Econocrats advise false economy

Joe Hockey and Tony Abbott shouldn't take all the blame for the low quality of the measures in the budget. I suspect they're victims of poor advice from the econocrats of Treasury and Finance.

Gary Banks, former boss of the Productivity Commission, says the public service's role is to inform policy choices. If so, it did an unimpressive job of informing an inexperienced government on the best way to exploit the unique political opportunity offered by the Coalition's very first budget.

We can never know exactly what advice passed between the bureaucrats and their masters, but it would be an unusual budget whose measures didn't arise from options provided by the presumed experts.

And a comment by Laura Tingle of The Australian Financial Review offers a clue: "Former Labor ministers were genuinely surprised after the May 13 budget that the new government had simply picked up the same raw policy proposals the public service had been serving up for years and included them in the budget ... It seemed no one in the new government ... recognised these as policy chestnuts from the bureaucracy's bottom drawer."

If that's right, it's an indictment of the bureaucrats' intellectual laziness and lack of expertise. It's the 21st century, but these people have sat for decades learning nothing but "here's where you could cut, minister".

A huge proportion of the spending on two of the nation's biggest and fastest-growing industries, education and health - industries whose performance has major implications for productivity and social wellbeing - passes through the federal budget, but all the budget bureaucrats have to offer is a list of things you could chop.

Since the budget measures focused almost exclusively on the spending side, and since those measures had the smell of the bookkeeper rather than the economist (economists are trained to think about subsequent, not just immediate, effects), I suspect it's Finance more than Treasury that's responsible for such a dismal performance.

What we needed were sophisticated initiatives aimed at raising the efficiency with which public services are delivered to the public.

What does the empirical literature and the experience of other governments tell us about what works and what doesn't? If Finance and Treasury aren't expert on this, why aren't they?

What we got instead were crude spending cuts - or, more often, cost-shifting. A high proportion of the savings will come merely from shunting more of the cost of education and health onto graduates, patients and the states. How much thought went into cooking that up?

The right answer to the growing cost of the Pharmaceutical Benefits Scheme, for instance, is to drive harder bargains on generics with the big foreign drug companies (which pose as Medicines Australia) and the chemists, and to force harder choices on the medicos who advise on which new drugs should be listed by giving them an annual spending cap.

So what did we get? A $5-a-pop increase in the already high general patient co-payment which, in any case, is indexed, with a smaller rise for pensioners. Could laying it on so thick discourage people from filling their prescriptions, thus worsening their health and eventually adding to public spending on healthcare?

Who knows? Who cares? No one in the budget bureaucracy, it seems. If the measure makes things worse rather than better, worry about that in a later budget. "I know, minister, let's whack up patient co-payments again. Tell 'em health costs are unsustainable."

It's a similar story with Medicare. Health economists have devised various ways of achieving greater efficiency, particularly in hospitals, but who's bothered about that? Why tax your brains when you could just chop spending on preventive health programs, slash grants to the states and introduce a $7 co-payment for GP visits and tests?

The co-payment will shift costs to the states and add to ill health and costs down the track, but who's worried? It will be costly to administer, but less so when we advise ministers to whack it up again in a few years' time because health costs are still rising "unsustainably".

But the most mindless false economy is surely the now 2.5 per cent annual "efficiency dividend" cut imposed on the budgets of government departments. Treasury complains it's had to cut staff numbers by one-third just since 2011. Finance must be suffering, too.

Wouldn't it be ironic if the budget bureaucrats were among the chief victims of their failure to give the pollies better advice on spending control? By now, of course, this would be their chief excuse for continuing bad advice. "We don't have the resources, minister."

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Teenagers suffering most from slow growth

I hate to say it, but the spectacular events that hit the headlines aren't necessarily the things most worth worrying about. The big news on the economy this week was the spectacular jump in the unemployment rate from 6 per cent to 6.4 per just during July. Not a big worry.

Question is, what does it prove? That the economy fell into a hole around the middle of the year? Doubt it. There's little other evidence that it did and a lot that it didn't.

That the slow upward creep in unemployment we've been seeing for about two years may have accelerated? Doubt that, too. Again, the other economic indicators aren't pointing that way.

(Indeed, some economists have been wondering if unemployment was close to peaking. So far this year employment has grown by an average of 15,600 jobs a month, compared with just 5100 a month last year.)

That the unemployment figures are volatile from month to month and this is an unexplained statistical blip that should be corrected next month? Seems a bit too big for that.

Truth is it's hard to know what the problem is. Easier to be sure when we've seen another month or two's figures.

But my guess is it's a once-only upward step in the measured rate of unemployment, caused by a seemingly small change in the questions that people in the Bureau of Statistics' monthly survey are asked so as to ascertain whether they've been "actively" seeking a job if they don't have one.

The change - made partly because of the switch to searching for jobs on the internet rather than at Centrelink - seems to have led to more people being classed as unemployed and fewer as "not in the labour force".

If this guess proves right, it's not so worrying. It doesn't change reality, just the way we measure it. In any case, we've long known that the official measure of unemployment is very narrow and understates the extent of the problem.

That's why the bureau publishes every quarter a broader measure of unemployment, which takes the official unemployment rate and adds the under-employed - people with jobs who aren't working as many hours a week as they'd like to - to give the "labour force underutilisation rate".

The figures for May show narrowly measured unemployment of 6 per cent, and an underemployment rate of 7.5 per cent, to give a broader measure of 13.5 per cent.

Less spectacular than this month's jump in the official rate but, to me, more worthy of worry is news that hasn't hit the headlines: the rapid worsening in teenage unemployment.

Whereas so far this year the trend rate of overall unemployment has risen by 0.2 percentage points, the trend rate for people aged 15 to 19 has risen by 2.8 percentage points to 19.3 per cent.

Note, this doesn't mean almost one youth in five is unemployed. Most people that age are in full-time education, so aren't in the calculation. Turns out about one in 20 of all 15 to 19 year-olds is unemployed and looking for a full-time job.

Many people have it in their heads that unemployment rises because people lose their jobs and employment falls. That's true only in recessions. It's rare for employment to fall - it fell only briefly even during the global financial crisis.

No, the main reason unemployment rises outside of recessions is that the economy isn't growing fast enough to employ all the extra people joining the labour force from education, as immigrants or as mothers rejoining.

That's what's been happening over the past two years. And young people - particularly those who leave school or training too early - have borne most of the burden of insufficient job creation. We should be doing much better by them than Work for the Dole and denying them benefits for six months to keep them hungry.

But there's nothing spectacular about this quiet suffering, so it doesn't hit the headlines. Much better to scandalise over factory closures, which surely signal the end of the world. So let's look at the facts on retrenchment, courtesy of a Bureau of Statistics study.

About 2 million people left their jobs over the year to February 2013 (the latest period for which figures are available). About 60 per cent of these left voluntarily and 21 per cent left because of their illness or injury, leaving 19 per cent - 380,000 - who left because they were retrenched.

That's a rate of retrenchment of 3.1 per cent. The rate hit 4 per cent in 2000, but then fell to a low of 2 per cent in 2008, just before the global financial crisis, then increased sharply to 3.1 per cent in 2010, where it has pretty much stayed since.

Over the year to 2013, all industries experienced retrenchments, but the most were in construction, 65,000; retailing, 40,000; and manufacturing, just under 40,000.

But the number of people employed in particular industries differs a lot so, judged by rate of retrenchment, utilities and construction come equal first with 6.4 per cent, then mining with 6 per cent, pushing manufacturing into fourth place with 4.5 per cent.

The rate of retrenchment is consistently higher for men because men tend to dominate those industries where retrenchment rates are higher, whereas retrenchment rates tend to be lower in industries dominated by women workers, such as education and health.

The likelihood of being retrenched falls as your level of educational attainment rises. We're more conscious of older workers being laid off but, in fact, retrenchment is greatest among workers aged 25 to 44.

And what happens to people who're laid off? For those retrenched over the year to February 2013, half were back in jobs by the end of the year, leaving 29 per cent unemployed and 21 per cent not in the labour force.

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Modellers bamboozle over cost of renewable energy

There's a lot of public support for the renewable energy target, which requires electricity retailers to get 20 per cent of their power from renewable sources by 2020. But now the country's being run by climate change "sceptics", let's get with the program. Forget the threat of climate change, stop worrying about your grandchildren and focus on what matters most: what this do-gooder scheme is doing to your cost of living.

Although before the election Tony Abbott professed support for the target, since the election he has instituted an expert review of it, headed by businessman Dick Warburton, former chairman of Caltex and prominent "sceptic".

The review commissioned a leading firm of economic consultants, ACIL Allen, to undertake modelling on the future effects of the target.

The preliminary report found that, between 2015 and 2020, the target would increase the average household electricity bill by $54 a year - a tad over $1 a week. This five-year average, however, conceals the estimation that the cost of the scheme will fall as each year passes.

So by 2020 itself, the increase will have reduced to just $7 a year. By the end of another 10 years, in 2030, the scheme is estimated to be actually reducing average household electricity bills by $91 a year, or $1.75 a week.

It's common sense that requiring electricity retailers to buy a certain proportion of their power from more expensive renewable sources - mainly wind power, but also solar - would add to the cost of their power, with the extra cost being passed on to consumers.

So why has ACIL Allen's modelling concluded the target will add to the price of electricity initially, but eventually subtract from it? The short answer is because electricity pricing is a complicated business.

It turns out that adding to the supply of renewable energy available reduces the wholesale price of electricity. This is because the price being paid for energy being put into the national electricity grid by particular generators varies minute by minute according to the balance of supply and demand.

In the middle of the night, when little power is being used, the wholesale price is very low. But on a cold evening - or, more likely these days, a very hot afternoon - the wholesale price can be stratospheric.

The trick to renewable energy is that it tends to be available when the demand for electricity is high. Experience around the world confirms the Australian experience that renewable energy does a great job of reducing spikes in wholesale prices on very hot and very cold days.

Another part of it is that though it costs a lot to build wind and solar generators, once they're built there are few "variable" costs. Wind and sun are free; coal and gas aren't. So the renewable generators offer to supply power to the grid at very low prices and this lowers the prices the coal and gas generators are able to ask for.

But none of this changes the fact that the electricity retailers have to pay for the "renewable energy certificates" that the target scheme requires them to buy. These certificates reduce the capital cost of setting up the wind and solar generators whose operations then reduce the wholesale cost of power.

So it turns out the renewable energy target scheme has the effect of reducing the wholesale cost of electricity while also adding to the costs of the electricity retailers. ACIL Allen's modelling suggests that, for the next five years, the extra retail cost will exceed the saving in wholesale costs, but after that the saving will exceed the extra cost.

See what this means? The case for saying we must get rid of the renewable energy scheme because it's adding too much to the living costs of struggling families has collapsed.

But there's where the story takes a twist. Modelling of the future cost of the renewable energy target, published by an equally prominent firm of economic consultants, Deloitte, comes to opposite conclusions.

Deloitte's modelling accepts that the renewable energy scheme is reducing wholesale costs, and roughly confirms ACIL Allen's finding about the higher cost to household customers until 2020. But whereas ACIL Allen expects the scheme to start reducing household costs after that, Deloitte expects the cost to stay positive until 2030, causing household bills to be between $47 and $65 a year higher than if the scheme was scrapped.

Why have two leading economic consultants reached such opposing conclusions? Perhaps because Deloitte's modelling was commissioned by the Chamber of Commerce and Industry, the Business Council and the Minerals Council.

Deloitte doesn't conceal that its modelling is in reply to ACIL Allen's. Would it surprise you if the fossil fuel industry wanted to see the renewable energy target abolished and was alarmed to know that modelling commissioned by the review had demolished the argument that continuing the target would add to people's electricity bills? Now the review will be able to pick whichever modelling results it prefers.

How did Deloitte reach such different results? By feeding different assumptions into its model. It seems to have assumed the cost of wind farms won't fall over time (which it probably will), whereas the price of gas for gas-fired generators won't rise much (which it already has).

Regrettably, economic modelling has degenerated into a device for bamboozling the public.

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Why no one is backing the budget

A big reason Joe Hockey isn't getting much support from independent observers like me in his battle to get the budget through the Senate is that so few of his contentious measures are worth fighting for.

If he were facing opposition from vested interests struggling to protect their privilege, or even just unthinking populism from the punters, it would be a different matter.

For a bit I thought I'd be in the trenches with him defending a plan to impose a temporary deficit levy on individuals with incomes above $80,000 a year but, as we now know, his boss insisted on lifting the threshold to a far-less-contentious $180,000 a year.

What would have made the lower threshold defensible is the inconvenient truth that so much of our present distance from budget surplus is explained by the folly of eight tax cuts in a row, the savings from which were skewed in favour of higher income-earners. This would have clawed back a bit of it.

It's remarkable anyone could put together a budget at once so unpopular and so lacking in Paul Keating's "quality cuts". Who did Hockey imagine would join him at the barricades apart from the mindlessly partisan commentators? (Even they haven't been particularly vociferous - although the government hasn't raised much of a banner to rally behind.)

In my initial assessment I said "I give Joe Hockey's first budgetary exam a distinction on management of the macro economy, a credit on micro-economic reform and a fail on fairness".

Nothing wrong with the F, and the D on macro management has stood up well. The decision to announce a lot of measures that didn't take much effect until the last year of the forward estimates, 2017-18, was a clever combination of macro-economic good sense - nothing to gain by hitting demand while it was expected to be weak - and political necessity.

By delaying the start of so many measures until after the next election Hockey was able to claim the budget didn't really break all the election promises Tony Abbott made when pushing his contention that a "budget emergency" could be fixed without pain.

It's not part of my religion to insist politicians keep irresponsible promises they should never have made. But that's not to say such blatant promise-breaking carries no political price. After all the fuss Abbott made about "Ju-liar" Gillard and his pretence about restoring trust in politicians, my guess is the price his government is paying is high. The pity is he could have won comfortably without such dishonesty.

On closer inspection, my C for micro reform was badly astray. Should have been an M for missed opportunity. There was a lot of cost shifting, but precious little that could be claimed to increase the efficiency with which the government delivers its many high-cost services or to reduce rent-seeking by private industries.

The greatest disappointment was that, after making a good start in eliminating handouts to the car makers and refusing to bail out fruit canners, Hockey dropped the ball on business welfare, thus leaving all his talk of ending "the age of entitlement" looking like nothing more than a shameful attack on the poor and disadvantaged.

One honourable exception was the decision to remove the always-indefensible subsidy to locally produced ethanol. Another was the plan to resume indexing the fuel excise.

Removing the carbon price involved allowing fossil-fuel industries to continue imposing external costs on the rest of the community and the intention to abolish the mining tax involves allowing much receipt of economic rent by foreigners to go grossly under-taxed. That's efficient?

Add to that the failure to remove the fuel excise credit, which constitutes a favour to miners and farmers but no one else, and you have to ask what hold the big three mining companies have over this government.

Similarly, take the cutting back on the age pension while doing nothing whatsoever to curb the excesses of the concessional tax treatment of superannuation, combine it with watering down the Future of Financial Advice Act despite the presence of gross information asymmetry, and you have to ask what hold the big four banks have over this government.

On its face, you could have expected the "deregulation" of university fees to bring significant gains in efficiency - but only if your understanding of economics had progressed no further than 101. To take a relatively small number of government-owned and still highly regulated agencies with a monopoly over credential-granting, allow them to set their own fees and then imagine an adequately competitive "market" would emerge isn't economics, it's magical thinking.

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Chinese economy overtaking US and getting more like it

It isn't so many years since I used to berate the denizens of the financial markets for their lack of interest in the economy that had so much influence on ours: China. How things have changed. So has China.

After averaging growth of 10 per cent a year for 30 years, China's economy is now struggling to achieve its reduced target of 7.5 per cent. The financial market participants' role has been to watch on with concern.

And this week comes news that, though the International Monetary Fund sees China coming close to target this year, it expects it to slow to 7.1 per cent growth in 2015 and slow further in following years.

More surprisingly, the fund says that China should slow down to give it a chance to work on its big problems, rapidly growing debt and a rapidly contracting real estate market. Fumble those and growth could be even lower.

But while so many of us have been so focused on China's difficulty maintaining its rate of growth, we've lost sight of how big it is and how fast it's still growing compared with the rest of us.

Compared, say, with the world's biggest economy, the United States. Except that, according to the calculations of Euromonitor International, China will overtake the US this year. That's when you compare the two economies using "purchasing-power parity", which makes allowance for the fact that one US dollar buys a lot more in China than it does in the land of the free.

With China biggest and the US second, then come India, Japan, Germany, Russia and Brazil. We come in at 17th, not far behind Indonesia. The world certainly is changing.

Of course, the Chinese and American economies remain very different. China is big because of its much bigger population - 1.4 billion versus 300 million. Its income per person remains a fraction of America's. A not unrelated fact is that the US's productivity (measured as gross domestic product per worker) is more than nine times higher than China's.

And the two countries' industry structure is also very different. Agriculture contributes 10 per cent to GDP in China but just 1 per cent in the US. But get this: it accounts for almost a third of the workforce, compared with just 1.4 per cent in the US.

Manufacturing makes up 30 per cent of China's GDP, but only 13 per cent of America's. That tells us a lot about why China's rise, and the growth in its exports of manufactures, has affected so many other countries as well as maintaining downward pressure on world prices.

But the biggest difference between the two economies is their relative emphases on consumption and investment. Euromonitor International estimates that this year private consumption will account for 68 per cent of GDP in the US, compared with 37 per cent in China.

Here, however, we get to the really important news: the Chinese authorities have embarked on a process of "rebalancing" the economy, increasing consumer spending and domestic demand and reducing the roles of exports and investment in heavy industry.

The Economist notes that consumer spending has already begun its expansion, with its share of GDP rising from less than 35 per cent in 2010 to more than 36 per cent last year. And this year it has accounted for more than half the growth in GDP.

A big reason for stronger consumer spending is rapid growth in wages. Get this one: over the five years to 2013, real wages in manufacturing rose by about 2 per cent in the US, but by 45 per cent in China. As always happens, the benefits of economic development do flow eventually to ordinary workers.

This strong growth in consumption involves faster growth in the services sector, with manufacturing's share of GDP having peaked at almost a third in 2007.

This structural change means people following the ups and downs of the Chinese economy ought to be following a different set of indicators, as Peter Cai of China Spectator noted last week with help from Guan Qingyou, an economist at Minsheng Securities.

Cai says the main reason Chinese policymakers care so much about the rate of growth in GDP is their belief that the economy needs to grow by at least 7.2 per cent to absorb 10 million new entrants to the labour market each year.

But this correlation has been breaking down since 2010. Slower growth in GDP has not led to weaker job creation. Gaun suggests this is because the expanding services sector has a greater capacity to absorb new job seekers.


More fundamentally, China seems to be approaching its "Lewis turning-point", where a developing country runs out of its supply of surplus rural labour. This would also help explain the rising real wages.

Financial market participants focus on the growth in "industrial production" (manufacturing, mining and utilities) as a predictor of GDP growth, and on the manufacturing PMI (purchasing managers' index) as a predictor of industrial production.

But Cai says the strong correlation between industrial production and GDP is breaking down because the services sector is growing a lot faster than the industrial sector. Last year, for instance, the services sector contributed 47 per cent of the annual growth in GDP, whereas the industrial sector contributed less than 40 per cent. So, it's better to focus on the services sector PMI.

A big problem for China-watchers is that you don't know how much faith to put in official statistics. Earlier in his career, Premier Li Keqiang let it be known that he, too, had his doubts. So he focused on railway freight volumes, electricity consumption and bank lending as offering a better guide.

Now others have developed a "Li Keqiang index". But here, too, Guan argues that its reliability has declined, because of changes in the structure of industrial electricity use and changes in financing. China is changing.

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Social and economic case for helping women work

Surely the most momentous social change of our times began sometime in the 1960s or '70s when parents decided their daughters were just as entitled to an education as their sons. Girls embraced this opportunity with such diligence that today they leave schools and universities better educated than boys.

Fine. But this has required much change to social and economic institutions, which we've found quite painful and is far from complete. It's changed the way marriages and families operate - changed even the demands made on grandparents - greatly increased public and private spending on education, led to the rise of new classes of education and childcare, changed professions and changed the workplace.

It has led to greater "assortative mating", where people are more likely to marry those not just of similar social background, but of a similar level of education.

For centuries the labour market was built around the needs of men. Changing it to accommodate the needs of the child-bearing sex has met much resistance, and we have a lot further to go. This is evident from last week's report of the Human Rights Commission, which found much evidence to show "discrimination towards pregnant employees and working parents remains a widespread and systemic issue which inhibits the full and equal participation of working parents, and in particular, women, in the labour force".

You can see this from a largely social perspective - accommodating the rising aspirations of women and ensuring they get equal treatment - or, as is the custom in this more materialist age, you can see it from an economic perspective.

By now we - the taxpayer, parents and the young women themselves - have made a hugely expensive investment in the education of women. It accounts for a little over half our annual investment in education.

If we fail to make it reasonably easy for women to use their education in the paid workforce, we'll waste a lot of that money. Our neglect will cause us to be a lot less prosperous than we could be.

Of late, economists are worried our material standard of living will rise more slowly than we're used to, partly because mineral export prices have fallen but also because, with the ageing of the baby boomers, a smaller proportion of the population will be working.

They see increased female participation in the labour force - more women with paid work, more working women with full-time jobs - as a big part of the answer to this looming catastrophe (not).

But how? One way would be to impose more requirements on employers, but in an era where the interests of business are paramount, politicians are reluctant to do that. Make employers provide childcare or paid parental leave? Unthinkable.

So, for the most part, taxpayers have picked up the tab. Government funding of childcare has reached about $7 billion a year, covering almost two-thirds of the total cost. The cost of government-provided paid parental leave is on top of that.

Governments' goals in childcare have evolved over time. In the '70s and '80s, the focus was on increasing the number of places provided. In the '90s, the focus shifted to improving the affordability of care, with the introduction of, first, the means-tested childcare benefit, and then the unmeans-tested childcare rebate. Under the Howard government, the rebate covered 30 per cent of net cost, but Labor increased it to 50 per cent.

More recently, increased evidence of the impact of the early years of a child's life on their future wellbeing has shifted governments' objectives towards child development and higher-quality, more educationally informed, childcare. This includes getting all children to attend pre-school. Linked with this has been a push to raise the pay of childcare workers.

The federal government asked the Productivity Commission to inquire into childcare and early childhood learning. Last week it produced a draft report. I suspect the pollies were hoping the commission would find a way to reduce regulation of what they kept calling the childcare "market"; thus improving workforce participation and "flexibility" while achieving "fiscal sustainability".

If so, they wouldn't have been pleased with the results. The main proposal was that the childcare benefit and rebate be combined into one, means-tested subsidy payment paid direct to childcare providers.

This would involve low-income families getting more help while high-income families get less. There would be a small additional cost to the government, but this could be covered by diverting money from Tony Abbott's proposed changes to paid parental leave. It was "unclear" his changes would bring significant additional benefits to the community.

The commission wasn't able to claim its proposals would do much to raise participation in the labour force, mainly because our system of means-testing benefits - which works well in keeping taxes low, something that seems to be this government's overriding goal - means women face almost prohibitively high effective tax rates as their incomes rise, particularly moving from part-time to full-time jobs.

Like the Henry tax review before it, the commission just threw up its hands at this problem. And even the commission couldn't bring itself to propose major reductions in the quality of education and care. Sorry, no easy answers on childcare.

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A more balanced budget might get through Senate

Joe Hockey and Tony Abbott are perfectly right in saying we need to get the budget back into surplus, we need to make a start now and that this will inevitably involve unpopular measures.

But this makes it all the more puzzling that, lacking a majority in the Senate and being unable to claim a "mandate" for breaking many election promises, they should adopt such a highly ideological and unfair collection of budget measures.

In a three-part essay on John Menadue's blog last week, Dr Michael Keating, former senior econocrat, argues that as a nation we're "unlikely to succeed in charting a viable way forward to fiscal sustainability until governments are prepared to subject their views to a proper conversation based on a clear appreciation of the pros and cons of the different alternatives.

"Only in that way can the public support be built that is required to achieve future fiscal sustainability. In present circumstances it is hardly surprising that this necessary support is not forthcoming, when less than 12 months ago the government promised in the election to both spend more and tax less and now seeks to impose a most unfair budget on the community with no prior warning nor any such mandate."

If we are to chart a way forward and establish the necessary public understanding and consensus, he says, we particularly need to drop the ideology surrounding the merits of taxation versus expenditure and consider the claims of each tax and expenditure proposal on its merits.

Just so. There are many ways to skin the budget cat - some fairer or more sensible than others - and it's absurd for the government and its barrackers to pretend, Maggie Thatcher-like, that the measures proposed in the budget are the only alternative to irresponsible populism.

Anyone who knows anything about successful "fiscal consolidation" knows it invariably involves a combination of spending cuts and tax increases (including reductions in tax concessions - "tax expenditures").

And anyone who knows much about economics knows there's little empirical evidence to support the ideology that economies with high levels of government spending and taxation don't perform as well as those with low levels.

Yet Hockey and Abbott thought it sensible to propose a 10-year budget plan that relied almost exclusively on cuts in government spending - apart from the temporary deficit levy and much unacknowledged bracket creep.

Keating points out that, combining all levels of government as a percentage of gross domestic product, Australia already has the lowest budget deficit and public debt compared with Canada, Japan, Britain, the US and the OECD average.

At 26.5 per cent, our level of total taxation seems higher than the Americans' 24 per cent, until you remember their budget deficit is 5 percentage points higher than ours. So the claim that we have a bloated, "unsustainable" level of government spending is itself unsustainable.

To restore some balance to proposed budget savings, to share the burden of budget repair more fairly and in answer to the challenge, well, what would you do? Keating suggests savings on the revenue side that would raise about $42 billion a year in 2017-18, the year most of Hockey's savings would cut in.

One objectionable feature of the budget was the way it laid into spending on the age pension while not merely ignoring the equally expensive superannuation tax concessions but actually reversing some of Labor's timid attempt to make aged-income support fairer. Keating estimates a more balanced approach to tax concessions could save $15.5 billion a year.

To extend the "end of entitlement" beyond welfare recipients to business welfare, he suggests ending the fuel excise rebate for miners and farmers, saving $7.5 billion a year. There's no economic justification for subsidising just one input among many of just two industries among many.

Abolishing the subsidy for private health insurance would save more than $7 billion a year. Many evaluations have shown this money would treat a greater number of patients if spent in public hospitals. Removing the 50 per cent discount on capital gains tax would save $5 billion a year, as well as making the taxation of various sources of income a lot fairer.

About $5.5 billion a year could be saved by restoring the carbon price mechanism and the minerals resource rent tax. That leaves $1.5 billion to be saved by restoring anti-avoidance measures implemented by Labor, Keating says.

We could get the budget back in the black without any loss of economic efficiency and do it in a way much fairer to ordinary voters - remember them? - and less partial to the Coalition's big business backers.

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Why we're still not free of the GFC

Almost six years since the global financial crisis reached its height, it's easy to forget just how close to the brink the world economy came. To someone like Reserve Bank governor Glenn Stevens, however, those events are burnt on his brain.

Which explains why he thought them worth recalling in a speech this week. And also why, so many years later, the major developed economies of the North Atlantic are still so weak and showing little sign of returning to normal growth any time soon.

When those key decision-makers who lived through 2008 and 2009 say that there was the potential for an outcome every bit as disastrous as the Great Depression of the 1930s, "I don't think that is an exaggeration", he says.

"Any account of the events of September and October 2008 reminds one of what an extraordinary couple of months they were. Virtually every day would bring news of major financial institutions in distress, markets gyrating wildly or closing altogether, rapid international spillovers and public interventions on an unprecedented scale in an attempt to stabilise the situation.

"It was a global panic. The accounts of some of the key decision-makers that have been published give even more sense of how desperately close to the edge they thought the system came and how difficult the task was of stopping it going over."

But, despite the inevitable "mistakes and misjudgments", the authorities did stop it going over. Stevens attributes this to their having learnt the lessons of the monumental mistakes and misjudgments that that turned the Great (sharemarket) Crash of 1929 into the Great Depression.

Economic historians (including one Ben Bernanke) spent decades studying the Depression and, in Stevens' summation, they came up with five key lessons: be prepared to add liquidity – if necessary, a lot of it – to financial systems that are under stress; don't let bank failures and a massive credit crunch reinforce a contraction in economic activity that is already occurring – try to break that feedback loop; be prepared to use macro-economic policy aggressively.

So far as possible, maintain dialogue and co-operation between countries and keep markets open, meaning don't resort to trade protectionism or "beggar-thy-neighbour" exchange rate policies. And act in ways that promote confidence – have a plan.

There was a lot of action and a lot of international co-operation, and it worked. As a result, we talk about the Great Recession, not the Great Depression Mark II.

"We may not like the politics or the optics of it all – all the 'bailouts', the sense that some people who behaved irresponsibly got away with it, the recriminations, the second-guessing after the event and so on," he says. "But the alternative was worse."

With collapse averted, the next step was to fix the broken banks. Their bad debts had to be written off and their share capital replenished, either by them raising capital from the markets or accepting it from the government.

Fixing the banks' balance sheets was necessary for recovery, but not sufficient. A sound financial system isn't the initiating force for growth, so stimulatory macro-economic policies were needed to get things moving.

On top of all the government spending to recapitalise the banks came a huge amount fiscal (budgetary) stimulus spending. Stevens says a financial crisis and a deep recession can easily add 20 or 30 percentage points to the ratio of public debt to gross domestic product.

Then you've got the weak economic growth leading to far weaker than normal levels of tax collections. Add to all that the various North Atlantic economies that had been running annual budget deficits for years before the crisis happened.

"So fiscal policy has not had as much scope to continue supporting recovery as might have been hoped," Stevens says. "Policymakers in some instances have felt they had little choice but to move into consolidation mode [spending cuts and tax increases] early in the recovery."

He doesn't say, but I will: this crazy, counterproductive policy of "austerity" has helped to prolong the agony.

With fiscal policy judged to have used up its scope for stimulus, that leaves monetary policy. Central banks cut short-term interest rates hard, but were prevented from doing more because they soon hit the "zero lower bound" (you can't go lower than 0 per cent).

But long-term interest rates were still well above zero and, in the US and the euro area, long-term rates play a more central role in the economy than they do in Oz. Hence the resort to "quantitative easing".

Under QE, the central bank buys long-term government bonds or even private bonds and pays for them merely by crediting the accounts of the banks it bought from. Adding to the demand for bonds forces their price up and yield (interest rate) down. And reducing long-term rates is intended to stimulate borrowing and spending.

Has it worked? It's intended to encourage risk-taking, but are these risks taken by genuine entrepreneurs producing in the real economy, or are they financial risk-taking through such devices as increased leverage?

Stevens' judgment is that it always takes time for an economy to heal after a financial crisis [because it takes so long for banks, businesses and households to get their balance sheets back in order - they've borrowed heavily to buy assets now worth much less than they paid] so it's too soon to draw strong conclusions.

For Stevens, the lesson is that there are limits to how much monetary policy can do to get economies back to healthy growth after financial crises. "If people simply don't wish to take on new business risks, monetary policy can't make them," he says.

Perhaps the answer is simply subdued "animal spirits" – low levels of confidence, he thinks. But, at some stage, sharemarket analysts and the investor community will ask fewer questions about risk reduction and more about the company's growth strategy.

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Putting people back in the rent or buy decision

So, the Reserve Bank has done the numbers and killed the Great Australian Dream: owning your home is no more lucrative than a lifetime of renting. Somehow, I doubt that will be the end of the matter - and nor should it be.

The strongest conclusion we should draw from the Reserve’s figuring is that, when you view home ownership purely as a financial investment, buying rather than renting isn’t the deadset winner most people assume.

It can be a close run thing, mainly because people take insufficient account of the costs of home ownership - not just all the interest they pay but the stamp duty and conveyancing costs, insurance, repairs and maintenance and the rates and other payments not borne by renters.

But our deeply ingrained belief that home ownership is a great investment is only one of our motives for wanting to own rather than rent. The other big one is security of tenure.

It’s nice to own your own place and make your own decisions about alterations and improvements, minor and major, about painting it or not painting, building up the garden or not bothering.

 It’s also nice to know you’re unlikely to have to leave it unless it’s your choice. Renters generally have a lot less say over how long the rental lasts, rent rises and changes of landlord.

The Reserve’s calculations take no account of these non-monetary considerations, which could easily be sufficient to bring ownership in as a clear winner in many people’s minds (starting with me).

And though those calculations are as careful and impartial as you would expect of the central bank, that doesn’t stop them being based on assumptions and averages like all such calculations, meaning they may or may not be a good fit with your own circumstances and preferences.

For instance, what’s true for average home prices across Australia, may not be true for Sydney. And what’s true for the whole of Sydney may not be equally true for inner ring, middle ring and outer ring homes.

We know the authorities expect huge growth in Sydney’s population over the next 20 or 30 years. And unless they greatly improve their performance on congestion, my guess is we will see inner-ring property prices grow a lot faster than Sydney prices generally.

The Reserve’s calculations roll together home owners and renters of all ages and stages. But switching rental accommodation is not the problem for young adults that it can be for families with school-age children.

The calculations assume home owners change homes every 10 years. If you have already, or intend to, stay put a lot longer than that then your investment is already performing, or is likely to perform, better than the figures suggest.

Of course, no calculations based on what’s happened to home prices and rents over the past 60 years is a foolproof guide to what they’ll do over the coming 60.

And remember, the low level at which the age pension is set tacitly assumes people own their homes outright. The value of your home isn’t included in the means test, but other investments are.

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Big cities have become the engine of the economy

Old notions die hard. If you took all the production of goods and services in Australia and plotted on a map where that production took place, what would it look like?

Any farmer could tell you most of the value is created in the bush. A miner, however, would tell you - a bunch of ads have told you - these days most of the wealth is generated in areas such as the Pilbara in Western Australia and the Bowen Basin in Queensland.

Then, of course, there are the great manufacturing states of Victoria and South Australia - with most work done in the suburbs of Melbourne and Adelaide, but also regional cities such as Geelong.

That make any sense to you? It's completely off beam.

A report issued this week by the Grattan Institute finds that, these days, 80 per cent of the dollar value of all goods and services in Australia is produced on just 0.2 per cent of the nation's land mass. Just about all of that is in our big cities, as close in as possible.

The report, by Jane-Frances Kelly and Paul Donegan, finds that big cities are now the engines of our prosperity. If you take just the central business districts of Sydney and Melbourne - covering a mere 7.1 square kilometres - you have accounted for almost 10 per of Australia's gross domestic product.

What do workers do in all those city offices? Nothing you can touch. That's how much the economy's changed.

To find the economy as many people still imagine it to be, you have to go back 50, even 100 years. About 100 years ago, almost half Australia's population of 4 million lived on rural properties or in small towns of fewer than 3000 people.

Many of these would have been market towns serving the agricultural economy. Agriculture and mining accounted for a third of the workforce. And only about one in three Australians lived in a city of at least 100,000 people.

These days, agriculture employs only 3 per cent of workers and contributes only 2 per cent of GDP. Our two biggest CBDs contribute at least four times that much.

By the end of World War II, manufacturing had become Australia's dominant industry. At its height in 1960, the report reminds us, manufacturing employed more than a quarter of the workforce and accounted for almost 30 per cent of GDP.

The rise of manufacturing shifted much of our economic activity - our prosperity - to the big cities, but mainly to the suburbs. Suburbs away from city centres had lower rents and less congestion.

Postwar growth in car ownership made possible the shift to a manufacturing economy with a strong suburban presence. It also led to the demise of many small towns and the rise of regional centres.

Today, however, manufacturing employs only 9 per cent of the workforce and accounts for just 7 per cent of GDP. The thing to note is that this seeming decline in manufacturing has involved only a small and quite recent fall in the quantity of things we manufacture in Oz.

Similarly, the decline in agriculture's share of employment and GDP has occurred even though the quantity of rural production is higher than ever. The trick is that these industries didn't contract so much as other parts of the economy grew a lot faster, shrinking their share of the total.

One of those other parts is mining, of course. But get this: "While Australia's natural resource deposits are typically in remote areas, workers in cities make a critical contribution to the industry's success," the report says.

"For instance, in Western Australia, where the most productive mining regions are located, more than one third of people employed in mining work in Perth."

That's partly because of fly-in fly-out, but mainly because many of these workers are highly skilled engineers, scientists, production managers, accountants and administrators.

So what explains the greater and still-growing economic significance of big cities, so that Sydney, Melbourne, Brisbane and Perth now contribute 61 per cent of GDP? The rise of the knowledge economy.

Increasingly, our prosperity rests not on growing, digging up or making things, but on knowing things. Our workforce is more highly educated than ever, and this is the result.

"Knowledge-intensive jobs are vital to the modern economy. They drive innovation and productivity, and are a critical source of employment growth. In the last 15 years there has been much higher growth in high-skilled, compared to low-skilled, employment," the report says.

Knowledge-intensive activities aren't confined to jobs in the services sector, but are also increasing in mining and manufacturing. They often involve coming up with new ideas, solving complex problems or finding better ways of doing things.

But here's the trick: it suits many of the knowledge workers, and the businesses that employ them, for those workers to be crowded into big cities, as close in as possible. When you're all packed in together, there's more scope for the transfers of expertise, new ideas and process improvements known as "knowledge spillovers".

Such spillovers come particularly through face-to-face contact. Large cities offer employers knowledge spillovers and a large skilled workforce. They also offer people greater opportunities to get a job, move to a better job, build skills and bounce back if they lose their job.

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Mining boom our gift to rich foreigners

The mining tax - whose last-minute reprieve may well prove temporary - is the greatest weakness in the argument that we gained a lot from the resources boom. The blame for this failure should be spread widely, with economists taking a fair share.

Late last week a majority of senators passed the bill repealing the minerals resource rent tax, but not before knocking out its provisions cancelling various programs the tax was supposed to be paying for.

The government is refusing to accept the amended version of the bill, arguing that "by voting to keep many of the associated spending measures [naughty - most are actually tax expenditures], senators have effectively voted to keep the mining tax".

We'll see how long that lasts. But if you're thinking the tax raises so little it hardly matters whether it stays or goes, you're forgetting something. When Labor allowed BHP Billiton's Marius Kloppers and his mates from Rio Tinto and Xstrata (now Glencore) to redesign the tax, they predictably opted to take their depreciation deductions upfront. Once they're used up, however, receipts from the tax will be a lot healthier - provided it survives that long.

You can blame Kevin Rudd, Wayne Swan and Julia Gillard for their hopeless handling of the tax. But don't forget to copy in Tony Abbott who, faced with a choice between the interests of Australian taxpayers and the interests of three foreign mining giants, sided with the latter in the hope they'd fund his 2010 election campaign.

You can also blame Treasury for originally proposing an incomprehensible, textbook-pure version of the tax which couldn't survive, and so getting us lumbered with a fourth-best version. It also did a bad job of quietly test-marketing the tax with its banking contacts and of estimating the likely receipts.

But where were all the economists - including academics - explaining to the public why the tax wouldn't discourage mining activity or otherwise damage the economy, as it suited the big miners to claim?

Where were the economists explaining the special need for a resources rent tax in the case of the exploitation of mineral deposits, particularly when the miners were so largely foreign-owned?

As usual, they were keeping their mouths shut. Contribute their expertise to the public debate? Why? Better just to criticise from the sidelines.

Part of the problem is an ethic among economists that regards it as bad form to distinguish between local and foreign investors for fear of inciting "economic nationalism" - a form of xenophobia. If an investment generates jobs and income, why does it matter whether the firms involved are local or foreign?

It's no doubt thanks to this ethic that we do such a bad job of measuring foreign ownership (and so deny ourselves the ability to use hard facts to fight xenophobic impressions that foreigners now own everything). But the best guess is that mining is about 80 per cent foreign-owned.

Trouble is, mining is an obvious exception to this generally sensible aversion to economic nationalism, for two reasons: because our abundant natural endowment makes minerals and energy such a huge source of economic rent and because mining is so extraordinarily capital-intensive.

Added to that, as Dr Stephen Grenville (a former senior econocrat who does make a useful contribution to the public debate, via the Lowy Institute) has written, "mining royalties, a state government domain, fall victim to special relationships and inter-state competition to attract projects".

Put all that together and you see why having an effective resource rent tax is so essential to ensuring Australians get a fair reward for the exploitation of their birthright. High economic rents, few jobs created and the lion's share of profits going to foreigners mean unless especially high rates of profitability are adequately taxed we don't have a lot to show for the resources boom.

Saying that isn't anti-foreigner, it's simple self-interest, the driving force of market economies. Foreigners are welcome, provided we get a fair share of the benefits. Foreign investment isn't meant to be a form of aid to rich foreigners.

It's true our rate of national saving increased during the boom. But a lot of this was foreign-owned mining firms reinvesting their profits in local expansion rather than repatriating them, thereby increasing their share of our productive assets.

Now the construction phase is ending, more of the (undertaxed) profits will be sent back home. And the capital-intensive production and export phase will mean each $1 billion of growth in GDP now creates fewer jobs than it used to. Thank you Labor, thank you Coalition, thank you economists.

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How to reform industrial relations

Tony Abbott's strategy for getting back into government was to make himself a small target by adopting few controversial policies. He mollified his big business backers by promising to hold many inquiries and take any proposals for controversial reform to the 2016 election.

But once in government Abbott couldn't avoid announcing many unpopular measures to get the budget back on track. These have hit his standing in the polls, while causing difficulty and delay in getting budget measures through the Senate.

It's likely a lot of them won't pass, implying the government will have to put a lot of effort into finding more palatable savings. Even then, some of this year's unpopular measures - particularly the age-pension changes - will have to be defended at the election.

Meanwhile, most of a year has passed without the government getting on with its promised inquiries into controversial issues such as industrial relations, tax reform and federal-state relations (think three letters: GST).

Not a lot of time is left for the various inquiry processes to report, for the government to consider the reports, decide what reforms it proposes and then explain and justify them to voters before the election.

Does Abbott's unexpected radicalism on budget measures presage equally radical proposals in these other issues? If so, the next election campaign will be a lot more exciting than the last one.

Or does all the hostility he has aroused just with his budget measures make it more likely Abbott won't want to bite off a lot more trouble on other fronts?

On the question of industrial relations reform, Abbott and his minister, Eric Abetz - not to mention the Productivity Commission, which will be conducting the inquiry - would do well to ponder a recent speech by Geoff McGill, a long-experienced industrial practitioner and now a visiting scholar at Sydney University's Workplace Relations Centre.

McGill observes that the history of federal industrial relations legislation "has been punctuated by swings in the IR pendulum across the political cycle". First the Howard government's Work Choices swung the pendulum in favour of employers, then the Labor government's Fair Work swung it back towards the unions.

Now big business and its cheer squad in the national dailies want the restored Coalition government to give the IR pendulum another shove back in the direction to the employers. Isn't this the way the political game is played?

It is. But McGill questions whether continuing to play that way is the best way to get where we want to go. The advocates of yet another round of industrial relations "reform" justified it mainly by arguing the need for faster improvement in the productivity of labour.

That's something all sides can agree is a desirable objective. But McGill shoots down some wishful thinking on the topic. "Productivity growth is a complex process and usually described in simplistic terms," he says. "It can never be assumed and is only evident after the event.

"There is little evidence to support claims that particular changes in industrial relations legislation will boost national labour productivity."

It's the substance of the employment relationship, not its legal form, which determines whether people are engaged and productive, he says. Productive workplaces are not the outcome of legislation, but of the quality of leadership and culture at the workplace.

Surely there must be a law against someone speaking such obvious sense.

McGill brings to mind another point. Much of the thinking behind "the end of entitlement" and the unpopular budget measures is about saying governments can't solve all your problems for you (just the opposite of the message all politicians spread during election campaigns). It's not possible and, in any case, it's not healthy for people to be so dependent on the authorities.

True enough. But if that's what the government is telling everyone from the young unemployed to uni students to age pensioners, why is it allowing big business to imagine its industrial relations problems should - or even could - be solved by the government changing the law?

Actually, my guess is most of business isn't silly enough to think that. The push is probably coming from lobbyists trying to justify their fee, journos trying to sell newspapers and a relative handful of belligerent employers facing equally belligerent unions and hoping the government will give them some new stick to beat over the heads of their opponents.

Another point of McGill's: if we want better industrial relations leading to greater productivity improvement and the main way for employers to bring this about lies in the workplace, maybe a better way to encourage them to focus on the domestic challenge is to give them a period of legislative stability rather than more changes in the rules of the game.

Most successful managers understand that getting along with people - winning their regard, respect, support, trust, loyalty and co-operation - works better than getting heavy and legalistic. That's how you get better industrial relations - by, as McGill says, putting more emphasis on the relations and less on the industrial.

Managers like to be kept in the loop. Guess what? So do workers. Smart managers keep their staff well informed about the company's performance and the challenges it faces, and give early warnings - even to the union - about any need for nasties like redundancies. They never risk a breakdown in relations by telling workers things they subsequently discover to be untrue.

You engender co-operation by treating people well, consulting them, giving them a degree of autonomy, rewarding loyalty and sharing the business's proceeds fairly between shareholders, managers and staff. Workers accept a hierarchical pay structure, but you don't cause envy and disaffection by rewarding some equals more than others.

And if you don't like outside union officials coming into your workplace, you keep your workers so happy they never need to call them in.

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