Our leaders would do better if their followers were thinking harder

Much has been said about the failures of Scott Morrison, Daniel Andrews and Gladys Berejiklian in our never-ending struggle to keep on top of the coronavirus. But just this once, let’s shift the spotlight from our fallible leaders to the performance of those they lead. I think we ourselves could be doing a better job of it.

There is, after all, much truth in the saying that we get the politicians we deserve. When we think we’re entitled to have good government served up to us on a plate, we’ve lost sight of the truth that well-functioning democracies require diligent citizens, not just honest and smart politicians.

Perhaps our biggest complaint has been that our leaders and experts keep changing their tune. Why can’t we be told simply and clearly what’s required of us? Why can’t the pollies decide what they want and stick to it?

It’s as though they’re making it up as they go along, chopping and changing when they realise they’ve taken another wrong turn. Hopeless.

Let me tell you the shocking truth: they are making it up. But if you were thinking harder you’d realise that’s all they can do. As Morrison rightly says, a new virus doesn’t come with an instruction manual.

Our political leaders are relying heavily on epidemiologists and other medical experts because pollies have so little knowledge and experience of pandemics. The medicos know a lot about viruses, epidemics, vaccination and immunology, but at the start they knew little about the characteristics of this particular virus.

They were forced to make assumptions about those characteristics but, as they’ve realised those assumptions were wrong, they’ve changed them.

At the start they thought the virus was spread in big droplets landing on surfaces within one or two metres, whereas now they think it’s more like smoke. Without strong ventilation, it builds up in the air. This explains much of the early uncertainty about whether masks were a good idea.

The medicos have relied on the findings of the limited studies available, but when bigger and better studies have come along with different findings, they’ve updated their views.

As I don’t think Keynes actually said, “When the facts change, I change my mind. What do you do, sir?” Or, as he did say, “It is better to be roughly right than precisely wrong.”

Those people carrying on about how confusing it all is and how incompetent our leaders are reveal their own intellectual laziness: their reluctance to think through complex, nuanced, ever-changing problems when they’d prefer to be back watching carefully choreographed “reality” television. And their ignorance of how science works, slowly groping towards an ever-changing best guess at the truth.

The media’s new-found interest in public health means formerly obscure academics have become TV stars and any boffin who disagrees with what the government’s doing about X gets an op-ed article to air their dissent.

You could say this is adding to the confusion, but it’s science proceeding the way science does. It’s academics doing what academics do – eternally arguing among themselves.

It’s tempting to tell them “not in front of the children”, but when you remember how lacking our leaders are in competence, openness and accountability, the last thing our democracy needs is for experts to keep their critique of government policies to themselves.

You might have thought that a bunch of media-innocent scientists and a news media devoted to highlighting the exceptional over the typical, seeking out controversy and not always untempted by the sensational, would make an explosive combination.

But for the most part, the media have been on their best behaviour, favouring their audience’s need for accurate, trustworthy information. That brings us to the Australian Technical Advisory Group on Immunisation, and its ever-changing recommendation on who should be receiving the AstraZeneca vaccine now it’s been found to carry a very rare risk of blood clotting.

The advice has changed partly because circumstances have changed, but mainly because the original advice led to considerable vaccine hesitancy at a time when the vaccine rollout is way behind, we have Greater Sydney in lockdown and loads of AstraZeneca is going begging while little of the alternative Pfizer vaccine is available.

The advisory group has been criticised, but I think it was a narrowly constituted group, which gave narrow advice when what the government needed – and should have sought from elsewhere – was advice taking account of a broader range of factors.

The public’s huge reaction against the vaccine is unwarranted and unfortunate at such a time. AstraZeneca is less risky than taking aspirin. But when the media gave such attention to the clotting risk, the overreaction wasn’t surprising.

Responsible reporters can say “very rare” as many times as they like but, as our science reporter Liam Mannix has explained, humans are notoriously bad at giving minuscule probabilities the weight they deserve.

The saver may be that, as highly social animals, when people see so many of their friends lining up to “bare their arms”, their hesitancy may evaporate. It’s a strange, messy world we live in.

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Privatisation has done too much to perpetuate monopolies

It always disturbs me to see how few of our econocrats and economic rationalists – “neo-liberals” to their lefty critics – are willing to acknowledge the many cases where, what looked like perfectly sensible micro-economic reform on the drawing board, turned into a disastrous rort in the hands of the politicians.

But that’s not true of one of the great survivors from the reform era. Rod Sims, now chair of the Australian Competition and Consumer Commission, who’s an experienced econocrat and formerly a key advisor on the 1993 Hilmer report on national competition policy, which urged increased competition at state as well as federal level.

At the commission’s annual regulatory conference last week, Sims criticised the many privatisations of government-owned businesses that have simply bundled up a public monopoly and sold it to the highest bidder, without doing anything to get some competition into the industry, or even to adequately regulate the prices charged by a now-privately owned monopoly.

“Privatising assets without allowing for competition or regulation creates private monopolies that raise prices, reduce efficiency and harm the economy,” Sims said.

Why would governments do such a terrible thing? Because they put short-term budgetary pressures ahead of the best interests of their voters, as consumers and business-users of essential services. It’s actually part of a trick that buys the appearance of good management at the price of paying more than necessary for essential services from now on.

The pollies say: “Look at how much I got for that business, look at how I’ve got the budget back to surplus and reduced government debt, look at how I’ve kept our triple-A credit rating”. (Just don’t look at how much more you’re paying for electricity, for using the airport and for imported goods.)

Adding to these short-term budgetary temptations is the way politics and public policy have become more tribal, more public bad/private good. More “binary” as Prime Minister Scott Morrison would say. By definition, the public sector is inefficient and the private sector is efficient, people think.

It follows that merely by changing the ownership of a business from government to private you’ve made it more efficient. But that’s not economics, it’s just prejudice. Economists believe that whether a business should be privatised should be judged case-by-case, and by the way it’s proposed to be done.

Sims says “privatisation can generate important benefits to the economy, such as improved incentives for cost control, investment and innovation to meet the needs of consumers”.

“There have been many examples of privatisations that have been done well and that have benefited Australia. The privatisation of Qantas was done appropriately, for example, and the privatisation of Telstra was accompanied with measures to promote rather than constrain competition.”

Governments can be bad owners of businesses because – thanks to budgetary pressures – they’re usually hungry for big dividends, but reluctant to provide the extra capital needed to keep up with innovation and changing consumer needs.

But I’ve never understood people who lament the privatisation of the Commonwealth Bank. Its treatment of customers was never very different to that of its three big privately-owned competitors. On aviation, we’ve long had trouble keeping enough competition in our domestic market, but Qantas had plenty of international competitors.

“The problem is that, in more recent years, many of Australia’s key economic assets have been privatised without regulation, and often with rules designed to prevent them ever facing competition. This makes us all poorer,” Sims says.

“You regularly hear people calling for micro-economic reform these days. The best way to do that is to expose more of our economy to competition, and by dealing with excessive market power. Australia has on a number of occasions been doing the opposite.

“Many monopolies are subject to regulation, such as gas pipelines, electricity networks, railways and the NBN. In contrast, many ports and airports, which are essential gateways for our economy, are largely unregulated, mostly due to decisions made when they were privatised.”

In its search for a top-dollar selling price, the Keating government stuffed up the privatisation of capital-city airports, particularly Sydney’s. But nothing Victorian governments have done compares in infamy with the behaviour of the Baird and Berejiklian governments in NSW.

They took the state’s three vertically integrated electricity companies – each owning power stations and electricity retailers – and sold them to the people offering to buy them at the highest price. They became the three oligopolists dominating the national electricity market, Origin Energy, AGL and EnergyAustralia.

Then, when they privatised NSW ports, they promised the new owner of the Botany and Port Kembla ports it would be compensated should the Port of Newcastle start handling containers, not just coal.

Then they made the new owners of the Newcastle port agree to pay this compensation should they set up a container facility. They were so proud of this deal they tried to keep it a deep dark secret.

When its existence became known, the ACCC tied to get it struck down by the court as anti-competitive. But it failed to persuade the judge that trying to maximise the sale price by including monopoly rights in the deal was anti-competitive.

Which shows that it’s not just the ulterior motives of politicians that can turn good reform into a travesty. It’s also that many privatisation deals end up before the courts, where economic questions are decided by judges “learned in the law” but, in too many cases, not as well-versed in economics.

I understand that, in a recent case where one of the state’s public-sector unions sought to object to the NSW government’s wage freeze before the NSW Industrial Relations Commission, an economist brought as an expert witness by the union mentioned that wage increases were supposed to reflect productivity improvement.

He was chastised by the bench for introducing such a novel and controversial notion so late in the proceedings. Really?

My point is that would-be reformers need to be a lot warier of doing more harm than good.

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Don’t be surprised if the economy surprises on the downside

The economy has been on a roller-coaster since the virus arrived early last year, dipping one minute, soaring the next. Now, with the Delta variant putting Sydney and Melbourne back in lockdown, we’re in the middle of another dip. But as you hang on, remember this: what goes down must come up.

When governments order many businesses to close their doors, and us to leave our homes as little as possible, it’s hardly surprising that economic activity takes a dive. What did surprise us was the way the economy bounced back up the moment the lockdown was eased.

We rushed out of our houses and started spending like mad. Not that we weren’t spending whatever we could while locked down. Another surprise was the way the presence of the internet changed what would otherwise have happened.

Apart from allowing most people with desk jobs to work from home, and talk face to face to people in other cities without getting on a plane, it allowed us to keep spending: ordering groceries and takeaways online, consulting doctors over the phone – I thought receptionists were there to stop you getting through to the great personage – buying exercise equipment and stuff to get on with fixing up the back bedroom.

As I keep having to remind myself, only God knows what the future holds – and He’s not letting on. But it’s part of the human condition to be insatiably desperate to know what happens next. We keep searching the world for the one person who might be able to tell us.

Since even the experts can’t be sure what will happen, they base their predictions on the hope that what happens this time will be much the same as what usually happens. Experts are people who remember last time better than we do.

But that way of predicting the future hasn’t worked this time. The epidemiologists – and all the related -ologists we hardly knew existed – know a lot about viruses but, at the start, little about the particular characteristics of this one. Their predictions have kept changing as they’ve had more to go on.

Last year’s recession was the fifth of my career (counting the global financial crisis, which I do). I thought that knowledge put me so far ahead of the game I was an expert expert. Wrong.

Ordinary recessions happen because the people managing the economy stuff up. The economy takes well over a year to unravel, then three or four years to wind back up. But this recession was completely different, having been knowingly brought about by governments, for health reasons. When at last they let us go back to business, however, that’s just what we did.

The initial, nationwide lockdown caused the economy’s production of goods and services (gross domestic product) to dive by an unprecedented 7 per cent in just the three months to the end of June last year. But then the economy bounced back by 3.5 per cent in the September quarter and a further 3.2 per cent in the December quarter after Victoria’s delayed release from lockdown.

In the period before the Delta strain sent Sydney back into humbling lockdown, GDP was ahead of what it was at the end of 2019. Total employment was also ahead, while the rate of unemployment was actually a little lower.

Since the present September quarter has two months left to run, and Sydney’s lockdown rolls on even though Melbourne’s has ended, it’s too early to be confident by how much GDP will fall but, depending on how long Sydney’s drags on, it’s likely to be a fall of less than 1 per cent or somewhat more than 1 per cent. However bad, a lot less than last time.

As for the December quarter – and barring some new outbreak, say a new letter in the Greek alphabet – it’s likely to show expansion rather than contraction. Victoria will be growing, NSW will be in bounce-back mode as soon as the lockdown ends, and the rest of Australia will be doing its normal thing.

So all those silly people desperate for a chance to repeat the R-word aren’t likely to get the excuse they imagine they need.

Another major respect in which coronacessions differ from normal recessions is that politicians can’t consciously decide to stop the economy without at the same time providing generous assistance to all the workers and businesses this will harm. Normally, the assistance comes much later and is less generous.

Despite cries for the return of JobKeeper, the arrangements Scott Morrison has hammered out with Gladys Berejiklian and Dan Andrews are, by and large, a good substitute for the measures used the first time around.

The other thing to remember is that the economy is in much better shape now than at the end of 2019. Households have more money in the bank, the housing market is booming, profits are up and businesses are complaining about staff shortages.

Not such a bad time to cope with a setback. It won’t be the end of the world.

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The real reason we’ve hit policy gridlock: fear of public opinion

You don’t have to agree we owe big business a living to know that our public policies are far from perfect and that every government’s job is to beaver away at improving them. Nor to know recent governments have tired of doing that. We each have our theories on why this has happened, but now someone sensible has analysed the reasons policy reform has ground to a halt.

John Daley, the man who spent the past decade building our leading non-aligned think tank, the Grattan Institute, having handed its leadership over to Danielle Wood, has just released his last report, Gridlock: Removing barriers to policy reform. It’s his magnum opus, worthy of study by everyone who thinks they know a bit about how modern Australia ticks.

Daley defines “reform” as “changes to policy that would improve the lives of Australians” (as opposed to improving the careers of our top business people).

He starts by demonstrating that the pace of reform really has slowed, and isn’t just old-timers remembering the glory days of Hawke, Keating and Howard and complaining about “the young people of today”. He dismisses the excuse that “you can’t float the dollar twice”, noting “there are plenty of other good policy ideas that governments have failed to adopt”.

Daley examines the fate of the many policy recommendations in the regular reports of the Organisation for Economic Co-operation and Development, but focuses on the success or failure of the 73 proposals made in Grattan’s reports over the decade to 2019, covering budgets, tax and welfare, retirement incomes, housing, transport and cities, health, energy (aka climate change) and education.

He finds that, of the 73 reforms, about a third were substantially implemented and two-thirds weren’t adopted. He identifies seven main potential blockages to good ideas going ahead: popular opinion, partisan shibboleths, vested interests, a weak evidence base, budgetary costs, upper house obstruction and federal-state disagreement.

By “partisan shibboleths” he means policy views that are contrary to the weight of policy evidence, but are almost universally held within a political party or party faction, while much less widely accepted in other circles.

“One of the functions of shibboleths is that they mark membership of a group – a ‘tribe’. A belief is likely to be more effective as a marker of membership when it is not rational – otherwise the belief would be shared by many people who are not part of the tribe,” he says.

It will surprise many that, by Daley’s reckoning, the biggest blocker by far is popular opinion, not opposition from vested interests or party shibboleths.

Of the 23 Grattan reforms that were substantially implemented, none was unpopular, and none was opposed by powerful vested interests without that opposition being countered by substantial independent evidence from government reports and the like.

Only one of the successful proposals ran counter to a party shibboleth, and only one involved a big budget outlay.

By contrast, the most common blockage among the 50 proposals that weren’t adopted was that they were unpopular with the electorate. That accounted for 15 of them.

After that came 10 blocked by party shibboleths (although three of these were also unpopular). Six of the remainder were actively opposed by powerful vested interests not countered by strong independent evidence. Three more were blocked because the evidence for them was poor or contradictory, and five were blocked because they involved large budgetary costs exceeding $2 billion a year.

As for the other potential causes of blockage, in only two cases could their rejection be attributed mainly to a failure to pass the Senate. Federal-state disagreement was a significant issue in only six of the proposed reforms that weren’t adopted, and all of them were probably blocked for other reasons.

It’s hardly surprising that popular opinion is a powerful force in a democracy. But this is worth remembering when we’re tempted to think that the power of vested interests and politicians’ corruptibility are the reasons governments don’t make the changes we think they should. Maybe they don’t because not enough people agree with us.

Daley finds that whereas, over the past decade – but not necessarily during the preceding “golden age of reform” – public opposition invariably doomed a reform proposal, popular support is no guarantee a policy will be adopted. However, it certainly improves the chances.

Where the immediate effect of a reform is to reduce taxes or prices for consumers, it’s likely to be popular. And public opinion has a tendency to focus on immediate effects rather than on promised longer-term benefits.

But liberal democracies have always been a delicate balance between popularly elected rulers and a whole series of institutions – ranging from the courts and central banks to expert administrators of everything from water allocation to child protection – designed to temper popular views.

People tend to trust these experts much more than politicians. And it’s long been accepted that the primary duty of elected representatives is to govern according to their judgment of what's in the interests of their electors, rather than simply following the opinion of their electors, Daley says.

Our not too distant past holds plenty of examples of governments pressing on with controversial policies, confident in the belief that public opinion can change once people experience the reality of a policy change they didn’t like the sound of.

When they do so, they end up winning a lot of respect – something they so obviously lack at present. “So it is surprising that unpopularity has become an automatic strike-out for policy reforms,” Daley says.

He concludes that, “in general, Australian governments today seem less willing to take on public opinion.” How have Australia’s institutions changed to make public opinion so much more decisive?

And what can we do to improve things? Good questions – for another day.

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Reduced competition between businesses is harming productivity

In the search for explanations of the slowdown in productivity improvement, the world’s economists are closing in on one of the significant causes: reduced competition between the businesses in an industry, giving them increased “market power” – ability to raise the prices they charge.

Research by various Treasury economists has found evidence of this happening in Australia. And this month US President Joe Biden acted to increase competition in various markets where it had been lacking.

A new study by Jonathan Hambur has added to earlier research by Treasury people finding that Australia’s private sector has shown less “dynamism” – ability to become more economically efficient over time – during the past decade or so.

Hambur has used a database of tax returns covering almost all Australian businesses to find that their “mark-ups” have increased by about 5 per cent since the mid-noughties.

To economists, a firm’s mark-up is the ratio of the prices it charges compared to its “marginal” cost of production – that is, the cost of the last unit it produced.

Hambur says that, while part of this increase seems to have been caused by technological change, it also shows an increase in firms’ market power and a decline in competition.

If so, this would explain about a fifth of the slowdown in the rate of productivity improvement we’ve seen over the past decade, since we already know the same period has seen slower reallocation of resources from low-productivity to high-productivity firms.

We measure productivity by comparing the quantity of the output of goods or services with the quantity of inputs of raw materials, labour and physical capital used to produce the output. Increasing output per unit of input is the main way we’ve been able to keep improving our material standard of living over the past two centuries.

And one of the ways an economy increases its productivity is by more of the production being done by the firms that are best at turning inputs into outputs at the expense of the less-efficient firms. Resources (inputs) are thereby “reallocated” to their most efficient use. What causes this reallocation to occur? Price competition between the firms in an industry.

Many people assume big companies can set whatever price they like. But this can’t be true. Even in the case of a single firm selling an important product, if the monopolist uses its considerable market power to set a price that’s simply too high for many people to afford, it will get to a point where it loses more from the sales it no longer makes than it gains from the extra profit it makes from those people still willing and able to pay the extra.

This is why economists say a firm wanting to maximise its profits is able to charge no more than “what the market will bear”. How much the market will bear depends mainly on the strength of the competition it faces from other firms selling the same product.

The textbook, neo-classical model of a “perfectly competitive” market – which is hugely oversimplified and has never existed in the real world – tells us the many firms in a market are able to charge a price no higher than their marginal cost of production (remembering that the “cost” includes a rate of profit just sufficient to discourage the owners of the firm from taking their financial capital to another market).

In this case, each firm that survives in the market will be able to charge only the identical market price set by the marginal cost. A firm that tries to charge more than the market price will sell nothing, whereas a firm that charges less will sell out immediately, but then go out backwards because it hasn’t covered its costs.

In the real world, there are a host of possible reasons why firms are able to charge a price higher than their marginal cost, and so make excess profit: because customers don’t know where to find the products that are cheaper but just as good, because customers are bamboozled by advertising and phoney “product differentiation”, because economies of scale and improved technology allow firms to get bigger and reduce their average cost of production.

Firms pursue scale economies and other innovations in the hope of making excess profits, but theory tells us that competition from other firms will end up forcing them to pass their cost savings on to their customers in the form of lower prices. The consumers always beat the capitalists.

When competition isn’t strong enough to make this happen, however, firms can and do earn mark-ups well above their marginal costs. Now Hambur has confirmed this happens in Australia. Worse, our mark-ups have increased over the past decade, telling us competition has weakened further and given our businesses greater market power.

With US economists finding similar evidence of reduced competition contributing to America’s own productivity slowdown, it’s not surprising to see President Biden acting to increase competition. Earlier this month he signed an executive order urging federal government agencies to crack down on anti-competitive practices ranging from agriculture to pharmaceuticals.

He denounced the present era of business monopolies. “Rather than competing for consumers [businesses] are consuming their competitors; rather than competing for workers they are finding ways to gain the upper hand on labour,” he said.

“Let me be very clear, capitalism without competition isn’t capitalism, it’s exploitation.”

Biden directed the Department of Justice and Federal Trade Commission to carefully review mergers and even challenge deals already put through.

He directed the trade commission to deal with competition concerns about the behaviour of Facebook, Apple, Alphabet’s Google, and Amazon, and to limit “killer acquisitions” where large internet platforms buy out potential competitors.

The justice department will launch a review of merger guidelines to determine whether they are “overly permissive”.

So, what could our government do about our own decline in competition? Well, we could start by tightening our own merger laws so the Australian Competition and Consumer Commission can be more successful in its efforts to protect us from anti-competitive takeovers.

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Getting to net-zero emissions an easier ride than some want to think

I have a mate who – in normal times, anyway – gives me a lift to the gym in his new all-electric Mercedes. He loves its lack of engine noise and amazingly fast acceleration when the lights change (not that I’m implying he’s a rev-head hoon the police should be watching). I’m no car lover, but it’s certainly a smooth, quiet ride.

Most of us accept that, as part of the world’s move to net-zero emissions by 2050, we’ll all be moving to electric cars. Other countries are already further down this road than us.

We’ve made big strides in shifting electricity generation to renewables, and our emissions are falling. But electricity production accounts for only a third of our total emissions. Transport, in all its forms, accounts for about 20 per cent of total emissions, so its move away from fossil fuels is another part of the transition we should get on with.

In all the years we’ve been arguing about climate change, people have tried to convince us how costly it will be. How disruptive to industry and our way of life. All the higher prices, the tax we’ll pay, the jobs we’ll lose.

So far, however, there’s been little extra cost or disruption. The rise of wind and solar power has happened without much pain. And a report this week from Tony Wood and colleagues at the Grattan Institute think tank suggests the move to electric vehicles can be achieved without angst.

More than 60 per cent of the transport sector’s 20 per cent of total greenhouse gas emissions comes from the tailpipes of cars and light commercial vehicles, including our two biggest selling cars, Toyota HiLux and Ford Ranger utes. That leaves trucks accounting for 20 per cent of the sector’s emissions and domestic aviation for about 10 per cent.

Australia has about 18 million light vehicles, up from fewer than 15 million in 2010. And we’re driving bigger, heavier cars than we were a decade ago. (All those appalling SUVs. One day they’ll run over my little Toyota Yaris.)

At present, electric vehicles make up just 0.7 per cent of new sales in Australia. This doesn’t count hybrid electric/petrol cars which, because of their continued use of fossil fuel, can’t be a lasting part of the shift, Wood says.

Our tiny all-electric share of new sales compares with 2 per cent in the US, 3 per cent in New Zealand, 11 per cent in Britain and 75 per cent in Norway.

Because it takes more than 20 years to replace our light vehicle fleet, for our transport sector to make a sufficient contribution to the target of net-zero total emissions by 2050 we’ll need to get to the point where all new light vehicles are electric by about 2035, he estimates.

Government projections suggest that, if the market is left to itself, the move to electric vehicles will cause light vehicle emissions in 2030 to be 7 per cent lower than they were in 2019. This isn’t good enough.

So what can be done to speed the shift? Wood says governments should reduce the main barriers to buying an electric car. First, the high cost of switching and limited choice and, second, the lack of charging points.

We pay an average of about $40,000 for a new car. But we have fewer than 30 electric models to choose from – much lower than overseas – and of these, just three models retail for less than $50,000.

As with all innovative products, the price of electric cars is coming down as the novelty wears off and sales increase. They’ll fall further as batteries become cheaper to make. But the point where the price of an electric car falls below an equivalent conventional car is still some years away.

So Wood proposes removing several taxes on the purchase of new electric cars. Scrapping state stamp duty would cut the price by up to 6.5 per cent, he estimates. Remembering that, these days, all vehicles are imported, removing federal import duty would cut the cost by up to a further 5 per cent.

Exempting electric cars from the federal luxury car tax – a tax of 33 per cent of the price exceeding the first $80,000 – until 2030 would also help.

Australia is alone among the rich countries in not having mandatory fuel efficiency and emissions standards. And there’s a suspicion some foreign makers send us only the high-emissions conventional models they have trouble flogging in other markets.

So to these carrots, Wood adds a stick: to phase out petrol and diesel cars, the feds should impose an emissions limit on light vehicles and reduce it to zero by 2035.

Many people hesitate to buy an electric vehicle because they worry about finding places to recharge. Wood says governments should require all new buildings with off-street parking to make provision for vehicle charging.

Getting everyone into electric vehicles wouldn’t solve our emissions problem, but it would help. And it’s another indication that the fears of huge costs and disruption are greatly exaggerated.

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Reality is catching up with our freeloading, populist climate deniers

Don’t be taken in by the Morrison government’s outraged cries of “protectionism” against the EU plan to impose a carbon tariff on our exports to Europe. It’s we who are in the wrong, failing to do what we should have to reduce emissions, in favour of politicking and populism.

What we’re seeing is just the reality of the world’s need to act to limit climate change catching up with a government and federal party which, since Tony Abbott used denialism to seize the party’s leadership from Malcolm Turnbull in 2009, decided to make global warming a party-political football: a way to beat your opponents, not a need to tackle the nation’s biggest problem.

It’s a condemnation of our business people that, when their own side of politics offered them a way to postpone the inevitable costs of adjusting to a low-carbon world, they happily embraced it.

It’s a condemnation of Australian voters that they were willing to allow their preferred party to tell them whether they cared or didn’t care about their children’s future. It should have been the other way round. “It’s all too hard; you do my thinking for me.”

But the game has moved on since those bad days, and now it’s not just the rest of the world that’s realised there’s no future in denying the reality of climate change and the need to act. As each day passes, we see more evidence that our own financial regulators, banks, investors and businesses are accepting the inevitable and modifying their behaviour.

All our state governments – most notably the Berejiklian Coalition government of NSW – have embraced the target that all other rich nations have embraced, net-zero emissions by 2050. Everyone can see that our refusal to take climate change seriously is wrong-headed and unsustainable.

So, apart from being a national embarrassment – we’re the person stopped for not wearing a mask, so to speak – it’s no bad thing that even other countries have stepped in to oblige our national government to shoulder its responsibilities.

As part of their plan to reduce their emissions by 55 per cent by 2030, the Europeans are toughening up the emissions trading scheme they introduced in 2005, which imposes a price on the carbon emissions of European industries.

To prevent this putting their industries at a disadvantage against imports from countries that don’t impose a similar carbon price on their own industries, the Europeans plan to use a “carbon border adjustment mechanism”, a tax on imported cement, fertilisers, aluminium and iron and steel to bring their carbon costs up to those faced by local producers.

This not only levels the playing field for local industry, it eliminates the incentive for producers to move their production to countries without carbon pricing.

These problems are ones we ourselves worried about when designing Kevin Rudd’s original carbon pollution reduction scheme (which the Coalition and the Greens voted down in 2010) and Julia Gillard’s carbon pricing scheme of 2012 (which was repealed by Abbott in 2014).

So what the Europeans want to do can’t honestly be called protectionism. It bears no similarity with the new import duties China’s imposing on some of our exports.

What’s true is that it’s a messy but necessary way of solving the “wicked” problem of climate change which, being global, can only be fixed by all of the world’s big emitting countries doing their bit. This is why we can expect many other big countries – starting with America, and maybe extending to Japan − to impose similar carbon border taxes on those countries that try to freeload on those doing the right thing, while helping to sabotage the good guys’ efforts in the process.

So there’s no reason for any of us who believe climate change is real and must be countered to have any sympathy for the Abbott-Turnbull-Morrison government. All its sins of expedience and populist politicking are finding it out. It took a bet that the rest of the world wouldn’t get serious, and we lost.

The point is, had we stuck with either the first or the second version of our own emissions trading scheme – which were actually designed to fit with the Europeans’ scheme – we wouldn’t have this problem.

By now our exporters would be paying our carbon tax to our government (or, if they weren’t yet, we could easily fix it) rather than paying the same tax to foreign governments. Why’s that a good idea?

From the beginning, this government has used climate change as nothing more than an opportunity to attack the other side of politics by pushing populist delusions that taxes are always and everywhere a bad thing. Bad for the economy. Yeah, sure.

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Reform not a dirty word when it benefits the many, not the few

The idea that the economy needs to be “reformed” has been hijacked by the business lobby groups. Their notion of reform involves making life better for their clients at the expense of someone else. But that doesn’t mean there aren’t things that could be changed to make the economy work better for most of us, not just the rich and powerful.

Trouble is, Scott Morrison shows little interest in any kind of reform, whether to advance business interests or anyone else’s. Reform involves persuading people to accept changes they don’t like the sound of, and increases the risk they’ll vote against you at the next election.

Morrison’s government is making heavy weather of our most urgent problem – getting all of us vaccinated against the virus ASAP – so maybe it’s not such a bad time for him to Keep it Simple, Stupid.

But we do have an election coming up, in which it’s customary to think about what improvements could be made over the next three years. And it’s not illegal for us to dream about what could be improved if sometime, somewhere we ever found leaders interested in doing a better job as well as staying in office.

Next to the pandemic, the most important problem we need to be working on is climate change. That’s stating the obvious, I know, but not to Morrison and his Treasurer, Josh Frydenberg, whose recent intergenerational report paid lip service to the issue but then proceeded to project what might happen to the economy and the federal budget over the next 40 years without taking climate change into account.

What’s surprising is that another Coalition government, Gladys Berejiklian’s in NSW, did take account of global warming in its state intergenerational report. It found that more severe natural disasters, sea level rises, heatwaves and declining agricultural production would reduce incomes in NSW by $8 billion a year in 2061 under a high-warming scenario compared to a lower warming one.

Clearly, climate change will be bad for everyone in the economy – some people more than others – while acting to reduce our emissions of greenhouse gases will be a cost to our fossil fuel industries.

But the world’s demand for our coal and gas exports is likely to decline whatever we do. Our government doesn’t believe climate change needs to be taken seriously but, fortunately for more sensible Australians, the rest of the world does, and is in the process of forcing “reform” on our obdurate federal government.

In the meantime, however, our electricity industry is finding it hard to know what to do because the Morrison government won’t commit itself to a clear plan on how we’ll make the transition to all-renewable power.

Worse, our abundance of sun and wind relative to most other countries makes us well placed to become a world renewables superpower – exporting “clean” energy-intensive manufactures, maybe even energy itself - if we act quickly.

Right now, however, our need to choose between being a loser from the old world or a winner in the new world is sitting in the too-hard basket.

Moving to less strategic issues, Danielle Wood, chief executive of the Grattan Institute, gives a high priority to lowering barriers to workforce participation by women, by making childcare more affordable and improving paid parental leave.

We’ve long seen the benefits of free education in public schools. Making “early childhood education and care” free would not merely make life easier for young families, it would get more of our kids off to a better start in the education system and allow women to more fully exploit the material benefits of their extensive education, not just to their benefit but the benefit of all of us.

The benefits of getting an education greatly exceed getting a better-paid job – education broadens the mind, don’t you know – but it makes no sense for girls, their families and the taxpayer to put so much effort and money into gaining a better education, then make it so hard for them to do well in the workforce when they have kids.

One factor that’s widening the gap between rich and poor in the advanced economies is years of “skill-biased” technological change, which is increasing the wages of highly skilled workers while doing little to increase the wages of unskilled workers. Indeed, many routine jobs are being replaced by machines.

This says one way to ensure Australian workers prosper in the digital future of work is to ensure our workforce is well educated and highly trained. We must be willing to spend – to invest – however much it takes to have a workforce capable of providing the more analytical, caring and creative skills employers will be demanding.

We need to do more to help our teachers teach better so that fewer kids leave school early without having acquired sufficient education to survive in the world of work. Some teachers are better at it than others; they need to be used to train younger teachers on the job and rewarded accordingly.

Universities need to be better funded by the federal government, so they can afford to give students a higher quality education, vice-chancellors aren’t so eternally money hungry, unis stop exploiting younger staff with insecure employment and aren’t so dependent on making money out of overseas students and thus obsessed by finding ways to game the international university league tables.

How’s all this to be afforded? By all of us paying somewhat higher taxes, how else? By politicians giving up their election-time pretense that taxes can come down without that leading to worse quality government services rather than better.

Throwing money at problems doesn’t magically fix them, you must use the money effectively. But when mindless cost-cutting is the source of much of the problem, nor is it possible to fix problems without spending more.

If our politicians would speak to us more honestly along the lines of “you get what you pay for”, that itself would be a welcome reform.

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The economy’s job is to serve our good health

What a tough, tricky world we live in. There we were, starting to think the pandemic – for us, at least – was pretty much over bar the jabbing, when along came a new and more contagious variant and knocked our confident complacency for six. It’s now clearer that getting free of the virus will be messier, more expensive and take longer than we’d hoped.

It’s natural to be impatient to see the end of this terrible episode in the nation’s life, but no one’s been more impatient to see the end of restrictions than Scott Morrison and the business lobby groups.

We should worry less about any continuing small risks and more about getting the economy working normally again, we were told. Why do those appalling premiers keep closing state borders? Don’t they understand how it disrupts businesses?

One theory that’s been blown away is the tribal notion that continuing problems keeping a lid on the virus were limited to dictatorial Labor states, not “gold standard” Liberal states. We’ve been reminded of what pride so often causes us to forget: success is invariably a combination of competence and luck.

Luck was running against Victoria, now it’s NSW’s turn. NSW did do better on contact tracing, but along came a variant that could spread faster than the best contact-tracing system could keep up with.

The nation’s macro-economists learnt some years ago that the best response to a recession is to “go early, go hard”. That’s something the exponential spread of viruses means epidemiologists have long understood.

The sad truth is, no matter how long NSW’s present lockdown needs to last before the virus is back under control, Premier Gladys Berejiklian’s critics are certain to say she waited too long and didn’t go hard enough.

And they’ll be right. If there’s ever a possibility of starting even a day earlier, it’s always right.

Is it a bad thing to want to limit the economic disruption caused by our fight against the virus? Of course not. But it’s a tricky choice. You don’t want to act unnecessarily, but the longer you take to realise you must act, the more disruption you end up causing.

Berejiklian’s problem is that she was being held up as the national pin-up girl of governments’ ability to cope with the crisis while minimising economic disruption.

The economy is merely a means – a vital means – to the end of human wellbeing. Health is also a means to achieving human wellbeing. But good health is so big a part of wellbeing it’s almost an end in itself. And prosperity isn’t much good to you if you’re dead.

So, as surveys show, most economists get what it seems many business people (and certainly, their lobby groups and media cheer squad) don’t get: in any seeming conflict, health trumps economics.

It’s also a matter of solving problems in the best order. Just as a war takes priority over material living standards, so does a major threat to our health. Fix the health problem, then get back to worrying about the economy.

To put it yet another way, “the economy” exists to serve the interests of the people who make it up; we don’t exist to serve the economy.

The people who want to exalt “the economy” tend to be those using “the economy” to disguise their pursuit of their own immediate interests, not the interests of everyone. “Keep my business going; if that means a few people die, well, I’m pretty sure I won’t be among ’em.”

Some economists estimate that the NSW lockdown will cost the economy (gross domestic product) about $1 billion a week. But don’t take that back-of-an-envelope figure too seriously. For a start, it’s not huge in a national economy producing goods and services worth about $2000 billion a year.

In any case, it’s misleading for two reasons. First, can you imagine what would be happening in the economy had St Gladys (or, before her, Dictator Dan) done nothing while the virus raged about us, getting ever worse?

Most of us would be in what Professor Richard Holden of the University of NSW calls “self-lockdown”. Which would itself be a great cost to the economy – not to mention the angst over the lack of leadership.

So don’t confuse the cost of the virus with the cost of the government’s efforts to limit its spread by doing the lockdown properly.

Second, remember that the economy rebounded remarkably quickly and strongly after the earlier lockdowns, making up much of the lost ground. Of course, the exceptional degree of income support for workers and businesses provided by the federal government does much to account for the strength of the rebound.

Which is why it’s good to see the federal-state assistance package announced on Tuesday, even though its cut-price version of JobKeeper, while being better than was provided to Victoria recently, isn’t as generous as it should have been.

Like Berejiklian, Morrison is still adjusting to his newly reduced circumstances.

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Don't believe the boys who cry 'interest rates to rise'

Heard the talk that a rise in interest rates is getting closer? So’s Christmas. Here’s my advice: the greatest likelihood is that a rise is still years away. But between now and then you’ll keep hearing stories that it’s on the way. Ignore them.

Why? Because though nature abhors a vacuum, it doesn’t do so as much as the financial markets and the financial media do. They form an unholy alliance because both make their living speculating about changes in interest rates.

They cannot abide a situation where rates don’t change for years on end. So they keep trying to convince themselves something’s about to happen. The financial markets jump at shadows and, whenever they do, the media breathlessly report this worrying development.

The plain truth is, no one knows what the future holds – not even me. But all of us crave to know what’s coming, and keep searching for the person who may be able to tell us. The traders in the financial markets – who do infinitely more buying and selling of securities and currencies than is required to meet the needs of their business customers – earn a well-buttered crust by betting with each other on what’s coming down the pipe.

The media make their living partly by catering to their customers’ unquenchable curiosity about the future. Any interesting opinion will do, though they know that bad news sells better than good. A rise in rates would be bad news for people with mortgages, but good news for people living on their savings in retirement. But the people who choose what news we’re told about can’t imagine they’ll be old themselves one day.

Although no one but God knows for certain what will happen to interest rates, you’d think the person likely to be best informed on the subject is the person with most influence over interest rates in Australia, the boss of our central bank, Reserve Bank governor Dr Philip Lowe.

For more than a year, Lowe has kept telling us – and the markets – that the Reserve is “unlikely” to raise the official interest rate “until 2024 at the earliest”. But there was much excitement last week when he changed this to saying the Reserve’s “central scenario” is that a rise won’t be needed “before 2024″ – that is, not for another two and a half to three years.

What this means is that, whereas it couldn’t see any likelihood a rise would be needed until 2025, it can now see a “range of plausible scenarios” where “further positive surprises” could make a rise appropriate some time during 2024.

The further surprises would mean that annual growth in wages exceed 3 per cent earlier that in the Reserve’s “central scenario”. Although its target is annual inflation of 2 to 3 per cent, and its statutory duty is to achieve full employment (something it now sees as necessary to get inflation back up into the target zone), wage growth of 3 per cent-plus is a key indicator because “history teaches that sustained [my emphasis] changes to the inflation rate are accompanied by sustained [ditto] changes in growth in labour costs”.

Our annual rate of wage growth hasn’t exceeded 3 per cent since March 2013 – more than eight years ago, long before the pandemic – so you see why the Reserve’s “central scenario” is that getting back to it is likely to take several years yet.

For much of this year, however, the financial markets have thought they knew better that the Reserve governor. And nothing he said last week persuaded them he might know more about his likely decisions than they did.

There was little change in futures market prices showing they expect a rate rise in a year’s time – July 2022 – and another in the first half of 2023.

Why do the markets think they know better? Well, because the world’s national financial markets are now so highly integrated, traders probably spend more time thinking about the global market leader, the US economy and Wall Street, than they do about our economy. And they’re always tempted to follow a simple decision rule: whatever the US Federal Reserve is doing, we’ll be doing soon enough.

They may be right in believing rising inflation pressures in the US will lead the Fed to start raising interest rates sooner than sometime in 2024 at the earliest. But what they miss is the big differences between our circumstances and the Yanks’ when it comes to prices and wages.

None of the advanced economies were roaring ahead before the arrival of the pandemic, but the US was travelling a lot faster than we were. So we have a lot more ground to make up than they do. Although most advanced economies have long had inflation rates below their central banks’ target range, ours has been a lot further below than the Americans’.

That’s probably because, over recent years, their market for labour has been a lot “tighter” than ours. Their rate of wage growth has been much less weak than ours has.

A big reason for this is that, in our labour market, the increased demand for workers has been more closely matched by an increase in the supply of workers, whereas theirs hasn’t been. Our rate of working-age people already participating in the labour force has risen to near-record highs, whereas theirs has been much lower.

A lot of the increase in our supply of labour has come from our relatively higher levels of immigration. This has ceased to be true since we closed our borders – which does a lot to explain why employment and unemployment have bounced back to their pre-pandemic levels much earlier than we were expecting – so one of Lowe’s uncertainties is how long this strange form of stimulus will last.

The American financial markets began worrying about the risk of rising inflation earlier this year. This is partly because President Biden has been applying huge amounts of budgetary stimulus, and because of rising commodity prices and reports of shortages of the supply of semiconductors and other things, caused by the pandemic’s disruption.

By contrast, our government is busy ending its big stimulus programs. And supply shortages are temporary. Increases in prices don’t become a lasting increase in the rate of inflation unless they lead to higher wages. That’s what Lowe means when he stresses that he won’t be putting up interest rates until enough time has passed to convince him the increases in inflation and wages are “sustained”.

The final thing to remember is that one reason the financial markets are so quick to jump to conclusions about what lies ahead is that, because they lay new bets every day, they know they can jump to a different conclusion in a few weeks’ time. To them, it’s all part of the fun of being a professional gambler.

If you actually enjoy worrying that interest rates may rise – all the thrills and spills along the way – then be the media’s guest. But if you have better things to do and just want a credible view about the future that doesn’t change any more often than it has to, feel free to ignore the markets’ fun and games.

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Little sign Morrison is serious about improving productivity

Improving the economy’s productivity is so central to lifting our material standard of living that politicians and big business people talk about it unceasingly. But the funny thing is, most of what they say makes little sense.

But first, let’s be sure we know what “productivity” means. It may be that politicians and business people get away with talking so much nonsense on the subject because so many of us aren’t sure.

A lot of people assume “productivity” is just a flash way of saying “production”. Wrong. It’s also possible people – particularly business people – think it means the same thing as profit, competitiveness or effort.

Wrong again. As Dr Richard Denniss and Matt Saunders, of the Australia Institute, say in a new paper, “while cutting the wages of a worker may lead to an increase in profit, and potentially improve the competitiveness of one firm compared to another, wage reductions do not result in an increase in productivity.

“Indeed, lowering wages may lead to a reduction in productivity if it dissuades firms from investing in labour-saving technology.”

The productivity of a business (or an economy) is the quantity of its output – production – of goods and services compared with the quantity of its inputs of raw materials, labour and physical capital.

It’s most commonly measured by dividing output by the quantity of usually the most expensive input, labour, to get output per hour worked.

The great achievement of capitalist economies is that they’ve been able to extract a bit more output from the average hour worked almost every year for the past two centuries.

It’s this improved productivity that almost wholly explains why the developed countries’ material living standards have got a bit better almost every year.

But how on earth has it been done? Mainly by advances in technology. Continuously since the Industrial Revolution, we’ve been inventing machines that allow us to produce goods using fewer and fewer workers.

This has greatly reduced the proportion of the workforce needed to work in farming, mining and manufacturing, but made it possible to afford far more people delivering services ranging from doctors and professors to people working in aged care, disability care and child care. Over the decades, total unemployment has been little changed by labour-saving technology.

The productivity of labour has been improved also by better education and training of workers, and by improvements in the way businesses are managed.

Now, as discussed last week, Australia’s rate of productivity improvement has slowed markedly since the global financial crisis. And, to be fair, we should remember that much the same has happened in the other rich economies.

But that’s no reason why the government shouldn’t be doing what it can to turn this around. And there’s been no shortage of talk about all the things the Coalition is doing to improve our productivity. What’s missing are signs that all this professed effort is doing much good.

It’s clear Scott Morrison hates being held accountable, but Denniss and Saunders have gathered a remarkable list of the claims he’s made, particularly while he was treasurer, to be working wonders on the productivity front.

In 2016, he claimed the creation of the Australian Building and Construction Commission was “an important reform . . . that will drive productivity, that will support wages growth, that will support increases in profits of small businesses so they can grow and expand”.

The same year he claimed the alleged “free-trade agreements” that the government had been making with other countries would “increase Australia’s productivity and contribute to higher growth by allowing domestic businesses access to cheaper inputs, introducing new technologies, and fostering competition and innovation”.

That’s a claim the Productivity Commission and many economists would strongly dispute.

Treasurer Morrison also claimed “the government is implementing a $50 billion national infrastructure plan to unlock our productive capacity, generate jobs, and expand business and labour market opportunities”. Train station car parks, for instance?

Other ministers have made similar claims, including Christian Porter’s assertion that his reform of wage-fixing rules would “make the bargaining system . . . more efficient and, most importantly, capable of delivering those twin goals of productivity and higher wages”.

This is not to mention the various tax cuts – in the rate of company tax for small business; the three-stage cuts in income tax, including the last stage, in 2024, which will give huge tax cuts to high income-earners despite adding $17 billion a year to an already swollen budget deficit – which are always justified as encouraging more effort, innovation and investment.

Trouble is, all this supposed achievement did nothing to encourage the authors of last week’s intergenerational report to raise their assumed rate of annual productivity improvement over the next 40 years.

Indeed, they cut the rate a fraction to 1.5 per cent a year. They said nothing about any of the above “reforms” helping to justify even that lower assumption, which is actually much higher than the 0.7 per cent average annual improvement achieved over the five years before the coronacession.

What’s more, both the report and Treasurer Josh Frydenberg acknowledge that it will take a lot more reform to get the rate of productivity improvement up to 1.5 per cent a year. What they don’t do is say what reforms they have in mind. Maybe we’ll be told after next year’s election. Or maybe it’ll just be more of the same sort of “reforms” Morrison has assured us are doing so much good.

In former times, big business worthies and conservative politicians used to tell us our goal must be to increase the size of the pie for everyone (which is what improved productivity does), not fight over the size of my slice of the pie compared to yours.

Maybe they’ve stopped saying this because, if we looked too hard at all the changes they assure us will improve productivity, we’d notice they’re aimed at increasing the slice of pie going to business owners and high income-earners.

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The real reason the budget may stay in deficit for the next 40 years

If you follow a rule that when a politician cries “look over there!” you make sure you stay looking over here, there’s much to be deduced from Treasurer Josh Frydenberg’s Intergenerational Report, before we put it up on the shelf with its four predecessors.

That’s especially so with a federal election coming by May next year. Elections are times when politicians try to convince us they can do the arithmetically impossible: cut taxes while guaranteeing adequate spending on “essential services” and getting on top of “debt and deficit”.

Intergenerational reports always involve sleight of hand. They’re always about getting us to focus on a certain aspect of the problem and ignore other aspects.

As Frydenberg admits, the five-yearly intergenerational reports “always deliver sobering news. That’s their role. It is up to governments to respond.”

He’s given us little idea of what that response will involve. But there’s little doubt about his sobering news: the budget is projected to stay in deficit in each of the 40 years to 2060-61.

And we’re left in no doubt about the stated cause of those deficits and growing government debt: excessive growth in government spending.

As the report’s authors confess in an unguarded moment, “the emphasis of the [successive intergenerational] reports rested on pressures that demographic change [that is, the ageing of the population] was likely to impose on future government spending”.

We’re told that, even after you remove the effect of inflation, government spending per person is projected to “almost double”. (And I thought only journalists were prone to exaggeration. “Almost double” turns out to be an increase of 73 per cent.)

Why the huge growth in real terms? Mainly because of huge growth in spending on healthcare, but also because of big growth in spending on aged care and interest payments.

Get it? Government spending will grow like steam because of the ageing of the population. Except that when you read the report’s fine print you find that’s not the main reason. Only about half the projected growth in health spending is explained by population growth and ageing.

The other half is explained by advances in medical “technology, changing consumer preferences and rising incomes”. That is, as Australians’ real incomes rise over time, they want to spend a higher proportion of that income on preserving their good health and living longer.

And improved medicines and procedures almost always cost more than those they replace. But voters won’t tolerate government delay in making the latest drugs and operations available under Medicare.

As for the projected greatly increased spending on aged care, only part of it’s due to the Baby Boomers eventually reaching their 80s. The rest is explained by “changing community expectations”.

That’s a bureaucrat’s way of saying that “after the royal commission confirmed all we’ve been told about widespread mistreatment of people in aged care, governments will have no choice but to stop doing aged care on the cheap”. That is, it’s the higher cost of better-quality care.

Expressed as a percentage of national income, spending on the age pension is expected to fall as bigger superannuation payouts put more people on part-pensions. And, even though this saving is projected to be more than offset by the increased cost to revenue of super tax concessions, the combined effect is that the retired will have a lot more money to spend than their parents did.

Now get this: whereas total government spending is projected to grow, in real terms, at an average rate of 2.5 per cent a year in the coming 40 years, this compares with growth of 3.4 per cent a year over the past 40 years.

So it’s not just that ageing doesn’t adequately explain the expected growth in government spending, it’s also that the projected 40 years of budget deficits can’t be adequately explained by excessive spending.

The real reason the spending horse is expected to outrun the taxing horse is that the taxing horse has been nobbled. At a time when the coronacession led to a huge blowout in the budget deficit, the government used this year’s budget to bring forward the second stage of its tax cuts, and will proceed with the third-stage tax cut in July 2024 despite the continuing deficits and rising debt.

Worse, the projections assume that, because projected tax collections would otherwise exceed the government’s self-imposed limit on taxation as a proportion of national income after 2035-36, we’ll be getting new tax cuts in each of the last 15 years up to 2061. Yes, really.

No wonder interest payments are projected to account for three-quarters of the budget deficit in 2060-61.

We can be sure Scott Morrison will go into the election campaign claiming the Liberals are the party of lower taxes. But what voters will have to decide is whether a re-elected Morrison government would “respond” to the Intergenerational Report’s projection of its existing policies by letting taxes grow, slashing spending on “essential services” or letting debt and deficit just keep keeping on.

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Our aspirations for a Big Australia need a big trim

Almost all the nation’s business people, economists and politicians believe too much population growth is never enough. But if there’s one thing I hope to be remembered for, it’s that I always subjected this case of group think to critical examination.

I remain to be convinced that a Big Australia would be better either for our material living standards or for our efforts to limit the damage our economic activity is doing to our natural environment – the erosion of the nation’s “natural capital”.

But, in any case, Treasurer Josh Frydenberg’s intergenerational report last week is a useful warning that our aspirations for a Big Australia need a big trim.

The pandemic is an immediate setback to such ambitions, but beyond that is the likelihood that most countries’ population growth is slowing and, in many countries, will eventually begin falling.

One big message from the report is that population growth over the next 40 years is projected to be much slower than earlier thought, with its size now expected to reach 40 million in the first half of the 2060s, about eight years later than the 2015 report projected.

This is explained by the pandemic, which is expected to cause a temporary fall in the birth rate and four years of below-average net overseas migration (foreigners arriving minus locals leaving). Annual net migration is expected actually to fall in the financial year just ended and in the new financial year, then take two years to return to 235,000 in 2024-25, at which level it then stays every year through to 2060-61.

That is, no catch-up is expected for the growth lost because of the pandemic. The assumed annual net intake of 235,000 is based on unchanged existing federal government policy on permanent and temporary migration levels.

The report’s “sensitivity analysis” shows that, were net migration projected to grow in line with the growing population (at a rate of 0.82 per cent a year) rather than stay at a flat 235,000 a year, real gross domestic product per person would be only a fraction higher in 2060-61, the labour force would be 1 million bigger and the old-age dependency ratio would be 2.8 workers per oldie rather than 2.7.

But you have to doubt whether future governments will remain free to just dial up their preferred level of annual immigration the way they have been over the past 40 years.

If there’s one demographic lesson we should have learnt by now, it’s that as families become more prosperous over the generations, they choose to have fewer children. This has become possible because of effective contraception.

Add growing longevity and you see why a declining fertility rate (expected number of births per woman), not just the retirement of the Baby Boomer bulge, has left all the developed economies with an ageing population. And, thanks to its one-child policy, the world’s most populous economy, China, also has a (rapidly) ageing population.

Like all the other rich countries, our fertility rate has long been below the population replacement rate of 2.1 babies per woman. Unlike most of the others, however, we’ve kept our population growing strongly by ever-increasing immigration.

To date we’ve had no trouble attracting all the skilled (and unskilled) workers we need, mainly from poor countries. We’ve even been able to make a lot of them pay full freight for their Australian-quality education before we scooped them up.

But with population ageing and old-age dependency ratios becoming more acute around the rich world, global competition to attract skilled workers from developing countries may become more intense.

On the other side of the equation, the supply side, as the poor countries become more developed, their living standards rise and their fertility rates fall, there may be fewer skilled workers willing to emigrate to the rich countries.

Population growth is already slowing in most developed and developing countries. It’s already falling in Japan and some European countries. It will start falling in China this decade. Our population growth is also likely to slow, and the day may come when – horror of horrors – it starts to fall.

Slower growth in the population means slower growth in the size of the economy, of course. But I can’t see why this should be a worry.

It’s notable that, though the intergenerational report projects a consequent slowing in economic growth over the next 40 years, it expects this to have little effect on economic growth per person and thus on living standards.

Whereas real GDP growth is projected to slow from 3 per cent a year over the past 40 years to 2.6 per cent over the coming 40, annual growth in real GDP per person is projected to slow only marginally from 1.6 per cent to 1.5 per cent.

Even that small slowing seems to be explained not by lower population growth, but by a similar fall in the assumed rate of average annual productivity improvement.

Taken at face value, this is an admission by the report’s authors that faster population growth makes little or no contribution to the improvement of our material living standards. The immigrants may gain by moving to Australia, but the rest of us don’t gain from their coming.

However, the report’s fine print (aka its technical appendix) advises that its projections “do not capture the broader economic, social or environmental effects of migration, such as technology spillovers or congestion”.

But if those effects were thought to be significant, you’d expect the authors to have made the effort to model them. And, of course, the effects are likely to be both beneficial and detrimental.

Looking at the economic effects, the advocates of high immigration always point to the benefit of greater economies of scale, while brushing aside the costs of the increased housing, capital equipment and public infrastructure that a bigger population and workforce must be provided with to ensure the productivity of its labour doesn’t fall.

Indeed, it’s possible our high rate of population growth is a factor contributing to our weak rate of productivity improvement.

Similarly, it’s inconsistent for advocates of high immigration also to be advocates of Smaller Government. When you’re causing congestion by failing to spend enough on the extra public infrastructure needed, including more schools and hospitals – perhaps because you’re trying to please discredited American credit-rating agencies – you shouldn’t be surprised if economic growth is weaker.

The need for governments to spend more on a bigger population is complicated and compounded by the division of responsibilities between federal and state governments. The budgetary costs and benefits of immigration are not spread evenly between federal and state governments.

The feds pick up most of the tax that immigrants pay, while the states pick up most of the cost of the extra infrastructure and services needing to be provided (especially since immigrants are denied access to many federal benefits for the first four years).

This reveals a major distortion in the intergenerational report’s continual claim that higher immigration does wonders to improve the budget. The federal budget, yes. But state budgets, probably the reverse.

Finally, there are the environmental consequences of a bigger population that both the intergenerational report and most business people, economists and politicians refuse to come to grips with.

Jenny Goldie, president of Sustainable Population Australia, reminds us that the intergenerational report “fails to take into account the environmental costs of urban encroachment on natural bushland, threatening iconic species such as the koala [and biodiversity more generally], and adding to carbon emissions.

“It fails to address the social costs of crowding, housing unaffordability and longer waiting times that generally accompany population growth,” she concludes.

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Business lobbies use the productivity slump for rent-seeking

It’s encouraging to see the scepticism with which this week’s intergenerational report from Treasurer Josh Frydenberg has been greeted. Any attempt to peer 40 years into the economy’s future will prove close to the mark only by happy accident.

But it’s discouraging to see the way the usual suspects have seized on the report’s most glaring weakness to do no more than push their vested interests in the name of “reform”.

This fifth version of the five-yearly intergenerational report allows us to see how far astray the report’s earlier projections have been, even though we’re only halfway towards the first report’s picture of the economy in 2041.

In their projections of growth in the population, its authors have repeatedly overestimated the fertility rate (expected number of births per woman) and underestimated the growth in net overseas migration (foreigners arriving minus locals leaving).

They predicted that the retirement of the Baby Boomers would see a fall in the rate at which people of working age participate in the labour force, but this “participation rate” has recently been at record highs.

It would be nice to think that, since the object of all these projections has been to alert us to looming pressures on the budget – caused, in particular, by the ageing of the population – governments have responded accordingly, thus making the reports’ prophecies self-defeating. Nice, but not likely.

The pandemic, and the expected four years of weak net overseas migration in particular, is rightly blamed for our population “growing slower and ageing faster” than previously expected. And slower growth in the size of the population means slower growth in the size of the economy.

We’re told that, whereas real GDP grew at the average rate of 3 per cent a year over the past 40 years, it’s now projected to slow to an average rate of 2.6 per cent over the coming 40.

But the justification for our obsession with economic growth is our desire for faster improvement in our material standard of living. And here’s a point Frydenberg hasn’t highlighted: according to the report’s calculations, the projected marked slowing in the economy’s overall rate of growth is expected to affect growth in GDP per person – a crude measure of living standards - only a little.

GDP per person’s average annual growth is projected to fall only from 1.6 per cent over the past 40 years to 1.5 per cent over the coming 40.

It’s here, however, that business and its media cheer squad have read the fine print and are deeply sceptical: that projection of GDP growth per person rests heavily on the mere assumption that the productivity of labour (output of goods and services per hour worked) will improve at the same average annual rate in the coming 40 years as it did over the past 30 years.

And they’re right. Of all the many assumptions on which the report’s mechanical projections depend, this assumption is far the most critical. As Frydenberg rightly says, improving productivity is what explains almost all the improvement in our standard of living over the decades.

And the sceptics are right to doubt that productivity will improve over the next 40 years at anything like the rate of 1.5 per cent a year. For a start, that 30-year average includes the 1990s, a decade when productivity improved at a rate far higher than experienced before or since.

For another thing, productivity improvement in recent years has been much weaker than usual.

So, purely by omission, the latest intergenerational report reminds us of the second biggest threat to our living standards: a continuing slump in productivity. (The biggest threat is the world’s inadequate response to climate change – another thing the report omits to take into account.)

What’s discouraging, however, is the way the business lobby groups have used this inadvertent reminder to bang the same old self-serving drum. The productivity slump has been caused by this government and its predecessors’ failure to continue the economic reform program begun by Hawke, Keating and Howard, we’re assured.

And what reforms do they have in mind? A cut in the rate of company tax for big business and changes in the wage-fixing rules to make the labour market more flexible for employers.

This lobbying is objectionable on three grounds. First, it implies that productivity improvement depends on an unending stream of changes in government policies, which is absurd. The day “reform” stops, productivity stops.

Second, it shifts the blame for weak productivity improvement from the actions of the private sector – in whose farms, mines, factories, offices and shops productivity either gets better or worse – to the politicians in Canberra.

Third, it seeks to disguise blatant rent-seeking as economic “reform”. Productivity would improve if business owners and high income-earners paid less tax, leaving the punters to pay more, and if the balance of bargaining power between bosses and workers shifted further in favour of bosses.

What this self-serving bulldust ignores is that productivity improvement has slumped in all the rich countries, not just in Australia because our pollies are so defective.

Michael Brennan, chair of the Productivity Commission, says the world’s economists are still debating the causes of the productivity slowdown.

They’ve pointed to “mismeasurement issues, a shift towards lower productivity industries, population ageing, a slowdown in the pace of technological discovery, a slowdown in the pace of technological diffusion, a plateauing of improvements in human capital, reduced rates of firm entry and exit, increased concentration and market power, lower capital investment, a shift to intangible capital and the slowing growth in global trade”.

As Melinda Cilento of CEDA, the Committee for Economic Development of Australia, has noted, “research by federal Treasury . . . showed leading Australian firms were not keeping up with leading global firms on productivity”.

Treasury would be much better employed continuing to research the causes of our productivity slump than doing literally unbelievable projections of what’s unlikely to happen over the next 40 years.

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Sorry, I'm too old to believe an ageing population is a terrible thing

If ever there was an exercise that, since its inception, has overpromised and under-delivered, it’s the alleged Intergenerational Report. A report on relations between the generations, on the legacy the present generation is leaving for the coming generation?

No, not really. If it was, it would be mainly about the need for us and the other rich countries to be acting a lot more seriously and urgently to limit climate change. The document Treasurer Josh Frydenberg unveiled on Monday is our fifth five-yearly Intergenerational Report.

Initially, the report made no mention of climate change. These days, following the obvious criticism, it always includes a brief chapter on the topic, before moving on to matters considered more pertinent.

This year the chapter runs to nine of the report’s almost 200 pages, in which the seriousness of the problem is acknowledged, along with the assurance “but don’t worry, I’m on it”. On every admitted dimension of the issue, we’re assured that reports have been commissioned, committees established and the government is spending $100 million on this and $67 million on that.

Another issue of relevance to relations between the generations is the ever-declining rate of home ownership as the price of houses rises ever higher. Can the aggrandisement of one generation at the expense of following generations continue? And are we content to witness the trashing of the Great Australian Dream? I found no discussion of this.

The sad truth is the Intergenerational Report is a creation of the Charter of Budget Honesty Act so, despite its grandiose name, it’s really only interested in the future state of the federal budget and in attempting to predict the size of the budget balance in 40 years’ time.

According to Frydenberg, the latest report delivers “three key insights”. First, our population is growing slower and ageing faster than expected. Second, the economy’s growth will be slower than previously thought. Third, while the federal government’s debt is sustainable and low by international standards, the ageing of our population will put significant pressures on both government revenue and its spending.

Get it? The real concern of this report – and its four predecessors – is what the ageing of the population looks likely to do to the federal budget over the next four decades. It thus echoes a longstanding concern of all the rich countries that the retirement of the Baby Boomers will put huge pressure on their budgets.

When you read the document minus the spin successive treasurers always put on it, this year’s version tells us what all five reports have told us: compared with the Europeans and Americans, we don’t have much of a problem.

The report’s big news is that our decision to close our borders as part of our response to the pandemic means our annual level of net immigration – foreigners arriving minus locals leaving – isn’t expected to return to normal until 2024-25.

According to Frydenberg, this is the first report “where the size of the population has been revised down”. But this is misleading. It doesn’t mean our population will fall, only that it won’t keep growing as fast as it has been and was expected to continue doing.

We’re now expected to have four years of below-normal net immigration, with no subsequent catch up. So whereas the previous report projected that the population would reach almost 40 million by 2055, it’s now expected to be no more than 39 million in 2061.

Since almost all the nation’s business people, economists and politicians believe too much population growth is never enough, this news will worry them. It doesn’t worry me. And I suspect most Australians will regard it as good news, not bad.

Frydenberg argues it’s bad because, since immigrants tend to be younger than the average Aussie, it will cause the population to age faster than was expected. This is arithmetically correct, but Frydenberg has given us an exaggerated impression of its extent.

He tells us that, in 1982, there were 6.6 people of traditional working age for every person over 65. Today, the ratio is down to 4.1, and by 2061 it will have fallen to 2.7. Wow. And what did the previous report tell us it would be down to by 2055? 2.7. Oh, no significant change.

Even so, isn’t that a worry? Not when you remember what economics teaches: that the economy adjusts in response to changing circumstances.

As Jenny Goldie, president of Sustainable Population Australia, has explained to the Treasurer, “as the working-age population shrinks and the labour market tightens, fewer people will be unemployed, and employers will improve wages and salaries to attract job seekers.

“This will have the effect of drawing more people into the workforce who were not working, or keeping people who would otherwise have retired.” Employers will no longer be able to afford their prejudice against hiring older workers.

If your instincts tell you not to believe those trying to convince you that people now living longer than they used to is a real worry, your instincts are right.

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Slowly, economists are revealing the weaknesses in their theories

Economics is changing. It’s relying less on theorising about how the economy works, and more on testing to see whether there’s hard empirical (observable) evidence to support those theories.

Advances in digitisation and the information revolution have made much more statistical information about aspects of economic activity available, and made it easier to analyse these new “data sets” using improved statistical tests of, for instance, whether the correlation between A and B is causal – whether A is causing B, or B is causing A, or whether they’re both being caused by C.

But another development in recent decades is economists losing their reluctance to test the validity of their theories by performing experiments. Let me tell you about two new examples of empirical research by Australian academic economists, one involving data analysis and the other a laboratory experiment.

We see a lot of calls for reform that take the form: change taxes or labour laws in a way that just happens to benefit me directly, and this will make “jobs and growth” so much better for everyone.

These reformers always convey the impression that the changes they want are backed by long established, self-evident economic principles. And they can usually find professional economists willing to say “yes, that’s right”.

But what gets me is that, when the self-declared reformers get their “reform”, it’s rare for anyone to bother going back to check whether it really did do wonders for jobs and growth. Wouldn’t there be something to learn if it was a great success, or if it wasn’t?

Do you remember back in 2017, when employers were campaigning for a reduction in weekend penalty rates? The retailers and the hospitality industry told the Fair Work Commission that making them pay much higher wage rates on Saturday and Sunday was discouraging some businesses from opening on weekends, to the detriment of the public’s convenience.

If only penalty rates were lower, more businesses would open on weekends, or stay open for longer, meaning consumers would spend more, and more workers would be employed for more hours, leaving everyone better off.

The employers got strong support from the Productivity Commission and some economist expert witnesses. So the commission decided to reduce the Sunday and public holiday penalty rates in the relevant awards by 25 to 50 percentage points, phased in over three years.

Associate Professor Martin O’Brien, of the University of Wollongong’s Sydney Business School, commissioned a longitudinal survey (looking at the same people over time) of about 1830 employees and about 240 owner-managers or employers, dividing the workers between those on awards and a control group of those on enterprise agreements (and so not directly affected).

The economists’ standard, “neo-classical” model of the way demand and supply interact to determine the market price, with movements in the price feeding back to influence the quantity that buyers demand and the quantity sellers want to supply, does predict that a fall in the price of Sunday labour will lead employers to demand more of it.

So what did the survey find? It could find no effect on employment in the retail and hospitality sectors. This is consistent with a growing body of mainly American empirical evidence that, contrary to neo-classical theory, increases in minimum wages have little effect on employment.

But here’s an interesting twist: a majority of employers reported not making the reduction in penalty rates and a majority of employees reported not receiving any reduction.

One explanation for this is that employers didn’t pass on the cuts because they valued staff loyalty and commitment. If so, this fits with the judgment of many labour economists that the relationship between a firm and its workers is far more nuanced than can be captured by the neo-classical assumption that price is the only motivator.

An alternative explanation, however, is that those employers didn’t cut the Sunday penalty rate because they weren’t paying it in the first place.

Turning to the laboratory experiment, it tests the much more theoretical assumption that the behaviour of people engaged in economic activities is guided by their “rational expectations” about what will happen in the future.

Economists have come to care about what people expect to happen because this affects the way people behave, and so affects the future we get. In recent decades, many mathematical models of the macro economy have used the assumption that people form their beliefs about the future in a “rational” way to make the maths more rigorous.

By “rational” they mean that people respond to new information by immediately and fully adjusting their expectations – beliefs – about what will happen to prices, the economy’s growth or whatever. Which is a lovely idea, but how realistic is it?

Dr Timo Henckel, of the Research School of Economics at the Australian National University, Dr Gordon Menzies, of the University of Technology Sydney, and Professor Daniel Zizzo, of the University of Queensland, analysed the results of an experiment conducted by Professor Peter Moffatt, of the University of East Anglia, involving 245 students answering questions.

On receiving each piece of new information, the subjects had first to decide whether to adjust their beliefs and then, if so, by how much. The experimenters found that the subjects reacted very differently.

They found that, in general, people don’t update their beliefs with each new piece of information. And when they do, they tend not to adjust their beliefs by as much as they probably should. In other words, people display a kind of belief conservatism, holding on to a belief for longer than they should.

They found that this conservatism is explained to some extent by people’s inattention – they were distracted by other issues – and to some extent by the complexity of the issue: it was “cognitively taxing”.

It turns out that very few people – just 3 per cent of the subjects – display the rational expectations economists assume in their model-building. Most people’s behaviour, the authors say, is better described as “inferential expectations”.

Now, you may not be wildly surprised by these findings. But, in the academic world, common sense doesn’t get you far. You must be able to demonstrate things the academic way.

Even so, Henckel says that the responses of the experiment’s subjects extend to many parts of life, from the behaviour of investors in the share and other financial markets – this is how bubbles develop – to people’s political convictions, where they hold on to beliefs for far too long, ignoring much contrary evidence.

Indeed, inferential expectations apply even to scientists, who form a view of the world which they will revise or overturn only if there is overwhelming evidence to the contrary. So don’t expect economic modellers to abandon their convenient assumption of rational expectations any time soon.

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Why people can be much nicer than economists assume

There’s a lot you can learn about the world of work – and human nature in general – from studying economics. Then again, there’s a lot you can’t learn from conventional economics – and, indeed, from the bum steers it can give you.

Consider this. The 18th century Scottish philosopher Adam Smith is said to be the father of economics. He wrote two monumental books, the second of which, The Wealth of Nations, contained the famous observation that “it is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest”.

The worthies who developed conventional economics – and its “neo-classical” model of how markets work, the main thing taught in economics courses – seized on this idea to describe an economy populated by profit-maximising firms and self-interested consumers, all of them competing with each other to get the best deal.

They developed Smith’s reference to the “invisible hand” of competition in markets to show how this self-interest on all sides miraculously ends up satisfying everyone’s wants. Hence modern economists’ eternal banging on about the benefits of competition.

But Smith’s first book, The Theory of Moral Sentiments, said something quite different: “How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, thought he derives nothing from it, except the pleasure of seeing it”.

So what’s it to be? Are we totally self-interested, or do we care about the wellbeing of others? Are we individuals competing against each other for the biggest bit, or are we caring souls who co-operate with others to ensure everyone gets looked after?

Short answer: we’re both. But study conventional economics and you’re told only about the selfish, individualistic, competitive side of our nature. The moral, collective, co-operative side is assumed away. Government is seen not as a force for good, but as an alien force whose intervention in the market risks stuffing things up.

If you wonder why so many of the predictions economists make prove astray, that’s part of the reason. But some years back, two American economists associated with the Santa Fe Institute in New Mexico, Samuel Bowles and Herbert Gintis, wrote A Cooperative Species, to try to balance the story.

In the process, they provide a more convincing explanation of why humans have become the dominant species on Earth – for good and ill.

They focus on the way humans co-operate with each other in many circumstances – including when hundreds of us work for a single business, which competes with other big businesses - and argue that we co-operate not only for self-interested reasons, but also because we are genuinely concerned about the wellbeing of others.

We try to uphold “social norms” of acceptable behaviour, and value behaving ethically for its own sake. For the same reasons, we punish those who exploit the co-operative behaviour of others.

“Contributing to the success of a joint project for the benefit of [your] group, even at a personal cost, evokes feelings of satisfaction, pride, even elation,” they say. “Failing to do so is often a source of shame or guilt.”

We came to have these “moral sentiments,” in Smith’s words, because our ancestors lived in environments, both natural and as constructed by humans, in which groups of individuals who were predisposed to co-operate and uphold ethical norms tended to survive and expand relative to other groups, thereby allowing these “pro-social” motivations to proliferate.

So they explain our motivations for caring about the wellbeing of others: we do it because it makes us feel good. But they also explain the distant evolutionary origins of our disposition to co-operate and its perpetuation to the present day.

Co-operation – engaging with others in a mutually beneficial activity - was part of the behaviour of homo sapiens when we were still living on the African savannah. We formed bands to make us more successful in hunting big animals.

But though co-operation is common in many species, human co-operation is exceptional in that it extends beyond our close relatives – whom we look after in obedience to our evolutionary urge to replicate our species – to include even total strangers. And we co-operate on a much larger scale than other species except the social insects, such as ants and bees.

We co-operate in political and military objectives as well as more prosaic everyday activities: collaboration among the employees in a firm, exchanges between buyers and sellers, and the maintenance of local amenities among neighbours.

So, though they don’t see it in these terms, economists focus on a form of co-operation that involves “reciprocal altruism”. Buyers benefit sellers; sellers benefit buyers.

But human co-operation goes much further, in that it takes place in much larger groups and in circumstances that are unlikely to be repeated. Why do people tip while passing through a country town? In my own town I have reason to care about my reputation. But if I’m in your town, why does it not occur to me to cheat you in some way?

Much experimental and other evidence shows that people gain pleasure from co-operating, or feel morally obliged to. On the other hand, people enjoy punishing those who exploit the co-operation of others, or feel morally obligated to do so.

“Free-riders,” as economists call them, frequently feel guilty and, if they are sanctioned by others, they may feel ashamed.

We may have started out co-operating to hunt wild animals and mind other people’s children, but today we co-operate to enjoy the benefits of “the division of labour” (we each specialise in something we’re good at), of market exchange and the pursuit of economies of scale (in irrigation, factories, information networks) and even warfare.

And we made all this work better by inventing governments capable of enforcing the rights to property and providing incentives for the self-interested to contribute to common projects.

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