You can trust politicians ... to do exactly what's best for them

What terrible shi ... people politicians are. Kevin Rudd decides he wants a "root and branch" review of Australia's tax system. The biggest and best review in the history of the universe. Federal, state, local, the lot. So our top econocrat, a tax expert, and four other highly qualified and busy people devote 18 months of their lives to a very thorough, thoughtful review.

What does Rudd do? Takes months to get around to looking at it then, when he does, picks the one big plum out of the pudding - a genuine, economic rationalists' licence to impose a great big new tax on an industry for which there's little voter sympathy - explicitly rejects 19 controversial recommendations and passes no comment on the remaining 120-odd.

Thanks very much, that's you off to a pigeonhole.

So let's ignore our appalling politicians and pay the Henry report the courtesy of considering what it has to say. Its key point is we need changing taxes for changing times. We're in the early part of a new century, our lives are changing, the position Australia finds itself in is changing, so how does our system of taxes need to change in response the major challenges we're likely to face over, say, the next 40 years?

Ken Henry and his fellow panel members identify three big trends we need to adjust to. The first is demographic change. The population is ageing and the higher proportion of older people will involve increased demand for spending on age pensions, aged care and healthcare, putting a lot of pressure on federal and state budgets.

You've heard that before from the pollies, but you haven't heard this: "We do not expect total tax burdens will rise in the next few years, but some increases in later times may be unavoidable." So taxes will be going up, not down as politicians like to fantasise. We need a "robust" group of taxes, the collections from which keep up with ever-increasing government spending, and the rates of which can be increased from time to time without causing distortions.

We need to ensure older people - facing choices about when to retire and whether to work part time in semi-retirement - aren't discouraged from working by rates of income tax that are too high. We also need to keep getting the bugs out of the taxation of superannuation so people are encouraged to save for their retirement income needs on top of the age pension.

The second major trend is globalisation. Australia has always needed to attract foreign capital because our opportunities for economic development far exceed our ability to save the capital needed to exploit them.

Globalisation is increasing the alacrity with which international investors (including pension funds) are willing to move money around the world in search of the highest returns. But development of the poor countries, particularly in Asia, means we're facing more competition in attracting the foreign investment we need.

When you boil it down, governments tax only four main things: land (including natural resources), capital, labour and consumption spending. The Henry panel believes the greater international mobility of capital - and the competition between small economies to attract that capital - means we can't get away with taxing it as heavily as we once did. This explains its recommendation to reduce company tax from 30 per cent to 25 per cent. It also believes globalisation is making highly skilled labour more internationally mobile and thus harder to tax at high rates.

But if mobile resources need to be taxed less, then immobile resources will have to be taxed more. Nothing's more immobile than land and natural resources. Hence the proposal for an annual land tax, at a low rate of, say, 1 per cent, on all land (but with the abolition of conveyancing duty).

And hence the proposal for a resource rent tax on natural resources. The coal and iron ore belong to all Australians, not the mining companies, and the use of this tax to effectively replace state royalties is just a way of ensuring the miners pay us a price for our resources that more accurately reflects their hugely increased value (as a result of globalisation and the economic development of China and India).

The third major trend is environmental degradation. Environmental pressures are emerging "in areas such as land degradation, species decline, water use and climate change", the panel says. Higher population and continued economic growth "will put pressure on our increasingly fragile ecosystems".

Our economic prospects are strongly linked to environmental sustainability. "The environment provides natural resources essential to Australia's productive capacity, and ecosystems that absorb and assimilate the waste generated by people and industry. Sound land and water management practices are essential to maintaining agricultural production; biodiversity enables technological progress, particularly in medical and pharmaceutical applications; and low atmospheric pollution is essential to climate stability."

People and businesses make decisions every day that affect environmental quality, but in many cases they aren't fully aware of their impact, or don't value those impacts as highly as others do, particularly future generations. "Accordingly, there is a role for government to influence decision making with a view to achieving better environmental outcomes."

The tax system can play a greater role in promoting sustainable policy outcomes by influencing the incentives that lead to environmental degradation. "An equally important consideration is to ensure that settings within the tax and transfer system do not unintentionally produce adverse environmental incentives or conflict with the broader environmental goals of ... other policy measures."

Bet you haven't heard that kind of talk about tax reform before. And what's the one big reform we need to get us moving on the right path? A carbon pollution reduction scheme.

Oh.

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In time we will get the nasties - but not just yet

If history is any guide, pretty much all the nasty changes proposed in the Henry tax review will be implemented.

We'll end up with a congestion tax on cars, much higher tax on wine, land tax on the family home, higher tax on capital gains, cutbacks in negative gearing, a tax on bequests and annual increases in petrol tax.

But it will take up to 25 years to happen. And few of the nasties will be taken up by the government that originally received the report.

That's what happened to the Asprey tax review of 1975, which recommended a host of things the Whitlam government wouldn't touch with a barge pole: a tax on capital gains, taxes on fringe benefits and entertainment expenses, something weird called dividend imputation, and a value-added tax (which John Howard delivered in 2000, exactly 25 years later).

Ken Henry's objective was to lay out another blueprint for long-term tax reform. So though Kevin Rudd has sworn not to touch most of Henry's nasties, don't imagine you've heard the last of them.

Rudd has sorted Henry's many recommendations into three boxes labelled Yes now, Maybe later and No never.

In the Yes-now box are all the nice ideas Rudd hopes will win him votes at the election this year, includ-

ing a great big new tax on mining companies and cuts in company tax, particularly for small business, and bigger superannuation concessions for low-income earners.

To these Rudd has added some good ideas of his own, such as higher super contributions by employers and a big new infrastructure fund.

In the Maybe-later box are various reforms Rudd has failed to specify but which, presumably, wouldn't worry most voters and would seriously antagonise only interest groups for whom the public doesn't have much sympathy.

If you can find anything there that you and enough others don't like, make a fuss and Rudd will quickly rule it out.

Rudd needs these reforms to justify his bid for re-election, to demonstrate all the wonderful improvements he needs to be allowed to get on with doing for us in his second term.

In the No-never box are all the nasties Rudd knows would cause him grief and cost him votes, no matter how much in the nation's interests they might be. These include all the nasties I listed at the start, plus higher tax on company cars, tougher tax rules for single-income families, anything a charity wouldn't like, ending dividend imputation and much else.

In other words, Rudd's response to Henry's recommendations has been determined by his top priority - political survival. For such a timid man, his willingness to commission such a potentially controversial review, timed to report on the eve of an election, was always a puzzle.

His dawning realisation that he'd be unveiling 1000 pages of trouble may do much to explain his decision last week to ignore "the great moral challenge of our time" and abandon his commitment to his emissions trading scheme because Tony Abbott had labelled it "a great big new tax".

Now Abbott will be trying to convince us Rudd has half a dozen big new taxes up his sleeve, waiting to be sprung on us. All the proposals Rudd says are in the No-never box are secretly in his Once-I'm-re-elected box.

But that's the bitter beauty of last week's political cowardice and failure of leadership. We needn't fear Rudd has any tax nasties up his sleeve because we now know he doesn't have the courage.

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Hot air obscures the real climate change story

The reduced, but still majority public support for action against climate change - which seems to have frightened Kevin Rudd off pursuing "the great moral and economic challenge of our time" - may be explained by the Coalition's "great big new tax" scare campaign.

But there have been other reasons for the public's disenchantment that rest just as much on misrepresentation of the facts.

If, for instance, you believe the Rudd government's commitment to an unconditional reduction in carbon dioxide emissions of 5 per cent by 2020 is a negligible effort, you're a victim of environmentalists' dishonesty.

And if you believe the Copenhagen summit in December ended in failure with nothing achieved, you're a victim of the climate change ostriches' propaganda (not to mention a media that over-reports minority scientific opinion, led by one Australian newspaper that's taken to selling itself by slanting its news reporting to fit the political prejudices of its target market).

Let's start with the commitment to reduce Australia's emissions by 5 per cent of their level in 2000 by 2020. It sounds pathetically small, but it's not. Why not? Because, left to their own devices, emissions are projected to keep growing strongly over the 20 years to 2020. We're already almost halfway through the period and emissions are up a lot.

It turns out that to reduce emissions in 2020 to 5 per cent less than their level in 2000 will require us to reduce them by 22 per cent of the level to which they'd otherwise have grown. Still think that sounds a negligible effort?

And get this: a big part of the reason our emissions will grow so rapidly if not constrained is the strong growth in our population over the period. So if you were to express the target in terms of the reduction per person, it rises to 28 per cent. Still think it's a pathetic effort?

Now try this: because the relationships involved aren't linear (they don't move in straight lines), it turns out that, still in per-person terms, our unconditional target to reduce emissions by 5 per cent would involve a reduction that was more than half the size of the 25 per cent reduction we offered to make if a watertight global deal could be done.

Why did Rudd and his ministers do virtually nothing to make sure people understood that a 5 per cent reduction was a lot bigger than it sounded? Probably because he wanted people to think it wasn't much. But also because he miscalculated badly, grossly underestimating the difficulty he would have getting his emissions trading scheme through Parliament and putting little effort into countering the climate change ostriches' scare campaign.

But why did the Greens pretend that 5 per cent was nothing when they must have known it wasn't true? Because it didn't suit the line they were pushing. It proves that the ever-virtuous Greens are just as capable of lying with statistics as the mainstream parties are.

Now for the mistaken notion that the Copenhagen meeting achieved no agreement between the rich and poor countries. Someone has remarked that the Copenhagen accord was "at once a profound disappointment and a major step forward".

It's true no legally binding global deal was done between the 194 countries attending - this was probably always an unrealistic expectation - but it's also true they avoided the temptation to do a deal they had no intention of honouring (which has happened before at international meetings).

But Dr Martin Parkinson, the secretary of the Department of Climate Change, argued in a recent speech that they did achieve a platform to build on to deliver an effective global agreement.

He said the accord represented a significant advance on the Kyoto Protocol in six respects.

First, both developed and developing countries have agreed to take responsibility for action to hold global temperature increase to below 2 degrees. This is the first time a wide range of countries has agreed on what constitutes dangerous climate change.

Second, for the first time ever both developed and developing countries have committed to action and to specify those commitments within the same framework - the new accord. While developed countries will continue to implement legally binding emission reduction targets, developing countries will also implement nationally appropriate measures to limit their emissions. "A truly historic breakthrough," according to Parkinson.

Third, these commitments will be supported by a framework to monitor implementation of targets and actions. This will provide the transparency and confidence that all countries - rich and poor - are meeting their commitments.

Fourth, developed countries have agreed to provide new and additional financing to developing countries of almost $US30 billion ($33 billion) over the period 2010 to 2012. They also agreed to mobilise $US100 billion a year by 2020 to support developing countries' climate change actions.

This funding will come from government contributions but also from the transactions entered into in global carbon markets as rich countries seek to meet their emissions reduction targets by buying carbon credits from poor countries.

Fifth, countries have agreed to establish a technology mechanism to drive the innovation and diffusion of clean technology.

Sixth, countries have agreed on the need for the immediate establishment of a mechanism to reduce emissions from deforestation and forest degradation in developing countries. This is a critical issue if we are to avert dangerous climate change.

Does all that sound like failure to you? Aided by a superficial media, we fell for the old human all-or-nothing fallacy: if we didn't get everything, it must have been a total wipeout.

The agreement was that individual countries would respond with their support within a few months. By now, 119 countries have indicated their support for the accord and 74 have submitted national pledges to limit or reduce their emissions by 2020.

The countries making pledges account for about 80 per cent of global emissions. They include, for the first time, the United States, China, India, Brazil, South Africa and Indonesia.

True, the pledges on the table aren't sufficient to avoid dangerous climate change. If implemented, they'd leave the world at least 3 degrees warmer. So we're not there yet. Australia's pledge was as we've discussed: an unconditional 5 per cent reduction as proof of our good faith, rising to a 25 per cent reduction with a strong global deal.

One blemish: this week our will-o-the-wisp Prime Minister made the unconditional 5 per cent conditional on what other countries have done by 2013.

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HOW AGEING AND THE RESOURCES BOOM WILL AFFECT WORKERS

Talk to Centrelink Financial Information Service Officers, Brisbane
March 24, 2010

With the recent publication of the federal government’s third intergenerational report since 2002 we’ve had another surge of concern about the ageing of the population. I want to try to clarify for you what this is likely to involve. It’s been generally portrayed as a bad thing - a threat - but, though it will certainly bring changes, many of those changes will be for the better. Let’s start by being clear on what ageing involves.

What is population ageing?

All of us get older every year, so what does it mean to say the population is ageing? It means the average age of all the people in Australia is rising - though by a lot less than 12 months each year. The average age would be falling if a lot more babies were being born to counter the fact that we’re getting older as individuals but, in fact, women are having fewer children than they used to in earlier decades (even though the fertility rate recovered a little in the noughties). The other factor is that the death rate is falling as we live longer lives. So a lower birth rate and rising longevity are the main causes of population ageing, but it’s being made more acute by the fact that the great bulge in the population that is the baby boomers (people born between 1945 and 1960), which is working its way through like a pig in a python, has reached the point where they’re turning 65 and starting to retire.

The latest report tells us that the number of people aged 65 to 84 is projected to more than double over the next 40 years, while the number over 85 more than quadruples. At present there are five people of working age to support every person of 65 or over, but this is projected to fall by almost half (to 2.7).

The ‘problem’ of ageing is exaggerated

Since a big part of the cause of ageing is that we’re living longer, you’d think this would be seen as a good thing, something to be celebrated. But ageing is almost always portrayed as a bad thing - a cause of many problems - and the latest intergenerational report is no exception. It tells us ageing will cause the economy to grow more slowly - our material standard of living won’t rise as quickly as it has been. As well, we’re told, increased spending on the aged will put great pressure on the federal budget, creating a ‘fiscal gap’ between government spending and revenue equal to 2.75 per cent of GDP by 2050, which is equivalent to about $35 billion a year in today’s dollars.

It’s true that the economy’s likely to grow a little more slowly in coming decades, mainly because of slower growth in the number of people joining the workforce. However, when you examine the report and its projections you find that most of the expected growth in government spending comes not from costs associated with the higher number of old people, but from the rising cost of new health technology and the likelihood that all of us will be demanding more and better healthcare. So the budget will have a problem with inexorably rising spending on healthcare. But though the politicians don’t like to admit it, the obvious solution to that problem is that we’ll all have to pay more tax from our rising incomes over the next 40 years.

It’s true that most other developed countries - the US, Britain, Europe, even New Zealand - will face serious budgetary problems coping with the growing cost of aged pensions and aged care. But that’s because their unfunded pension schemes are much more generous than ours, being unmeans-tested and, in many cases, related to the individual’s pre-retirement income. We don’t have problems to anything like the same degree because our age pension is so frugal, being means-tested and flat-rate. The compulsory super scheme we’ve put in to supplement the age pension - so that most people will retire with a combination of age pension and private pension - is an accumulation scheme that makes no promises about how much you’ll end up with.

Many ageing problems will solve themselves

The next point I want to make is that many of the ageing problems people point to will, to some extent, sort themselves out. Where they don’t, the government will sort them. The point is that our economy is ‘dynamic’ - it changes over time in response to situations that arise. People don’t just sit there accepting their fate, they try to do something about it. And though it’s wrong to imagine that ‘market forces’ have magical powers to eliminate all problems, it’s equally wrong to imagine they have no power to improve matters and that the only solutions come from government action.

Take for instance the often-heard complaint that the babyboomers can’t afford to retire because they haven’t saved enough. There’s truth in this complaint - even though I have to say that this problem arises because the babyboomers are sure they couldn’t get by on the age pension - even though all previous generations have - and even though they haven’t bother to save much. But here’s the real point I’m making: if it’s true the babyboomers can’t afford to retire then they won’t retire. They’ll keep working, even if only part-time. And every year they postpone their retirement is one extra year of saving plus one less year of having to support themselves in retirement.

And, indeed, this trend has already begun. In the 1980s and early 90s we saw a trend towards earlier and earlier retirement. Some of this was voluntary - such as federal public servants whose pension scheme had a quirk that encouraged them to retire just before they turned 55 - but a lot was involuntary, particularly for less-skilled blue-collar workers being made redundant from manufacturing. As you know, people are able to get access to their superannuation savings from the age of 55 - and earlier if they’re made redundant.

But that was a long time ago, and though some public servants may still be retiring early because of quirks in their super schemes, for about the past decade the tide has been turning and the proportion of 55 to 64 year-olds participating in the labour force has been rising, not falling. That is, people are tending to retire later. Since 2001 the participation rate for men aged 55 to 59 has risen from less than 72 per cent to more than 78 per cent. Since 1993 the participation rate for men aged 60 to 64 has risen from 54 per cent to almost 60 per cent. I expect this trend has a lot further to run.

You can see the federal government seeking to reinforce this trend, first by phasing up the female age pension age from 60 to 65; second, by introducing tax-free treatment of retirement income provided the individual has turned 60; and now in last year’s budget by beginning to phase the age pension age up to 67. The limited outcry over these moves is a sign they fit with people’s changing social attitudes. We’re living a lot longer than we used to, and are healthier than we used to be, so it follows that we can work for more years before we retire. It doesn’t make much sense for all of our extra years of life to be spent in retirement. What about manual workers whose bodies may not hold up for another two years to 67? We already make provision for them - disability support pension.

The pension age is being raised in most developed countries and I don’t think we’ve seen the last of our government’s efforts to raise the de facto retirement age. The next step - which may be recommended in the Henry tax reform report - would be to raise the age at which tax-free retirement benefits are available to align it with the age pension age. Nor do I think that 67 is the highest the pension age will go.

It’s often said that, whether or not older people want to keep working, they can’t because of employer prejudice against older workers. Older workers are the first to be laid off and the last to be rehired, we’re told. I’m sure there was a lot of truth to this complaint and there may be some lingering vestige of such a prejudice, but I’m equally sure it’s disappearing and probably largely gone.
Why? Because, at a time of population ageing, where skilled labour is perpetually in short supply, it’s a luxury employers can no longer afford. And most of them have already figured that out.

So I believe employers’ attitude towards older workers is in the process of reversing itself. One consequence of ageing is that fewer and fewer young people will be leaving education each year and joining the workforce (though this will be countered to some extent if we achieve high levels of skilled immigration). This being the case, employers will be anxious to retain the services of their existing, older - but skilled and experienced - workers. They’ll generally be sorry to see them retire and willing to offer the flexible arrangements necessary to have them stay on, even if only part-time.

Older workers possess something economists call ‘firm-specific knowledge’. They know how things are done; they know why they’re done that way and not some other way. When in the recessions of the early 1980s and the early 1990s big companies followed the corporate fashion of the time and sought to impress the sharemarket by announcing mass redundancies, they learnt the hard way that getting rid of your older workers involved also excising the firm’s ‘corporate memory’, so that it lost the ability to do certain things. Some of these key people had to be brought back, sometimes at great expense and as an admission of error. It’s no longer fashionable for big companies to try to impress with huge layoffs, and I suspect that part of the reason for this is the belated recognition that getting rid of your corporate memory isn’t a smart thing to do.

As older workers become more inclined to stay on, and employers become more desirous of having them stay on, governments are increasingly likely to change the tax laws to accommodate and encourage this trend. That’s because reversing the trend to early retirement represents the easiest and most obvious way to reduce the economic and budgetary costs of ageing. The next best way is to do more to help mothers return to the workforce and help more to work full-time rather than part-time. It’s probably no coincidence that we’re now finally seeing some action on paid parental leave.

The changing balance of supply and demand for labour

The key to understanding how ageing will affect workers is to understand the basic economic forces we’re dealing with - the changing balance of the supply and demand for labour. You also need to understand where we’re coming from. The economy is now emerging from a period of about 30 years - starting in the mid-1970s - when the number of people wanting to work greatly exceeded employers’ demand for workers and the rate of unemployment was always high. According to the economic textbook, such a position can’t be sustained because the price of labour (wages) will always adjust to bring supply and demand into balance. But the labour market doesn’t work the way textbooks say it does and, as I say, we went through a protracted period in which the supply of labour exceeded demand.

The supply of people wanting work was plentiful for three main reasons. First, because of the high fertility rate in the 50s, 60s and 70s, a lot of young people were entering the labour force each year. Second, because the bulge of babyboomers were at their prime working age. And third, because changing social attitudes and rising levels of educational attainment were prompting a lot of married women to return to the workforce.

As a consequence of this period of excess supply of labour, the balance of power in industrial relations shifted decisively in favour of employers. We saw a marked decline in strikes and other industrial disputes and, indeed, the steady decline of the union movement. More to the point for our present purposes, employers realised there was rarely any shortage of people wanting to work for them and so they became a lot more picky. They could demand higher levels of education than were needed to perform the tasks involved; they could favour married women over young people (more reliable); they could decline to interview any job applicant who’d been unemployed for more than a month or so and, above all, at a time of rapidly changing technology they could favour hiring young people over older people, whether those oldies were job applicants or existing employees. I can remember a time in the days of the Fraser government when there were concerns about high youth unemployment, it was considered virtuous to bundle older workers into retirement to make way for the younger generation.

Why did employers behave like this? Because the excess supply of labour allowed them to. The trouble is, because this excess lasted for 30 years, many people have come to regard it as part of the natural order - the way the world has always worked and always will.

In truth, that era has ended and we’ve entered a new era where employers’ demand for labour now exceeds the supply of people wanting to work. And this means the balance of industrial power is shifting from the employers back to the workers, just where it was in the post-war period that ended in the mid-70s. Why has the balance of supply and demand shifted? In a word, because of ageing. With an older population, you get more people who consume but don’t produce. So the demand for labour remains strong, but the supply of labour declines. To be more specific, we have fewer young people joining the workforce each year as the low rates of fertility in the 80s and 90s have their effect and as the babyboomers start surging into retirement.

The point is, it’s this change in the balance of demand and supply that gives workers the upper hand and forces employers to change their behaviour in line with the changed economic reality.

Employers will stop favouring young people over older people because they have to. There just won’t be enough young people entering the labour market to allow them to discriminate against older workers.

More generally, shortages of skilled labour will become commonplace, and rather than giving their workers a hard time, employers will have to try harder to retain the services not just of older workers but of all workers and discourage them from being poached by rival firms. Salaries will be higher, perks will be greater and employers will be a lot more solicitous of their workers’ welfare. Firms will vie to be seen as the ‘employer of choice’ in their industry. Why will they? Economic necessity.

This is the amazing thing about the portrayal of ageing as a great problem for the economy. It will be a problem for employers, but just the opposite for workers.

Before I move on, let me warn you about something. At about the time of the first intergenerational report in 2002, people focused their minds on ageing, looked at their existing workforces and noticed the high proportion of babyboomers, all of whom were about to retire. They did a bit of manpower planning and projected that, within 10 or 20 years there’d be huge shortages of doctors, nurses, teachers and many other professions. You could add all these shortages together and conclude that, with all these unfilled vacancies, the economy will surely grind to a halt. But I warn you against such a conclusion. Why? Because, as I said at the beginning, the economy is dynamic. Or to put it another way, because nature abhors a vacuum. Those massive projected shortages won’t transpire because, to a greater or lesser extent, people will find a way to overcome them. They’ll try to attract skilled immigrants, they’ll look for labour-saving solutions, they’ll allow nurses to do the work of doctors, or whatever.

I haven’t left myself much time to talk about the effect of the resources boom. In the last part of the noughties, immediately before the global financial crisis, we were in the grip of a resources boom, getting sky high prices for coal and iron ore as China and India undertake the massive and protracted installation of all manner of infrastructure needed to turn them into developed economies. The result for us was a booming economy, the lowest unemployment rate in 30 years and widespread shortages of skilled workers. We’ve been through resources booms before and the GFC seem to bring that one to an end as all the others had ended. But China and India turned out not to be greatly affected by the global recession. They have resumed their rapid march towards economic development, their demand for our resources has continued unabated and, after falling somewhat, resource prices are on the way up. We’re in for another period of huge investment in increased mining capacity, including a huge investment in LNG facilities. So the resources boom is back on, it seems like it won’t be long before the economy is back to full employment and skill shortages, and Asia’s heightened demand for our minerals and energy could run on for a decade or two.

If so, this will have profound effects on our economy. It will keep our exchange rate and interest rates high, and lead to a much bigger mining sector, but smaller manufacturing, agriculture and tourism sectors. It will change the mix of occupations accordingly, and it will change the nation’s geographic balance, favouring rapid growth in Western Australia and Queensland and much slower growth in the other states. Population will shift to the mining states as it has been for some time. That will be great for Queensland, though it will continue suffering the same problems it’s been suffering from for a while: growing pains.

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WHAT POLICY INSTRUMENTS ARE APPROPRIATE FOR THE GFC?

Talk to Graduate School of Government, University of Sydney
March 18, 2010

Before I get on to talking about the policy response to the GFC I want to go back to first principles and remind you that while, as public servants, you take government policy activity for granted - it’s what you’re employed to do - the appropriate role of government (whether, and under what circumstances, governments should intervene in markets) is perhaps the most contentious topic in politics and economics. The political philosophy of libertarianism - which gives primacy to individual liberty and carries a presumption against the need for government intervention - is overrepresented in the political debate in Australia and particularly the US. While by no means all economists are libertarians, most have a big streak of it in them because the dominant model of conventional, ‘neo-classical’ economics is built on the assumptions that people always act rationally and that markets are self-righting.

The ground rules for intervention

While the public is always urging governments to intervene to correct problems, real or perceived, and politicians are almost always keen to leap in, economists have a two-stage test before they accept such a need: 1) a significant instance of ‘market failure’ has to be demonstrated and 2) the ability of government intervention to correct the market failure - or at least do more good than harm - has to be demonstrated.

Market failure arises where:

a) there is insufficient competition within the market to produce the outcomes the model promises, or

b) there are ‘externalities’ (that is, where the actions of the participants in a market transaction have consequences for third parties [eg the wider community] whether those consequences are negative [eg generation of pollution] or positive [eg my education -or my invention of some improved technology - benefits other people]), or

c) where the goods or services being exchanged display the qualities of ‘public goods’. The two key qualities are that they a non-rivalrous (my consumption of the good doesn’t reduce the quantity of it available to others eg knowledge, use of the internet) and non-excludable (no one can be effectively excluded from using the good eg free-to-air television). The standard egs of public goods are lighthouses and defence spending, but there are other, less perfect examples. The free market will produce less of a public good than is in the best interests of the community because it’s so hard for private firms to make sufficient profit from producing it. This is why governments often end up producing those goods and services which have partial or complete public goods characteristics.

Other classes of market failure arise because of transaction costs, agency problems, or information asymmetry.
But there is also such a thing as government failure - where government intervention in the market makes things worse rather than better, or when the modest benefits don’t justify the considerable costs (eg the home insulation scheme?). There is a political/economic theory known as ‘public choice’ which holds, among other things, that politicians and bureaucrats always act in their own interest rather than the public’s interest, and that, whatever their original motivations, all government regulation of industry ends up being captured by the industry and turned to the industry’s advantage in, say, reducing competition within the industry (to the incumbents’ advantage), increasing protection or in persuading the government to subsidise industry costs.

Where I do stand in this debate? I believe market failure is common and that governments should usually act to correct it. But I also believe in govt failure and some degree of truth in the public choice critique. Governments and their bureaucrats do sometimes act in their own interests rather than the public’s and some regulation is captured and perverted by those being regulated. So I believe in intervention, but I also believe that getting intervention right, minimising unintended consequences and doing more good than harm is a tricky business, requiring a lot of careful thought, trial and error, experimentation, learning from experience and project evaluation. This is why I’m pleased to see you studying Policy in Practice and interested in discussing the choice of appropriate policy instruments.

Now let’s turn to the GFC. But before we do, let me just say this: one reason I was moved to remind you of the libertarian, free market, laissez faire view of the world is that it’s been very much in evidence in the debate about the causes and cures of the GFC, particularly in the US. It seems blatantly obvious to most people (including, I think, most economists) that the GFC is a case of massive market failure, but there have been plenty of libertarian-leaning economists in the US (and some here) willing to argue the crisis was really the product of government failure - government intervention gone wrong - and argue that the proposed regulatory response to correct the problem was unnecessary or even counterproductive. This, of course, is a line of argument that powerful interests in the financial markets are happy to hear and willing to sponsor.

I could talk about the GFC from a global perspective, but I’m going to concentrate on the Australian perspective - which, of course, is very different from that of the North Atlantic economies in the eye of the storm. (You can draw me out on the more global view in question time.)

The policy response to the crisis can be divided into two strands: 1) the macroeconomic response - the policy actions necessary to restore stability to the real economy, to lessen the recession and hasten the recovery and 2) the regulatory response - the policy actions necessary to correct the regulatory failures that permitted the crisis to occur and reduce the likelihood of a similar crisis recurring. I’m going to devote most time to discussing the choice of instruments in the macroeconomic response, but I will briefly discuss the prudential regulation response. (Again, you can draw me out in questions.)

The two main instruments available for macro management - the short-term stabilisation of demand as the economy moves through the business cycle - are fiscal policy (the manipulation of govt spending and taxation to influence the strength of demand) and monetary policy (the manipulation of interest rates to influence demand). Under the Keynesian influence, fiscal policy was the dominant instrument used in the post-war period, but from the mid-1970s the dominance switched to monetary policy. I want to start by explaining why fiscal policy fell out of favour with policy-makers - why they changed their view on which policy instrument was more appropriate for use in the day-to-day management of aggregate demand - and then explain why, contrary to that established view that fiscal policy was passé, it has been given a major role in the macro response to the GFC, both here and around the world.

Why fiscal policy fell out of favour with policy-makers

There has never been any denial that the budget’s automatic stabilisers should and do play an important counter-cyclical role. Rather, the query has been over discretionary policy. At least since the time of the Fraser government, monetary policy has been the primary instrument used for the short-term management of demand, with fiscal policy playing a back-up role at best. There was a great concern that policy adjustments needed to be more timely, to ensure their effects on economic activity were counter-cyclical rather than pro-cyclical. Policy-makers identified three causes of delay, and concluded that monetary policy was better than fiscal policy on two out of the three.

First, the recognition lag - the time it takes policy makers to realise that a policy adjustment is needed. This is caused mainly by delays in the publication of economic indicators and, on the face of it, you would expect it to apply equally to both policy arms. However, monetary policy has sought to reduce the lag by adopting a forward-looking or pre-emptive approach where policy adjustments are based on forecasts of inflation, with actual indicators used mainly to update the forecasts. Particularly because of the next point, this is easier to do with monetary policy than fiscal policy.

Second, the implementation lag - the time it takes to actually change the policy setting after it has been decided that it should be changed. Here, monetary policy wins hands down; it’s significantly more flexible. The stance of monetary policy is reviewed at every monthly meeting of the Reserve Bank board and could be changed even more frequently if necessary. Changes are easily implemented the following morning after the decision has been made. Policy can be changed in small or large, frequent or infrequent steps, without any implication that earlier decisions were wrong. By contrast, fiscal policy is usually adjusted only in May each year and though mini-budgets are possible, for them to come too soon after a budget, or for there to be too many of them, could attract criticism over short-sightedness. More significantly, there are delays while cabinet decides the particular tax or spending changes to make, while the legislative authority is passed through parliament, and while the administrative arrangements needed to put decisions into effect are put in place.

Third, the transmission lag - the time it takes for the implemented measure to affect economic activity. Here, fiscal policy wins. Government spending affects economic activity as soon as the money leaves the government’s coffers, while tax cuts or cash bonuses (transfer payments) affect activity as soon as the recipient chooses to spend the money. By contrast, Reserve Bank research shows that a sustained change in interest rates of 1 percentage point causes a change of 0.33 percentage points in real GDP in the first year, with a further 0.33 points in the second year and a further 0.17 points in the third, giving a total effect after three years of 0.83 percentage points.

But despite this advantage on the transmission lag, fiscal policy lost out because of its poor performance on the recognition and implementation lags.

Why fiscal policy is back in favour

It was always easy to predict that fiscal policy would come back into fashion just as soon as the economy dipped into recession. The politician who could resist the temptation to use the budget to stimulate the economy during recession has yet to be born.

But there were two other, more economic arguments favouring greater reliance on fiscal policy which arose from the particular nature of the global financial crisis. First, the synchronized nature of the global recession - because all developed economies were hit at the same time by the same developments in global capital markets - gave fiscal policy a comparative advantage. When a single country goes into recession, easing monetary policy can help stimulate the economy also by lowering its exchange rate, thus making its export and import-competing industries more price competitive. But that can’t happen when all the country’s trading partners go into recession and ease monetary policy at the same time, because there’s no one to depreciate against.

When a single country goes into recession, easing fiscal policy has the disadvantage that some proportion of the stimulus leaks overseas in the form of higher imports. But in a synchronized recession, when all countries ease fiscal policy at the same time their leakages cancel each other out. Each country suffers a leakage from imports, but also enjoys an injection from exports.

Second, the fact that this global recession had its origin in a crisis on the financial side of the economy was another factor counting in favour of fiscal policy. When you’ve got an impaired banking system, lower interest rates may not be passed through to households and businesses and, even if they are, the banks may be unwilling to lend. Further, if you’ve got an impaired banking system, the official interest rate will probably soon be close to zero, leaving no further room for conventional monetary easing, although ‘quantitative easing’ remains open. Countries in this situation are caught in the legendary Keynesian ‘liquidity trap’ - a classic justification for favouring fiscal policy over monetary policy.

That last argument doesn’t apply to Australia, of course, but all of these arguments explain why the circumstances of this global recession prompted even the ultra-orthodox International Monetary Fund to urge its members to respond to the downturn with fiscal policy.

A further, local factor is that, this time, worries about the recognition and implementation lags were countered by the peculiar nature of this crisis. We were able to see the shock coming, and start acting to counter it, well before it actually reached us across the Pacific (apart from the instantaneous effect on business and consumer confidence as Australians watched the crisis unfolding on TV every night).

Before we move on, I should warn you that fiscal policy has not replaced monetary policy as the dominant instrument of macro management. And Dr David Gruen of our Treasury has noted that the special circumstances that made fiscal policy such a necessary and major element in the response to the GFC aren’t likely to be present in future recessions.

The regulatory response to the GFC

As you know, in the heat of the crisis, in October 2008, the Rudd government responded by producing two new policy instruments: the government guarantee of all small deposits in banks and other deposit-taking institutions. This was in response to a lot of people moving their money to banks they perceived to be bigger and safer, thus causing significant problems for some of our smaller banks. An unwanted side effect of the guarantee was to prompt other people to move their savings out of unguaranteed non-bank trusts (such as mortgage trusts) requiring those trusts to freeze withdrawals for a time. Second, the government guaranteed the bank’s large deposits and wholesale funding, in return for a variable fee. This was necessary to ensure they could continue to obtain the considerable overseas funds they needed to continue operating, in the face of a world where most other developed countries’ government had guaranteed their banks. Because this latter guarantee was quite expensive for the banks, they stopped using it as soon as they could, and now it will be removed at the end of this month. It tended to advantage the bigger banks over the smaller ones. As yet, nothing has been done to regularise the guarantee of small deposits, which the government should really be charging for, thereby reducing the competitive advantage accorded to the guaranteed sector.

Looking at the regulatory response more broadly, I won’t discuss the regulatory failures that permitted the crisis to occur - particularly as there weren’t any great failures in the regulation of our banks - but go straight to discussing the improvements in regulatory instruments being worked up at the international level by two bodies associated with the Bank for International Settlements in Switzerland (the central bankers’ club): the Basel Committee on Banking Supervision and the Financial Stability Board. As part of the G20’s renovation of these bodies, Australia has a seat on both.

They are working on proposals to tighten up the international standards on the adequacy of the capital banks are required to hold - that is the limits on the extent to which banks may increase their gearing - including by closing loopholes in the capital adequacy standard and by introducing a supplementary leverage ratio. They are also working up proposals to require banks to improve their liquidity - their ability to pay their debts as they fall due - by holding greater highly liquid assets (such as government bonds, which can really be sold on the market) sufficient to tide them over for, say 20 days, if their short-term funding was suddenly cut off (as it was during the crisis).

This is all fine and much needed internationally, but the Australian banks - and the Australian authorities, especially APRA and the Reserve Bank - are concerned that the rules may be more onerous here than is justified by the good performance of our banks. These rules will increase the cost of ‘intermediation’ - which is what banks do, act as an intermediary between savers and investors, lenders and borrowers. Raising the cost of intermediation would mean widening the gap between the average interest rate the banks pay to borrow funds and the average interest rate the banks charge their borrowers. This increased cost would be passed on to the banks’ customers, particularly their borrowers. These higher interest rates to borrowers would act to dampen economic growth. That is, there is a price to be paid for making banking safer and less exposed to crises. A particular worry of the Australian banks and our authorities is that, as the liquidity requirement now stands, it would require our banks to hold more government bonds than are actually on issue.

Once the new capital and liquidity standards have been agreed on internationally, it will be up to the national authorities in each country (APRA in our case) to adapt them to local conditions and apply them locally. In theory, this means we don’t have to comply with any requirement that doesn’t suit us. In practice, however, we will be under considerable pressure from other countries to comply with the higher standards. Our banks need to borrow from overseas and want to operate in other countries, and their reputations would suffer if a perception arose that they were being inadequately regulated at home.

At present, our authorities are working on the two committees to ensure the final requirements are sufficiently flexible to accommodate the Australian case. To the extent that they fail, APRA will have to walk a fine line to modify the new standards in a way that doesn’t damage Australia’s reputation.

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AUSTRALIA’S OUTLOOK FOR POLITICS AND GOVERNMENT IN 2010

Talk to Australian Business Economists Annual Forecasting Conference, Sydney, December 8, 2009

After the tumultuous events in Canberra last week, it now seems clear the next federal election will be a double dissolution held not much earlier than normal - late September - with climate change and Work Choices as its main issues. It also seems likely that Kevin Rudd will win in a landslide.

Mainly through over-reach, Mr Rudd has managed the most remarkable wedge of his opponents, driving a huge divide between the party faithful and the wider electorate. The polls show majority support for an emissions trading scheme, even among Liberal voters. The only respect in which that support wavered was on the question of whether it needed to be approved before Copenhagen. The polls show no evidence of growing disapproval of an ETS, suggesting that all the emails and phone calls flooding into Liberal members’ offices insisting the ETS be blocked were coming from the party faithful, whose main motive was distrust of anything proposed by Labor, and so were quite unrepresentative of the wider electorate.

The Liberals

So the party that lived by the wedge while in government is now dying by the wedge while in opposition. The distinction, however, is that whereas Labor always ended up spurning its heartland in favour of the wider electorate, the Liberals have chosen to go the other way. Mr Rudd has positioned Labor slightly to the right of centre, and now has succeeded in pushing his opponents further away from the middle ground.

Tony Abbott won the Liberal leadership by accident. Polling before the leadership contest revealed him to be the least popular among the three contenders. The majority intention within the parliamentary party was always to pass the job to Joe Hockey, but that didn’t happen, mainly because of his ambivalence towards taking the job before this election and because of his reluctance to repudiate his support for the ETS. Some in the party have charged Mr Hockey with being indecisive, but I think he’s been fortunate and is now well positioned to take over the job from Mr Abbott when the party tires of him, as seems inevitable. Mr Abbott is an immensely likeable person in the flesh, but few voters will get to meet him in the flesh. As his very first days in the job demonstrate, he’ll be incapable of concealing his extreme views on social issues and quite conservative views on issues such as individual contracts, unfair dismissal and nuclear power. This expression of his views in advance even of the selection of his shadow cabinet suggests he’s unlikely to be more consultative than his predecessor. Some politicians do change their spots when they attain high office, but I doubt if Mr Abbott will. The pollster Rod Cameron has branded him ‘unelectable’ and I’ll be surprised if the election results don’t bear him out.

Mr Abbott has made it clear he intends to be a lot more obstructionist than Malcolm Turnbull was, opposing almost everything the Government tries to get through the Senate. The Opposition is so divided that that just about the only thing it can agree on is hatred of the Labor usurpers. This sentiment is shared by its party faithful, so they too will be gratified. But more pragmatic opposition leaders don’t let through a lot of government legislation because of a sense of public duty, they do it because they know the electorate hates obstructionism and negativity in its politicians. Once again, the Libs will be preaching to the choir, not the unconverted.

It’s worth remembering that the hardliners in the parliamentary party tend to be senators and people with very safe seats, whereas the moderates who supported Mr Turnbull and wanted the ETS passed and out of the way tend to have marginal seats. So if the party suffers a significant loss of seats at the election, this will tend push it further to the right. Perhaps that could save Mr Abbott after all.

The ETS legislation

Don’t be in any doubt about the status of the ETS. The Government has made clear it remains committed to getting it passed as amended by the agreement with Mr Turnbull. Once you’ve conceded ground to the rent-seekers, there’s no going back. And that means Mr Rudd, who must have a scheme, has no choice but to call a double dissolution. There’s no way the Liberals will agree to any ETS , and since there’s no way the Government will gain a majority in the Senate at the next election, its only hope of getting the bill passed is at a joint sitting after a double dissolution. Whether or not the election is a double dissolution, it seems likely the balance of power in the Senate will shift to the Greens in their own right. So were the Government simply to try its luck at getting the bill through the next parliament, it would have to throw out all the concessions it has granted to business and move the scheme in entirely the opposite direction, an utterly unattractive prospect for Mr Rudd.

The Double Dissolution

However, Mr Rudd has no desire to pull on a double dissolution early next year for several reasons: it would clash with state elections in South Australia and Tasmania on March 20; it would put the two houses out of kilter and thus truncate the next term by about a year; it would give Mr Abbott too little time to blot his copybook, and finally because modern politicians seem genuinely reluctant to risk annoying the electorate by calling early elections.

The Government has announced its intention to bring the amended bill back into parliament in February, even though it’s highly unlikely to be passed. It has left the press gallery with the impression it will then wait three months and put the bill up to be rejected again. This new trigger, it says, would allow it to take the amended bill to the joint sitting rather than the original bill. But I understand the constitution allows it to amend the bill at a joint sitting, so its true motive is probably just to delay the double dissolution until later in the year, for the reasons I’ve given.

For constitutional reasons, the Government is unlikely to want to hold a double dissolution election before July 1, but it must be called before August 10. This suggests the most likely time for the election to be held is the second half of September - which wouldn’t be considered particularly ‘early’ by most people.

It’s not always the case that the rejected bills that provided the trigger for a double dissolution rate much attention in the election campaign, but I have no doubt the ETS will be a key issue in this campaign. The Opposition will run a scare campaign about Labor’s ‘big new tax’ and Labor will have to explain and defend its scheme. But Mr Abbott’s and Julie Bishop’s inability to stop themselves speaking in defence of individual contracts and unfair dismissal will leave it open for Labor to run its own scare campaign about the return of Work Choices. If I’m right, the 2010 election campaign will be fought on the same two policy issues that contributed most to the Liberals’ defeat in 2007 (apart from the it’s-time factor). Remarkable.

Rudd’s over-reach

On the face of it, Mr Rudd has brilliantly wrong-footed his opponents, almost guaranteeing they’ll perform poorly at the election - and maybe the one after that. But I think it got out of control and he over-reached himself, damaging his opponents more than he intended to and failing to achieve various of his objectives. For a start, he failed to get through legislation he could boast about at Copenhagen. He further debauched his ETS at a cost of $7 billion but has nothing to show for it; he’s lumbered with a double dissolution he pretty clearly didn’t want, he’s facing a more obstructionist Opposition between now and the election, and has to fight the election trying to counter an almighty scare campaign about ‘a big new tax,’ a prospect he doesn’t relished.

Although he can’t avoid a double dissolution if he wants his ETS, it has costs. Because they halve the quota of votes needed to be elected, double dissolutions favour minor parties and disadvantage the major parties in the Senate. Labor’s expected to make a net gain of only one Senate seat; Mr Rudd might have done better than that in an ordinary half-Senate election. The number-crunchers expect Senator Fielding to disappear but be replaced by some other independent, and Senator Xenophon to gain a running mate. The Greens would have gained the balance of power in their own right in a half-Senate election, but a double dissolution will give them even more seats.

Mr Rudd was playing politics with policy. Despite agreeing to special concessions earlier this year that made a complex policy even more so, he long ago stopped explaining and defending the ETS, preferring all the attention to be on the brawling Coalition. He did nothing to counter the alarm being spread by Barnaby Joyce and Alan Jones, nor to refute the self-serving exaggerations of various industry lobbies. He allowed the ETS to be further perverted to provide Mr Turnbull with the cover he needed to be able to support the bill, leaving unchallenged the fiction that it was ‘deeply flawed’ but had now been improved to ‘save tens of thousands of jobs’. But in his desire to have the world watch the Liberals tearing into each other he over-reached, undermining Mr Turnbull by failing to counter the propaganda spread by Mr Turnbull’s opponents in the Coalition, and thereby allow opposition within the Coalition to grow to the point where Mr Turnbull was overwhelmed.

The invisible recession

At this conference two years ago, the greatest problem of the newly elected Rudd Government was that it had won office at a time when a recession was overdue and, with the economy travelling near full employment and the Reserve Bank vigorously applying the brakes, it was facing a high likelihood of recession some time in its first term. At this conference one year ago, after the culmination of the global financial crisis with the collapse of Lehman Brothers, it looked certain we were facing a severe recession, but one that could easily be blamed on forces beyond the Government’s control. Kevin Rudd was off the hook: don’t blame me, it’s the GFC.

What a lot has changed in 12 months. Today, after the application of huge fiscal and monetary stimulus, we’re emerging from a recession so mild the public can’t see that we had one. So the old business cycle has been completed and a new one begun with only the most moderate collateral damage. Through a combination of good luck and good management - its own and its predecessor’s - the Rudd Government is home scot free: it’s presided over a recession as feared, but one that generated little pain and no blame. The one small risk is that, as memories fade, the whole thing may come to be regarded by some as a Government beat-up: a lot of carry on about nothing. Such forgetfulness would strength the Opposition’s claim that Rudd has gone on a pointless spending spree leaving nothing to show but huge deficits and debt that will burden our children and grandchildren. The fear of government debt does have some potential to worry the economically unsophisticated, but its potency is greatly diminished by the Opposition’s general lack of credibility. The fading memory of the cash splashes and the likelihood of further interest rate rises next year won’t help Labor’s re-election campaign, but they’re unlikely to represent a significant problem to a government that remains so popular.

The painless Prime Minister

A further year to observe Kevin Rudd has served only to deepen my disappointment in him and confirm the reservations I expressed last year. He’s a much more skilful - that is, cynical - politician than most of us realised, but he’s no great reformer and, thus, no great leader. He’s a weak leader, lacking ideology and conviction apart from his unquenchable desire to stay in power. Combine his lack of commitment to particular policy reforms with his preoccupation with political objectives and you understand his reluctance to do anything that imposes pain on anyone and thus could threaten his popularity.

In his unconscious mind he’s still in opposition, ready to throw overboard any mildly unpopular policy that could stand between him and (re-)election. Perhaps because of his success with the recession, and partly because of his frenetic pace of activity, it’s yet to occur to him that governments get judged by their achievements, rather than their busyness, and that to get truly memorable achievements up and running involves taking risks and putting noses out of joint. John Howard understood this with his determination to introduce his two cherished reforms, the GST and Work Choices. He almost lost an election over the GST and he only pulled back from the full-bore Work Choices when he realise how deeply unpopular it was with Howard’s Battlers. It’s too early in Mr Rudd’s career as Prime Minister for it to have occurred to him that, unless he gets some genuine reforms into place, he risks the same judgment made of Malcolm Fraser: he managed to stay in power for X years, but what is there to show for it? A leader who lacked the courage to lead, who was only ever prepared to use his credit points to secure his re-election, never to buy reform.

Mr Rudd is no economic rationalist because he simply hasn’t absorbed ‘the economist’s way of thinking’. From his chronic inability to set priorities or to delegate you see he has no inherent conception of opportunity cost. He has no inbuilt suspicion of interventionist solutions. Combine this with his lack of ideology - his dearth of prior beliefs about how the world works and should work - and you see the best label for him is that he’s a ‘pragmatic interventionist’. He is pro-business rather pro-market, seeing economists as just another interest group to be propitiated from time to time. He is keen to ensure business remains generally on side, so interest-group appeasement is a major part of his modus operandi.
From his utterances he has an ambivalent attitude towards economic rationalism, blaming ‘neo-liberals’ for the global financial crisis and accusing his Liberal opponents of being neo-liberals, while claiming the credit for Labor for all the Hawke-Keating government’s microeconomic reforms. He also claims to have instigated an extensive program of micro reform himself through COAG, involving ’27 regulatory reform agendas, covering areas such as financial regulation, consumer protection, trade licences, food regulation, occupational health and safety, and chemicals and plastics laws’. Most of this involves answering the call of big business for a ‘seamless economy’ through the reduction of differences between the states. It’s true that a huge program has been initiated, but it’s also true that negotiations have bogged down and little progress has been made in two years, partly because the prime ministerial caravan has moved on to other, greener fields. Mr Rudd loves the grand gesture - signing the Kyoto protocol, apologising to the Stolen Generations, announcing ‘the most comprehensive [Defence review] of the modern era’, promising to rebuild the Victorian bushfire towns ‘brick by brick, school by school’ and to be there with these communities in ‘the months and years that lie ahead’ - but so far always falls down on the follow-through.

Much has been made of Mr Rudd’s policy wonkery and commitment to process, but there’s precious little of value to show for it. The truth is that, because of his inability to set priorities and delegate, his interest in every policy consideration hasn’t improved the quality of decisions. Rather, his obsession with personally approving every detail has produced a behind-the-scenes shambles, where decisions pile up waiting for his attention, unreasonable demands are made on public servants, everything runs late and policy elements are thrown together at the last minute. While Mr Howard kept a tight rein on policy decisions, he didn’t usurp the role of his ministers the way Mr Rudd does. The cabinet has become a rubber stamp for decisions made by Mr Rudd’s kitchen cabinet, the Strategic Priorities and Budget Committee, composed of himself, Julia Gillard, Wayne Swan and Lindsay Tanner. There are even suggestions that the other three merely get to comment on the propositions Mr Rudd brings to this committee.

It’s become much clearer that it’s politics Mr Rudd is on about, not good policy. Presumably, much of his obsession with detail is directed to getting the politics right. Smart leaders try to starve their political opponents of oxygen by purporting to ignore them; Mr Rudd can’t resist criticising and baiting his opponents at every opportunity, often with a phony appeal for bipartisanship. What he doesn’t seem to have realised is that by debating the Opposition’s criticisms, he brings them more media attention than they’d otherwise get. Hence the seriousness with which the press gallery has taken the Opposition’s carry-on about deficits and debt, and the ill-informed claim that the planned fiscal stimulus needs to be curtailed.

Mr Rudd is even more obsessed with dominating the 24-hour news cycle than Mr Howard was. The motive is to keep the initiative away from the Government’s critics, give the appearance of ceaseless devotion to duty and keep the media so busy they don’t have time to hunt out their own stories - such as why promises haven’t been kept or why policies aren’t delivering. The main instrument is to produce a continuous stream of (usually pretty minor) ‘announceables’. The price of this media management is that it wastes the time of bureaucrats, distracts the attention of ministers and gives spin doctors primacy over policy wonks.

Mr Rudd is not a Labor animal. He has no powerbase within the party, no union links (or much sympathy with unions), no great factional support and no mates. His undoubtedly strong support within the party at present is based purely on his political success; he enjoys little affection or loyalty. But even on this he is stretching the forbearance of his party with his delight in giving jobs to the Liberal boys. At one level this is a clever political tactic, wrong-footing his opponents and increasing his apolitical appeal to wayward Liberal and swinging voters. It’s saying: I can’t be such a bad manager if all these big-name Liberals are happy to work for me.

At another level, however, it’s storing up trouble for the future. If your modern Labor politician is, like Mr Rudd himself, less driven by a desire to implement traditional Labor policies and more attracted to attaining and enjoying the spoils of office, then Mr Rudd is advancing how own enjoyment of power at the expense of his underlings’ advancement. It’s something they will remember when the day comes that Mr Rudd loses his winning touch. The other point is that his willingness to appoint people whom he has criticised so heavily in the past, and the alacrity with which they accept the offer to work for a Government they have branded as incompetent, exposes the phoniness of much political rhetoric.

Rudd Government’s second year

Mr Rudd’s first year involved the commissioning of a huge number of inquiries; his second year has involved the receiving of many of those reports without many decisions about implementing their recommendations. So far there’s been a lot of talk and a lot of spending, but not much reform.

A few weeks back Lindsay Tanner offered a list of reforms in which, he said, ‘substantial progress has been made’. His list included: developing a national trade licensing system, improving processes in the regulation of the construction industry, improving environmental assessment and the development of a national construction code.

Of course, you could argue that for much of the year the Government had its hands full responding to the global financial crisis. I think it did a very good job on this, not just in the alacrity and Treasury-provided skill with which it applied fiscal stimulus, but also in the cleverness with which it managed business and consumer confidence - a key element in making the recession so mild. Oppositions have to find things to oppose, but I suspect an element in the Opposition’s disapproval of the fiscal stimulus was resentment that Labor had used the good budgetary position it inherited from the Libs to spend a lot of money and buy a lot of popularity in the name of staving off recession.

There’s something in this. If you look carefully at the stimulus packages you see tell-tale signs of political as well as economic calculation. The first cash splash, for instance, was supposed to be aimed at those welfare recipients so credit-constrained that they were highly likely to spend all the cash without delay. How then do you explain the decision to exclude people on unemployment benefits from the bonuses, while including self-funded retirees?

Political considerations explain it easily. Dole recipients were also left out of the second cash splash. And what about the decision to build a new building at every primary school in the country, whether public or private? It can be readily defended as spreading the stimulus to the building industry far and wide, but consider the political attractions.

This year’s budget wasn’t bad, but wasn’t particularly good. Its main measure was an excessively generous increase in pensions. This seemed largely politically motivated because age pensioners are hardly the most needy welfare recipients, and steps were taken to limit the flow-on to the more needy but less politically powerful sole parents and people on the dole. This measure was hugely expensive, with the cost growing each year forever. True, this cost was largely offset by five measures - including the phasing up of the age-pension age, and the cutbacks in salary sacrifice for superannuation - which could be classed as reductions in middle-class welfare.

Well done. Only problem is, whereas these reforms could have been used to undo some of the spending and tax-cut extravagance of the Howard years and thus help get the budget back into surplus, they were in a sense ‘wasted’ on helping to pay for a new extravagance of the Rudd Government.

The year ahead and tax reform

Aside from the election, the two big economic issues for 2010 will be the budget and the Government’s response to the report of the Henry taxation review. Despite the imminence of the election, I expect the budget to be a restrained affair, with any new spending programs covered by savings elsewhere. Total government spending in 2010-11 is likely to fall in real terms - for the first time in 20 years - because of the planned withdrawal of stimulus. The Government will have a terrible struggle to achieve its commitment to limit its real spending growth to 2 per cent a year, but not in the election year.

Turning to the tax review, although it’s due to report to the Government before Christmas, the Government isn’t likely to make its report public until February or March next year. Even so, we have an idea of what to expect.

The report is intended to lay out a blueprint for the direction of reform over the next 25 years, to act as a guide to governments in their day-to-day decision-making. Would some particular decision move us towards or away from the ideal destination we are hoping to reach eventually? So although the report may include some popular proposals the Rudd Government could implement before the 2010 election, and some which it could promise to implement in its second term, it will also contain controversial proposals the Government is likely to disavow. This was the initial fate of the Asprey report of 1975, which included such obviously politically impossible recommendations as the introduction of a capital gains tax, a fringe benefits tax, a dividend imputation scheme and even a goods and services tax. Dr Henry is hoping to produce the next Asprey report.

As always, the report will focus on improving the pursuit of the three objectives of good tax design: efficiency, equity and simplicity. But it will be looking for reforms that, while increasing allocative efficiency, can also be advocated as increasing fairness. For instance, the 50 per cent discount on the tax on capital gains can be criticised as distorting taxpayer choices, but it can also be criticised as unfair because such a high proportion of all capital gains are enjoyed by a handful of high income-earners.

Often, simplicity is the objective that loses out in the effort to find better trade-offs between equity and efficiency. But not this time. Dr Henry has long been concerned about the growing complexity of the tax law and the greater risks this generates for those (generally poorer) taxpayers who lack access to good advice. He is determined to strike a blow for simplicity, which he believes will also increase fairness. A major gain for simplicity would be achieved if, rather than continuing to have to run to the expense of paying a tax agent to prepare their annual tax returns, most people were able to submit a pre-filled return just with a few clicks of a mouse.

The great workhorse of tax reform is the maxim: broaden the base to cut the rate. So we can expect to see plenty of examples of the report proposing that exemptions and special deductions from a particular tax be reduced so as to finance a general reduction in the rate of the tax. Both sides of such a reform could be expected to reduce the tax’s distortion of producers’ and consumers’ choices. One example could be rationalising the differing rates of tax on different forms of alcohol, without that leading to any increase in overall receipts from alcohol taxes.

Until now, a guiding principle of tax reform has been the ideal of ‘comprehensive income taxation’. This is the notion that a dollar of income is a dollar of income, so it should be taxed at the same rate regardless of how it is derived - from work, profits, dividends, interest, rent or capital gain. Sometimes the comprehensive ideal is seen in terms of nominal income but, it should really be based on real income - meaning that allowance should be made for the inflation-compensation component of interest income and capital gains. However, Dr Henry has noted that the comprehensive income ideal has fallen out of favour with tax economists around the world, implying that it will be abandoned in the report in favour of a dual tax system, where there is one rate scale for earned (work) income and a different one for investment income.

In any case, the comprehensive income tax ideal has, in practice, been honoured in the breach. Income from the different ways of saving is taxed at radically different rates because of a multitude of special arrangements. Dr Henry calculates that, at present, for a middle income-earner on a nominal marginal tax rate of 31.5 per cent, the real effective marginal rate of tax is minus 40 per cent for saving through superannuation, zero for saving through paying off owner-occupied housing and plus 54 per cent for saving through bank accounts. The tax rate on saving through ownership of rental property is plus 24 per cent if the property is owned outright, but minus 22 per cent if negatively geared. The tax rate on saving through listed Australian shares is plus 10 per cent if the shares are owned outright, but minus 35 per cent if negatively geared. I doubt if Dr Henry would be pointing to these hugely anomalous results if he wasn’t intending to propose that something be done about them.

The report is likely to recognise the need to ensure Australia attracts sufficient foreign investment to meet its continuing investment needs, but seems likely to recommend only a small reduction in our present company tax rate of 30 per cent. It may recommend an increase in the resources rent tax on mining companies.

On superannuation, where the present concessional taxing arrangement greatly favours those on higher marginal tax rates (that is, those who already have the greatest capacity to save), the report is likely to recommend arrangements that redirect more of the tax benefit to those on lower marginal rates. It may also propose phasing up the age at which people are able to access their super savings from the present 55 years (with the ability to receive benefits tax free at 60 years) to align with the recent decision to phase up the age for age-pension eligibility to 67.

With the cut-in point for the top personal income-tax rate of 46.5 per cent having been lifted to $180,000 a year - so that now only 2 per cent of taxpayers are subject to the top rate - the report is not likely to recommend the top rate be lowered.

The report will also recommend reform of state taxes. It may propose that steps be taken to harmonise the tax bases (including tax-free thresholds and exemptions) and possibly rates between the states. It is unlikely to propose the abolition or reduction of payroll tax - which is essentially similar in its effects to the goods and services tax - although it may propose national harmonisation, with a lower tax-free threshold in exchange for a lower tax rate. The report may recommend the removal of stamp duty on insurance policies, but it won’t recommend removal the of stamp duty on property conveyancing for as long as the family home remains exempt from capital gains tax.

Finally, Dr Henry is very concerned about environmental issues and the need to internalise to the price system the external costs of environmental degradation. To this end, it seems clear he will propose the introduction of graduated road user charges - congestion pricing - to replace fuel tax and registration fees.

Observations on monetary policy

It’s been another bad year for business economists and markets in their attempts to second-guess the Reserve Bank’s rate adjustments. It was a year in which people forgot a lot of the Reserve-watching rules we were supposed to have learnt a long time ago. Most people spent most of the year on the wrong tram in terms of their expectations, even though they were switching trams. People spent the first part of the year expecting a lot more easing than eventuated, then the second part expecting more tightening than eventuated. People have trouble picking the turning points - the point where easing stops and then the point where tightening starts, or vice versa - but then when they finally pick up the new trend they go overboard and get the pace wrong, expecting a lot more a lot sooner than eventuates.

A big part of the trouble the market has interpreting the Reserve’s utterances arises from its self-absorption. It interprets the Reserve’s remarks from its own perspective rather than the perspective of the speaker. Because the market is always forward-looking, it assumes that when the governor talks about not being ‘too timid to lessen the stimulus in a timely way’ he must be talking about the future, when, being a bureaucrat concerned with explaining and justifying the recent decision to get on with lessening the stimulus (a move some business economists criticised as premature), he was talking about the past. The market may be focused on the future, but bureaucrats find it much easier to talk about what they’ve done, rather than what they intend to do. In that particular episode, some people were saying that by next month the case to start tightening would be clear, but if it was already that close to being clear, why wait? The board didn’t.

Having said that, I have to add that the Reserve is far from adept at sending clear signals to the market. As a professional communicator I have a simple rule: if the punters take the wrong message from what you say, it’s always your own fault. You’d think the Reserve would have learnt by now that its backward-looking self-justifications were often taken to be hints about the future and would know to label those justifications more carefully.

But there’s also inconsistency in the Reserve’s behaviour. For some months it kept repeating that its reduction of monetary stimulus would be ‘gradual’, but its action last week in making an unprecedented three rate rises in a row leaves me at a loss to know what meaning it intended us to attach to the word ‘gradual’. Was it just a signal that it didn’t intend to tighten in steps of 50 or 100 basis points? I suspect the truth is that, for reasons undisclosed, it decided to throw ‘gradual’ overboard.

Turning to the outlook for 2010, the Reserve will be seeking to manage the economy in a new expansion phase. Earlier this year, when the governor was seeking to prepare people for the commencement of a new tightening phase, he spoke often of the need to start moving the stance of policy ‘towards’ neutral, but the media usually reported this as ‘to’ neutral. There’s an important distinction between ‘towards’ and ‘to’. But whether that distinction will turn out to have any content I wouldn’t be sure.

Since the Reserve will be responding to the data as they roll in - and this year has reminded all of us how appallingly bad we are at predicting what data will roll in - it’s certainly possible that, by this time next year, the stance of policy will be back to neutral or even on the tight side. But for this to happen, the economy would need to be growing very strongly - well above trend - and underlying inflation’s return to the middle of the target range would have to have faltered.

Last year I observed that when interest rates are a long way from neutral - in either direction - you probably shouldn’t stay there for long. I think this attitude has been an important part of the governor’s thinking this year, as reflected in his references to the need to end the emergency setting of rates now the emergency has passed. Against this, you might have thought that when he judges the emergency component to have been withdrawn he would pause for some months while deciding when he judges a continuation of the tightening to be warranted. But whether the Reserve ends up sticking to this logic is anyone’s guess.

As rates rise during the year the question of just where neutral is will become more important and it’s possible the Reserve will feel the need to offer more guidance on the question than it has. So far, the governor has declined to nominate a figure, except to say that the long-run average cash rate is between 5 and 6 per cent. I usually take this to mean the neutral rate is 5.5 per cent, near enough, but there’s an argument to say it should be lower than it was if the banks’ spreads above the cash rate are higher and credit standards are more demanding. Trouble is, there’s another argument to say it should be higher than it was if faster population growth and unusually high rates of investment spending have raised our potential growth rate. This leaves me thinking the two arguments probably pretty much cancel each other out, leaving neutral remaining near enough to 5.5 per cent. We can expect to hear more such speculation as next year progresses.

And as the year progresses many observers’ minds will be exercised on the question of how the approach of the election will affect the timing of rate rises. My guess is that this question will exercise the observers’ minds more than it does the governor’s. He’s already said he knows of no convention that monetary policy should not be adjusted during election campaigns. Mr Stevens is a very straight shooter. He doesn’t play political games and his idea of being apolitical is to focus on doing his job as normal and make sure no one can accuse the Reserve of failing to do what needed to be done.

Decisions about changing the setting of policy from one month to the next are judgment calls, as much a matter of art as science. This is why, as I’ve said before, monetary policy is set in the governor’s gut. Many people imagine he has a game plan in his head and if only you could know what that plan is you could predict rate movements with great accuracy. I think that was much truer of his predecessor than it is of Mr Stevens. All you can say is that he reacts to the data as it comes in and makes up his mind before or during the monthly meeting.

So if you’re going to be second-guessing the Reserve again next year I wish you good luck. You’ll have your work cut out and I doubt you’ll be getting many reliable signals from the Reserve.

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CAN THE NOBEL PRIZE REFORM ECONOMICS?

Talk to University of Sydney Department of Government and International Relations
October 29, 2009

Economists often suspect that Australia’s quite extensive quarantine restrictions - against apples from New Zealand, for instance - constitute a form of disguised protection. But when Alexander Downer was Minister for Foreign Affairs he was having none of that. ‘I want to assure you,’ he once said, ‘that our quarantine laws are based strictly on science - [pause] - political science.’

I wanted to say a few words about economics but, since this is a political science function, I thought I should compromise and speak about the politics of economics. It’s not hard to meld the two disciplines because, as many of you would have heard a fortnight ago, this year’s Nobel Prize in Economics was won for the first time by a woman, Elinor Ostrom, who isn’t even an economist, but a political scientist. (Her win caused Michael Jackson some chagrin, because she’d once offered him a job, which he’d turned down.) The person Ostrom shared the prize with, Oliver Williamson, is regarded as an economist, although the person who drew his work to my attention was a sociologist, and it certainly reads as if it was written by a sociologist.

Before we go any further - and in case there are any people from the hard sciences who’ve strayed into the room - I should confess that the economics Nobel isn’t a real Nobel. It wasn’t provided for in Alfred Nobel’s will - I’ve heard he didn’t have much regard for economists, though I’m sure that can’t be true - but was established just 40 years ago under the sponsorship of the Swedish central bank, and styles itself as the Swedish Riksbank Prize in Economic Sciences in memory of Alfred Nobel. That reference to ‘economic sciences’ is sus, for a start. I’m not convinced economics is a science, let alone more than one. But it certainly implies that the sponsors saw economics as a broad church.

This year’s awards - to a political scientist and an economic sociologist - come at a critical time for economics - in both senses of the word. In the wake of the global financial crisis, economics has come under considerable criticism for its failure to foresee that trouble was brewing. There’s been a lot of soul-searching within the profession, some of it quite acrimonious. In America they’ve been arguing on blogs; in Britain they’ve been sending petitions to the Queen.

A lot of the blame is going to the unrealistic assumptions on which conventional economics is based - as epitomised by the ‘efficient-markets hypothesis’ - and on the effort economists have made over the past 40 years to make their discipline more scientifically rigorous by making it more mathematical. The two criticisms are linked because the unrealistic assumptions are needed to make the equations work. In America, last year’s Nobel Laureate, Paul Krugman, concluded that ‘the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth’. In Britain, the eminent petitioners agreed with what they said were the complaints of three Nobel laureates that ‘in recent years economics has turned virtually into a branch of applied mathematics, and has been become detached from real world institutions and events’.

The annual awarding of the Nobel prize is a bit like the Melbourne Cup for economists. It generates considerable excitement among younger academic economists and, no doubt, quite a lot of covetousness among older economists - especially in America, which has taken out two-thirds of the awards so far. There’s a lot of betting on who’ll win. This year in the betting at Ladbrokes, the odds-on favourite was the same as last year: someone from the University of Chicago, Eugene Fama.

Really? Really? The man who dreamt up the efficient-markets hypothesis was the favourite to win the Nobel in the year after the GFC? There could hardly be a better illustration of the insularity of the economics profession - truly, they don’t live in our world. Fortunately, those anonymous souls who nominate and vote on the prize - including, I suspect, a disproportionate number of Swedes - are a little more politically attune.

And so, in the aftermath of the GFC, they gave the prize to a female political scientist and an economic sociologist. That’s the first noteworthy feature of the award: it wasn’t even given to real economists. Second shock: neither Laureate made a ‘formal’ contribution. Their contributions lacked the two qualities academic economists admire most: ‘elegance’ and ‘parsimony’. Meaning? They wrote their papers in words, not equations. Wow. Third shock: neither Laureate’s work fits the conventional right/left, libertarian versus interventionist dichotomy. Rather, they drew conclusions neither side would be particularly comfortable with.

Fourth shock: Elinor Ostrom’s work in particular is essentially empirical. Rather than theorising about the world on the basis of mathematically convenient assumptions, she’s spent her career doing field studies - ranging from irrigation systems in Nepal and grazing on the grasslands of Asia to lobster fisherpersons in Maine - to disprove a favourite theory of economists about the alleged ‘tragedy of the commons’. Although Ostrom’s contribution clearly concerned an economic issue, the fact she is a political scientist means few economists have heard of her - even though her 7000 citations on Google Scholar exceed the well-known Williamson’s by 40 per cent.

My daughter told me last night that, according to her psychology lecturer at this august institution, economists are psychologists dealing with bigger numbers. I would have said economists were psychologists who hadn’t read the textbook. Economics is amazingly inward looking. Economists know little about other social - or physical - sciences, bar mathematics. In particular, they know far less psychology, sociology and ecology than they should.

It seems clear to me the Nobel selectors were sending a pretty clear message to economists, about the need for them to widen their horizons, become more multidisciplinary and more empirical. Can the Nobel Prize reform economics? Well, economists believe in incentives, and it’s a pretty powerful incentive. If it doesn’t work, it won’t be surprising to see the prize going more often to those psychologists and political scientists who do the economists’ job for them.

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TALK TO UNIVERSITY OF SYDNEY PROFESSORS DINNER

Sydney University
October 6, 2009

You may know that about once a month I appear on the Journos’ Forum segment on Richard Glover’s drive time program on ABC Radio 702. I usually appear with Greg Sheridan, foreign editor of The Australian, and Jennifer Byrne of the First Tuesday Book Club on ABC TV. Greg is a terribly right wing character but, in person, a really nice bloke with a great sense of humour. My role is to act as straight man for Greg’s jokes. Whenever Jennifer can’t make it, Richard hunts around for another token female and once a few years ago he came up with Jana Wendt. I was beside myself with excitement: at last l was getting to meet the great, the beautiful Jana. But when the great day came and I walked into the room, she instantly greeted me with, ‘G’day Ross, how’s it going?’. How come we were so well acquainted when we’d never before clapped eyes on each other?

Well, since that wasn’t the first time it had happened to me when meeting a celebrity TV journalist, I think I know. Big-name TV journalists are infinitely more famous - and more highly paid - than someone like me. But there’s something a broadsheet newspaper columnist has that they haven’t got and really envy - professional gravitas. So they want to be able to think of themselves as close colleagues of all the top journos in the profession.

The moral of the story is that many people crave intellectual recognition. So when I was asked to speak to a room full of Sydney University professors, there was no way I was going to say no. Of course, once the gratification had worn off, it’s also a bit daunting. No matter what topic you choose to speak about, there’ll be people in the audience who know a lot more about it than you do. Were I to speak on any economic topic - the weaknesses of economics, for instance, or the economists’ failure to forewarn of the global financial crisis - there’d be sure to be someone furiously arguing the toss. But not to worry: I’ve thought of a topic I know a lot about and, particularly since my mate Rod Tiffen isn’t here, none of you know much about: journalism. I want to make some comparisons between journalists and academics and explain a few things about journalism that improve your understanding of it.

I used to feel sorry for professors. All of them think they’re a lot smarter than I am, but I earn far more than they do - unless they’re doing a mighty lot of consulting work. And the fact that you guys have got time to come here tonight suggests you’re not doing a lot of consulting. Whenever I write about the money-grubbing ways of the medical profession I get indignant letters from doctor’s wives arguing that their husband deserves his high income because of all the years of study he had to put in. I’m often tempted to ask whether they think an academic who spent eight years getting a PhD in Italian deserves to be paid as much as a doctor. The link between years of study and salary seems a tenuous one, with the explanation for the weak correlation embodied somewhere in the words ‘market forces’. But I stopped feeling sorry for professors: they may be as poor as church mice, but their employment gets them at least 10 times more overseas travel than I get. You can never find them when you want them because they’re always away delivering a paper to a conference in Seoul. And all their frequent flyer miles get them regular overseas holidays, to boot. I console myself with the knowledge that they have to travel steerage (unless they’re on a consulting job, of course).

Actually, I quite like professors. That’s to say, I don’t dis-like them as much as I dislike lecturers and senior lecturers and even aspros. I long ago formed the theory that only when academics gain a chair do they feel licensed to express an opinion. Until they’ve attained that point they’re not game to say anything they can’t reference to someone’s paper. Just why they feel it’s poor form to express an opinion but perfect form to quote someone else’s opinion is something I’ve never understood.

There’s a lot of rivalry and professional jealousy in journalism, something I’ve used to my advantage. The great thing is that, when you’re first to get on to a new topic, or to think of a slightly different way to write a column, no matter how successful it is your competitors simply won’t abase themselves by copying you - nor give you the satisfaction of being copied. This, of course, is quite contrary to what’s predicted by the economists’ neoclassical model. But the rivalry in journalism is nothing to the rivalry and jealousy in academia. They say that the less there is to fight over, the more furiously academics battle. Sometimes the fights are ideological, but the trouble with academics is that, though they love to argue, they tend to take things personally (which is a mark of the introvert). And that can end up meaning the fights aren’t about rival theories. It’s been a great disappointment to me that, in this university, Political Economy and straight economics never boxed it out intellectually, but sat in opposite corners of the faculty hating each other’s guts, until finally PE was cast into the outer darkness of the Arts faculty. This absence of engagement was to the great disadvantage of both sides’ students because, in my never-humble opinion, each side was incomplete without the other.

You may not know that there are two broad classes of journalist: writers (mainly reporters, but also opinion writers such as me) and sub-editors (better understood by their American name, copy editors). So reporters and writers write the copy and subs sub it - check it for spelling, grammar and libel, then write a headline for it and find it a hole to fill in the paper. So writers and subs have the same status, but different roles. Every young person entering journalism starts as a reporter, but some stay as reporters, where they get out and about, while others gravitate to the office-bound desk job that is subbing. What drives this sorting process? It’s long been clear to me that extroverts stay as reporters and writers, whereas introverts become subs (provided they can spell). Subs are supposed to consult reporters before they change their copy, but they often don’t because they’re so desperately afraid of possible confrontation.

I mention this because it’s long been clear to me that the people who become academics tend also to be introverts - they prefer reading books to talking to people. Reporters, by contrast, love talking to people. My mate Rod Tiffen says it’s just as hard to persuade an academic to talk to someone as it is to persuade a journo to read a book. I remember once, long before the internet, a reporter asked me how much the inflation rate was. I said I didn’t know, but gave him very detailed instructions of where to find the CPI press release a few steps away in the Herald library. When I asked him about it later he said: ‘Oh it was OK. I rang the Bureau of Stats and asked them what it was’. When young economic journalist recruits come to me - usually from this university; from Political Economy, in fact - I lose no time in telling them: in journalism we never do Research, we phone experts and ask them what they think. Eventually, of course, they learn that it’s often a waste of time to phone academic experts. Why? Because journalists are always dealing with some new development, but many academics don’t keep up with the latest news in their field and, being academics, they’re not willing to give an on-the-record reaction to the latest development the journo has just summarised for them. If you hate being pestered by phone calls from journalists, this is a great way to ensure you aren’t.

Academics are often highly critical of the things they read or see in the media. I don’t want to shock you, but journos are often just as critical of academics. Much of this criticism is unfair and, more to the point, uninformed. Each side judges the other by its own standards and finds the other wanting. What both sides fail to understand is that they’re playing different games, with different rules and different objectives. Both sides are involved in writing, but they write in very different genres. When I go into the budget lockup each year I get five hours to read and digest a stack of budget papers a foot high and write a punchy comment for the front page of the next morning’s paper. The very purpose of the lockup is to ensure I get no time to consult experts independent of the government before deadline. Not surprisingly, I sometimes misjudge the budget’s objectives and motivations and have to modify my views in subsequent days. Sometimes I even get some of the facts wrong. By contrast, for many years the leading economic academic journal in Australia used to publish a budget review in which leading macroeconomics professors delivered a carefully considered and measured (and possibly refereed) judgment. Just one problem: this review appeared at least six months after budget night. Journalism is said to be the first draft of history, but it’s a very rough draft. The public can’t wait six months to be told what the budget adds up to. Even so, there’s a useful place for the academics’ carefully researched and considered judgment on the budget. Each profession has a different role to play; there’s little to be gained by each judging the other by standards inappropriate to the role the other plays. The reason journos use the phone rather than a library is the extreme time pressures they’re under.

I’ve always been contemptuous of the Marxist theory of the press, that the media is an integral means by which the capitalists keep the workers in thrall. If this implies some sort of conspiracy by the media barons, it’s rubbish. Even so, I’ve come to believe that in many ways the media do help keep the wheels of the capitalist economy turning. It took me years in journalism to realise I was part of the fashion business - we deal with the latest, not just in clothes, but in movies, TV shows, restaurants, discos and much else, including ideas. But the paradox is that this Marxist approach seems to blind many academics to our capitalist motivation. They love to try to explain our behaviour in ideological terms and can’t see the bleeding obvious: the main reason we do what we do the way we do it is because we’re trying to make a quid. Our primary motive isn’t ideological, it’s commercial. What’s more, humans’ evolutionary drive to compete means that, despite its lack of commercial motivation, the ABC behaves much the same way as its profit-motivated rivals do.

Academia is - supposedly, hopefully - dedicated to the search for truth. But contrary to what many academics and media-users imagine, the news media isn’t. Although we’re supposed to be truthful in what we say, and many journalists are anxious to reveal an unexpected truth in some area, it’s a mistake to think the news media is on about the search for truth. Why not? Because much of the time the truth is dull. Media owners are dedicated to profit maximisation, and their minions seek to do this by selling a product called ‘news’. What is news? Whatever sells. What sells - what’s ‘newsworthy’ as journos say? Anything happening out there that our audience will find interesting or important, although the interesting will always trump the important. Paris Hilton is interesting but of no importance; the latest change in the superannuation rules is important but deadly dull - guess which one gets more media coverage?

Maybe 99 per cent of what happens in the world is of little interest: it’s the old, not the new; the good, not the bad; the usual, not the unusual. It’s dog bites man, not man bites dog. Much of the criticism of the media rests on the unspoken assumption that the media’s role is to give us an accurate picture of the world around us. We don’t have first hand experience of much of what’s happening around us and we need the media to inform us.

Sorry, but that’s just not what we do - because we don’t think there’s much of a market for it. Let me tell you two stories and then I’ll stop. Stories to demonstrate how we select news - how what we do bears no relation to the scientific method that guides so much of what academics do. Once when I was answering a question at a Treasury seminar in Canberra it occurred to me to say this: when social scientists take a random sample they may examine the sample and discard any outliers that could distort their survey, throwing them on the floor. A journalist is someone who comes along, finds them on the floor and says, ‘these would make a great story’.

Final story: I happened to be in the Herald’s daily news conference in February this year on the day Kevin Rudd’s $42 billion stimulus package was announced, with all its (then) $950 cash handouts. We discussed searching for a farmer who’d get $950 because he was in exceptional circumstances, $950 because he paid tax last year, $950 because his wife also works, $4750 because he has five school-age kids, and maybe another $950 because one of the kids is doing a training course. And, of course, he’d have a big mortgage, meaning he’d also save $250 a month because of the 1 per cent cut in interest rates announced the same day. Had we found such a person and taken a good photo of him he’d have been all over our front page. The point is that we were search for the most unrepresentative person we could find. Why? Because our readers would have been fascinated to read about him. It’s reasonable to expect the media to be accurate in the facts they report but, even if they are, it’s idle to expect them to give us a representative picture of the world. We’re not in that business.

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