INFLATION, TAX & THE COST OF LIVING

May 2024

The economy has been going through huge ups and downs since COVID arrived in early 2020. Since most of you weren’t taking a great deal of notice of the economy that long ago, let me give you a quick summary. To slow the spread of the virus while a vaccine was being developed, governments locked the economy down, getting as many people as possible to work from home, closing schools and many shops, and telling people to stay in their homes as much as possible. Australia’s borders were closed to people coming and going, though many overseas students were encouraged to return to their home countries. The Australian states closed their borders to interstate travel.

This hugely reduced economic activity, causing an immediate recession and sending unemployment shooting up. But to ensure this didn’t cause lasting damage to the economy, the Reserve Bank cut the official interest rate to almost zero and the federal government spent a fortune on JobKeeper payments and many other things. As well, the state governments spent up big.

This worked like a charm. As soon as the lockdowns ended, the economy rebounded. Once people were allowed out of their homes, they really caught up with their spending. The economy boomed, with employment growing and unemployment falling like a stone. The boom, coming before our borders had been reopened to immigrants, caused the rate of unemployment to fall to 3.5 per cent, its lowest in almost 50 years. With job vacancies far exceeding unemployment, the economy had returned to full employment for the first time in five decades. Everything seemed wonderful, until we – like the other advanced economies – noticed prices shooting up.

The return of inflation

Until then, and like all the advanced economies, Australia had enjoyed years of low inflation, with the rate of price increases staying in the RBA’s target range of 2 to 3 pc on average since the mid-1990s. In the years before the pandemic, the RBA even had trouble getting inflation up to the bottom of the target range. But from early in 2022, prices started rising rapidly and, by the end of 2022, inflation reached a peak of 7.8 per cent. Similar things were happening in the other advanced economies. What caused this sudden surge in inflation, the worse we had seen for 30 years?

Two quite separate developments. The first factor was us being hit by global supply-side price shocks arising from disruptions caused by the pandemic. When people were locked up in their homes, they couldn’t get out and buy services such as restaurant meals, go to shows and sporting matches, or travel. But they could use the internet to buy things to improve their homes, new appliances or even new cars. So, while spending on services collapsed, spending on goods took off.  This sudden surge in the purchase of goods led to shortages – including a shortage of computer chips - and higher prices. Because, these days, all the rich countries import many manufactures from places such as China, this surge in demand for goods led to shortages of ships and shipping containers. So the pandemic led to temporary supply shortages, which pushed up prices.  As well, Russia’s attack on Ukraine caused a big increase in oil and gas prices.

But the second factor, adding to these problems on the supply – or production – side of the economy, was a strong surge in the demand for goods and services. Where did this come from? From all the economic stimulus the managers of the macro economy had applied during the lockdowns to hold the economy together. The official cash rate was already down to 0.75 per cent, but the RBA cut it almost to zero, 0.1 per cent. It also used unconventional measures – “quantitative easing”, or the buying of second-hand government bonds – to lower medium-term interest rates. As well, from a virtually balanced budget in the financial year to June 2019, the government’s hugely increased spending caused annual deficits of $85 billion (4.3 pc of GDP), $134 billion (6.4 pc of GDP) and, in 2021-22, $32 billion (1.4 pc). The state governments greatly increased their spending also.

With the wisdom of hindsight, it’s clear the economic managers provided a lot more monetary and fiscal stimulus than turned out to be needed. As a result, this excess demand for goods and services outstripped our businesses’ ability to increase their production of goods and services, thus causing prices to rise. So the surge in prices in 2022 had two quite different causes. The supply-side problems were beyond our control, but would sort themselves out in time. The excessive demand, however, was caused by our own miscalculations and so required the economic managers to move the two instruments for managing the strength of demand – monetary policy and fiscal policy – from a stimulatory setting to a restrictive setting.

The policy response to high inflation

The RBA responded to the worsening inflation in May 2022, just before the federal election in which the Morrison Coalition government was replaced by the Albanese Labor government. The RBA began increasing the official cash rate and, by November 2023, had raise it 13 times, from 0.1 pc to 4.35 pc. Note that, although 4.35 pc is not high by the standards of earlier decades, this was the biggest and fastest increase in rates ever, meaning it had a particularly sharp effect on those households with big home loans. There’s no doubt the present “stance” of monetary policy is very restrictive.

The surge in tax collections

And while all this was happening to monetary policy, the budget’s “automatic stabilisers” were tightening fiscal policy. Since the change of government in May 2022, the boom in the economy and the return to full employment caused income tax collections to grow strongly. (As well, the world prices of iron ore and other export commodities have stayed much higher than Treasury was expecting, causing mining companies to pay more company tax than expected.)

When more people get jobs, they go from being on JobSeeker to paying income tax. When strong demand for labour allows those who want to to move from part-time to full-time work, they pay more income tax. And when higher inflation causes people to get bigger pay rises, this increases their average rate of income tax, often by pushing them into a higher tax bracket. What people call “bracket creep”, economists call “fiscal drag”. It’s one of the budget’s main built-in, “automatic stabilisers” which, without any explicit decision by the government, act automatically to take a bigger tax bite out of people’s pay rises, so leaving them less to spend and helping to slow demand.

The incoming Labor Treasurer Jim Chalmers’ main part in this has been to spend as little of this revenue windfall as possible, allowing almost all of it to flow through to the budget’s bottom line. So, from a deficit of $32 billion in the year to June 2022, the budget flipped to a surplus of $22 billion in the year to June 2023. That’s a turnaround of $54 billion, equivalent to 2.3 pc of GDP. The “stance” of fiscal policy switched from expansionary to contractionary, adding to the downward pressure on demand coming from monetary policy. And we know from the new budget that fiscal policy stayed contractionary in the financial year just ending, 2023-24, with another surplus of $9 billion expected.

The price mechanism and “gouging”

Before I move on to the question of the cost of living, I must tell you about a big difference between the thinking of economists and the thinking of normal people. Economists believe that the best way to allocate resources in an economy is via the use of markets. They believe that the forces of supply and demand in a particular market interact to set the price of the particular good or service. And they believe that, when something happens to disrupt the market, the “price mechanism” works to bring demand and supply back together, and re-establish “equilibrium”. If something happens that causes the demand for a product to exceed its supply, sellers are able to increase the price they are charging. This price increase sends different messages to the buyers than to the sellers. The message to buyers is: don’t use any more of this product than you have to, and see if you can find cheaper substitutes for it. The message to sellers is: producing this product has become more profitable, so make more of it. So, putting the two sides together, the “price mechanism” works to reduce demand and increase supply, thus causing the price to fall back to pretty where it was before the disruption.

I hope you know all that. The point is that when businesses respond to excess demand for their product by using the opportunity to raise their prices, economists regard this as the completely normal way markets work to restore equilibrium. It’s thus a good thing. But consumers see it very differently. They often object to businesses raising their prices even though their costs haven’t increased. They criticise it as “gouging” the customers. (My opinion? I think markets don’t always work as well as economic theory assumes they do.)

The cost of living

Whereas economists focus on inflation and ensuring prices don’t rise too rapidly, and worry about wages rises in response to the higher prices helping to keep inflation high, ordinary people worry about the rising “cost of living”. They focus on how fast prices are rising – particularly the prices they see in the supermarket - but tend not to notice that what matters most to them is whether their wage or other income is keeping up with prices. And many may not notice that they suffer when their wage rises cause their average rate of income tax to rise, leaving them less money to spend.

Voters have had a lot to complain about in the past two years or so. Consumer prices have rising at a much faster rate than usual. As well, until recent months their wages haven’t kept up with the rise in prices. And the government has been taking a bigger tax bite out of their wages.

But what makes it worse is that the standard way central banks and governments stop the cost of living rising so fast is to make it worse to make it better. When prices are rising because households’ demand for goods and services is rising faster than the economy’s ability to supply them, the standard response by the economic managers is to squeeze households’ budgets so they can’t spend as much. When this causes demand for their products to slow, businesses aren’t able to raise their prices as much. The main way the RBA squeezes households is by raising the interest rates they pay, particularly on their mortgages. And this time, for different reasons, rents have been rising rapidly.

All this presents a problem for our politicians. The voters are crying out for them to do something to fix the cost-of-living crisis. But the only way the authorities can achieve a lasting improvement in the rate at which prices are rising is to keep the pain on for a while yet. This is why Mr Chalmers is doing fairly minor things like giving every household a $300 electricity rebate. What will do much more to ease some of the pain is the rejig of the long-planned stage 3 tax cuts. Those tax cuts are the main reason the budget is now expected to swing from a surplus of $9 billion in the year just ending, to a deficit of $28 billion in the new financial year. The budget’s forecasts say this move to expansionary fiscal policy will not stop inflation returning to the target range in the coming year and will ensure we avoid recession and achieve a “soft landing”, with the unemployment rate rising no higher than 4.5 pc. Let’s hope this is what happens.

Read more >>

Treasury tells all: how the housing market is so stuffed up

Would you believe that our ever-rising house prices are a sign there’s something badly wrong with our housing market? Would you believe our housing arrangements are worse than in the other rich countries?

Well, I would when that’s what Treasury is admitting in the annual sermon it tacks onto the budget papers. This year it’s about meeting our housing “challenge”.

In a well-functioning economy, its industries can respond to the increase in demand for their good or service by increasing their supply without much delay. Of course, it takes a lot longer to build a new house or apartment than it does to churn out more ice-creams or haircuts.

But, even so, our housing industry has been too slow to respond to the increased demand for housing. This comes from our rising population which, thanks to continuing high levels of immigration, has grown faster than most of the other rich countries.

Figures from the Organisation for Economic Co-operation and Development, a group of mainly advanced economies, show that our number of dwellings per 1000 people increased only from 403 to 420 between 2011 and 2022. This compared poorly with most other countries.

In 2011, our level of housing supply was just 92 per cent of the OECD average. And by 2022 it had fallen to 90 per cent. This was behind countries such as Canada, the United States and England.

Our completions of new private dwellings reached a peak of more than 200,000 a year in 2018-19 but have since fallen to about 160,000 a year. This has left us with an acute shortage of properties available to buy or rent.

Nationwide, the number of homes being offered for sale has fallen since 2015, while the number offered for rent has been falling since early 2020.

Speaking of renting, Treasury says the rental market is considered to be in balance – meaning renters have little trouble finding a place and landlords have little trouble finding a tenant – when the vacancy rate is about 3 per cent. In cities such as Sydney and Melbourne it’s now down to about 0.5 per cent. Ouch.

Not surprisingly, when demand grows faster than supply can keep up with, prices rise. The rise in the cost of newly built homes, and the cost of renting, have contributed significantly to the general cost-of-living crisis.

So, why has our housing industry become so slow to respond to increased demand? Treasury says the causes are “multifaceted, complex and affect all stages of the housing construction process, including all levels of government and industry”.

One way to improve the market’s response to greater demand is to accelerate the construction process. But Treasury says that completion times for apartments, townhouses and detached houses actually worsened by 39 per cent, 34 per cent and 42 per cent respectively over the 10 years to June 2023.

Calculations (or, if you want to sound more scientific, “modelling”) by a federal government agency says that, over the next six years, the nation’s existing unmet demand will never be satisfied unless completion times are speeded up. In six years’ time, we’ll still have a backlog of about 39,000 dwellings.

Treasury says the expectation that churning out homes faster will help to lower house prices is supported by empirical research. One study found that those OECD countries that built more housing over the 15 years to 2015 experienced lower real growth in house prices.

Another study showed that adding an extra 50,000 homes a year for a decade could reduce house prices by up to 20 per cent.

So, what can be done to increase the housing industry’s annual output? Treasury says planning and zoning restrictions can limit the speed at which land is made available.

Delays in approving development applications by local councils can be excessive. I think councils and government departments are monopolists and, like all monopolists, they take advantage of the lack of competition.

Private sector monopolists whack up their prices and don’t worry about the quality of the service they provide. Public monopolists make you jump through hoops that aren’t strictly necessary, and they fix your problem in their own good time.

I wonder whether, over all these years, those outfits have ever had much pressure on them to lift their game. If that changed, I’m sure we could get more homes built per year.

Treasury says average times for the approval of development applications vary by state, with Victoria and NSW experiencing the longest waiting times early this month of 144 and 114 days, respectively.

It shouldn’t surprise you that Treasury wants housing to be delivered in well-located areas where the demand is greatest.

Dense development in the “missing middle” of major cities, where households can reside closer to jobs in areas with higher quality amenities and infrastructure, has been limited by planning and zoning restrictions and slow release of infill land, Treasury says.

Global supply constraints and price shocks on imported building materials associated with the pandemic have added to the cost of construction, driving up the price of newly built homes. Although prices aren’t rising as fast as they were, they haven’t fallen back.

Shortages of building labour have also increased the prices of newly built homes and slowed the pace of construction. The growth in non-dwelling construction activity has drawn labour away from home building. The productivity of labour in construction has not improved since the early 2000s.

The industry blames these shortages on the drop-off in rates of skilled migration during the pandemic. But I wonder if the deeper problem is that the former ready availability of imported labour tempted the industry to save money by failing to train as many apprentices as they should have.

So, what’s the Albanese government doing about this mess? It’s finally grasped the nettle and is spending big – $32 billion, including $6 billion in this month’s budget – to “address historical underinvest in the housing system” and build 1.2 million new, well-located homes. We’ll see how they go.

Read more >>

We need to talk (sense) about immigration

It’s a safe bet there’ll be much talk about immigration between now and the next federal election, due this time next year. Peter Dutton has seen to that. Trouble is, much of it will just be hot air, much of it will be misleading and much will reflect the vested interests of the person doing the talking.

And some of it will reveal us at our worst: our tendency to blame incomers for all our ills. The more ignorant among us will shout abuse at some poor soul they see on the street whose clothing or skin colour looks different.

But none of that says our immigration policy isn’t a legitimate subject for sensible debate. Personally, I’d like to see it a lot lower.

You know strange things are happening when the leader of the Liberal Party says he wants to slash immigration. The Libs are, and have always been, the party of high migration.

But they’ve fallen on hard times with the loss of so many heartland seats to the teals, and Dutton figures his best hope of winning is to pick up seats in the outer suburbs, where their social class says people should vote Labor, but their social values give them greater affinity with the conservatives.

It’s because many immigrants gravitate to the outer suburbs that the locals find it easier to blame them for traffic congestion and other overcrowding, rather than governments’ failure to build enough infrastructure.

Ordinary Australians have always tended to think there’s been too much immigration. But the Liberals support it because it’s what business wants. The easiest way to increase profits is to sell into a growing market. Consider what you’d want if you were in the business of building new homes.

In recent times, Labor has supported high immigration too, mainly because it doesn’t want to get offside with business.

Almost all economists support strong immigration. I suspect that’s because their obsession with economic growth makes them susceptible to the fallacy that bigger is always better. Not if it comes at the expense of quality.

The economists do have one sensible point to make. Many people fear the migrants will take all the jobs. But the dismal scientists refute this. The newcomers and their families add about as much to the demand for labour to produce more goods and services as they add to the supply of workers.

All this – the gap between voters’ doubts about immigration and the pressure on governments to keep it coming – helps explain what seasoned political observers know: the pollies professed enthusiasm for cutting immigration is a lot stronger during election campaigns than it is after an election’s become a receding memory.

As for Dutton’s proffered solution, it doesn’t amount to much and would do little to fix the problems he claims he wants to fix. By the same token, the government’s claims that his plans would hasten the end of the universe are exaggerated.

Here’s a tip. Any pollie banging on about what they intend to do to the “permanent migration” program either doesn’t know what they’re talking about or, more likely, is pretty sure you don’t. What affects the economy’s workings is not permanent migration so much as “net overseas migration”, which is arrivals minus departures (ignoring people coming or going on short visits).

This actually went negative when we closed our borders during the pandemic, but soared after we reopened them. Net migration exceeded 520,000 in the year to June 2023, and over the year to this June may be as much as 400,000.

This huge surge is what’s causing the fuss. A lot of the swing is explained by incoming overseas students, which the universities will tell you is a wonderful thing. It’s one of our biggest export earners, and the unis have come to rely on this income to fund much of their research work.

I have some sympathy for them. Successive federal governments have made them more dependent on overseas students by using this as an opportunity to limit the support the unis get from the budget.

Even so, it seems clear that the inflow of students needing somewhere to live has contributed to the recent acute shortage of rental accommodation and added to the jump in rents.

The Albanese government wants to see a big drop in net migration and, to this end, is talking about imposing caps on how many overseas students the unis can admit.

The unaffordability of home ownership is a good issue for the election campaign, but Dutton is drawing a long bow in linking it to immigration. Homes have become harder to afford over several decades for various reasons. The recent immigration surge won’t have made much difference.

What’s true is that the more people we let in, the more capital investment – in the form of homes, business equipment and public infrastructure – we need to meet their needs. When this investment fails to keep up with the growth in the population, problems arise and the benefits to the economy that the advocates of high immigration have promised don’t happen.

Read more >>

How the budget was hijacked by a $300 cherry on the top

Talk about small things amusing small minds. It looked like a textbook-perfect exercise in budget media management by Anthony Albanese’s spin doctors. Until it blew up in the boss’s face. Trouble is, it wasn’t just the tabloid minds that got side-tracked. So did the supposed financial experts.

Budget nights are highly stage-managed affairs, as the spinners ensure all the mainstream media are focused on the bit the boss has decided will get the budget a favourable initial reception.

You pre-announce – or “drop” to a compliant journo – almost all the budget’s measures, big or small, nice or nasty. This time they even revealed the exact size of the old year’s surplus. But you hold back one juicy morsel, knowing the media’s obsession with what’s “old” and what’s “new” will guarantee it leads every home page.

I call it the cherry on the top. And this time it was the $300 energy rebate going to all households. A prize for everyone (except the pensioners, who last year got $500) and proof positive that Jim Chalmers feels their cost-of-living pain. (It would have been much better to announce the rejig of the stage 3 tax cuts, of course, but Albo had to play that card early, to help with a dicey byelection.)

How were the spinners to know the punters would be incensed when they realised it would even be going to Gina Rinehart? And get this: if a billionaire owned, say, 10 investment properties, they’d be getting 11 lots of $300. Outrageous.

The way some tabloids tell it, the punters were so offended they were rioting in the streets, demanding Chalmers stick their $300 up his jumper. It was the Beatles returning their MBEs.

Why wasn’t the rebate means tested? Perfectly good reason: because that would have been more trouble and expense than it was worth. Don’t bother mentioning: because, apart from being a popular giveaway, the rebate’s other purpose was to help reduce the consumer price index by 0.5 of a percentage point, and means testing it would have reduced the reduction.

How so many shock jocks and journos could get so steamed up about such a small thing is hard to explain. But what’s much harder to explain is why so many otherwise sensible economists got so steamed up about the wickedness and counterproductive wrongheadedness of it.

I think it’s a perfectly sensible device to hasten progress in getting inflation down to the target zone, and by no means the first time governments have used it. The temporary energy rebate will cost $3.5 billion over two years and the continuing increase in the Commonwealth rent allowance for people on social security will cost $880 million over its first two years.

So while it’s true that increased government spending adds to inflationary pressure, to argue furiously about $4.4 billion in an economy worth $2.7 trillion a year shows the lack of something the late great econocrat Aussie Holmes said every economist needed: “a sense of the relative magnitudes”. It’s chicken feed.

But the financial experts’ righteous indignation about what they see as an inflationary attempt to fudge the inflation figures seemed to utterly distort their evaluation of the budget and its effect on the macroeconomy.

The budget was a “short-term shameless vote-buying exercise” in which Labor abandoned all pretence of fiscal responsibility and went on a massive spending spree. The budget’s return to surplus had been abandoned, leaving us with deficits as far as the eye could see. We now had a permanent “structural deficit”. The hyperbole flowed like wine.

It’s true that the policy decisions announced in the budget are expected to add $24 billion to budget deficits over the next four years. But if, as the financial experts assert, getting inflation down ASAP is the only thing we should be worrying about, then it’s really what’s added in the coming year that matters most. Which reduces the size of Chalmers’ crimes to less than $10 billion.

It’s true, too, that the expected change in the budget balance from a $9 billion surplus in the financial year just ending, to a deficit of $28 billion in the coming year, is a turnaround of more than $37 billion. Clearly, and despite Chalmers’ denials, this changes the “stance” of fiscal policy from restrictive to expansionary.

But the financial experts seem to have concluded this development can be explained only by a massive blowout in government spending. Wrong. It’s mainly explained by the $23-billion-a-year cost of the stage 3 tax cuts.

Perhaps they were misled by the budget’s Table of Truth (budget statement 3, page 87) which, like everything in economics, has its limitations. The tax cuts don’t rate a mention. Why not? Because they’ve been government policy since 2018, and so have been hidden deep in the budget’s “forward estimates” for six years.

But whatever its main cause, surely this shift to expansionary fiscal policy puts the kybosh on getting inflation back down to the target range? Well, it would if shifts in the stance of the macroeconomic policy instruments were capable of turning the economy on a sixpence.

Unfortunately, the first rule of using interest rates to slow down or speed up the economy is that this “monetary policy” works with a “long and variable lag”.

The financial experts seem to have forgotten that managing the strength of demand – and fixing inflation without crashing the economy – is all about getting your timing right.

So is predicting the consequences of a policy change. Two years of highly restrictive monetary and fiscal policies won’t be instantly reversed by a switch to expansionary fiscal policy. As the new boss of the Grattan Institute, Aruna Sathanapally, has wisely noted, at the heart of the budget is the sad truth that the economy is weak, which is one reason inflation will fall.

The inflation rate peaked at just under 8 per cent at the end of 2022. By March this year it had fallen to 3.6 per cent. To me, that’s not a million miles from the Reserve Bank’s target range of 2 per cent to 3 per cent.

But the financial experts seem to have convinced themselves there’s a lot of heavy lifting to go. They even quote one brave soul saying the Reserve will need two more rate rises. I think it’s more likely we’ll get down to the target in the coming financial year, and that the move to expansionary fiscal policy will prove well-timed to help reverse engines and ensure the Reserve achieves its promised soft landing.

Chalmers’ decision to use the $300 rebate to reduce the consumer price index directly by 0.5 of a percentage point adds to my confidence. It’s particularly sensible if, as the financial experts have convinced themselves, the inflation rate’s fall is now “sticky”.

Those dismissing this decline as merely “technical” display their ignorance of how wages and prices are set outside the pages of a textbook. To everyone but economists, the CPI is the inflation rate. It’s built into many commercial contracts and budget measures.

It’s a safe bet this device will cause the Fair Work Commission’s annual increase in minimum award wage rates – affecting the bottom quarter of the workforce – to be about 0.5 of a percentage point lower than otherwise. And do you really think employers won’t take the opportunity to reduce wage rises accordingly? I doubt they’re that generous.

Read more >>

Budget's message: maybe we'll pull off the softest of soft landings

When normal people think about the economy, most think about the trouble they’re having with the cost of living. But when economists think about it, what surprises them is how well the economy’s travelling.

It’s been going through huge ups and downs since COVID arrived in early 2020. By 2022, it was booming and the rate of unemployment had fallen to 3.5 per cent, its lowest in almost 50 years. Meaning we’d returned to full employment for the first time in five decades.

Trouble was, like the other rich economies, prices had begun shooting up. The annual rate of inflation reached a peak of almost 8 per cent by the end of 2022.

The managers of the economy know what to do when the economy’s growing too fast and inflation’s too high. The central bank increases interest rates to squeeze households’ cash flows and discourage them from spending so much.

The Reserve Bank started raising the official “cash” interest rate in May 2022, just before the federal election. It kept on raising rates and, by November last year, had increased the cash rate 13 times, taking it from 0.1 per cent to 4.35 per cent.

While this was happening, Treasurer Jim Chalmers was using his budget – known to economists as “fiscal policy” – to help the Reserve’s “monetary policy” to increase the squeeze on households’ own budgets, reducing their demand for goods and services.

Why? Because, when businesses’ sales are booming, they take the chance to whack up their prices. When their sales aren’t all that brisk, they’re much less keen to try it on.

The government’s tax collections have been growing strongly because many more people had jobs, or moved from part-time to full-time, and because higher inflation meant workers were getting bigger pay rises.

As well, iron ore prices stayed high, meaning our mining companies paid more tax than expected.

Chalmers tried hard to “bank” – avoid spending – all the extra revenue. So, whereas his budget ran a deficit of $32 billion in the year to June 2022, in the following year it switched to a surplus of $22 billion, and in the year that ends next month, 2023-24, he’s expecting another surplus, this time of $9 billion.

So, for the last two years, Chalmers’ budget has been taking more money out of the economy in taxes than it’s been putting back in government spending, thus making it harder for households to keep spending.

Guess what? It’s working. Total spending by consumers hardly increased over the year to December 2023. And the rate of inflation has fallen to 3.6 per cent in the year to March. That’s getting a lot closer to the Reserve’s target of 2 to 3 per cent.

The Reserve’s rate rises have been the biggest and fastest we’ve seen. Wages haven’t risen as fast as prices have and, largely by coincidence, a shortage of rental accommodation has allowed big increases in rents.

And on top of all that you’ve got the budget’s switch from deficits to surpluses. Much of this has been caused by bracket creep – wage rises causing workers to pay a higher average rate of income tax, often because they’ve been pushed into a higher tax bracket.

Bracket creep is usually portrayed as a bad thing, but economists call it “fiscal drag” and think of it as good. It acts as one of the budget’s main “automatic stabilisers”, helping to slow the economy down when it’s growing too quickly and causing higher inflation.

The Reserve keeps saying it wants to get inflation back under control without causing a recession. But put together all these factors squeezing household budgets, and you see why people like me have worried that we might end up with a hard landing.

Which brings us to this week’s budget. The big news is that in the coming financial year the budget is expected swing from this year’s surplus of $9 billion to a deficit of $28 billion.

This is a turnaround of more than $37 billion, equivalent to a big 1.3 per cent of annual gross domestic product. So, whereas for the past two financial years the “stance” of fiscal policy has been “contractionary” (acting to slow the economy), it will now be quite strongly “expansionary” (acting to speed it up).

Some people who should know better have taken this turnaround to have been caused by a massive increase in government spending. They’ve forgotten that by far the biggest cause is the stage 3 tax cuts, which will reduce tax collections by $23 billion a year.

The same people worry that this switch in policy will cause the economy to grow strongly, stop the inflation rate continuing to fall and maybe start it rising again. But I think they’ve forgotten how weak the economy is, how much downward pressure is still in the system, and how long it takes for a change in the stance of policy to turn the economy around.

Treasury’s forecasts say the economy (real GDP) will have grown by only 1.75 per cent in the financial year just ending, will speed up only a little in the coming year and not get back to average growth of about 2.5 per cent until 2026-27.

So, the rate of inflation will continue falling and should be back into the target range by this December. All this would mean that, from its low of 3.5 per cent – which had risen to 4.1 per cent by last month – the rate of unemployment is predicted to go no higher than 4.5 per cent.

That would be lower than the 5.2 per cent it was before the pandemic, and a world away from the peak of about 11 per cent in our last big recession, in the early 1990s.

So maybe, just maybe, we’ll have fixed inflation and achieved the softest of soft landings. Treasury’s forecasting record is far from perfect, to put it politely, but it is looking possible – provided we don’t do something stupid.

Read more >>

Budget will make us better off now, but worse off later

It’s said you can tell a government’s true priorities from what it does in its budget. If so, the top priority of Anthony Albanese’s government is not to have any priorities.

Rather than focusing on fixing the most pressing of our many problems, his preference is to be seen doing a little to alleviate all of them. In this budget, (almost) every voter wins a prize.

Certainly, every powerful interest group gets something to placate it. Of course, when you’re handing out so many prizes, most of them aren’t all that big.

Unfortunately, it’s a strategy that works better politically – where every vote counts – than economically, where sticking to what you’re good at brings better returns.

Fortunately, however, this budget has been “back-end loaded”. Most of what’s likely to be wasteful spending will come sometime in the next 10 years. Most of the budgetary cost of the sensible decisions starts from the first day of the new financial year, in just seven weeks’ time.

So let’s start with the good half of the budget, and leave the bad stuff for later.

By far the greatest political pressure on the government is to ease the intense cost-of-living pressure that so many people are feeling. Since most of the pressure has been caused by rapidly rising prices, this is also the government’s most immediate economic problem.

The trouble for Treasurer Jim Chalmers is that the standard remedy for rapid inflation involves making the pressure worse to make it better. You use higher interest rates and a bigger tax bite out of people’s pay rises to make it harder for households to keep spending, which stops businesses from raising their prices as much.

This explains Chalmers’ repeated but contradictory statement that he wants to ease the cost of living without weakening the efforts – by the Reserve Bank and his own budget surpluses – to get inflation down.

But this is where Albanese’s predilection for the each-way bet actually makes sense. Chalmers has found a way to do the seemingly impossible: ease living pressures a bit, while weakening the inflation fight only a bit.

He’s done this, first, by introducing a $300 power-bill rebate for all households, increasing the rent allowance paid to people receiving welfare benefits, and freezing the cost of prescriptions for two years.

This not only helps those people; it also reduces the rise in the consumer price index somewhat. And this, in turn, brings closer the day when the Reserve Bank starts cutting interest rates.

But second, by his rejig of the stage 3 tax cuts. This may be old news, but it’s by far the biggest measure in the budget. Most wage earners will realise how big it is – and how much it helps – when it increases their take-home pay at the start of July.

Albanese and Chalmers took a tax cut the previous government had intended to be of real benefit only to those on incomes well above the average, and changed it to ensure all taxpayers got something.

See? Everyone gets a prize. Everyone on incomes below about $150,000 a year gets more; everyone above that gets less than first intended. As a measure to ease living costs, it’s now far more effective.

Why won’t this $23 billion-a-year tax cut weaken the inflation fight? Because it has been government policy since 2018. It’s likely effect on households’ spending has been built into the Reserve Bank’s decisions to raise interest rates 13 times. Good stuff.

But it’s when we turn to the longer-term Future Made in Australia plans that you see the folly of Albanese’s efforts to stay friends with every interest group on every side.

By far the most important task Albanese must accomplish to secure our economic future is to achieve a smooth transition from fossil fuels to renewables – most of it done by 2030 – without blackouts and avoidable jumps in the cost of electricity.

But, more than that, he must ensure our continuing income from exports by establishing new green, further-processing industries exploiting our new-found strength of being among the world’s cheapest producers of renewable energy. This can be what will keep us prosperous when the world stops buying our fossil fuels.

The government spending needed to get these green industries started is included in the Future Made in Australia project. Trouble is, so is money for a lot of crazy ideas, such as setting up in competition with China as a producer of solar panels.

Albanese’s problem is he wants to say yes to everyone and everything, not just stick to the main chance. He’s saying he can turn us into a renewable energy superpower with one hand while, with the other, he lets the gas industry steam on to 2050 and beyond.

This does not fill me with confidence in the Albanese government’s capability. Quite the reverse.

Read more >>

Labor's persistent refusal to fix the JobSeeker payment is shameful

Remarks by Treasurer Jim Chalmers seem to say there’ll be no one-off increase in the pitifully inadequate rate of unemployment benefits in Tuesday night’s budget. If this is wrong, I’ll be delighted to offer an abject apology. If it’s right, Anthony Albanese and his ministers should hang their heads in shame. They claim to be the good guys, but they aren’t.

And the unions – which, as recent changes in industry policy reveal, have great behind-the-scenes influence over Labor governments – should be ashamed of themselves as well, for their failure to get Albo and co. up to the mark. They claim to represent the interest of the workers, but it turns only those who have jobs. Those still looking for one are on their own.

Do you realise Australia has the lowest benefits for the short-term unemployed among 34 countries in the Organisation for Economic Co-operation and Development?

The lowest? Really? Does that make us the poorest of all those countries? No, of course not. We’d be comfortably among the richest.

So how’s it explained? Well, perhaps we don’t mind if people in other countries think of us as among the stingiest of the rich countries. The kind of person who’d walk past someone in trouble without offering them help. The kind who thinks anyone without much money must be lazy.

Australians tend to think of people on the age pension as poor, but a single pensioner gets $556 a week, which is $170 a week more than the single adult rate of the JobSeeker payment.

In 1996, the dole was about 90 per cent of the age pension, but it’s been allowed to fall steadily and now, despite two small one-off increases in recent years, is little more than two-thirds of what the oldies get.

To cut a long story short, this is because, since the early days of the Howard government, the pension has been indexed to wage growth, while unemployment benefits remain indexed to the consumer price index.

By now, the dole is 26 per cent below the OECD’s poverty line, set at 50 per cent of median (dead middle) income. There are other ways to measure poverty, but the dole’s below all of them.

A common argument for keeping unemployment benefits low is that we don’t want to discourage the jobless from going to the bother of doing a paid job. Talk about treat ’em mean to keep ’em keen.

But this is self-justifying nonsense. The single dole is now just 43 per cent of the full-time minimum wage.

A better argument is that benefits are so low people can be left unable to afford the fares and other costs involved in seeking a job.

Chalmers’ excuse for not increasing JobSeeker is that “we can’t afford to do everything”. But if you believe that, you haven’t thought about it.

Of course we can’t afford to do everything, but a rich country like ours, with a federal budget that will spend more than $700 billion next financial year, can certainly afford to do any particular thing it really wants to.

That’s the point: you can include it among all the things you’ll do if you really want to. Economists are great believers in “revealed preference”: judge people not by what they say, but by what they do.

Budgets reveal a government’s true priorities. What it spends on is what it most wants to do; what it “can’t afford” is something it doesn’t really want.

So the real question is why the government doesn’t want to fix JobSeeker. Well, it’s no secret. It might be the right thing to do, but there are no votes in it. Indeed, there may be votes to be lost.

It’s normal to envy those doing better than we are. But Australians suffer from the strange illness of “downward envy”. “I have to go out to work, while those lazy blighters sit around at home with their feet up, enjoying daytime television.”

And, of course, any money Labor spends helping one of the most deserving groups in society is money it can’t spend trying to buy the votes of the less deserving.

So, terribly sorry, love to help, but just can’t afford it.

If you’re looking for evidence that neither side of politics is up to much, you’ve just found some. I fear you’ll get more on Tuesday night.

Read more >>

The economy is just the means to an end. So, is it working?

We spend a lot of time hearing, reading and arguing about The Economy, and we’ll be doing a lot more of all that after we’ve seen Tuesday night’s federal budget.

But while we’re waiting, let’s take a moment to make sure we know what we’re talking about. What’s the economy for? How does it work? What does it do? Who owns it? Who runs it?

Why am I suddenly so deep and meaningful? Because Dr Shane Oliver, AMP’s chief economist, has written a note saying the economy doesn’t seem to be giving us what we want.

As individuals, it’s easy to think of the economy as something that’s outside ourselves, something that does things to us, over which we have little control.

As individuals, that’s true. But if you take us altogether, it’s not true. Why not? Because if you took all the people out of the economy, there wouldn’t be an economy. What’s more, you wouldn’t need one.

You’d be left with a lot of homes and other buildings, roads, cars and machines that had been abandoned, were just sitting there and so were worthless.

So, in that sense, the economy belongs to all of us because it is us. It’s most of us getting up each morning, going to work and earning a living, and all of us spending what’s been earnt.

Most of us have paid work, some of us do unpaid work, while some of us are still getting an education and others are too old or sick to work. But all of us consume.

So don’t think of the economy as high finance beyond your understanding. It’s actually as basic as you can get. This is why it’s important to remember the economy is just a means to an end.

At its most elemental, the end we’re seeking is for the economy to provide us with food, clothing and shelter, plus a few luxuries. But all of us want to do more than barely subsist. We want our lives to bring us enjoyment.

Economists say we want all our earning and spending to bring us “utility”. A better word would be satisfaction. But it’s no stretch to say what we want from our lives is happiness. And it’s on happiness that Oliver finds we aren’t doing as well as we should be.

All this is why the best way to think about the economy is that it belongs to all of us. Legally, however, most of the capital – whether physical or financial – is owned by companies, big and small. So most of us are employed by companies.

Where does government fit in? Apart from employing a lot of workers, it owns most of the roads and other public infrastructure. It makes the laws that limit what businesses (and the rest of us) are permitted to do and the way we do it.

Governments discourage some business activities and – as we’ve seen with the Albanese government’s recent announcements – seek to encourage others.

But the central bank also uses its control over short-term interest rates to “manage” the strength of the private sector’s total demand for goods and services, encouraging it when unemployment is high, and – as now – discouraging it when inflation is high.

As well, the federal government uses its budget – government spending on one side, taxes on the other – to discourage or encourage private demand. Hence, all the fuss next week.

But how are we, and other rich countries, going in our efforts to use our economic activity – earning and spending – to keep us happy and getting happier? Not well, according to Oliver’s research.

For Australia, he finds that, though our real annual gross domestic product per person has increased fairly steadily over the past 20 years, the average score we give ourselves on our satisfaction with our lives (as surveyed by the World Happiness Report) has actually been falling over the same period.

It’s a similar story for the United States, where its real GDP per person has risen steadily since 1946, while the proportion of Americans describing themselves as “very happy” has fallen slowly over most of that period.

In particular, he finds that younger people in the US, Canada, Australia and New Zealand are the least happy age group. This is a major change from 20 years ago.

Why is this happening? We can all have our own theories, but I think the big mistake many of us – and certainly, most economists – make is to focus on improving our material standard of living: using our increasing income to buy bigger and better things. Homes, cars, smartphones, whatever.

Trouble is, our materialism puts us on a “hedonic treadmill”. We think buying a bit more stuff will make us happier and, at first, it does. But pretty soon the thrill wears off – we get used to our higher standard of living – and tell ourselves it’s actually the next new thing that will make us happy.

Many people use their pursuit of promotions and higher income to make them happier by raising their social status. But this, too, is a step up you can get used to. And, in any case, it’s a zero-sum game. If passing you on the status ladder makes me happier, why won’t being passed by me make you less happy?

Actually, as I explained in a book I wrote some years back, there’s a lot of evidence that what’s better at giving us lasting satisfaction is the quality of our relationships with partners, family and friends. Beats just buying more stuff or getting a promotion.

And while it’s true that the economy, and our small role in it, can be seen as just a means to an end, it turns out that “extrinsic” benefits – such as wanting to earn money because of the nice things it buys – aren’t as satisfying as “intrinsic” benefits: such as finding a job you enjoy doing, not just do for the money it brings.

Read more >>

When politicians talk of 'security', be on your guard

I doubt if you’re waiting with bated breath for next Tuesday night’s federal budget but, since it’s the big set-piece event of my year, I’ve started limbering up. I’ve set my bulldust detector to ping every time I see or hear the word “security”. May I suggest you do the same?

We’ve been hearing a lot of that word lately, particularly from Anthony Albanese and his treasurer, Jim Chalmers. It comes with many adjectives – energy security, food security and, of course, national security – and with many spooky euphemisms: risk, strategic, sensitive, critical and sovereign, not to mention the spookiest of them all, terrorism.

In Albanese’s landmark speech on A Future Made in Australia, he assured us that “strategic competition is a fact of life”. “Nations are drawing an explicit link between economic security and national security,” he told us.

“We must recognise there is a new and widespread willingness to make economic interventions on the basis of national interest and national sovereignty,” he said. His government would be guided by three principles, the second of which was that “we need to be more assertive in capitalising on our comparative advantages and building on sovereign capability in areas of national interest”.

His government would be “securing greater sovereignty over our resources and critical minerals”.

Indeed so. When Chalmers announced the government’s new foreign investment rules last week, they seemed to be all about security.

“By providing more clarity around sensitive sectors and assets,” Chalmers said, “our reforms will give businesses and investors greater certainty while safeguarding our national security.

“National security threats are increasing due to intensifying geopolitical competition and risks to Australia’s national interests from foreign investment have evolved at the same time as competition for global capital is becoming more intense.”

The reforms to our foreign investment rules would “boost economic prosperity and productivity, while strengthening our ability to protect the national interest in an increasingly complex economic and geostrategic environment.

“We are dedicating more resources to screening foreign investment in critical infrastructure, critical minerals, critical technology, those that involve sensitive data sets, and investment in close proximity to defence sites, to ensure that all risks are identified, understood and can be managed – balancing economic benefits and security risks,” Chalmers said.

And a bolstered foreign investment compliance team will use the minister’s “call-in power” to review investments that come to pose a national security concern.

My goodness. If you were the excitable type (which I’m not), you could wonder whether the economy’s being put on a war footing. Or maybe it’s that Treasury’s been taken over by Defence and Foreign Affairs. Or ASIO.

Of course, it may be that the government and its spooks know something terrible they’re not telling us. Perhaps some foreign enemy is, as we speak, preparing to do us in.

But if you’ve spent years studying the behaviour of politicians (which I have), you wonder if it’s something less life-threatening and more self-serving. Is there an election coming up, for instance? Do voters have complaints about the economy that you’d like to draw attention away from?

The independent economist Saul Eslake says that, as the government seeks to use “national security” and “economic security” as a rationale for a major shift in economic policy, two things concern him deeply.

First, the tendency to use “security” as a justification for a policy initiative opens the door to interventions that are, in the infamous phrase of former Treasury secretary Dr Ken Henry, “frankly, bad”. Decisions that, without the “security” label, wouldn’t pass muster.

Second, grounding a policy decision in “security” gives politicians an excuse to shut down any questioning of the justification for that decision.

“When governments say something is a matter of ‘national security’, they usually refuse to say why it is; that it would be wrong to allow grubby considerations of ‘cost and benefit’ to interfere with their judgments about ‘security’, or even that it is borderline unpatriotic to question a decision made on ‘security’ grounds,” Eslake says.

It’s not the first time Eslake has expressed such concerns. Here’s a quote from an article he wrote in this august organ in late 2011.

“If you want a government to do something that entitles you to some form of protection from competition (especially overseas competition), some kind of subsidy or tax break, or some other privilege not enjoyed by ordinary folk, but you know that your proposal wouldn’t pass any kind of rigorous, independent, arms-length scrutiny ... then your best chance of getting what you want is to succeed in portraying it as being somehow essential in order to enhance some form of ‘security’,” he wrote.

Sometimes I even wonder how AUKUS – the wisdom of which many defence experts quietly doubt – came about. How much of it was the Americans’ idea, and how much was ours?

What we do know is that, without any prior debate, Scott Morrison suddenly unveiled it as a fait accompli and great coup. Had Labor opposed it, we’d have been straight into a khaki election.

But Labor accepted it without demur and the costs or benefits we’ll discover over the next decade or two.

Read more >>

Productivity isn't working, so why not try being more ethical?

Economists and business councils have been telling us for years that we must improve our productivity if we want to be more prosperous but, so far, they’ve had little success. Surely, there’s something else we could try?

As we’ll see, it’s something for Treasurer Jim Chalmers to ponder as he puts the finishing touches to next Tuesday’s budget.

Economists have many strengths, but they don’t win many prizes for thinking outside the box. Productivity is the obvious way to increase our prosperity but, despite all the admonition, for years it’s been hard to achieve, both here and in the other rich economies. It’s clear there’s a lot economists don’t know about how productivity is improved.

So, is there nothing else we could do to improve the way the economy works and the satisfaction it brings us? Of course there is – particularly when you remember this isn’t just about dollars and cents. Don’t you think life would be better if we could do all our earning and spending in an economy that generated less angst?

I’m indebted to Dr Simon Longstaff of the Ethics Centre for reminding me that behaving more ethically would be a good way to get better results from the economy.

Huh? How does that work? Let me tell you.

Ethics is a set of beliefs about the right way for people and organisations to behave, particularly in their relations with other people. Often, the right thing for us to do in particular circumstances is obvious.

It’s obvious, for example, that we should (almost) always obey the law. It’s just that obeying the law isn’t always convenient or inexpensive. And sometimes when our own interests are top of mind, it’s hard to see what’s obvious to everyone else.

In any case, because differing groups of people have differing beliefs and motives and objectives, ethical dilemmas – deciding what’s the right thing to do in all the circumstances – are common, particularly in business. That’s why we have a new profession of ethicists offering advice to organisations, of which Longstaff is the most prominent.

But what’s that got to do with the economy?

Well, let’s be clear. The only reason we should need to do the right thing is that it’s the right thing to do. And the only reward we should expect is being able to sleep well at night in the knowledge that we’re treating people justly, often at some cost to ourselves.

However, as Deloitte Access Economics has demonstrated in a report for the Ethics Centre, there is a strong “business case” for behaving ethically. A case that makes sense not just for individuals and businesses, but also for the treasurers and Treasuries responsible for improving the way the economy’s working.

The case rests on an obvious, but often forgotten truth: market economies rely on a high degree of trust. Trust between buyers and sellers. Trust that you’re not selling me a dud. Trust that your cheque won’t bounce.

Trust that you’ll let me return it if there’s a problem. Trust that you’ll honour your promise to service the thing for the next X years. Trust that you won’t pinch someone else’s bag from the airport carousel. Trust that you’ll repay the money I lent you.

Trust that if I let you check yourself out at my supermarket, you won’t slip in a few things you didn’t ring up. Trust that if I work for you, you’ll treat me fairly. Trust that the law will back me up if you do the wrong thing.

Point is, the more confident we are that we can trust each other – trust the businesses we deal with – the more smoothly and cheaply the economy runs and the more business gets done. When we have to spend a lot of money on security and making sure we’re not ripped off, the costs mount up, and we end up not doing all the transactions we could.

So, how do we get more trust into the economy? How do workers, employers and businesses get themselves a good reputation? By always behaving ethically. (I could say this also applies to politicians, but that would be pushing it.)

Research by Access Economics finds evidence that fewer unethical decisions lead to better mental and physical health for individuals. And evidence that unethical behaviour leads to poorer financial outcomes for business. And evidence that ethical behaviour results in higher wages.

But Access also reminds us of the evidence that our ethical standards could be a lot higher than they are. The World Values Survey finds that only a bit over half of Australians think most people can be trusted. The Governance Institute finds that, on a scale running from minus 100 to plus 100, Australia ranks at plus 45, or “somewhat ethical”.

Then there’s the string of royal commissions finding unethical or even illegal behaviour in institutional responses to child abuse, misconduct in the banking industry, and aged care. And that’s before we get to the epidemic of “wage theft” that so many otherwise respectable big businesses have had to admit to – all of it purely accidental, apparently.

OK, OK, we could do a lot better, with that producing tangible economic benefits. But how? Well, one approach would be for economists and econocrats to switch their sermonising from productivity to ethical behaviour.

Perhaps not. What would help is for ethical questions to get a lot more of our attention. As sociologists understand, but most economists don’t, businesses – like the rest of us – tend to want to do what others are doing. If we’re all being ethical, I don’t want to be seen as uninterested in ethical behaviour.

If we could give ethics a higher profile, we’d probably get more of it. If expert advice on ethical problems was more readily available, more would be asked for. If there were more training and meetings and conferences on the topic, more decisions would be examined for their ethical implications.

Longstaff’s Ethics Centre has a proposal to improve our “ethical infrastructure” by teaming up with the universities of Sydney and NSW to establish an Australian Institute of Applied Ethics, which would be open to receiving requests from governments and the private sector to report on major ethical questions facing the nation. It would be a bit like the Productivity Commission or the Australian Law Reform Commission, but it would not be a government body.

It would also contribute to education, training and leadership development, building the practical skills of good decision-making on ethical issues in the private and public sectors.

Copying the pattern used to establish the hugely successful Melbourne-based Grattan Institute, the proposal is for the federal government to contribute $30 million towards a $40 million one-off endowment. The new institute would be funded from the earnings on this endowment, plus earnings from providing education, training and other services.

We’ll learn on budget night whether Chalmers and his boss are acting on this sensible idea for achieving a better economy, or whether they will be content with more platitudes on the need for greater productivity.

Read more >>

Is a Future Made in Australia a good or bad idea? Maybe a bit of both

What exactly is a Future Made in Australia? You can read the long speech Anthony Albanese made about it and still not be sure. My guess is it’s a slogan designed by spin doctors to mean whatever you’d like it to mean.

As I wrote on Monday, what I hope it means is that the government intends to secure our economic future by ensuring all the income we’re going to lose from the world’s decision to stop buying our exports of fossil fuels is replaced by us using our new-found comparative advantage of being able to produce renewable energy more cheaply than most other countries.

We can produce masses of the stuff but, because it’s expensive to export, we can set up new industries which use the renewable energy to produce green iron, green aluminium and various other green minerals and then sell them to the world.

Because such industries don’t yet exist, the businesses that start them will inevitably make mistakes from which later businesses will learn. So it makes hard-headed economic sense for the government to cover much of the cost of this learning-by-doing “positive externality” – this spillover benefit to the wider economy for which the original businesses will go unrewarded.

If that’s what Albanese means by making our economic future, he deserves all the support and encouragement the rest of us can give him.

But I fear his slick slogan was designed to remind people of the old goal of trying to ensure that as many as possible of the goods we consume are Made in Australia.

This was our aim for about half a century until, in the 1980s, the Labor government of Bob Hawke and Paul Keating rolled back the import duties protecting our inefficient manufacturing industry and opened our economy to the world.

But why would Albo and his smart economists, Jim Chalmers and Chris Bowen, want to reverse the bipartisan policy of the past 40 years and take us back to the future?

Well, some polling produced this week by Essential Report offers some big clues. Asked to what extent they supported or opposed the Future Made in Australia policy, 30 per cent of respondents said neither. I take this to mean most hadn’t heard of it, or weren’t sure what it involved.

But 51 per cent supported the policy, leaving only 19 per cent opposing it. Unsurprisingly, Labor voters were more supportive than Liberal voters. But this is surprising: two-thirds of Greens voters supported it.

Why so much support for the government policy with a snappy name but so little detail? More clues followed. Fully 70 per cent of respondents agreed with the statement that “the pandemic showed we cannot be wholly reliant on global supply chains”.

And 63 per cent agreed that “it was a mistake to allow the Australian car industry to close,” with 43 per cent agreeing that “the days of globalisation, where we just imported cheap goods from overseas are over”.

Against that, however, only 37 per cent agreed that “it is not the government’s job to support Australian businesses that can’t compete overseas,” and only 34 per cent that “the market will make the best decisions and government should stay out of the way.”

Get it? There’s strong support for the goal of self-sufficiency and making as much as we can locally – keeping the jobs and the profits at home, not sending them abroad.

It’s noteworthy, too, that support for Made in Australia is much stronger among those aged 55 and above than among those aged 18 to 34. Believing that a country must make things, not just deliver services is, thankfully, more a hangup of the old.

So, if Albo and his spin doctors see benefit in playing to the Bring Back Manufacturing crowd, it wouldn’t be so surprising.

Just so long as you don’t forget this: keeping the jobs at home seems no more than common sense but, when you think it through, you see it’s a great way to be poorer, not richer.

One of the main ways humans have made themselves richer over the centuries is what economists call “the division of labour” and the rest of us call specialisation.

We can use the same amount of labour to produce more goods and services by having workers specialise in doing what they do best. By now, the process of specialisation – which no doubt has yet further to run – has reached the point of specialisation within specialties.

But obviously, specialisation can’t work without exchange: I sell my stuff to you; you sell your stuff to me. And what makes economic sense for individuals also makes sense for countries. We don’t maximise our material prosperity by stopping specialisation and exchange at the border.

Countries also need to specialise in what they do best, exchanging their surplus production with other countries specialising in what they do best. Economists call this pursuing our “comparative advantage”.

Autarky – the pursuit of national self-sufficiency – seems like a good idea, but one of the most useful things economists do for the community is to explain why, contrary to common sense, self-sufficiency is a great way to be poorer than we need to be.

It’s a dumb idea because it involves wilfully forgoing the benefits of specialisation and the “gains from trade”. When we insist on making items we aren’t good at, those things will cost more that importing the same goods from those countries better at it than we are.

So we end up forcing Australians to buy the inferior and more expensive locally made goods by imposing a special tax or “duty” on the imports. This leaves us less money to spend on other locally made goods and services. So jobs created in the inefficient part of the economy come at the expense of jobs in the efficient part, causing us to be less well-off than we could be. Well done.

Read more >>

It's not perfect, but our health system is one of the best

When it comes to self-belief, Australians are funny. We have no doubt that Australia punches well above its weight in almost every sport. And our Diggers are braver and more dependable than the rest. In other departments, however, we don’t rate ourselves highly.

Australians pay among the lowest taxes of all developed nations, but the belief that we’re among the highest taxed is so widely believed it’s impervious to facts.

Take the latest headline that we’ve been “flattened by the biggest tax increase in the world”. “There, I knew it,” I hear you mutter. Well, not quite.

It’s true, as the story said, that in 2023 working Australians suffered the biggest increase in their average tax rates in the developed world, according to figures issued by the Organisation for Economic Co-operation and Development.

The increase was caused by bracket creep and the Morrison government’s sneaky decision to end the “low- and middle-income tax offset” (a move that never made it to a press release, meaning most of the media didn’t notice and didn’t tell their audience about).

But that doesn’t in any way confirm our belief that we’re highly taxed. It may have been true last year, but it will be far from true this year as the huge stage 3 tax cuts take effect in July.

Nor is it confirmed by the repeated assertion that we are more dependent on income tax than any of the other OECD countries. This is literally true, but only because, unlike almost all the others, we don’t impose separate social security contribution taxes on the incomes of workers and employers.

The more important point, however, is that so far we’ve been talking only about the biggest and most noticeable of our taxes, personal income tax. Surely you don’t think that’s the only tax we pay?

What about a little thing called the goods and services tax? (Or, to other rich countries bar the United States, value-added tax.) Our tax rate of 10 per cent is way lower than even the Kiwis’, let alone all the Europeans’. They’re up in the 20s.

No, all told, we pay less tax than almost all the others. But how would you rate us on, say, healthcare? My guess is most people’s answer would be, at best, nothing to write home about.

Wrong. We keep hearing about problems with Medicare, but every country’s healthcare system has its shortcomings. New research by the Productivity Commission – hardly known for its boosterism – has found that our health system “delivers some of the best value for money of any in the world”.

The commission has been measuring the productivity of our healthcare system – roughly, what we get for what we pay – and, for the first time, taking account of changes in the quality of that care.

In principle, the system covers all our spending on healthcare: public and private; hospitals, GPs and specialists, whether paid for by taxpayers, health insurance or directly out of our pockets.

Over this century, our total spending on healthcare has risen from 8 per cent of national income to about 10 per cent – meaning it’s grown much faster than the economy has, including the growth in our population.

The continued rise in the average age of our population, the growing burden of chronic diseases and our expectations that governments will keep spending more to improve our health means our spending on healthcare will continue to grow faster than on most other things.

This being so, it’s important to check that the increased spending is leading to better health. The researchers were able to check the performance of only part of the system: the treatment of cancers, cardiovascular diseases, blood and metabolic disorders, endocrine (organs and glands) disorders, and kidney and urinary diseases.

These account for about a third of healthcare spending. The study found that, after allowing for changes in quality, the “multifactor” (that is, combining labour and physical capital) productivity of this care improved by about 3 per cent a year over the six years to 2017-18.

If that doesn’t impress you, it should. It compares with productivity improvement of just 0.8 per cent a year in the whole market sector of the economy.

Importantly, all the healthcare improvement came from improved quality in the treatment of ailments. This arose from technological advances in how they are treated, rather than from simply doing more with less. And the gain was in lives saved rather than the reduced illness of people living with those diseases.

But here’s the kicker. When the commission compared the level of our productivity with that of 27 other rich countries (after allowing for differences in risk factors, such as obesity – the big one – smoking, diet, alcohol and age) it found we came third, beaten only by Iceland and Spain.

Coming a distant last was the United States. The Yanks win two prizes: one for the most expensive system, the other for coming last on value for money. Why? Because their system is designed to maximise medicos’ incomes. At which they take away another prize.

Read more >>

How Albanese can make Australia's future the smart way

Thank goodness we’ve finally got someone saying something sensible about Anthony Albanese’s Future Made in Australia. So far, it’s been a phoney war between the old fogeys from the Productivity Commission – all government subsidies are rent-seeking – and the Bring Back Manufacturing Brigade, pushing the notion that making goods is more economically virtuous than providing services and quoting bulldust measures of “economic complexity” to prove it.

The man talking sense – adroitly picking his way through the blind ideology, partisanship and rent-seeking to find the sound economics – is Rod Sims, former chair of the Australian Competition and Consumer Commission and now chair of Professor Ross Garnaut’s brainchild, the Superpower Institute. Sims spoke to the Melbourne Economic Forum last week.

For reasons I’ll explain another day, the Productivity Commission old-timers are right to insist that the basic principles of economics haven’t changed. We must resist the false promise of self-sufficiency and stick to doing the things we’re particularly good at – our “comparative advantage” – which, throughout our history, has included exploiting our “natural endowment” of some of the most valuable deposits of minerals and fossil fuels in the world.

On the other hand, though the basic economic principles haven’t changed, the Back to Manufacturing Brigade is right – or half right – in saying that the circumstances in which the world economy now finds itself have changed radically.

This is not because, in its present period of craziness, the United States has turned protectionist, staging a trade war with China and subsidising various local industries. Others acting contrary to their own best interests – their comparative advantage – is not a sign that we should go crazy too.

No, the big change is the world’s grudging realisation that if we want to stop global warming, we must cease burning fossil fuels and switch to renewables. The move to net zero emissions of greenhouse gases by 2050 will surely be the biggest and fastest structural change the industrialised world has ever experienced.

The implications of this euphemistically named “transition” are huge for every economy, but for ours, they are monumental. Why? Because, as Sims points out, Australia is the world’s largest exporter of coal and gas, combined.

What everyone knows but doesn’t seem to get is that, within a decade or two, our economy will have been hit by a meteor. The world will have stopped buying our fossil fuels. It will have taken a huge chunk of our natural endowment and declared it worthless.

So, our greatest comparative advantage is in the process of ceasing to exist. This is what Albanese lacked the courage to say in his happy-clappy speech about a Future Made in Australia.

This is what the generals busy fighting the last war don’t get. This is why their implication that the government should sit back and see how the market reacts to this sudden drop in our standard of living is bad economics.

What we must do is something we’ve never needed to do before: hunt around in our natural endowment to find something else offering us a new comparative advantage. This is why we’re so heavily indebted to Garnaut for being the first to realise and trumpet the news that, in a decarbonised world, all our sun and wind have suddenly gone from being of little value to hugely valuable.

Australia has much more sunlight than most other countries and as much wind as the best of them. What makes this so valuable is that it’s so expensive to turn renewable energy into a form that can be exported.

Sims demonstrates the value of our new comparative advantage with the example of iron metal. At present, we export iron ore, the metallurgical coal used to reduce the iron ore to iron metal, and both the thermal coal and gas, which can provide the heat to make the iron metal.

We export the ingredients and let others bake the cake because that’s what makes economic sense. In the coming zero-carbon world, however, it will make economic sense to produce green iron in Australia.

Green iron is likely to need green hydrogen in place of the coking coal that turns the ore into metal. However, making green hydrogen requires a massive amount of renewable energy to power the electrolysers that split water into hydrogen and oxygen.

So green iron should be made in Australia because the economics has been turned on its head. If it costs, say, $100 to mine a tonne of metallurgical coal in Australia, you can send it to China for just an extra $5 or $10. But if hydrogen costs $100 to make here in Oz, it will cost at least another $100 to ship it to China.

With hydrogen, you need to turn it into ammonia, at great expense, to be able to ship it, and then you need to turn it back into hydrogen at the other end. This is complex and will involve much leakage.

So renewable energy should be used close to where it’s produced. Sims says all overseas studies he’s seen suggest that Australia is likely to be the cheapest place in the world to make green iron. Those trying to make green iron by importing hydrogen will be uncompetitive.

It should be the same story for green aluminium, green fertiliser, green silicon and green aviation fuel. We will be able to export our masses of surplus renewable energy embedded within those many products.

So, yes, we can have a lot more manufacturing in our future. And the best place for this further processing will be close to the regional sources of sun and wind-produced electricity.

But while green iron-making technology is proven, it’s not yet been done at scale, Sims says. Those who go first will inevitably make mistakes, from which others will learn. Those mistakes will be costly for the first mover but hugely beneficial to those who come after.

In other words, this learning by doing is a “positive externality” – a benefit to other businesses and the community generally for which the first business isn’t rewarded.

This is the hard-headed economic justification for temporary government grants to firms starting out in industries directly related to the exploitation of our new-found comparative advantage.

(The key “negative externality” relevant to the transition to renewable energy is the cost to the environment from the use of fossil fuels to make steel and many other things that the relevant businesses aren’t required to pay for, thus putting renewable energy producers at a price disadvantage – something the former Productivity Commission bosses keep forgetting to mention.)

But, Sims rightly warns, if all the Made in Australia talk means subsiding businesses making solar panels, wind farm components, batteries and electrolysers – in none of which we have a comparative advantage – then there’s no way we’ll become a superpower, and the extra manufacturing jobs will come at the expense of jobs in all other industries. Labor voters and the ACTU take note.

Read more >>

Sorry, it's not gallantry that wins wars, it's economic might

Welcome to the Anzac long weekend (sort of). This column is brought to you by your friendly economists, who want to get one thing straight: whatever their causes, wars are usually won by the side with the most economic resources.

This is just one of the many fascinating things you learn from a new book, The Shortest History of Economics, written by Dr Andrew Leigh, former economics professor turned minister in the Albanese government. (The book’s name is misleading. It’s really the shortest account of the part the economy has played in the world’s history. Well worth a read.)

Leigh says the first industrial-scale war following the Industrial Revolution was America’s Civil War during the first half of the 1860s.

“With the use of mass-produced weapons, railroads, steamships and telegraphs, the Civil War was industrial in its scale, and in its carnage,” he says. More than 600,000 combatants – one in five soldiers – lost their lives.

A striking thing about that war was the imbalance of resources between the two sides, strong support for the saying that God is usually on the side with the bigger battalions.

At the outset, the North had a population of 21 million – more than twice the South’s. The South was primarily an agricultural economy, with the North producing 90 per cent of the country’s manufactured goods, including 97 per cent of its firearms.

What’s surprising is that the South held out as long as it did. The war was prolonged by the North’s poor military tactics.

From an economic perspective, wars are often financed by printing money, with ultimate inflationary consequences. The South used this to fund 60 per cent of its costs, whereas the North needed only 13 per cent.

To economists, a significant effect of World War I was that it brought a hasty end to the world’s first experience of globalisation, with greatly increased trade and migration between Europe and the “new world”, fostered by the advent of steel-hulled steamships and the telegraph, and the absence of boring things like passports and visas.

Not until after the Great Depression and World War II did the barriers keeping countries apart begin falling back, thanks to advances in air travel, shipping, containerisation and telecommunications, plus reductions in import protection and banking regulations.

Today, many people believe that greater trade, tourism and other economic contact between countries reduce the likelihood of war. I think there’s truth to this, but the strong commercial ties between the combatants in World War I didn’t stop it happening.

Did you know that, at the outbreak of war in 1914, most of Germany’s shipping trade was insured by Lloyd’s of London?

The Allied powers (Britain, France, Russia and their allies) had far more resources than the Central powers (the German Empire, the Austro-Hungarian Empire and their allies). The Allied powers had five times the population, 11 times the territory and three times the income, according to Leigh.

That the conflict took four years and claimed about 20 million lives reflects the ineptitude of the generals and the intransigence of the political leaders, he says. But the side with the larger economic base won.

Moving on to World War II, which started in 1939 and ran for six years, its outcome, too, could have been predicted from the economic fundamentals.

Compared with the Axis powers (Germany, Italy, Japan and their allies), the Allied powers (Britain, France and their allies) had more than twice as many people, more than seven times as much territory, and a combined income that was 40 per cent higher, Leigh tells us.

Germany did well at first, thanks to the skill of its generals, such as Erwin Rommel, but the war proved primarily a contest of industrial production, Leigh says, and the Allied powers had more resources at their disposal.

This was true even midway through the war because, although Germany had annexed much of Europe, the United States and the Soviet Union had joined the conflict on the side of the Allies. In 1942, the Allied powers still retained a decisive advantage in people, territory and income, he says.

Consider aircraft carriers. Although Japan fully understood their great strategic value, the Allies built nine-tenths of the carriers produced during the war.

The combatant nations differed in how much of their economies they devoted to the war effort. Italy never devoted more than a quarter of its gross domestic product to the war, whereas, at its peak, Japan was devoting more than three-quarters. Britain and Russia managed to deliver more than half their national output to the war, while the US devoted two-fifths.

Together, this gave the Allies a substantial advantage. They produced at least twice as many rifles, tanks, aircraft, mortars and warships. According to Leigh, the Axis powers were literally outgunned.

The overall damage to economies done by World War II was more devastating than in World War I, largely because the technology of killing had advanced so much in the intervening years.

In the air, the first war’s biplanes and zeppelins played a relatively minor role, whereas the second war saw squadrons of bombers devastating cities with incendiary – and ultimately atomic – bombs.

All up, World War II claimed three times as many lives as World War I had done.

But let’s finish on a more positive note. Leigh says the peace that followed World War II was more enduring, partly because countries learnt the lessons of the previous conflict. Through the Marshall Plan, the US provided $US13 billion to Western Europe, equivalent to about 3 per cent of the region’s annual economic output.

In Germany and Japan, the occupying powers put great emphasis on restoration, with the result that both became major industrial powers within a generation.

And economists, including Keynes, played a central role in building international economic institutions – including the Bretton Woods system of fixed exchange rates, the International Monetary Fund, the World Bank and the forerunner to the World Trade Organisation – that would sustain peace.

Read more >>

Buildings as batteries. For net zero, we need bright ideas like this

There’s a joke about the economist who thought he saw a $20 note on the ground but didn’t reach down for it because he knew that, if there had been such a note, someone else would have picked it up long ago. Sometimes we don’t see what’s there to be seen because we aren’t expecting to see anything.

Have you ever been in the city at night, looked up to see all the office blocks with lights ablaze, and wondered why they were wasting so much electricity? Perhaps it’s because people are working late, or the cleaners are busy. In any case, it’s not lighting that uses so much power: it’s heating and cooling.

But your instincts are right. All those office blocks have an important part to play in our efforts to limit further climate change. How? Keep reading.

As every sensible person knows, but prefers not to think about, the most important single challenge we face as a nation is to play our part in achieving the global goal of reducing emissions of greenhouse gases to net zero by 2050.

This is far more important to our kids’ future than the housing calamity or the cost-of-living crisis, both which will pass soon enough.

And, as most people realise, the main strategy we’re pursuing to reduce emissions is to eliminate the use of coal and gas in the production of electricity, then use this clean power for as many of our energy needs as possible. The move to electric vehicles is a big part of this.

All of which is much easier said than done. We’re already getting much of our energy from renewable sources – solar and wind power – but we need a lot more of it. And we need it to be available before our ageing coal-fired power stations give up the ghost. We can use some gas to tide us over, but it too must go.

Another part of the problem is reconfiguring our huge system of “poles and wires” transmitting electricity around the country. We need high-voltage powerlines joining up the eastern states. Currently, powerlines mainly transmit from huge coal-fired power stations located near coal mines to the nearest big city.

Trouble is, the solar and wind farms replacing the old power stations are spread all over the place. And then there’s the need to link all the solar systems on people’s roofs into the network.

Further complicating the transition from fossil fuel to renewables is the problem all those looking for an excuse to do nothing love pointing to: what happens when the sun’s not shining and the wind’s not blowing?

The short answer is that we have to capture and store some of the free energy that’s coming while the sun is shining, so we can use it at times when it isn’t. Batteries are the obvious way to do this. But we can achieve the same effect by pumping a lot of water up a hill, then letting it run back down to power a generator at night. Or you can do something vaguely similar in an office block.

While we’re working on all this, however, climate change is making our summers hotter and increasing the demand for air conditioning. The way we see it at present, we have to increase the capacity of our electricity transmission network so we can cope with peak demand on a few very hot afternoons each year without blackouts.

But this extra capacity goes unused for all the other days of the year, which is wasteful. Surely there must be a cheaper way to avoid blackouts?

This is where Craig Roussac, founder of Buildings Alive, a company that helps commercial building managers to better manage their use of energy and so reduce their emissions, has had a bright idea, which he’s developed with Dr Richard Denniss, boss of the Australia Institute.

On hot summer days, building managers could turn their cooling a degree or so lower in the morning, then let the temperature rise slowly in the afternoon, while everyone else had their air conditioners going full blast.

Because the wholesale price of electricity jumps at times of peak demand, this would save the building owners money. Lower peaks being cheaper, this would reduce the average retail price being paid by the rest of us.

It would also reduce the need for new investment in transmission capacity – the cost of which is passed on to electricity users. Above all, it would immediately reduce emissions, at zero extra cost.

But if it’s such a smart idea, why aren’t people doing it already? Mainly because the electricity industry makes its living by selling more of the stuff, not less. But also because the energy efficiency ratings awarded to buildings don’t encourage businesses to change the timing of their demand.

Now, obviously, sorting out our office buildings would make only a small contribution towards achieving net zero. But the idea of changing the timing of our demand during peak periods could be spread to other classes of buildings, including apartment blocks and even detached houses.

Read more >>

ATTENTION ECONOMICS TEACHERS: change in the mechanics of controlling the cash rate

 You need to read this very clear explanation by Isaac Gross of Monash:

Copy and paste:

      https://bit.ly/441sCOY 

Read more >>