Our days of productivity improvement may be gone for good

The Productivity Commission’s five-yearly report on our productivity performance seems to have sunk like a stone but, before it disappears without trace, it has one important thing to tell us: the obvious reason productivity improvement has slowed, and why, ceteris paribus, it will probably stay slow.

Economists like trying to impress people with Latin phrases. Many conclusions in economics depend on the assumption of ceteris paribus – all other things remaining unchanged. Economists are always holding all other variables constant while they see what effect a change in variable A has on variable B.

Trouble is, in the real world, all else almost never stays unchanged. In which case, the relationship between A and B that you thought you could rely on has been stuffed up by some other variable or variables between C and Z.

Back to the point. Everyone thinks they know what productivity means, but they often don’t. The commission’s report says productivity improvement is “the process by which people get more from less: more and better products to meet human needs, produced with fewer hours of work and fewer resources”.

“In many cases this growth occurs with lighter environmental impact” – a truth many scientists just can’t seem to get their heads around.

The report says that over the past 20 years, the rate of improvement in productivity has slowed in all the rich countries, but with Australia slowing more than most.

Why? Many reasons, no doubt, but one big one that ought to have been obvious, since the American economist William Baumol noticed it in the 1960s.

The fact is that most improvements in the productivity of labour come from advances in technology. You give workers better, “labour-saving” machines to work with, which allow them to produce more in a typical hour of work.

(The other big one is giving workers more education and training, which allows them to work more complicated machines – including computers and software – design more complicated machines and programs, and service complex machines.)

Trouble is, it’s easier to improve productivity in some industries than others. In particular, industries that produce goods – on farms, in mines and in factories – can, and have, hugely increase their productivity by mechanising and computerising. Same in utilities, transport and communications.

In the production of services, however, it’s much harder. Although some services can be delivered digitally – streaming video, say – with little involvement by workers, most services are delivered by people, from less-skilled services delivered by waiters, cleaners, bedmakers and shop assistants, to highly skilled teachers, nurses, doctors, lawyers and prime ministers.

You can give these workers a car or a mobile or a screen, or give a hairdresser a better pair of clippers, but there’s not a lot you can do to speed them up. As Baumol famously remarked, it takes an orchestra just as long to play a symphony today as it did in 1960 – or 1860.

After two centuries of playing this game, we’ve ended up with goods industries that are highly “capital-intensive” – lots of expensive equipment; not many workers – and service industries that are highly “labour-intensive”: many workers; not much equipment.

Which means the productivity of labour is sky-high in the goods sector, but not great in the services sector.

But here’s the trick. You might expect that wages will be much higher in the high-productivity goods sector and much lower in the low-productivity services sector. But no. Wage rates do vary according to the degree of skill a worker possesses, and on the demand for that particular skill.

But a cleaner in a factory gets paid pretty much the same as a cleaner in a lawyers’ office. And a doctor gets much the same working in a big factory’s clinic as in a hospital.

Why’s that? Because, if an economy is working properly (which ours isn’t at present), it’s the economy-wide improvement in productivity that tends to increase all real wages by about the same percentage.

This is brought about by market forces. Despite their low productivity, employers in the services sector have to pay higher wages to stop their workers moving to higher-paying jobs in the goods sector.

Remember too, that over time, mass production lowers the prices of manufactured goods. That’s particularly true if you judge it by how many hours of labour it costs to buy, say, a car or a restaurant meal.

What we’re saying is that, in rich, high-productivity economies such as ours, labour is the more expensive resource, and capital the less expensive resource.

It’s also true that there’s a limit to how much you can eat, how many cars you can drive and how many TV sets you can watch, but no yet-discovered limit to how many services you can pay other people to perform for you.

Put all that together and the goods sector’s share of the economy keeps getting smaller, while the services sector’s grows – to 80 per cent of the economy (gross domestic product) and 90 per cent of total employment.

But it also means that the sector which has little ability to improve the productivity of its labour also has to keep paying more for its labour as the goods sector increases the productivity of its labour.

Gosh, that’s not nice. No, which is why Baumol said that the services sector suffers from “cost disease”. And the services sector’s huge and growing share of the economy explains why productivity in the economy overall is improving more slowly than it used to.

But it could become even worse. If, as it seems, the goods sector has finally exploited almost all its potential to become more productive, and there’s not a lot of obvious scope to improve the services sector’s productiveness, it’s hard to see how we’ll get much more productivity-driven growth in the economy.

What a dismal prospect. Talk about the problems of affluence. You know, I don’t think the world’s poor have any idea how hard life will become for us.

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Voters turn from the big parties, increasing political competition

John Howard is right to describe the NSW election result as a “conventional change of government”. An old and disfigured government was tossed out and the other side given a go. It’s common when a government’s been in power for a decade or more. But don’t let this convince you nothing’s changed about the way we vote.

What’s happening is that the longstanding two-party system of government is breaking down before our eyes. Years of bad behaviour by the Coalition and Labor are leading more people to vote for minor parties and independents.

This means it’s become rare for any government, state or federal, to be elected with a big majority. Majorities now tend to be narrow, and minority governments are common, particularly at state level.

The big two are always telling us a “hung parliament” would be a terrible thing, causing “chaos and confusion”. Not true. They say this because it would be a terrible thing for them, requiring them to do deals with people they hate, to get the numbers to govern.

The “crossbenchers” usually drive a hard bargain. NSW’s four-year, fixed-date elections were forced on Liberal premier Nick Greiner in 1991 by three independents. Julia Gillard’s short-lived carbon tax was forced on her by the Greens, when she fell short of a majority in 2010.

So weaker governments are bad for the major parties, but good for democracy and voters, who get more to choose from.

Why is any of this the business of an economics writer? Because the nature of competition between a few big players in a market – “oligopoly” – is a subject economists study. And two-party government has a lot in common with markets dominated by two huge companies – duopoly.

But first, a closer look at the latest election. The “landslide” to Labor is looking a fair bit less than it looked on Saturday night. Chris Minns hasn’t yet secured a majority, and if he does, it will be narrow. Why? Because so many people are voting for minor parties and independents. At this stage in the counting, 28 per cent of voters spurned the big two. This compares with almost 32 per cent at the federal election last May, where the big swing away from the Liberals gave Labor just a narrow majority.

In NSW, the Greens look to have retained their three seats in the lower house, with independents looking sure of eight seats, and probably more. One of the new independents was backed by teal money.

An American economist named Harold Hotelling is famous for talking about a beach with two ice-cream sellers. From the swimmers’ perspective, the best place for them would be one at the quarter-mark and the other at the three-quarter mark. This would minimise the distance anyone had to walk to get a cone.

But Hotelling figured that the two would end up back-to-back at the centre of the beach. Why? Because that was the way each could ensure the other got no more than half the “market share”.

The social psychologist Hugh Mackay says that the key to competition is to focus on the customer, not your competitor. That’s just what oligopolists and our political duopolists don’t do.

If there’s one thing most people don’t understand about politics it’s the way each big party obsesses about what the other side’s doing, and how it will react to what they do.

It was this that caused Anthony Albanese to go to last year’s election promising to do nothing that could offend anyone much. Promise to make needed but controversial changes and the other side launches a scare campaign. It’s only when politicians tell us how bad the other side’s policies would be that we’re tempted to believe them.

The two sides are always trying to “wedge” each other by announcing a bad but popular policy and hoping the other side will be silly enough to oppose it.

Trouble is, they rarely fall for it. They sidestep the wedge by supporting the policy. Which means both sides end up agreeing to do bad things. This is why Albanese agreed to the AUKUS pact sight unseen and, earlier, to stick with the stage three tax cut that’s biased against Labor voters.

This is where the minor parties come in, particularly those sharing the balance of power in the Senate. They can use their power to stop, or at least tone down, the bad policies the government of the day foolishly locked itself into.

Consider this. Last week Climate Change Minister Chris Bowen loudly vowed not to negotiate with the Greens over his “safeguard mechanism”. But by Monday, wiser heads had prevailed, and a deal was done, making the mechanism much more effective.

The big two each offer voters a policy package-deal not very different to the other one’s. Whichever package you pick will include policies you don’t like. But the minor party and independent “new entrants” to the political market give consumers a wider choice by forcing the big guys to “unbundle” their packages.

Sounds more like democracy’s supposed to be.

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Labor is just pretending to be tough on climate change

Labor talks the talk, but doesn’t walk the walk. Last week’s “final warning” from the Intergovernmental Panel on Climate Change – and the Albanese government’s refusal to be moved by it – should be a game-changer in our assessment of Labor’s willingness to do what must be done.

The IPCC’s message – driven home by UN Secretary-General Antonio Guterres – was that we’re almost out of time to avoid much of the worst climate change. Whatever plans we had to reduce greenhouse gas emissions, we must step them up, and speed them up.

Regarding last year’s federal election, the message is that Labor’s plan is complacent and compromised, and the Greens and teals were right to demand much tougher, faster action.

But not only did Climate Change Minister Chris Bowen show no sign of getting the UN’s message, he announced his refusal to negotiate with the Greens to make improvements to his “safeguard mechanism” legislation.

You need to know that Albanese Labor hates the Greens more than it hates the Liberals. Bowen could have decided to use the need to win the Greens’ support for his bill in the Senate as cover for making the bill stronger than Labor promised in the election campaign.

Instead, he decided to put the interests of our grandchildren second to this fabulous chance to “wedge” the Greens. They could either vote for Labor’s bill as is, or they could join the Coalition in voting it down – just as they did when they voted down Kevin Rudd’s carbon pollution reduction scheme in 2009.

This would leave the government with no means of achieving its target of reducing emissions by 43 per cent by 2030. And, Bowen bellowed in the House, that would be all the Greens’ fault. (It doesn’t seem to have occurred to Bowen and his boss that if they go to the 2025 election having done nothing to fight climate change, blaming it all on the Greens won’t be a good enough excuse.)

But last week showed that the problem with Labor isn’t just its political cynicism and game-playing. Until last week, it was possible to see the Greens’ demand that no new coal and gas projects be approved as the kind of over the top zealotry you’d expect from those crazies. And, as it happens, the teals.

This is what Guterres said last week in welcoming the IPCC’s final warning. “The climate time-bomb is ticking.” We do have time to defuse it, “but it will take a quantum leap in climate action”.

We must “massively fast-track climate efforts by every country and every sector and on every timeframe”.

He was proposing an “acceleration agenda” with, specifically, “no new coal and the phasing out of [existing] coal by 2030 in [the rich] countries and 2040 in all other countries. Ending all international public and private funding of coal” and “ceasing all licensing or funding of new oil and gas”, as already proposed by the International Energy Agency and “stopping any expansion of existing oil and gas reserves. Shifting subsidies from fossil fuels to a just energy transition”.

That’s not some crazy greenie, that’s the UN secretary-general.

Yet, the very same week, Bowen had the temerity to claim that stopping new projects would be “irresponsible”. That’s now the opposite of the truth.

It’s not by chance that Bowen is the Minister for Climate Change and Energy. It’s not just the Coalition that’s in bed with the fossil fuel industry; Labor is too. Labor just does a better job of covering it up.

Federal Labor will not commit to stopping the proposed 116 new coal and gas projects. When Albanese went to India recently, he took fossil fuel people with him, so they could sell more coal.

The many state Labor governments are committed to approving new projects. That’s another thing that happened last week: on election night in NSW, the new state Labor minister made it clear the Minns government would not be stopping new projects.

Labor wants to be in bed both with those who want real action on climate change and the fossil fuel industries. Someone famous once said, “No one can serve two masters”. One of his saintly followers once prayed, “Lord, make me pure – but not yet”. That’s Labor.

Which brings us to the safeguard mechanism Labor is refusing to improve. Bowen has conned some conservation groups into supporting his plan because, though it’s not perfect, “something is better than nothing” and “it’s a start: get it passed, and seek to improve it later”.

Come in, sucker. What last week shows is that there isn’t time to improve it later. Labor has tried to wedge the Coalition by building its reduction scheme on the base of Tony Abbott’s safeguard mechanism, which was largely for show and did nothing to reduce emissions.

But if Labor is taking over an ineffective scheme from the secret climate change deniers, now’s the time to make it effective, not later. The fact is, the safeguard mechanism is riddled with loopholes.

The first loophole is our fossil fuel exports. Under the UN’s rules, a country is responsible for the emissions that occur on its own territory. Bowen’s renovations would, in theory, reduce the local emissions of our biggest polluting industries. It would also reduce the local emissions from any big new coal and gas export projects.

But it would permit other countries to maintain or increase their emissions from fossil fuels they bought from us. The UN will blame them for those emissions, not us. Great loophole, eh?

Trouble is, greenhouse gas is a global problem, not a local one. And we’re one of the biggest exporters of fossil fuels in the world. We export far more future emissions than we emit ourselves. So, what we do at home doesn’t add to climate change nearly as much as what others do with the coal and gas we sell them.

Bowen’s version of Abbott’s safeguard mechanism has a second major loophole. The big polluters must either progressively reduce their emissions according to the government’s phase-down, or buy the equivalent carbon credit offsets from someone else – often a farmer who’s planted more trees.

First problem is that there’ll be no limit to the extent that a polluter can resort to carbon credits. So it’s possible they’ll continue pumping out greenhouse gases, and mainly just buy credits from elsewhere.

This could lead to far more reliance on credits than the UN agreements envisaged. Credits were supposed to be used mainly by industries, such as cement and steelmaking, that find reducing emissions exceptionally difficult.

The other problem is that a lot of the carbon credit offsets are dodgy – they’re not like for like as a substitute for genuine emission reductions.

These were the main loopholes in Bowen’s rejigged safeguards mechanism that the Greens, the teals and Senator David Pocock were hoping to see improved by negotiations with Labor.

They make it debatable whether, in this case, something is better than nothing. One advantage of voting down Bowen’s bill would be to stop Labor pretending it had done something meaningful about climate change while actually prolonging the future of our fossil fuel industries.

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Much prosperity comes from government and the taxes it imposes

The Productivity Commission’s job is to make us care about the main driver of economic growth: productivity improvement. Its latest advertising campaign certainly makes it sound terrific. But ads can be misleading. And productivity isn’t improving as quickly as it used to. We’re told this is a very bad thing, but I’m not so sure.

The commission’s latest report on our productivity performance, “Advancing Prosperity”, offers a neat explanation of what productivity is: the rise in real gross domestic product per hour worked. So it’s a measure of the efficiency with which our businesses and government agencies transform labour, physical capital and raw materials into the goods and services we consume.

The economy – GDP – can grow because the population grows, with all the extra people increasing the consumption of goods and services, and most of them working to increase the production of goods and services.

It also grows when we invest in more housing, business machinery and construction, and public infrastructure. But, over time, most growth comes from productivity improvement: the increased efficiency with which we deploy our workers – increasing their education and training, giving them better machines to work with, and organising factories and offices more efficiently.

Here’s the ad for productivity improvement. “There has been a vast improvement in average human wellbeing over the last 200 years: measured in longer lives, diseases cured, improved mobility [transport and travel], safer jobs, instant communication and countless improvements to comfort, leisure and convenience.”

That’s all true. And it’s been a wonderful thing, leaving us hugely better off. But here’s another thing: neither GDP nor GDP per hour worked directly measures any of those wonderful outcomes. What GDP measures is how much we spent on – and how much income people earned from – doctors, hospitals and medicines, good water and sewerage, cars, trucks and planes, occupational health and safety, telecommunications, computers, the internet, and all the rest.

The ad man’s 200 years is a reference to all the growth in economic activity we’ve had since the Industrial Revolution. We’re asked to believe that all the economic growth and improved productivity over that time caused all those benefits to happen.

Well, yes, I suppose so. But right now, the commission’s asking us to accept that our present and future rate of growth in GDP and GDP per hour worked will pretty directly affect how much more of those desirable outcomes we get.

That’s quite a logical leap. Maybe it will, maybe it won’t. Maybe the growth and greater efficiency will lead to more medical breakthroughs, longer lives, cheaper travel etc, or maybe it will lead to more addiction to drugs and gambling, more fast food and obesity, more kids playing computer games instead of reading books, more time wasted in commuting on overcrowded highways, more stress and anxiety, and more money spent on armaments and fighting wars.

Or, here’s a thought: maybe further economic growth will lead to more destruction of the natural environment, more species extinction and more global warming.

Get it? It doesn’t follow automatically that more growth and efficiency lead to more good things rather than more bad things. It’s not so much growth and efficiency that make our lives better, it’s how we get the growth, the costs that come with the growth, and what we use the growth to buy.

Trouble is, apart from extolling growth and efficiency, the Productivity Commission has little to say about how we ensure that growth leaves us better off, not worse off.

Economics is about means, not ends. How to be more efficient in getting what we want. The neoclassical ideology – where ideology means your beliefs about how the world works and how it should work – says that what we want is no business of economists, or of governments. What we want should be left to the personal preferences of consumers.

The Productivity Commission has long championed neoclassical ideology. It wants to minimise the role of government and maximise the role of the private sector.

It would like to reduce the extent to which governments intervene in markets and regulate what businesses can and can’t do. It has led the way in urging governments to outsource the provision of “human services” such as childcare, aged care and disability care to private, for-profit providers.

It wants to keep government small and taxes low to maximise the amount of their income that households are free to spend as they see fit, not as the government sees fit.

Fine. But get this: in that list of all the wonderful things that economic growth has brought us, governments played a huge part in either bringing them about or encouraging private firms to.

We live longer, healthier lives because governments spent a fortune on ensuring cities were adequately sewered and had clean water, then paid for hospitals, subsidised doctors and medicines, paid for university medical research and encouraged private development of pharmaceuticals by granting patents and other intellectual property rights to drug companies.

Governments regulated to reduce road deaths. They improved our mobility by building roads, public transport, ports and airports. Very little of that would have been done if just left to private businesses.

Jobs are safer because governments imposed occupational health and safety standards on protesting businesses. The internet, with all its benefits, was first developed by the US military for its own needs.

The commission says that when we improve our productivity, we can choose whether to take the proceeds as higher income or shorter working hours.

In theory, yes. In practice, all the reductions in the working week we’ve seen over the past century have happened because governments imposed them on highly reluctant employers. Ditto annual leave and long-service leave.

I don’t share the commission’s worry that productivity improvement may stay slow. It won’t matter if we do more to produce good things and fewer bad things. But that, of course, would require more government intervention in the economy, not less.

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Most of us don't really want to be rich, for better or worse

When it comes to economics, the central question to ask yourself is this: do you sincerely want to be rich? Those with long memories – or Google – know this was the come-on used by the notorious American promoter of pyramid schemes, Bernie Cornfeld. But that doesn’t stop it being the right question.

It’s actually a trick question. Most of us would like to be rich if the riches were delivered to us on a plate. If we won the lottery, or were left a fortune by a rich ancestor we didn’t know we had.

But that’s not the question. It’s do you sincerely want to be rich. It ain’t easy to become rich by your own efforts, so are you prepared to pay the price it would take? Work night and day, ignore your family and friends, spend very little of what you earn, so it can be re-invested? Come unstuck a few times until you make it big? Put it that way and most of us don’t sincerely want to be rich. We’re not that self-disciplined and/or greedy.

The question arises because the Productivity Commission’s five-yearly report on our productivity performance has found that, as a nation, we haven’t got much richer over the past decade – where rich means our production and consumption of goods and services.

When business people, politicians and economists bang on about increasing the economy’s growth, they’re mainly talking about improving the productivity – productiveness – of our paid labour.

The economy – alias gross domestic product – grows because we’ve produced more goods and services than last year. Scientists think this happens because we’ve ripped more resources out of the ground and damaged the environment in the process.

There is some of that (and it has to stop), but what scientists can never get is that the main reason our production grows over the years is that we find ways to get more production from the average hour of work.

We do this by increasing the education and training of our workers, giving them better machines to work with, and improving the way our businesses organise their work.

But the commission finds that our rate of productivity improvement over the past decade has been the slowest in 60 years. It projects that, if it stays this far below our 60-year average, our future incomes will be 40 per cent below what they could have been, and the working week will be 5 per cent longer.

It provides 1000 pages of suggestions on how state and federal governments can make often-controversial changes that would lift our game and make our incomes grow more strongly.

So, this is the nation’s do-you-sincerely-want-to-be-rich moment. And my guess is our collective answer will be yeah, nah. Why? For good reasons and bad. Let’s start with the negative.

If you think of the nation’s income as a pie, there are two ways for an individual to get more to eat. One is to battle everyone else for a bigger slice. The other is to co-operate with everyone to effect changes that would make the pie – and each slice - bigger.

For the past 40 years of “neoliberalism”, which has focused on the individual and sanctified selfishness, we’ve preferred to battle rather than co-operate.

Our top executives have increased their own remuneration by keeping the lid on their fellow employees’ wages. Governments have set a bad example by imposing unreasonably low wage caps.

Then they wonder why their union won’t co-operate with their efforts to improve how the outfit’s run. Workers fear there’ll be nothing in it for them.

It’s the same with politics. Governments won’t make controversial changes because they know the opposition will take advantage and run a scare campaign.

But there are also good reasons why we’re unlikely to jump to action in response to the commission’s warning. The first is that economists focus on the material dimension of our lives: our ability to consume ever more goods and services.

We’re already rich – why do we need to be even richer? There’s more to life than money, and if we gave getting richer top priority, there’s a big risk those other dimensions would suffer.

Would a faster growing economy tempt us to spend less time enjoying our personal relationships? How would that leave us better off overall (to coin a phrase)?

How much do we know about whether the pace of economic life is adding to stress, anxiety and even worse mental troubles?

If we did go along with the changes the commission proposes, what guarantee is there that most of the increased income wouldn’t go to the bosses (and those terrible people with more than $3 million in superannuation)?

What we do know is that we should be giving top priority to reducing the damage economic activity is doing to the natural environment, including changing the climate. If that costs us a bit in income or productivity, it’s a price worth paying.

And there are various ways we could improve our lives even if our income stopped growing. Inquire into them.

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Handle with care: Productivity Commission's advice on getting richer

If you accept the Productivity Commission’s assumption that getting richer – “advancing prosperity” – is pretty much the only thing that matters, then the five priority areas it nominates in its five-yearly review of our productivity performance make a lot of sense.

But when you examine the things it says we should do to fix those five areas, you find too much of its same old, same old, preference for neoclassical ideology over empirical evidence.

And you find no acknowledgement that part of our claimed failure to improve the productivity of the “government-funded non-market services sector” has occurred because, over recent decades, governments have acted on the commission’s advice to keep the public sector small and taxes low by outsourcing the provision of human services to profit-motivated businesses.

Which, if anything, has made matters worse rather than better. As witness: the mess we’ve made of aged care and vocational education and training, and the ever-growing cost of the National Disability Insurance Scheme.

The report is quick to explain that improving productivity does not mean getting people to work harder. Perfectly true. It’s supposed to mean making workers more productive by giving them better training and better machines to work with.

Except that when you see the commission recommending a move to “modern, fit-for-purpose labour market regulation” – including, no doubt, getting rid of weekend penalty pay rates – you realise the commission has learnt nothing from the failure of John Howard’s Work Choices, nor from the failure of the reduction in Sunday penalty payments to lead to any increase in weekend employment, as had been confidently predicted.

So, what the commission is really advocating is that the balance of power in wage bargaining be shifted further in favour of employers and away from workers and their unions. Which probably would lead to people working harder for little or no increase in pay.

What the commission should have said, but didn’t, is that workers would be more co-operative with bosses’ efforts to improve the productivity of their firms if they were more confident they’d get their fair share of the benefits.

At present, they have good reason to doubt that they would.

What’s conspicuously absent from all the bemoaning of the slowdown in our rate of productivity improvement, is any acknowledgement that there’s also been a huge fall in the rate of the flow-through to real wages of what improvement we are achieving.

Until that’s fixed – until the capitalist system goes back to keeping its promise that the workers will get their fair share of the benefits of capitalism – Australia’s households have no rational reason to give a stuff about what’s happening to productivity.

Back to the point. Productivity improves when you produce the same things with fewer inputs of labour or capital, or produce more – either more quantity or better quality – with the same inputs.

And the report is exactly right to say that steadily improving our productivity is the key to improving the nation’s material standard of living. The rich world has more than two centuries of proof of that truth.

The first of the report’s five priority areas is achieving a “highly skilled and adaptable workforce”. Dead right. This is economics 101. Economists have known for yonks that investing in “human capital” is the obvious way to increase productivity.

(And it’s the better-educated and trained workers who can most easily adapt to the changing demand for labour that the digital revolution and other technological advance will bring.)

But the commission long ago stopped pointing this out, while state and federal governments put their efforts into quite different objectives. The Howard government, for instance, spent hugely on expanding parents’ choice of private school.

“I’m a Callithumpian, and I’d like to send my kid to a Callithumpian school, where they won’t have to mix with sinners.” Next, we had the limited success of the Gonski-inspired push to fund schools based on student need rather than entrenched privilege and religion.

And then we wonder why school results have got worse and so many kids leave school with inadequate numeracy and literacy. How they’ll be advancing our prosperity in an ever-changing world I hate to think.

Which raises a recent “learning” by economists, that doesn’t seem to have reached the commission: if you ignore what your “reforms” are doing to the distribution of income between the top and the bottom, don’t be surprised if your productivity goes off.

For some inexplicable reason, growth in the number of the downtrodden makes the average look worse.

Meanwhile, with universities, the highest priority of successive federal governments – Labor and Liberal – over the past 30 years has just been to get them off the budget.

The feds have made them hugely dependent on attracting overseas students and charging them full freight. One way they’ve coped is by making university teaching by the younger staff part of the gig economy.

Apart from putting the public unis (but not the few private unis) on a starvation diet during the lockdowns, the Morrison government’s last effort to punish what it saw as a hotbed of socialism was a hare-brained scheme to encourage students to choose courses that made them “job-ready” by, among other things, doubling the tuition fees for a BA.

Fortunately, this failed to discourage the students, but did make the humanities a far more profitable product for the unis to push.

To be fair, another recent “learning” does seem to have got through to the commission. It’s third priority for attention is “creating a more dynamic and competitive economy”.

Research by Treasury has found strong empirical evidence that our economy has become less dynamic – less able to change and improve over time. Fewer new firms are being created, and fewer workers are being induced to change their jobs pursuing higher pay.

Our industries have become more oligopolised – allowed by our permissive takeover laws - and, not surprisingly, their profit margins (“markups,” in econospeak) have been creeping up.

No official will admit it, but it seems pretty clear that the reason the Reserve Bank has been raising interest rates so far and so fast – despite falling real wages – is the part that oligopolistic pricing power is playing in our high inflation rate.

And now further Treasury research has confirmed that our high degree of industry concentration (markets dominated by a few huge firms) has given employers greater power to limit the rise in wages.

All this makes it unsurprising that our rate of productivity improvement has weakened. It also helps explain why, over the past decade, virtually none of what improvement in the productivity of labour we have achieved has been passed on to real wages.

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Ever wondered why your wages aren't rising?

It’s dawning on people that when the competition between businesses isn’t strong, firms can raise their prices by more than the increase in their costs, and so fatten their profit margins. What’s yet to dawn is that weak competition also allows businesses to pay their workers less than they should.

In standard economic theory, it’s the intense competition between firms that prevents them from overcharging for their products and earning more than a “normal” profit.

Normal profit gives the owners of the firm just sufficient return on the capital they’ve invested to stop them leaving the industry and trying their luck elsewhere.

The theory assumes the industry has numerous firms, each one too small to influence the market price. In today’s world, however, many markets are dominated by just two, three or four huge firms.

These firms are big enough to influence the market price, especially when it’s so easy for them to collude tacitly with their rivals.

We see the four big banks doing this every time interest rates are raised. They have an unspoken agreement not to compete on price.

EverI say they have “pricing power”, but many economists say they have “monopoly power”. How can a handful of firms have monopoly power? Because economists don’t use that term literally. On a scale of one to 1000 firms, we’re right down the monopoly end.

Dr Andrew Leigh, the Assistant Minister for Competition, and a former economics professor, has been giving a series of speeches about recent empirical studies on how competitive our markets are.

In one, he quoted the findings of Jonathan Hambur, a researcher who pivots between Treasury and the Reserve Bank, that Australian firms’ “mark-ups” – the gap between their cost of production and their selling price – have been rising steadily.

But in a further speech this month, Leigh turned the focus from what “market concentration” (among a few massive companies) means for the industry’s customers, to what it means for its employees.

So, in econospeak, we’re moving from monopoly to “monopsony”. Huh? Taken literally, monopoly means a market in which there’s a single seller meeting the demand for the product. Monopsony means there’s a single buyer from the people supplying the inputs to production. Workers supply the firm with the labour it needs.

The term was introduced by Joan Robinson, a colleague of Keynes at Cambridge, who was among the first to question the standard theory of how markets work. She was 30 in 1933 when she published her dissenting view that truly competitive markets were rare.

She argued that monopsony was endemic in the labour market and employers were using it to keep wages low. If there are few employers competing for workers, those workers have fewer “outside options” (to move to another firm offering higher pay or better conditions).

This limits workers’ bargaining power and gives employers the power to keep wages lower.

At the time, few economists took much interest. But in recent years there’s been a growing focus on market power by academic economists.

For instance, monopsony was cited in a US Supreme Court ruling against Apple in 2019. A report by Democrats in the US House of Representatives accused Amazon of using monopsony power in its warehouses to depress wages in local markets.

Evidence from the US, Britain and Europe has demonstrated that increases in labour market concentration – fewer employers to work for – are associated with lower wages.

Leigh says economists have long known that people in cities tend to earn more than those in regional areas. His own research found that when someone moves from a rural area to a major Australian city, their annual income rises by 8 per cent.

“The economics of monopsony suggests that an important part of the urban wage premium can be explained by greater employer competition in denser labour markets,” Leigh says.

Leigh reminds us that Australia’s average full-time wage ($1808 a week last November) was only $18 a week higher than it was 10 years ago, after allowing for inflation. Many things would explain this pathetic improvement, but one factor could be employers’ monopsony.

We know that the rate at which people move between employers has fallen. But over a person’s working life, the biggest average wage gains come when people switch employers. And when some people leave, the bargaining power of those who stay is increased.

This decline in people moving could be caused by increased employer monopsony. Hambur has done a study of employment concentration between 2005 and 2016.

He found that, within industries where concentration rose, growth in real wages over the decade was significantly lower.

When a firm has a large share of the industry’s employment, the gap between the value of the work a worker does, and the wage they’re paid in return, tends to grow.

He found that employment in regions close to major cities is twice as concentrated as in the cities. In remote areas it’s three times.

Read this carefully: Hambur found that labour markets had not become more concentrated over the decade. But at every degree of concentration, its negative impact on wages had more than doubled.

So, employers’ market power could well be a factor helping to explain the virtual absence of real wage growth over a decade. Hambur finds that the greater impact of employer concentration may have caused wage growth between 2011 and 2015 to be 1 per cent lower than otherwise.

This would help explain why not all the (weak) growth in the productivity of labour during the period was passed through to real wages – as conventional economists and business people always assure us it will be. Weak competition allowed employers to keep a lot of it back for themselves.

Part of the competitive process is new firms entering the industry. New firms usually poach staff away from the existing firms. But we know the rate of new entry has declined.

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Don't miss the good news among the bad: we've hit jobs, jobs, jobs

Here is the news: not everything in the economy is going to hell. Right now, jobs, jobs, jobs are going great, great, great.

The news media (and yours truly) focus on whatever’s going wrong – the cost of living, interest rates, to take two minor examples – because they know that’s what interests their paying customers most.

This bias in our thinking exists because humans have evolved to be continually on the lookout for threats. Those threats used to be wild animals, poisonous berries and the rival tribe over the river, but these days they come more in the form of politicians who aren’t doing their job and business people on the make.

If you’re not careful, however, the preoccupation with bad news can leave you with a jaundiced view of the total picture. Everything’s bad and nothing’s good.

But it’s rare for anything to be all bad or all good. And, particularly where the economy’s concerned, it’s common for good things and bad things to go together.

For instance, when unemployment is high, inflation is usually low. And when inflation is high, unemployment’s usually low. (It’s in the rare event where they’re both high at the same time – “stagflation” – that you know we’re really in trouble.)

So, when our present Public Enemy No. 1 – Reserve Bank governor Dr Philip Lowe – began a speech last week by making this point, I realised I should make sure that you, gentle reader, hadn’t missed the rose among all the thorns.

Lowe said the high inflation we’re experiencing was “one of the legacies of the pandemic and of Russia’s invasion of Ukraine”. But “another remarkable, but less remarked upon, legacy of the pandemic is the significant improvement in Australia’s labour market”.

“Significant improvement” is putting it mildly. Have you heard of “full employment”, where everyone who wants a job has one? It’s the way our economy used to be for about three decades following World War II.

But you have to be as ancient as me to remember what it was like. One reason I quit my job and embarked on a course that eventually led me to this august organ was the knowledge that, should I need to get a job, all I had to do was wait until next Saturday’s classified job ads, and pick the one I wanted.

That’s full employment. And the world hasn’t been like that since Gough Whitlam was prime minister. Until now. We have more people with jobs than ever in our history.

At about 3.5 per cent, the rate of unemployment is lower than at any time since 1974. And before any of the imagined experts let fly on Twitter, this is not because any government, Labor or Liberal, has fiddled the figures.

What’s true is that, in recent decades, more people have been under-employed – they haven’t been able to get as many hours of work as they’ve needed.

But as Lowe says, in recent times, people have found it easier to obtain more hours of work. So the rate of underemployment is at multi-decade lows, and the proportion of jobs that are full-time is higher than it’s been in ages.

We now have 64 per cent of people of working-age actually in a job, the highest ever. The proportion of people either already in a job or actively seeking one – the “participation rate” - is also at its highest.

A lot of this is explained by the record high in women’s participation in the labour force.

Lowe says the rate of participation by young people is “the highest it has been in a long time” and the youth unemployment rate is “the lowest that it has been in many decades”.

If all that’s not worth celebrating, I don’t know what is.

But for all those desperate to find a negative – often for reasons of partisanship – it’s not that you can’t believe the figures. It’s this: can you believe they’ll continue?

With the Reserve raising interest rates so fast and far to slow the economy’s growth and reduce inflation pressure, it’s clear that this is as good as it gets in the present episode.

For the past couple of months, we’ve seen the figures edging back a fraction from their best, and on Thursday we’ll see if that’s yet become a trend.

At present, Lowe is at the controls bringing the economic plane in to land. He’s aiming for a soft landing, but may miscalculate and give us a bumpy landing which, to mangle the metaphor, will send unemployment shooting up.

If so, we may have had just a fleeting glimpse of full-employment nirvana before it disappeared into the mist.

But for the more optimistically inclined, even if the landing is harder than planned, we’ll have started from a much lower unemployment rate than in past recessions, meaning it won’t go as high as it has before, and it should be easier to get back to the low levels we’d now like to become accustomed to.

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Why economists keep getting it wrong, but never stop doing sums

Why are economists’ forecasts so often wrong, and why do they so often fail to see the freight train heading our way? Short answer: because economists don’t know as much about how the economy works as they like to think they do – and as they like us to think they do.

What happens next in the economy is hard to predict because the economy is a beehive of humans running around doing different things for different reasons, and it’s hard to predict which way they’ll run.

It’s true we’re subject to herd behaviour, but it’s devilishly hard to predict when the herd will turn. Humans are also prone to fads and fashions and joining bandwagons – a truth straightlaced economists prefer to assume away.

I think it embarrasses economists that their discipline’s a social science, not a hard science. Their basic model of how the economy works became entrenched long before other social sciences – notably, psychology – had got very far.

They dealt with the human problem by assuming it away. Let’s assume everyone always acts in a rational, calculating way to advance their self-interest. Problem solved. And then you wonder why your predictions of what “economic agents” will do next are so often astray.

Actually, the economists don’t wonder why they’re so often wrong – we do. They prefer not to think about it. Anyway, there’s this month’s round of forecasts we need to get on with.

The economists’ great mission over the past 80 years has been to make economics more “rigorous” – more like physics – by expressing economic relationships in equations rather than diagrams or words.

These days, you don’t get far in economics unless you’re good at maths. And the better you are at it, the further up the tree you get. The academic profession is dominated by those best at maths.

Trouble is, although using maths can ensure that every conclusion you draw from your assumptions is rigorously logical, you’ll still get wrong answers if your assumptions are unrealistic.

In the latest issue of the International Monetary Fund’s magazine, the ripping read named Finance and Development, a former governor of the Bank of Japan reminds his peers about the embarrassing time in 2008, after the global financial crisis had turned into the great recession, when Queen Elizabeth II, visiting the London School of Economics, asked the wise ones why none of them had seen it coming.

With frankness uncharacteristic of the Japanese, the former governor observed that King Charles could go back and ask the same question: why did no one foresee that the economic managers’ response to the pandemic would lead to our worst inflation outbreak in decades?

One answer would be: because all our efforts to use computerised mathematical modelling to make our discipline more rigorous have done little to make us wiser. The paradox of econometric modelling is that, though only the very smart can do it, the economy they model is childishly primitive, like a stick-figure drawing.

The best response some of the world’s economists came up with, long after the Queen had gone back to her palace, was that academic economists had largely stopped teaching economic history.

These days, economists can’t do anything much without sets of “data” to run through their models. And before computerisation, there were precious few data sets. But those who forget history are condemned to . . .

The great temptation economists face is the one faced by every occupation: to believe your own bulldust. To be so impressed by the wonderful model you’ve built, and so familiar with the conclusions it leads you to, you forget all its limitations – all the debatable assumptions it’s built on, and all the excluded variables it isn’t.

As part of the academic economists’ campaign for an inquiry into the Reserve Bank, some genius estimated that the Reserve’s reluctance to cut its already exceptionally low official interest rate even lower in the years before the pandemic had caused employment to be 250,000 less than it could have been.

Only someone mesmerised by their model could believe something so implausible. Someone who, now they’ve got a model, can happily turn off their overtaxed brain. There’s no simple linear, immutable relationship between the level of interest rates and the strength of economic growth and the demand for labour.

At the time, it was obvious to anyone turning their head away from the screen to look out the window that, with households already loaded with debt, cutting rates a little lower wouldn’t induce them to rush out and load up with more – the exception being first-home buyers with access to the Bank of Mum and Dad, who as yet only aspired to be loaded up.

To be fair to the Reserve in this open season for criticism, it’s far more prone to admitting the fallibility of its modelling exercises than most modellers are – especially those “independent consultants” selling their services to vested interests trying to pressure the government.

In its latest statement on monetary policy, the Reserve explains how its modelling finds that supply-side factors explain about half the rise in the consumer price index over the year to September 2022.

But then it used a more sophisticated “dynamic stochastic general equilibrium model” which found that supply factors accounted for about three-quarters of the pick-up in inflation.

The Reserve’s assistant governor (economic), Dr Luci Ellis, told a parliamentary committee last month that this “triangulation” left her very confident that the demand side accounted for at least a quarter and probably up to a third of the inflation we’ve seen.

(Remembering the debate about the extent to which the present inflation surge reflects businesses sneaking up their profit margins – their “mark-ups,” in econospeak – note that this second model includes “mark-up” as part of the supply side’s three-quarters. Always pays to read the footnotes.)

One of the tricks to economics is that many of the economic concepts central to the way economists think are “unobserved” – the official statisticians can’t measure them directly. So you need to produce a model to estimate their size.

A case in point is the economists’ supposed measure of full employment, the NAIRU – non-accelerating-inflation rate of unemployment – the lowest the rate of unemployment can fall to before this causes wage and price inflation to take off.

Some of those business economists who believe the Reserve hasn’t raised interest rates nearly enough to get inflation down justify this judgment by saying our present unemployment rate of 3.7 per cent is way, way below what conventional modelling tells us the NAIRU is: about 5 per cent.

But Ellis told the parliamentary committee that the Reserve had rejected this estimate. The “staff view” was that the NAIRU had moved from “the high threes to the low fours”, and this was what its forecasts were based on.

So why dismiss the conventional model? Because, Ellis explained, it’s driven solely by demand-side factors. It’s “not designed to handle the supply shocks that we have seen over COVID”.

Oh. Really. Didn’t think of that. Mustn’t have had my brain turned on.

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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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