay, the “response lag” – the time it takes for the measure, once begun, to work its way through the economy and have the desired effect on demand – monetary policy is subject to “long and variable lags”.

Lowe said it took interest rate changes 18 months to two years to have their full effect. But I say most budgetary changes – particularly tax changes – wouldn’t take nearly that long. So, that’s a win for fiscal.

The sad truth is that measures to strengthen demand by cutting interest rates, or cutting taxes and increasing government spending, are always popular with voters, whereas measures to weaken demand by raising interest rates, or raising taxes and cutting government spending, are always unpopular.

This meant politicians were always reluctant to increase interest rates when they needed to, Lowe said. This is a good argument for giving the job to the econocrats at the central bank and making them independent of the elected government.

This became standard practice in the rich economies, although we didn’t formalise it until the arrival of the Howard government in 1996. Lowe advanced this as a good reason to stick with monetary policy as the dominant tool for short-term stabilisation of demand.

Against that, using monetary policy to get to the rest of us indirectly via enormous pressure on the third of households with mortgages shares the burden in a way that’s arbitrary and unfair.

What’s more, it’s not very effective. Because such a small proportion of the population is directly affected, the increase in interest rates has to be that much bigger to achieve the desired restraint in overall consumer spending.

But if the economic managers used a temporary percentage increase in income tax, or the GST, to discourage spending, this would directly affect almost all households. It would be fairer and more effective because the increase could be much smaller.

Various more thoughtful economists – including Dr Nicholas Gruen and Professor Ross Garnaut – have proposed such a tool, which could be established by legislation and thus be quickly activated whenever needed.

A special body could be set up to make these decisions independent of the elected government. Ideally, it would also have control over interest rates, so one institution was making sure the two instruments were working together, not at cross purposes.

Another possibility is Keynes’ idea of using a temporary rate of compulsory saving – collected by the tax office – to reduce spending when required, without imposing any lasting cost on households.

They say if it ain’t broke, don’t fix it. It’s obvious now that macroeconomic management needs a lot of fixing.

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Caring folk care about early learning. So do hard-nosed economists

So, what did you make of the Albanese government’s Early Years National Summit at Parliament House on Friday? What? You didn’t hear about it? Well, yes, it got little coverage from the media. Yet another case of us letting the urgent and the controversial crowd out the merely very important and the encouraging. Maybe it’s a pity Peter Dutton hasn’t said he was thinking of opposing it.

In truth, the government’s election promise – to do a better job of delivering what’s now called ECEC, early childhood education and care – is its most expensive and, after climate change, probably its most important. The two have much in common, of course: the wellbeing of our kids and grandkids.

Note the way our need for affordable and available childcare has morphed into a concern to start children’s education much earlier than age 5.

Neuroscience long ago established that our brains develop continuously from birth to adulthood, but the development in the first five years of life is crucial to later development. It’s determined partly by our genes, but also by our experiences in the early years. Children who are badly treated, or don’t get enough attention, are likely to have problems in later life.

To put it more positively, there’s now much evidence that good quality early childhood programs help children get a better education. Starting earlier seems to help kids “learn how to learn”. All children benefit, but those from disadvantaged homes benefit most.

Other research shows that early learning leads to better health, reduced engagement in risky behaviours such as smoking, drinking, drug taking and over-eating, and stronger civic and social engagement.

These benefits to individuals are, in themselves, sufficient justification for government spending on early learning. But the benefits spill over to their families and the wider community.

As well, the economy benefits from having more people working rather than in and out of unemployment. This improves government budgets by increasing the number of taxpayers, as well as by reducing the need for remedial spending on school drop-outs or people with literacy problems. Or those who’ve got into trouble with the police.

The American economist and Nobel laureate James Heckman has found that quality early education helps break the cycle of generational poverty. And skills developed through quality early childhood education can last a lifetime.

Last week’s summit brought together 100 experts to help the government develop an “early years strategy”. To see what’s been happening, it helps to start with childcare, then move on to early education.

The Morrison government reduced the cost of childcare for second and subsequent children, but Anthony Albanese topped that by promising to increase the subsidy to up to 90 per cent for the first child, starting in July.

This was Labor’s biggest election promise, costing more than $5 billion a year. It has also asked the Productivity Commission to review the childcare system and asked the Australian Competition and Consumer Commission to develop a mechanism to regulate the cost of childcare.

But cost is only one problem. Many families have trouble finding a place for their kid. Research by Victoria University’s Mitchell Institute has found that more than a third of Australians live in regional and rural areas where three children vie for each place. Areas with the highest fees usually have the highest availability of places, suggesting private providers go not only where the demand is, but also where they’re likely to make higher profits.

I trust you noticed that all those wonderful benefits came from quality care. Successive federal governments have worked to increase the quality of childcare, including improved ratios of staff to kiddies. This helps explain why the cost of childcare keeps rising.

Politicians and economists tend to see the main benefit from more and cheaper childcare as allowing more women to get paid employment. This is about gender equity, not just a bigger economy.

But another reason childcare keeps getting dearer is the push for childcare to be about early education – “play-based learning” – not just child minding. This means getting better qualified carers, including a proportion with teaching qualifications.

The other part of the early education push is the introduction of “universal” preschool education for 4-year-olds. The previous government started this some years ago, with the states. Now the push is for preschool to be extended to 3-year-olds. And last year the Victorian and NSW premiers announced plans for greatly increased early childhood spending, particularly on preschools.

What more the feds will be doing, we’ll know when they produce their early years strategy. But whatever the plan, it’s unlikely to succeed unless it involves higher pay for childcare workers – paid for by the government, not parents.

Considering the many benefits of early education, however, the extra cost should be seen as an investment in our children’s wellbeing. Not to invest what’s needed would be to “leave money on the table”, as economists say.

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Central banking: don't mention business pricing power

Despite the grilling he got in two separate parliamentary hearings last week, Reserve Bank governor Dr Philip Lowe’s explanation of why he was preparing mortgage borrowers for yet further interest rate increases didn’t quite add up. There seemed to be something he wasn’t telling us – and I think I know what it was.

We know that, as well as rising mortgage payments, we have falling real wages, falling house prices and a weak world economy. So it’s not hard to believe the Reserve’s forecasts that the economy will slow sharply this year and next, unemployment will rise (it already is), and underlying inflation will be back down to the top of the 2 per cent to 3 per cent target range by the end of next year.

So, why is Lowe still so anxious? Because, he says, it’s just so important that the present high rate of inflation doesn’t become “ingrained”. “If inflation does become ingrained in people’s expectations, bringing it back down again is very costly,” he said on Friday.

Why is what people expect to happen to inflation so crucial? Because their expectations about inflation have a tendency to be self-fulfilling.

When businesses expect prices to keep on increasing rapidly, they keep raising their own prices. And when workers and their unions expect further rapid price rises, they keep demanding and receiving big pay rises.

This notion that, once people start expecting the present jump in inflation to persist, it becomes “ingrained” and then can’t be countered without a deep recession has been “ingrained” in the conventional wisdom of macroeconomists since the 1970s.

They call it the “wage-price spiral” – thus implying it’s always those greedy unionists who threw the first punch that started the brawl.

In the 1970s and 1980s, there was a lot of truth to that characterisation. In those days, many unions did have the industrial muscle to force employers to agree to big pay rises if they didn’t want their business seriously disrupted.

But that’s obviously not an accurate depiction of what’s happening now. The present inflationary episode has seen businesses large and small greatly increasing their prices to cover the jump in their input costs arising from pandemic-caused supply disruptions and the Ukraine war.

Although the rate of increase in wages is a couple of percentage points higher than it was, this has fallen far short of the 5 or 6 percentage-point further rise in consumer prices.

So Lowe has reversed the name of the problem to a “prices-wages spiral”. In announcing this month’s rate rise, he said that “given the importance of avoiding a prices-wages spiral, the board will continue to play close attention to both the evolution of labour costs and the price-setting behaviour of firms in the period ahead”.

Lowe admits that inflation expectations, the thing that could set off a prices-wages spiral, have not risen. “Medium-term inflation expectations remain well anchored,” but adds “it is important that this remains the case”.

If that’s his big worry, Treasury secretary Dr Steven Kennedy doesn’t share it. Last week he said bluntly that “the risk of a price and wage spiral remains low, with medium-term inflation expectations well anchored to the inflation target.

“Although measures of spare capacity in the labour market show that the market remains tight, the forecast pick-up in wages growth to around 4 per cent is consistent with the inflation target.”

So, why does Lowe remain so concerned about inflation expectations leading to a prices-wages spiral that he expects he’ll have to keep raising the official interest rate?

There must be something he’s not telling us. I think his puzzling preoccupation with inflation expectations is a cover for his real worry: oligopolistic pricing power.

Why doesn’t he want to talk about it? Well, one reason could be that the previous government has given him a board stacked with business people.

A better explanation is that he’s reluctant to admit a cause of inflation that’s not simply a matter of ensuring the demand for goods and services isn’t growing faster than their supply.

Decades of big firms taking over smaller firms and finding ways to discourage new firms from entering the industry has left many of our markets for particular products dominated by two, three or four huge companies – “oligopoly”.

The simple economic model lodged in the heads of central bankers assumes that no firm in the industry is big enough to influence the market price. But the whole point of oligopoly is for firms to become big enough to influence the prices they can charge.

When there are just a few big firms, it isn’t hard for them reach a tacit agreement to put their prices up at the same time and by a similar amount. They compete for market share, but they avoid competing on price.

To some degree, they can increase their prices even when demand isn’t strong, or keep their prices high even when demand is very weak.

I suspect what’s worrying Lowe is his fear that our big firms will be able keep raising their prices even though his higher interest rates have greatly weakened demand. If so, his only way to get inflation back to the target band will be to keep raising rates until he “crunches” the economy and forces even the big boys to pull their horns in.

It’s hard to know how much of the surge in prices we saw last year was firms using their need to pass on to customers the rise in their input costs as cover for fattening their profit margins.

We do know that Treasury has found evidence of rising profit margins – “mark-ups”, as economists say – in Australia in recent decades.

And a study by the Federal Reserve Bank of Kansas City has found that mark-ups in the US grew by 3.4 per cent in 2021.

But for Lowe (and his predecessors, and peers in other central banks) to spell all that out is to admit there’s an important dimension of inflation that’s beyond the direct control of the central banks.

If he did that, he could be asked what he’s been doing about the inflation caused by inadequate competition. He’d say competition policy was the responsibility of the Australian Competition and Consumer Commission, not the Reserve. True, but what an admission.

In truth, the only person campaigning on the need to tighten competition policy in the interests of lower inflation is the former ACCC chair, Professor Rod Sims. Has he had a shred of public support from Lowe or Kennedy? No.

Final point: what’s the most glaring case of oligopolistic pricing power in the country? The four big banks. Since the Reserve began raising interest rates, their already fat profits have soared.

Why? Because they’ve lost little time in passing the increases on to their borrowing customers, but been much slower to pass the increase through to their depositors. Has Lowe been taking them to task? No, far from it.

But his predecessors did the same – as no doubt will his successors, unless we stop leaving inflation solely to a central bank whose only tool is to fiddle with interest rates.

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Inflation is too tricky to be left to the Reserve Bank

The higher the world’s central banks lift interest rates, and the more they risk pushing us into recession, the more our smarter economists are thinking there has to be a better way to control inflation.

Unsurprisingly, one of the first Australian economists to start thinking this way is our most visionary economist, Professor Ross Garnaut. He expressed his concerns in his book Reset, published in early 2021.

Then, just before last year’s job summit, he gave a little-noticed lecture, “The Economic Consequences of Mr Lowe” – a play on a famous essay by Keynes, “The Economic Consequences of Mr Churchill”.

Academic economists are rewarded by their peers for thinking orthodox thoughts, and have trouble getting unorthodox thoughts published. Trick is, it’s the people who successfully challenge the old orthodoxy who establish the new orthodoxy and become famous. John Maynard Keynes, for instance.

In his lecture, Garnaut praised the Australian econocrats who, in the late 1940s, supervised the “postwar reconstruction”. They articulated “an inclusive vision of a prosperous and fair society, in which equitable distribution [of income] was a centrally important objective”.

The then econocrats’ vision “was based on sound economic analysis, prepared to break the boundaries of orthodoxy if an alternative path was shown to be better”.

It culminated in the then-radical White Paper on full employment, of 1945, under which policy the rate of unemployment stayed below 2 per cent until the early 1970s.

Garnaut’s earlier criticism of the Reserve was its unwillingness to keep the economy growing strongly to see how far unemployment could fall before this led to rising inflation. “We haven’t reached full employment [because] the Reserve Bank gave up on full employment before we got there.”

Now, Garnaut’s worry is that “monetary orthodoxy could lead us to rising unemployment without good purpose”.

“Monetary orthodoxy as it has developed in the 21st century leads to a knee-jerk tendency towards increased interest rates when the rate of inflation... rises.

“I have been worried about the rigidity of the new monetary orthodoxy since the early days of the China resources boom.” He had “expressed concern that an inflation standard was replacing the gold standard as a source of rigidity in monetary policy”.

Ah. That’s where his allusion to Churchill comes in. In 1925, when he was Britain’s chancellor of the exchequer, Churchill made “the worst-ever error of British monetary policy” by following conventional advice to suppress the inflationary consequences of Britain’s massive spending on World War I by returning sterling to the “gold standard” (Google it) at its prewar parity.

The consequence was to plunge Britain into deep depression years before the Great Depression arrived.

“If we continue to tighten monetary policy – raise interest rates – because inflation is higher that the target range, then we will diminish demand... in ways that seriously disrupt the economy.

“High inflation is undesirable, and it is important to avoid entrenched high inflation. But not all inflation is entrenched at high levels. And inflation is not the only undesirable economic condition.

“There is a danger that we will replace continuing improvement to full employment with rising unemployment – perhaps sustained unnecessarily high unemployment.

“That would be a dreadful mistake. A mistake to be avoided with thoughtful policy.”

Such as? Garnaut has two big alternative ways of reducing inflation.

First, whereas in the early 1990s there was a case for independence of the Reserve Bank because, with high inflation entrenched, it needed to do some very hard things, he said, “what we now need is an independent authority looking at overall demand, and not just monetary policy.

“We need an independent body playing a role in both fiscal and monetary policy... It would be able to raise or lower overall tax rates in response to the macroeconomic situation.”

Second, we shouldn’t be using higher interest rates to respond to the surge in electricity and gas prices caused by the invasion of Ukraine.

Because of the way we’ve set up our energy markets, the increases in international prices came directly back into Australian prices. This put us in the paradoxical position of being the world’s biggest exporter of liquified natural gas and coal, taken together, but most Australians became poorer when gas and coal prices increased.

“Many Australians find this difficult to understand. If they understand it, they find it difficult to accept.

“Actually, it’s reasonable for them to find it unacceptable,” he said.

So, what to do? We must “insulate the Australian standard of living from those very large increases in coal, gas and therefore electricity”.

How? One way is to cause domestic energy prices to be lower than world prices. The other is to leave prices as they are, but tax the “windfall profits” to Australian producers caused by the war, then use those profits to make payments to Australian households – and, where appropriate, businesses – to insulate them from this price increase.

By causing actual prices to be lower, the first way leaves the Reserve less tempted to keep raising interest rates. Which, in turn, should avoid some unnecessary increase in unemployment.

There are two ways to keep domestic prices lower than world (and export) prices. One is to limit exports of gas and coal to the extent needed to stop domestic prices rising above what they were before the invasion.

The other way is to put an export levy (tax) on coal and gas, set to absorb the war-cause price increase.

Either of these methods could work, Garnaut said. Western Australia’s “domestic reservation requirement” specifying the amount of gas exporters must supply to the local WA market, has worked well – but this would be hard to do for coal.

This week Treasury secretary Dr Steven Kennedy said the measures the government actually decided on could reduce the inflation rate by three-quarters of a percentage point over this year.

Garnaut’s point is that we’ll end up with less unemployment if we don’t continue leaving the whole responsibility for inflation to an institution whose only tool is to wack up interest rates.

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It's no wonder the young hate Boomers like me

As I get older, more parts of my body are giving me gyp and I spend more of my life seeing doctors, but the people I don’t envy are the young. They may be fit and keen, but everywhere they look they see problems.

The big advantage of capitalism is supposed to be that it makes each generation better off than the last. But that’s breaking down before our eyes. The really harmful problem we’re leaving them is climate change, of course, but there’s much more than that.

They’re better educated than ever but, for many, it doesn’t seem to get them a secure, decently paid job. Even so, they leave education owing big debts to the government.

But, coming well behind climate change, the biggest disservice the older generation has done to them is to let the price of a home keep reaching for the sky.

We’re now at the point where each successive age group contains an ever-lower proportion of people who’ve managed to buy the home they live in.

In contrast, the aged have never had it better. The only thing they have to fear – and the young have to look forward to – is still needing to rent privately in retirement.

We’ve turned housing into Lotto. If you manage to win, they shower you in wealth. If you don’t win, you get screwed. Renters have few rights because, as we all know, it’s just a temporary state for the young.

And then the Baby Boomers (like me) wonder why the young seem to hate them. It’s not true that all Baby Boomers are rolling in it. Some of them don’t even own their own home. But most of them (like me) were able to buy early in their lives, when first homes were affordable. Since then, they’ve just sat back in delighted amazement as their wealth has multiplied.

Of course, if there’s anything wrong with the way the world’s run, it wasn’t anything I did, it was those terrible pollies. Yeah, nah.

Since older home owners have always far out-numbered the young would-be home owners, the politicians have always run the housing game to favour those who love seeing property prices rise – and, now you mention it, wouldn’t mind buying another house as an investment.

At present, it’s easy to conclude the big problem with housing affordability is rising interest rates and so blame it all on the Reserve Bank boss Dr Philip Lowe. But, as I’ve written elsewhere, although it’s reasonable to ask whether putting interest rates up and down is a sensible and fair way to manage the economy, that’s a separate issue.

Home loans take two to tango: how much you have to borrow and the interest rate on the loan. The interest rate cycles up and down around a relatively stable average, whereas the amount you need to borrow has gone up and up, decade after decade.

True, house prices are falling at present, but this is just returning them to where they were before they took off during the pandemic. It’s a safe bet that, once they’ve finished falling, they’ll resume their upward climb.

This is why oldies are wrong to scoff at young people complaining about mortgage interest rates of 5 per cent. “In my day, I had to pay 17 per cent!” Yes, you did – for a year or so in the early 1990s, when the amount you had to borrow was much less.

What’s true is that, right now, it’s mainly younger people who borrowed huge sums in the past few years who’re really feeling the pain.

But the real question is why house prices have risen so far for so long. They’ve risen much faster than incomes. The Grattan Institute calculates that whereas typical house prices used to be about four times incomes, now they’re more than eight times – and even more in Melbourne and Sydney.

But why? Not because of anything the Reserve Bank has done. Nor so much because we’ve failed to build enough additional houses and units to accommodate the growth in the population.

More because our tax and social security rules have made home ownership a highly attractive, government-favoured form of investment, not just a place you can call your own and not be chucked out of as long you keep up the payments. People who buy investment properties out-compete would-be first home owners, bidding up the price.

But also because there’s more competition to buy homes in particularly desirable areas. Spots near the beach or the river, for instance, but also places near where the jobs are.

People have been crowding into the big cities, trying to get close to the CBD with all its well-paid office jobs, but the older home owners fight hard to discourage governments from making room for younger newcomers. “It’s so ugly.”

And the bank of mum and dad (yes, I’ve done it) is helping prices stay high, while widening the divide between those young people with well-placed parents and those without.

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Interest rates: Lowe's not the problem, the system is rotten

When interest rates seem likely to be raised more than they need to be, it’s only human to blame the bloke with his hand on the lever, Reserve Bank governor Dr Philip Lowe. But it’s delusional to imagine that fixing the problem with “monetary policy” is simply a matter of finding a better person to run it.

This assumes there’s nothing wrong with the policy of using the manipulation of mortgage interest rates as your main way of managing the economy and keeping inflation low and employment high. In truth, there’s a lot wrong with it.

It ought to be a happy coincidence that, just as our central bank is making heavy weather of its first big inflation problem in decades, the Albanese government had already commissioned a review of its performance.

Treasurer Jim Chalmers will receive its report late next month. But particularly because the review is headed by an overseas central banker, it’s likely to recommend relatively minor changes to the way the Reserve performs its present role – changing the composition of its board, for instance – rather than answer a more fundamental question: can’t we find a better way to manage the macroeconomy than relying so heavily on dicking around with interest rates?

It’s a pity you have to be as ancient me to know there’s nothing God-ordained about the notion that central banks must have primary responsibility for stabilising the economy, with the elected government’s “fiscal policy” (the manipulation of government spending and taxes) playing a subsidiary role, and the central bankers being independent of the elected government.

This arrangement became the conventional wisdom only in the mid-1980s, after many decades of relying mainly on using the budget, with monetary policy’s job being to keep interest rates permanently low.

The fact is that, as instruments for managing demand, monetary policy and fiscal policy have differing strengths and weaknesses. The switch from fiscal to monetary primacy seemed to make sense at the time, and to hold the promise of much more effective stabilisation of the economy as it moved through the ups and downs of the business cycle.

Then, we were very aware of the limitations of fiscal policy. But after 40 years, the limitations of monetary policy have become apparent. For one thing, we learnt from the weak growth in the decade following the global financial crisis that monetary policy is not effective in stimulating growth when interest rates are already very low and households already loaded with debt.

Now we have high inflation caused primarily by problems on the supply (production) side of the economy. Can monetary policy do anything to fix supply problems? No. All it can do is keep raising interest rates until the demand for goods and services falls back to fit with inadequate supply.

But as a tool for limiting demand, monetary policy turns out to be primitive, blunt and unfair. Its manipulation of interest rates has little effect on borrowing for business investment, and little direct effect on all consumer spending except spending on mortgaged or rented housing.

In practice, this means monetary policy relies on manipulating the housing market to influence consumer spending indirectly. When you want to encourage demand, you cut mortgage interest rates to rev up the housing market. When you want to discourage demand, you raise rates to smash the housing market.

Putting up mortgage interest rates discourages people from buying housing – including newly built homes, which hits the home-building industry directly. But by increasing mortgage payments and rents, it hits consumer spending indirectly, by leaving households with less to spend on other things.

See how round-about monetary policy is in achieving its objective? It hits some people hard, but others not at all. As a reader wrote to me: “It just doesn’t make sense to me that one segment of the population is going through financial pain and suffering when others aren’t affected. Surely, there are [other] ways the government or Reserve Bank can bring inflation under control?”

Good point. Why does stabilising the economy have to be done in such a round-about and inequitable manner? As other readers would tell me, why do older people dependent on interest income have to take a hit whenever the Reserve decides to encourage borrowing and spending by cutting interest rates?

Truth is, central banks can’t afford to worry about whether dicking around with interest rates is fair or unfair: it’s the only tool they’ve got. To someone with a hammer, every problem is a nail.

And although economists have forgotten it, there are other, less round-about and less unfair ways to discourage or encourage consumer spending. In the olden days, governments added a temporary surcharge or discount to the income tax scale.

These days, you could do the same to the rate of the goods and services tax. If you didn’t trust the pollies to do it, you could give the power to an independent commission.

The Reserve rightly asserts that many of the price rises we’ve seen can’t be explained by supply problems, but must be attributed to excessive demand, caused by all the stimulus unleashed during the pandemic.

It fits the monetary policy-primacy mindset to blame this on excessive fiscal stimulus via all the temporary government spending and tax breaks. But a much better case can be made that the excess came from monetary policy.

Indeed, the response to the pandemic may have been far less inflationary than it proved to be had the Reserve left it all to fiscal policy. Since, with the official interest rate already down to 0.75 per cent, it was already almost out of ammunition, I expected the Reserve to sit it out and leave the heavy lifting to fiscal policy.

But no, like the other rich-country central banks, the Reserve leapt in. And, not content with cutting the official rate to 0.1 per cent, it resorted to various unconventional measures, lending to the banks at discount rates and buying several hundred billions-worth of government bonds to lower also multi-year housing fixed interest rates.

While the Reserve was doing this, both federal and state governments were offering people special concessions to buy newly built homes. The combined effect was to give the housing industry a humungous boost. House prices soared, as did the cost of a new home once the supply of building materials and labour ran out.

Guess what? If you take the part of our rise in consumer prices that can’t be attributed to supply problems and imported inflation, you find much of it’s explained by the cost of building a new home, which rose by an amazing 27 per cent over the 18 months to December.

It’s reasonable to believe that our inflation wouldn’t be nearly as bad, had the Reserve left the coronacession to fiscal policy, as it should have. Why didn’t it? Because it, like the other rich-country central banks, now thinks it owns macroeconomic management.

It just had to be out there, pushing the treasurer and Treasury away from the microphone and showing it was in charge – while it made matters worse. This is the central banking problem we - and the other rich countries - should be grappling with.

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Globalisation has stopped, but it's not actually reversing - yet

In case you’ve been too worried about your mortgage to notice, the era of ever-increasing globalisation has ended. There’s a backlash against greater economic integration and a risk it will start going backwards, causing the global economy to “fragment”.

The process of globalisation involves the free flow of ideas, people, goods, services and financial capital across national borders, leading to economic integration. But, as a new post on the International Monetary Fund’s blog site reminds us, globalisation is not new, and the process has ebbed and flowed over many decades.

The post charts the progress of globalisation back more than 150 years. Using openness to international trade – measured as global exports plus imports as a proportion of world gross domestic product – it divides that period into five successive eras.

First came the era of industrialisation between 1870 and 1914, when increasing trade between Europe and the “new world” of North America, Argentina and Australia was driven largely by technological advances in transportation – including steel-hulled, steam-driven ships and refrigeration for shipping meat – which lowered the cost of trade.

The laying of undersea cables to improve communication between countries also helped.

Then came the era of wars and protectionism, beginning with the start of World War I in 1914 and finishing with the end of World War II in 1945.

In between came the Great Depression of the 1930s, which was made much worse than it needed to have been by governments trying to protect their domestic industries by using high import duties (“tariffs”) to keep people buying local.

It sounds like a great idea when you do it to other countries. It turns into a stupid idea when they retaliate and do it to you, leaving everyone worse off.

After trade had increased from 30 per cent of world GDP to more than 40 per cent during the era of industrialisation, it had fallen back to about 15 per cent by the end of World War II.

Third came the era of tariff reform between 1945 and 1980. Even before the war had ended, the Allies knew they’d have to fix the world economy. They decided to move to a system of fixed exchange rates and establish the IMF and the World Bank. Most importantly, they set up the General Agreement on Tariffs and Trade (now the World Trade Organisation).

The GATT arranged eight successive “rounds” of multilateral trade negotiations, in which the developed countries agreed to big reductions in their barriers to imports. Thanks to all this, trade doubled from 15 per cent of world GDP to 30 per cent.

This led on to the era of “hyperglobalisation” between 1980 and 2008, with the fall of the Berlin Wall in 1989 and collapse of the Soviet Union, bringing the Cold War to an end.

The eighth, biggest and final, “Uruguay” round of the GATT, in 1994, focused on increasing trade between the developed and developing countries, with many poor economies joining the WTO.

China’s economy began growing rapidly after it was opened up in the late 1970s, and in 2001 it was permitted to join the WTO, hugely increasing its trade.

The era also brought a move to floating exchange rates and deregulation of banking systems, leading to much increased investment between rich and poor countries.

As well, big advances in telecommunications, computerisation and the advent of the internet allowed a surge of trade in digital services, including data processing.

Resulting from all this, trade reached a peak of more than 55 per cent of world GDP in 2008, on the eve of the global financial crisis and the ensuing Great Recession.

The IMF bloggers label the present period, with figures from 2008 up to 2021, the era of “slowbalisation”. To date, those figures bear this out: trade has reached a plateau of about 55 per cent. More recent figures show world trade has largely bounced back from the initial effects of the pandemic’s global coronacession.

It seems the combined effect of the Great Recession and rising protectionist sentiment has stopped trade from continuing to shoot up relative to world GDP, but not caused it to fall back – or not yet.

Less optimistic observers, however, refer to present as the era of “deglobalisation”. They worry that we’re in the early stages of a period of “policy-induced geoeconomic fragmentation”.

It’s not hard to see what’s worrying them. First we had Britain deciding to leave the European Union, then the election of Donald Trump, vowing to “make America great again” by whacking up tariff barriers against the exports of friend and foe alike, and starting a trade war with China.

Now we have the use of trade and other economic sanctions by many countries to punish Russia in its war against Ukraine, which is fragmenting world trade.

US President Joe Biden has toned down his predecessor’s excesses, but not abandoned the trade war. This doesn’t seem to be about protectionism so much as America’s desire not to be overtaken by China as the world’s dominant superpower. In particular, the US wants to stay ahead of the Chinese in advanced digital technology, by denying them access to the latest and best semiconductors.

The risk is that the two could end up dividing the global economy into separate trading blocs, America and its democratic friends versus China and its autocratic friends. This would almost certainly slow the economic growth of both groupings.

And, as economist Dr John Edwards has written, dividing the trading world into good guys and bad guys would not suit us, nor our region. Our exports to China greatly exceed our exports to the US and other close security allies.

And all the East Asian economies – including Japan and South Korea – have China as a major trading partner. For that matter, China and the US are major trading partners of each other.

Fortunately, and despite all the sparring we’ve seen, Edwards and others find no evidence that the US and China have yet started to “decouple”.

Let’s hope economic sense prevails, and it stays that way.

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If GPs want more money, they'll have to be less alergic to change

Who’d be Anthony Albanese? Everywhere he looks, another problem. Now it’s the GPs. They’ve become a lot harder to get to see, and more expensive. Even getting them to return your call can take days.

It’s become so bad even the premiers are complaining. What’s it got to do with them? When some people find it too hard or costly to see a GP, they take their problem to a public hospital’s emergency department, where waiting times are long, but there’s no charge.

Even the ambos are complaining that too many of their call-outs are to take someone with a minor problem to the emergency department.

The GP “crisis” was discussed at the national cabinet meeting on Friday, which received the final report of the Strengthening Medicare Taskforce. You can find the report on the internet but, although it’s mercifully short at 12 pages – with lots of lovely glossy photos of happy, good-looking Aussies, I doubt you’d find it very informative.

Remember the joke that a camel is a horse designed by a committee? The pictures suggest it’s intended for ordinary readers, but it’s written in bureaucratic code that would be crystal clear to any expert who already knew what it was saying.

You wade through guff about “access to equitable, affordable, person-centred primary care services” and “co-ordinated multidisciplinary teams” to find the odd bit you understand.

See if I do better. According to the doctors’ union, the AMA, the reason GPs have become so hard to find is that the federal government isn’t paying them enough. Whereas in the old days half of all medical graduates became GPs, now it’s down to about 15 per cent.

So, pay them more. Problem solved.

What the report’s saying is: sorry, not that simple. It’s true the Coalition government inherited a temporary freeze in Medicare rebates – the amount of a doctor’s bill that’s paid by the feds – in 2013, and continued it until 2018. And although the schedule of rebate payments has been increased annually since then, the increases have been much smaller than inflation.

Why? Partly because the Liberals were trying to prove they could cut taxes without damaging “essential services” such as Medicare.

But also because they knew something was wrong with the way general practice works. They needed to pay GPs differently to do different things. Rather than pay more and more the old way, they’d hold back until they – or some future government – worked up the courage to make changes.

Over the almost 40 years of Medicare, there’s been a big change in the problems people bring to their GPs. Because we’re living longer, healthier lives, much more of our problems are chronic – someone with heart trouble or diabetes has to wrestle with it for the rest of their lives – rather than acute: something that’s easily and quickly fixed.

But the present (subsidised) fee-for-service way of remunerating doctors is designed to suit acute problems, not chronic conditions. It involves waiting for problems to arise, not early diagnosis or stopping chronic conditions getting worse.

It encourages GPs to keep consultations short, avoiding long discussions of multiple problems.

A change no one wants to talk about is the way sole practitioners or partnerships of doctors are giving way to companies owning chains of practices staffed by doctors they employ.

When you separate the person delivering the care from the person watching the bottom line, you increase the likelihood doctors are pressured to keep consultations short and order many tests – a further reason to be cautious about reinforcing GPs’ dependence on fee-for-service.

The report wants to move to “blended” funding, with acute consultations continuing to be fee-for-service, but GPs paid lump sums for developing and managing “care plans” for particular patients with chronic conditions.

While it’s true fewer medical graduates are becoming GPs, it’s not the whole truth. As the Grattan Institute reveals, “Australia has more GPs per person than ever before, more GPs than most wealthy countries, and record numbers of GPs in training.”

How do other countries with good healthcare get by with fewer GPs? By making sure their GPs can’t insist on doing things that could be done by other health workers – nurses, nurse practitioners (nurses trained to do some of the more routine things doctors do), pharmacists and physios.

This is what “co-ordinated, multidisciplinary team-based care” means. Changing GPs’ surgeries into more wide-ranging “primary care clinics” is also about making it easier for patients to move between different kinds of care, with GPs taking more responsibility for the total package, and all the various doctors and paraprofessionals having access to a patient’s medical history.

There’s nothing new about this. Federal governments have been trying to improve the performance of primary care for decades – with little success. Why? Because they’ve had so little co-operation from the premiers and the GPs themselves.

The true message of the latest report is: Medicare reform must not just be about more money to do the same things the same way.

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Want a better economy? Design better policies, don't just pick sides

A wise person has said that our brains love to make either-or choices. Which is why it’s wise not to waste much energy on the concocted furore over Treasurer Jim Chalmers’ 6000-word essay musing on future economic policy.

The world is a complicated place, and so are the choices we make about what we need to do get an economy that improves the lives of the humans who constitute it, including those at the bottom, not just the top.

But our brains look for ways to simplify the many choices we face. The simplest choice is binary: between A and B, black or white, good or bad. This fits with our tribal instincts. My tribe versus the rest, us and them, the good guys versus the bad guys.

Our two-party political system has been built to keep things simple. And thus, to minimise the need for hard thinking. Many people don’t have time to decide what they think about this policy or that, so they pick a political party and outsource their thinking to it.

“Am I for it or against it? Tell me what my party’s saying, and I’ll know what I think.” There’s plenty of survey evidence that people who voted for the government – any government – are more inclined to think the economy’s going well, whereas those who voted for the other side think it’s going badly.

Too much of the outrage over Chalmers and his essay has come from media outlets whose business plan is to pander to the prejudices of a particular “market segment”.

Economists like to think of themselves as rational and objective, but economics and economy policy are highly susceptible to binary choices, and fads and fashions.

All I’ve seen over the years has made me a believer in the pendulum theory of history: we tend to swing from one extreme to the other. After World War II, people – particularly in Britain and Europe - were very aware of the failings of the private sector, so they decided to nationalise many industries.

By the time Maggie Thatcher and Ronald Reagan arrived, people had become very aware of the failings of government-owned businesses. So they decided to privatise many industries.

The big binary issue in economic policy is broader than privatisation, it’s government intervention in markets. Should governments intervene as little as possible, or as much as is necessary? To put it in the comic book terms beloved by Chalmers’ partisan critics: we face a choice between the free market or socialism.

Except that we don’t. My point is that the truth – and the ideal place to be – is unlikely to be found at one extreme or the other. It’s much more likely be somewhere in the middle.

To me, this is what economics teaches. It’s why economists say we should make decisions “at the margin” and are obsessed by finding the best “trade-off” between our conflicting objectives.

We want to be free to do as we choose, but we also want to be protected from instability (high inflation and high unemployment) and unfair treatment in its many forms.

The period of deregulation and privatisation instigated by the Hawke-Keating government in the mid-1980s, known locally as “micro-economic reform” motivated by “economic rationalism”, eventually degenerated into a belief in public bad/private good under subsequent governments, and was dubbed “neoliberalism” by leftie academics.

While the inclination to favour business and sell off government businesses remained under the former Coalition federal government, it had no commitment to minimising government intervention. Its willingness to impose its wishes on electricity and gas producers, for instance, was often on display.

And while the big reforms undertaken in the name of economic rationalism – floating the dollar, deregulating the banks, ending import protection, and introducing national competition policy – have served us well, many of the privatisations and efforts to outsource provision of government services have not.

In 2023, we’re left somewhere between the two extremes, with an economy that’s not working nearly as well as we need it to. Chalmers and Labor’s other ministers will have to intervene – but do so in ways they’re reasonably sure will make matters better rather than worse.

That’s the hard part, and their econocrat advisers aren’t nearly as well-equipped as they should be to tell them “what works and what doesn’t”.

Why not? Because we’ve done far too little hard thinking about the problems, preferring to take refuge in the happy delusion that the answer lies at one extreme or the other.

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Why the customer doesn't always come first

The world is a complicated place. I have no doubt that the capitalist, market-based way of running an economy delivers the best results for workers and consumers. But that doesn’t mean companies never do bad things, nor that every business always does the right thing by its customers.

The father of modern economics, Adam Smith, famously said that “it is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest”.

But, he argued, the “invisible hand” of “market forces” – the interaction of demand and supply in moving prices up and down – takes all the self-interest of businesses and the self-interest of consumers and turns them into businesses getting adequately rewarded for delivering just the right combination of goods and services to all the people in the economy.

There’s a huge amount of truth to that simple – if hard to believe – proposition. But it’s not the whole truth. One way to think of it is that, as Winston Churchill said of democracy, it’s the worst way of doing it – except for all the other ways. In this case, except for leaving all the decisions about what and how much to produce to the government.

So, to say capitalism is the best way of organising an economy isn’t to say it’s without fault. That it never does things badly.

In a speech this week, Rod Sims, the former chairman of the Australian Competition and Consumer Commission, but now a professor at the Australian National University, said that although companies regularly proclaim that they put their customers first, “companies clearly do not always have the interests of their customers in mind”.

So what are the reasons that, almost 250 years after Smith’s discovery, capitalism doesn’t always give consumers a good deal.

Sims can think of six reasons market forces don’t live up to their billing.

For a start, meeting customer needs may not be the main way companies increase their profits. Businesses are motivated to make profits and to increase those profits. But being the best at meeting the needs of customers isn’t the only way, or even the dominant way, firms succeed, Sims says.

For a firm to stay ahead of its rivals by continually improving its products and services is difficult. And eventually another firm works out how to do things better and cheaper than you.

“Commercial strategy therefore is largely about building defences against the forces of competition. To make it more difficult for other firms to develop a better product. Or, if they do, to limit their access to customers,” he says.

Another reason is that company executives are under considerable sharemarket pressure to increase short-term profits. Companies strive to grow because this attracts investors, the value of their shares rises and their top executives get bigger bonuses.

Sims says many companies set high growth targets to meet the expectations of the sharemarket. Often these targets are higher than the economy’s growth, meaning not all firms can meet or exceed market expectations.

So, in some cases, company executives see no alternative but to push the boundaries to achieve the targets they’ve been set.

That’s bad, but it becomes worse if the poor behaviour of a few causes normal competitive pressure to keep getting better than the others to reverse and become a race to the bottom.

Sims says that in well-functioning markets firms compete on their merits. Firms that offer what consumers value, displace firms that don’t. But the opposite can occur if poor behaviour goes undetected and unpunished, so it gives bad players a competitive edge.

“Firms can win customers through misrepresenting their offers and employing high-pressure selling tactics,” he says. As well as hurting consumers, such behaviour hurts rival firms, tempting them to protect their market share by employing the same questionable tactics.

Yet another problem occurs when firms see nothing wrong with what they’re doing, but their customers do. They (and economists) see nothing wrong with offering a better price – or interest rate – to new customers than they’re charging their existing customers.

But those older customers commonly react with outrage when they discover they’ve gone for years paying more than they needed to. They feel their loyalty has been abused.

Speaking of loyalty, Sims’ final explanation of why customers may be treated badly is that executives may feel their obligations to their company compel them to pursue profit to the maximum, even if their behaviour pushes too close to the boundaries of the law and isn’t the behaviour they would engage in privately.

So, what should be done about all these instances of “market failure” – where markets don’t deliver the wonderful benefits advertised by economists?

Sims has two remedies. First, as he argued strongly while boss of the competition and consumer commission, it needs stronger merger laws to help it prevent anti-competitive mergers. The courts require evidence about what will happen after a merger has occurred, but it’s hard for the commission to prove what hasn’t yet happened.

“The courts seem largely unwilling to accept commercial logic; that if you have market power you will use it. The courts can sometimes seem naive,” he says.

Second, we need a law against unfair practices, as they have in the United States, Britain and most of Europe.

“Our current laws are poorly suited to stopping behaviour ranging from online manipulation of consumers, to processors saying they will reject farm goods unless the prices agreed before the goods were shipped are now lowered.”

In the end, it’s simple. All the claims that capitalism will deliver a great deal for consumers are based on the assumption that businesses face stiff competition from other businesses to keep them in line.

But when too many markets are dominated by a few huge companies, service goes down and prices go up by more than they should.

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Labor's new plan to reduce our emissions is riddled with loopholes

While I was on holiday, I noticed a tweet that left me in no doubt about the subject of my first column back. It said: “I genuinely think the next generation will not forgive us for what we have done to them and the world they will have to live in.”

I, too, fear they won’t. I don’t know whether our political leaders ever think such thoughts, but it fills me with dread. Maybe the pollies think what I reluctantly think: With any luck, I’ll be dead before the next generation realises the full extent of the hell our selfish short-sightedness has left them in.

But the climate seems to be deteriorating so rapidly I’m not sure I’ll get off that easily. I love my five grandkids, but I’m not looking forward to the day they’re old enough to quiz me on “what I did in the war”. What was I saying and doing while our leaders were going for decades kicking the problem down the road as the easiest way to get re-elected?

“Well, I was very busy writing about the shocking cost of living – oh, and rising interest rates.” Really? Is that the best excuse you can offer, Grandad?

We elected a bloke called Albo who promised to try a lot harder than his predecessors to reduce our emissions of greenhouse gases. He said he’d cut them by 43 per cent by 2030. He was quick to put that target into law, and his people worked through the Christmas holidays to outline the “safeguard mechanism” he’d use as his main measure to achieve the reduction.

While the rest of us were at the beach, Climate Change Minister Chris Bowen announced a few weeks ago that Australia’s 215 biggest industrial polluters – running coal mines, gas plants, smelters and steelworks – will have their emissions capped, with the caps lowered progressively by 30 per cent come 2030.

Businesses whose emissions exceed their cap will face heavy fines. To the extent they can’t use cleaner production processes to reduce their emissions, they’ll be allowed to buy “carbon credits” from other heavy polluters who’ve been able to reduce their emissions by more than required, or from farmers who’ve planted more trees.

Trouble is, it wasn’t long before the experts started pointing to all the holes in the scheme. For a start, the combined emissions of these biggest polluters account for only 28 per cent of Australia’s total emissions.

For another thing, the notion that, as well as reducing the carbon we’re adding to the atmosphere, we should find ways to remove some of the carbon that’s already there is a good one in principle, but riddled with practical problems.

Whereas the carbon we emit may stay in the atmosphere for 100 years or more, the carbon sequestered by a new tree will start returning to the atmosphere as soon as it dies or is cut down. It’s hard to measure the amount of carbon that tree-growing and other agricultural activities remove, which makes such schemes particularly easy to rort.

In his recent report into expert criticism of our carbon credits scheme, Professor Ian Chubb sat on the fence. While judging the scheme to be “well designed”, he identified various dubious practices that should be outlawed. And he stressed that big polluters must not rely on buying carbon credits to the extent that they’re able to avoid reducing their emissions in absolute terms.

A further weakness in the government’s scheme comes from its refusal to prohibit any new coal mines and gas plants, despite the International Energy Agency and other international agencies saying the world won’t have any chance of avoiding dangerous climate change if it’s relying on new gas or coal projects.

So, the scheme involves leaning on our existing 215 biggest polluters to reduce their emissions by 30 per cent, while allowing a bunch of new big emitters to set up, provided they then start cutting those emissions back.

Really? This is how we’re going to cut our total emissions by 2030? Seriously?

Last year a reader rebuked me for failing to make it clear that nothing Australia does to reduce its own emissions can, by itself, have any effect on our climate. Why not? Because climate is global, and we’re not big enough to have a significant effect on total world emissions.

The best we can do is set a good example, then pressure the bigger boys to do likewise. So far, we’ve been setting them a bad example.

It’s the global scale of the problem that makes our efforts actually to increase our exports of coal and gas so irresponsible – and, to our offspring, unforgivable. We’re the world’s third-largest exporter of fossil fuels, after Saudi Arabia and Russia.

Australia’s emissions within our borders are dwarfed by the emissions from the coal and gas we export. But never mind about that. Let’s just extract a few more shekels before the balloon goes up.

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