AI will make or break us - probably a bit of both

Depending on who you talk to, AI – artificial intelligence – is the answer to the rich world’s productivity slowdown and will make us all much more prosperous. Or it will lead to a few foreign mega tech companies controlling far more of our lives than they already do.

So, which is it to be? Well, one thing we can say with confidence is that, like all technological advances, it can be used for good or ill. It’s up to us and our governments to do what’s needed to ensure we get a lot more of the former than the latter.

If all the talk of AI makes your eyes glaze (or you’re so old you think AI stands for artificial insemination), let’s just say that AI is about making it possible for computers to learn from experience, adjust to new information and perform human-like tasks, such as recognising patterns, and making forecasts and decisions.

Scientists have been talking about AI since the 1950s, but in recent years they’ve really started getting somewhere. It took the telephone 75 years to reach 100 million users, whereas the mobile phone took 16 years and the web took seven.

You’ve no doubt seen the fuss about an AI language “bot”, ChatGPT, which can understand questions and generate answers. It was released last year and took just two months to reach 100 million users.

This week the competition minister, Dr Andrew Leigh, gave a speech about AI’s rapidly growing role in the economy. What that’s got to do with competition we’ll soon see.

He says the rise of AI engines has been remarkable and offers the potential for “immense economic and social benefits”.

It “has the potential to turbocharge productivity”. Most Australians work in the services sector, where tasks requiring the processing and evaluation of information and the preparation of written reports are ubiquitous.

“From customer support to computer programming, education to law, there is massive potential for AI to make people more effective at their jobs,” Leigh says.

“And the benefits go beyond what shows up in gross domestic product. AI can make the ideal Spotify playlist for your birthday, detect cancer earlier, devise a training program for your new sport, or play devil’s advocate when you’re developing an argument.”

That’s the optimists’ case. And there’s no doubt a lot of truth to it. But, Leigh warns, “it’s not all upside”.

“Many digital markets have started as fiercely competitive ecosystems, only to consolidate [become dominated by a few big companies] over time.”

We should beware of established businesses asserting their right to train AI models on their own data (which is how the models learn), while denying access to that data to competitors or new businesses seeking to enter the industry.

Leigh says there are five challenges likely to limit the scope for vigorous competition in the development of AI systems.

First, costly chips. A present, only a handful of companies has the cloud and computing resources needed to build and train AI systems. So, any rival start-ups must pay to get access to these resources.

As well, the chipmaker Nvidia has about 70 per cent of the world AI chips market, and has relationships with the big chip users, to the advantage of incumbents.

Second, private data. The best AI models are those trained on the highest quality and greatest volume of data. The latest AI models from Google and Meta (Facebook) are trained on about one trillion words.

And these “generative” AI systems need to be right up-to-date. But the latest ChatGPT version uses data up to only 2021, so thinks Boris Johnson and Scott Morrison are still in power, and doesn’t know the lockdowns are over.

Which brings us, third, to “network effects”. If the top ride-hailing service has twice as many cars as its rival, more users will choose to use it, to reduce their waiting times. So, those platforms coming first tend to get bigger at the expense of their rivals.

What’s more, the more customers the winners attract, the more data they can mine to find out what customers want and don’t want, giving them a further advantage.

This means network effects may fuel pricing power, entrenching the strongest platforms. If AI engines turn out to be “natural monopolies”, regulators will have a lot to worry about.

Fourth, immobile talent. Not many people have the skills to design and further develop AI engines, and training people to do these jobs takes time.

It’s likely that many of these workers are bound by “non-compete” clauses in their job contracts. If so, that can be another factor allowing the dominant platforms to charge their customers higher prices (and pay their workers less than they should).

Finally, AI systems can be set up on an “open first, closed later” business plan. I call it the drug-pusher model: you give it away free until you get enough people hooked, then you start charging.

Clearly, the spread of AI may well come with weak competitive pressure to ensure customers get a good deal and rates of profit aren’t excessive.

Just as competition laws needed to be updated to deal with the misbehaviour of the oil titans and rail barons of 19th century America, so too we may need to make changes to Australian laws to address the challenges that AI poses, Leigh says.

The big question is how amenable to competition the development of AI is. In other, earlier new industries, competition arose because key staff left to start a competing company, or because it made sense for another firm to operate in a different geographic area, or because customers desired a variant on the initial product.

“But if AI is learning from itself, if it is global, and if it is general, then these features may not arise.” If so, concentration maybe more likely than competition.

Get it? If we’re not careful, a few foreign mega tech companies may do better out of AI than we do.

Read more >>

NSW budget: no horror, but Labor still had three dirty jobs to do

This is no horror budget, although it’s unlikely to be popular – except perhaps with the state’s public sector workers. For the rest of us, there are various minor cuts to be annoyed by.

Actually, it’s unrealistic to expect the first budget of a new government to be anything but sombre and penny-pinching. That’s the way the political cycle turns.

Indeed, had this budget been full of goodies, it would have been a worrying sign – that the Minns government didn’t know its business and was off to a start likely to help shorten its life.

It will be easy for critics to attack the big pay rises already delivered and planned for public sector workers.

Labor looking after its union mates. If they’re just public servants, why feed them? And how can such big pay rises possibly be afforded?

But the notion that we could go for year after year holding down the wages of nurses, teachers, ambos, firies and all the rest, simply because they weren’t working for the private sector, was always delusional.

When you look at it, almost everyone working for the state government is providing an essential service bar a few pen-pushers in offices near Macquarie Street.

And the inevitable has happened: the state can’t attract and keep workers when they can find better-paid jobs somewhere in business.

Where will the money come from? How about asking the people who benefit from those essential services – which is all of us – to pay slightly higher taxes?

But the states have little scope for raising taxes, so the $2.7 billion over four years to be raised from the (probably too small) increase in coal royalties is a good start.

Treasurer Daniel Mookhey had three dirty jobs to do in this budget. First, continue the slow return to the usual small operating surplus – used to help fund part of the state’s massive spending on infrastructure and other capital works – after the huge spending and borrowing necessitated by the pandemic.

Second, “repurpose” some of the government’s spending from his predecessors’ priorities to the Labor government’s priorities.

Third, reverse or correct some of the wrong-headed and damaging policies pursued by the previous government.

Mookhey is dismantling the designed-to-mislead Transport Asset Holding Entity (even the name tells you it’s some kind of fiddle), as well as the gimmicky NSW Generations Fund, as well as easing the costs of outer-suburb motorists hit hard by the ever-increasing tolls used to pay for the motorways now ringing Sydney.

You license Transurban and other developers to overcharge motorists then, when it starts really hurting, you transfer part of the cost back to state taxpayers more generally.

This makes sense? Fortunately, Mookhey says this arrangement is just until they get time to fix the problem properly.

Meanwhile, as the budget papers admit, the tricksy acronyms – TAHE and NGF – are “masking an ongoing underlying budget result deficit”.

Huh? Officially, this financial year’s expected operating deficit of $7.8 billion (well down on last year’s deficit of $10.1 billion) should turn into a surplus of more than $800 million next financial year.

Allow for the previous government’s fiddles, however, and this year’s expected deficit is actually $8.6 billion, and next year’s surplus becomes just a balanced budget.

It’s wonderful how honest pollies can be about their opponents’ misdemeanours.

On housing, the budget trumpets its help for first-home buyers and renters (renters have problems? Who knew?) with the “faster planning program” and the “essential housing package”.

Sounds good. But experience suggests we save the applause until we see results actually delivered.

On early childhood education and care, the budget continues the big improvements initiated by the Perrottet government, moving to universal preschool access and increasing the number of childcare places.

The budget does a little to remember what is so often forgotten when savings are needed: the state’s duty to look after kids without parental care.

With budgets, there’s always books to balance and money to worry about. But behind all those dollars are people, whose needs are real.

Read more >>

How to make big business deliver for us, not just the fat cats

When we’ve got big business behaving badly, what can we do about it? Most of the answer’s obvious: strengthen the laws against misbehaviour, greatly increase the penalties and then, most obvious of all, police them vigorously until the fat cats get the message.

As the banking royal commission showed, much of the misbehaviour uncovered involved breaking the existing law. And the casinos in Sydney and Melbourne seem to have been breaking the law.

If PwC’s decision to pass on to other clients the information it had been given by the Tax Office after promising to keep it confidential wasn’t illegal, it should have been. And obviously, the many big businesses found to have been paying their workers less than they were legally entitled to were breaking the law.

The High Court has just confirmed that Qantas’ dismissal of 1700 workers was illegal, just as the Federal Court had originally found it to be many months ago. Qantas had appealed against the Federal Court decision but failed, so it took its appeal to the High Court and was again rebuffed.

Think how much shareholders’ money was spent trying to escape what most people would have thought was the company’s legal duty to its employees. And how much the shareholders will now have to pay to compensate the unlawfully dismissed employees.

Now the Australian Competition and Consumer Commission is taking legal action against Qantas, alleging it continued selling fares on flights it had already cancelled. Should the airline lose the case, it will be up for hefty fines.

It’s hard to believe that in all these cases big businesses, with their own legal departments, didn’t know that what they were doing could be found to be against the law. Much easier to believe they thought the chances of being prosecuted were low.

It’s possible some thought that, should they be prosecuted, they could afford the legal firepower to find a way to get them off the hook. But I think the main reason so many big companies have been acting as they have is their confidence that they wouldn’t be prosecuted.

Of course, in competitive markets – even markets like ours, where competition on price isn’t nearly as strong as it’s supposed to be – when one big business is seen to be gaining an advantage by finding neat legal arguments, the temptation for other businesses to do the same is intense. And it’s all too human to assume that the test of what’s ethical behaviour is what you imagine everyone else is doing.

Remember, too, that although many personal crimes are committed in the heat of the moment, big-business lawbreaking is likely to be the result of carefully considered advice.

That’s why penalties for business lawbreaking need to be very high. I think going to jail – even for just a few months – would be a highly effective deterrent. Think what your spouse would say if you got caught.

But why have chief executives been so confident their misdeeds would go undiscovered and unpunished? Because for a long time, it was pretty true.

During the now-ended era of “neoliberalism” – the doctrine that what’s good for business is good for the economy – successive governments used nods and winks to let corporate watchdogs, competition and consumer watchdogs, and wages watchdogs know their job was to look impressive without ever biting anyone.

And, if that wasn’t enough, governments would deny them the funds needed to police adequately the laws they were responsible for. Even the Tax Office wasn’t funded to do as many audits of taxpayers as it should have done – despite those audits bringing in far more revenue than they cost.

But, as I say, the neoliberal era is over, a victim of the manifest failure of much privatisation and outsourcing, and the exposure of big business misconduct by investigative journalists – most of them working for this august organ and the ABC.

And, of course, the crossbenchers are using Senate committees to draw attention to failures the two major parties would prefer to go unnoticed.

Once the public’s attention is aroused, governments have to act, calling royal commissions and being seen enforcing the law.

Now the watchdogs are better funded, and the ACCC is calling for stronger powers. Last week its chair, Gina Cass-Gottlieb, told a parliamentary committee that many unfair trading practices currently fall outside the scope of Australian consumer law, “despite causing considerable harm for consumers, small business [note that; big businesses often mistreat small businesses] and competition”.

She was referring to practices such as making it hard for people to cancel digital subscriptions, online sites with opaque and confusing trading terms for small businesses, manipulative sales practices such as misleading scarcity claims (“Hurry, stocks limited”), or deceptive design patterns such as sites that confuse you into buying things you didn’t actually want.

In the post-neoliberal world, there’s much cleaning up to be done.

Read more >>

Productivity debate descends into damned lies and statistics mode

Last week we got a big hint that the economics profession is in the early stages of its own little civil war, as some decide their conventional wisdom about how the economy works no longer fits the facts, while others fly to the defence of orthodoxy. Warning: if so, they could be at it for a decade before it’s resolved.

Economists want outsiders to believe they’re involved in an objective, scientific search for the truth and are, in fact, very close to possessing it. In reality, they’ve long been divided by ideology – views about how the world works, and should work – which is usually aligned with partisan interests: capital versus labour.

You see this more clearly in America, where big-name “saltwater” (coastal) academic economists only ever work for Democrat administrations, while “freshwater” (inland) academics only work for the Republicans.

In the 1970s, the world’s economists argued over the causes and cures for “stagflation” – high inflation and high unemployment at the same time. Then, in the 1980s, we had a smaller, Australian debate over how worried we should be about huge current account deficits and mounting foreign debt, won convincingly by the academics, who told the econocrats to forget it – which they did.

Now, the debate is over the causes of the latest global surge in inflation. At a time when organised labour has lost its bargaining power, while growing industry “concentration” (more industries dominated by an ever-smaller number of big companies) has reduced the pressure from competition and increased the pricing power of big firms, is a lot of the recent rise in prices explained by businesses using the chance to increase their profit margins?

A related question is whether it remains true that – as business leaders, politicians and econocrats assure us almost every day – all improvement in the productivity of labour (output per hour worked) is automatically reflected in higher real wages.

And that’s the clue we got last week. The Productivity Commission issued a study, Productivity growth and wages – a forensic look, that concluded that “over the long term, for most workers, productivity growth and real wages have grown together in Australia”.

So, all the worrying that silly people (such as me) have been doing – that the workers are no longer getting their cut of what little productivity improvement we’ve seen in recent years – has been proved to be a “myth”.

For the national masthead that prides itself on being read by the nation’s chief executives, this was a page one screamer. Apparently, even though real wages are 4 per cent lower than they were 11 years ago, workers are getting “their fair share of pie”.

When workers’ real wages rise by less than the improvement in labour productivity, the study calls this “wage decoupling”. It says “it is important to get the facts right on wage decoupling. Unfortunately, debates about the extent of wage decoupling, its sources and its implications are often dogged by differences in the methods and data”.

“This is because analysts can pick and choose among a wide range of measures of real wage growth, and their choices can lead to different, sometimes misleading conclusions.”

This is very, very true. Trouble is, sauce for the goose is sauce for the gander. The clear inference is that “the commission’s preferred measure” is the single correct way of measuring it, whereas all those who get different results to us are just picking the methodology that gives them the results they were hoping for.

Get it? I speak the objective truth; you are just fudging up figures to defend your preconceived beliefs about how the world works. Yeah, sure.

I hate to disillusion you, gentle reader, but this is what always happens in economics whenever some group says, “I think we’re getting it wrong.” They produce calculations to support their case, but some don’t like the idea, so they produce different calculations intended to refute it.

Because economics is factionalised, most debates degenerate into arguments about why my methodology is better than yours. That’s why a change in the profession’s conventional wisdom can take up to a decade to resolve. But intellectual fashions do change.

The study finds that the mining and agriculture industries – which account for only 5 per cent of workers – have experienced major wage decoupling over the past 27 years, but for the remaining 95 per cent of workers, in 17 other industries, the difference between productivity growth and real wage growth has been “relatively low”.

Sorry, but that’s my first objection. It’s not relevant to compare productivity growth by industry with real wage growth by industry. Some industries have high productivity, some have low productivity and, in much of the public sector, productivity can’t be measured.

Despite the things it suits the employer groups to claim, the reward held out to workers for at least the past 50 years has never been that their real wages should rise in line with their own industry’s productivity.

For reasons that ought to be obvious to anyone who understands how markets work, it’s never been promised that, say, carpenters who work in mining or farming should have rates of pay hugely higher than those who work in the building industry, while the real wages of carpenters working in general government should never have changed over the decades because their (measured) productivity has never changed.

It’s an absurd notion that could work only if we could enforce a rule that no one could ever change jobs in search of a pay rise.

No, as someone somewhere in the Productivity Commission should know, the promise held out to the nation’s employees has always been that economy-wide average real wages should and will rise in line with the trend economy-wide average improvement in the productivity of labour.

When you exclude the two industries that contribute most to the nation’s productivity improvement, it’s hardly surprising that what’s left is so small you can claim it wasn’t much bigger than the growth in most workers’ real wages.

Then you tell the punters that, over 27 years, they are less than 1 percentage point behind – a mere $3000 – where they were assured they would be.

The report finds – but plays down – that the national average real wage fell behind the national average rate of productivity improvement by an average of 0.6 percentage points a year – for 27 years.

That’s if you measure wages from the boss’s point of view (which is economic orthodoxy) rather than the wage-earner’s point of view. But I can’t remember hearing that fine print explained in the thousands of times I’ve heard heavies telling people that productivity improvement automatically flows through to real wages.

View wages from the consumer’s perspective, however, and the national average shortfall increases to 0.8 percentage points a year. And nor did anyone ever tell the punters that it may take up to 27 years for their money to arrive.

You guys have got to be kidding.

Read more >>

All the reasons interest rates are a bad way to manage the economy

 

In outgoing Reserve Bank governor Dr Philip Lowe’s last speech, he made a striking acknowledgement: monetary policy – the manipulation of interest rates to encourage or discourage spending – “has its limitations, and its effects are felt unevenly across the community”. We should “aspire to something better”.

He’s right. So, here’s my full list of monetary policy’s limitations.

When the economy’s growing strongly, and the demand for goods and services exceeds the economy’s ability to supply them, thus pushing up prices, the need is for all of us to reduce our demand – aka our spending.

Raising interest rates is intended mainly to leave people with less money to spend on other things. But obviously, it only has this effect on people who’ve borrowed a lot, meaning its main effect is on people with big home loans.

Trouble is, only about a third of all households have a mortgage. The rest own their home outright or are renting. And some proportion of those with mortgages have had them for years and by now don’t owe much.

This is what Lowe means by saying monetary policy’s effects are felt unevenly across the community. Younger people with super-sized mortgages really feel it, while the rest of us don’t feel much.

So, using interest rates to discourage spending can be seen as unfair: it picks on only those who happen to have big mortgages.

But the unfairness is multiplied because monetary policy’s selectivity limits its effectiveness. To achieve the desired slowdown in total spending, the 25 per cent or so of households with big mortgages have to be hit all the harder.

But that’s just the most obvious of monetary policy’s “limitations”. Another is its effect not on the people who borrow from banks, but on those who lend to them, aka depositors.

These people – many of whom are retired and depending on interest earnings for their livelihood – should be getting a steady income. Instead, their income bounces around, depending on whether the central bank is trying to encourage or discourage spending.

How is this fair to depositors? And remember this: in principle, when the central bank obliges the banks to increase mortgage interest rates by, say, 4 percentage points, that increase should be passed through to the interest rates on deposits.

In practice, however, this rarely happens in full. With just four big banks dominating the mortgage market, their pricing power lets them widen their interest rate margin between what they pay for deposits and what they charge borrowers.

So, part of the pain the central bank imposes on people with mortgages ends up fattening the pay of bank executives and the dividends of bank shareholders. How is this fair?

Remember the failure of the Silicon Valley Bank in America? It had a lot of money parked in US government bonds, but was wrong-footed by the US Federal Reserve’s sudden move to jack up interest rates.

Central banks are responsible for ensuring the stability of the banking system. But their use of interest rates to manage demand can add to banking instability in a way that other means of influencing demand wouldn’t.

It hasn’t been a problem in Australia, however, because our much more oligopolised banking system means our banks are hugely profitable and so less likely to fall over.

On the other hand, whereas in the US and elsewhere home loans have an interest rate that’s fixed over the long life of the loan, most of our home loans have rates that can be changed as often as the bank thinks necessarily.

It’s this that makes monetary policy more immediately effective – and painful – in Australia than in other economies. A reason we should start the move away from monetary policy.

Lowe is right to say that monetary policy isn’t primarily to blame for the high cost of housing. It is, as he says, the result of the way we’ve encouraged our politicians to bias the system in favour of those who already own a home, to the disadvantage of those who’d like to own one.

Even so, watching all those young people signing up for massive loans while interest rates were at unprecedented lows during the pandemic made me wonder if the Reserve’s moving of interest rates up and down doesn’t create a FOMO effect: when rates are low, first-home buyers load up with debt – and bid up house prices – for “fear of missing out” when rates go back up.

As Lowe acknowledged after his speech, the continued use of monetary policy as pretty much our only means of slowing demand is threatened by another, quite different development: the slow disappearance of the world long-term real interest rate, which has had the lasting effect of lowering world nominal interest rates by about 3 percentage points, and so bringing them much closer to the “zero lower bound”, known to normal people as just zero.

This means interest rates can still be raised to discourage borrowing and spending but – as we’ve witnessed over the past decade – often can’t be cut very far to encourage borrowing and spending.

At the time of the global financial crisis in 2008, and again during the pandemic, the US Federal Reserve and the other big central banks sought to overcome this barrier by resorting to unconventional “quantitative easing” (QE) – mainly, buying shed loads of second-hand government bonds to force down longer-term interest rates.

One of the main effects of this has been to lower the country’s exchange rate at the expense of its trading partners. Which is why, once the Fed starts doing it, other central banks feel they have to do it too, in self-defence.

But while “QE” seems quite effective in raising the prices of assets such as shares, it’s not very effective in boosting demand for goods and services and thus encouraging economic growth.

I think history will judge QE to have been a bad idea. It will be another reason we’ll need to become much less reliant on interest rates to manage the economy.

Read more >>

Big business should serve us, not enslave us

When my brain was switching to idle on my recent break, I thought of two central questions. First, for whose benefit is the economy being run – a handful of company executives at the top, or all the rest of us? Second, despite all the hand-wringing over our lack of productivity improvement, would it be so terrible if the economy stopped growing?

Then the whole Qantas affair reached boiling point. So we’ll save the economy’s growth for another day.

You’ve probably heard as much as you want to know about Qantas and its departed chief executive Alan Joyce. But Qantas’ domination of our air travel industry makes its performance of great importance to our lives. And Qantas is just the latest and most egregious case of Big Business Behaving Badly.

We’ve seen all the misconduct revealed by the banking royal commission, with the Morrison government accepting all the commission’s recommendations before the 2019 election, then quietly dropping many of them after the election.

We’ve seen consulting firm PwC caught abusing the trust of the Tax Office, with further inquiry revealing the huge sums governments are paying the big four accounting firms for underwhelming advice on myriad routine matters.

We’ve seen Rio Tinto “accidentally” destroying a sacred site that stood in its way and, it seems, almost every big company “accidentally” paying their staff less than their legal entitlement.

Now, let’s be clear. I’m a believer in the capitalist system – the “market economy” as economists prefer to call it. I accept that the “profit motive” is the best way to motivate an economy. And that the exploitation of economies of scale means we benefit from having big companies.

But that doesn’t mean companies can’t get too big, nor that all the jobs and income big businesses bring us mean governments should manage the economy to please the nation’s chief executives.

It should go without argument that governments should manage the economy for the benefit of the many, not the few. The profit motive, big companies and their bosses should be seen as just means to the end of providing satisfying lives for all Australians, including the disabled and disadvantaged.

We allow the pursuit of profit, and the chosen treatment of employees and customers, only to the extent that the benefits to us come without unreasonable cost to us. Business serves us; we don’t serve it.

In other words, we need a fair bit of the benefit to “trickle down” from the bosses and shareholders at the top to the customers and workers at the bottom. That’s the unwritten social contract between us and big business. And for many years, enough of the benefit did trickle down. But in recent years the trickle down has become more trickle-like.

This is partly explained by the way the “micro-economic reform” of the Hawke-Keating government degenerated into “neoliberalism” – the belief that what’s good for BHP is good for Australia. This would have been encouraged by the way election campaigns have become an advertising arms race, with both sides of politics seeking donations from big business.

Another cause was explained by a former Reserve Bank governor, Ian Macfarlane, in his Boyer Lectures of 2006: “The combination of performance-based pay and short job tenure is becoming increasingly common throughout the business sector ... It can have the effect of encouraging managers to chase short-term profits, even if long-term risks are being incurred, because if the risks eventuate, they will show up ‘on someone else’s shift’.”

The upshot of neoliberalism’s assumption that business always knows best is to leave the nation’s chief executives – and their boardroom cheer squads – believing they’re part of a commercial Brahmin caste, fully entitled to be paid many multiples of what their fellow employees get, to retire with more bags of money than they can carry, and to have politicians never do anything that hampers their money-grubbing proclivities.

Their Brahminisation has reached the point where they think they can break the law with impunity. They’re confident that corporate watchdogs and competition and consumer watchdogs won’t come after them – or won’t be able to afford the lawyers they can.

Chief executives for years have used multiple devices – casualisation, pseudo contracting, labour hire companies, franchising and more – to chisel away at workers’ wages. And that’s before you get to the ways they quietly chisel their customers.

The fact is that the error and era of neoliberalism are over, but the Business Council and its members have yet to get the memo. They’re continuing to claim that cutting the rate of company tax would do wonders for the economy (not to mention their bonuses) and that the Albanese government’s latest efforts to protect employees from mistreatment would make their working arrangements impossibly “inflexible”.

But the more Qantases and Alan Joyces we call out while they amass their millions, the more the public wakes up, and the more governments see we want them to get the suits back under control.

Read more >>

How Philip Lowe was caught on the cusp of history

Outgoing Reserve Bank boss Dr Philip Lowe was our most academically outstanding governor, with the highest ethical standards. And he was a nice person. But if you judge him by his record in keeping inflation within the Reserve’s 2 to 3 per cent target – as some do, but I don’t – he achieved it in just nine of the 84 months he was in charge.

Even so, my guess is that history will be kinder to him than his present critics. I’ve been around long enough to know that, every so often – say, every 30 or 40 years – the economy changes in ways that undermine the economics profession’s conventional wisdom about how the economy works and how it should be managed.

This is what happened in the second half of the 1970s – right at the time I became a journalist – when the advent of “stagflation” caused macroeconomists to switch from a Keynesian preoccupation with full employment and fiscal policy (the budget) to a monetarist preoccupation with inflation and monetary policy (at first, the supply of money; then interest rates).

My point here is that it took economists about a decade of furious debate to complete the shift from the old, failing wisdom to the new, more promising wisdom. I think the ground has shifted again under the economists’ feet, that the macroeconomic fashion is going to swing from monetary policy back to fiscal policy but, as yet, only a few economists have noticed the writing on the wall.

As is his role, Lowe has spent the past 15 months defending the established way of responding to an inflation surge against the criticism of upstarts (including me) refusing to accept the conventional view that TINA prevails – “there is no alternative” way to control inflation than to cut real wages and jack up interest rates.

If I’m right, and economists are in the very early stages of accepting that changes in the structure of the economy have rendered the almost exclusive use of monetary policy for inflation control no longer fit for purpose, then history will look back more sympathetically on Lowe as a man caught by the changing tide, a victim of the economics profession’s then failure to see what everyone these days accepts as obvious.

Final speeches are often occasions when departing leaders feel able to speak more frankly now that they’re free of the responsibilities of office. And Lowe’s “Some Closing Remarks” speech on Thursday made it clear he’d been giving much thought to monetary policy’s continuing fitness for purpose.

His way of putting it in the speech was to say that one of the “fixed points” in his thinking that he had always returned to was that “we are likely to get better outcomes if monetary policy and fiscal policy are well aligned”. Let me give you his elaboration in full.

“My view has long been that if we were designing optimal policy arrangements from scratch, monetary and fiscal policy would both have a role in managing the economic cycle and inflation, and that there would be close coordination,” Lowe said.

“The current global consensus is that monetary policy is the main cyclical policy instrument and should be assigned the job of managing inflation. This is partly because monetary policy is more nimble [it can be changed more quickly and easily than fiscal policy] and is not influenced by political considerations.”

“Raising interest rates and tightening policy can make you very unpopular, as I know all too well. This means that it is easier for an independent central bank to do this than it is for politicians,” he said.

“This assignment of responsibility makes sense and has worked reasonably well. But it doesn’t mean we shouldn’t aspire to something better. Monetary policy is a powerful instrument, but it has its limitations and its effects are felt unevenly across the community.”

“In principle, fiscal policy could provide a stronger helping hand, although this would require some rethinking of the existing policy structure. In particular, it would require making some fiscal instruments more nimble, strengthening the (semi) automatic stabilisers and giving an independent body limited control over some fiscal instruments.”

“Moving in this direction is not straightforward, but some innovative thinking could help us get to a better place,” Lowe said.

“During my term, there have been times where monetary and fiscal policy worked very closely together and, at other times, it would be an exaggeration to say this was the case.”

“The coordination was most effective during the pandemic. During that period, fiscal policy was nimble and the political constraints on its use for stabilisation purposes faded away. And we saw just how powerful it can be when the government and the Reserve Bank work very closely together.”

“There are some broader lessons here and I was disappointed that the recent Reserve Bank Review did not explore them in more depth,” Lowe said.

So was I, especially when two of Australia’s most eminent economists – professors Ross Garnaut and David Vines – made a detailed proposal to the review along the lines Lowe now envisages. (If Vines’ name is unfamiliar, it’s because most of his career was spent at Oxbridge, as the Poms say.)

But no, that would have been far too radical. Much safer to stick to pointing out all the respects in which the Reserve’s way of doing things differed from the practice in other countries – and was therefore wrong.

In question time, Lowe noted that one of the world’s leading macroeconomists, Olivier Blanchard, a former chief economist at the International Monetary Fund (and former teacher of Lowe’s at the Massachusetts Institute of Technology), had proposed that management of the economy be improved by creating new fiscal instruments which would be adjusted semi-automatically, or by a new independent body, within a certain range.

Lowe also acknowledged the way the marked decline over several decades in world real long-term interest rates – the causes of which economists are still debating – had made monetary policy less useful by bringing world nominal interest rates down close to the “zero lower bound”.

How do you cut interest rates to stimulate growth when they’re already close to zero? Short answer: you switch to fiscal policy.

But what other central banks – and, during the pandemic, even our Reserve Bank – have done was resort to unconventional measures, such as reducing longer-term official interest rates by buying up billions of dollars’ worth of second-hand government bonds.

Lowe said he didn’t think this resort to “quantitative easing” was particularly effective, and he’s right. I doubt if history will be kind to QE.

However, there’s one likely respect in which the ground has shifted under the economists’ feet that Lowe – and various academic defenders of the conventional wisdom – has yet to accept: the changed drivers of inflation. It’s not excessive wages any more, it’s excessive profits.

More about all this another day.

Read more >>

Jury still out on how much hip pocket pain still coming our way

It’s not yet clear whether the Reserve Bank’s efforts to limit inflation will end up pushing the economy into recession. But it is clear that workers and their households will continue having to pay the price for problems they didn’t cause.

Prime Minister Anthony Albanese didn’t cause them either. But he and his government are likely to cop much voter anger should the squeeze on households’ incomes reach the point where many workers lose their jobs.

And he’ll have contributed to his fate should he continue with his apparent intention to leave the stage-three income tax cuts in their present, grossly unfair form.

The good news is that we’re due to get huge hip pocket relief via the tax cuts due next July. The bad news is that the savings will be small for most workers, but huge – $170 a week – for high-income earners who’ve suffered little from the squeeze on living costs.

Should Albanese fail to rejig the tax cuts to make them fairer, you can bet Peter Dutton will be the first to point this out. But he’ll need to be quick to beat the Greens to saying it.

Those possibilities are for next year, however. What we learnt this week is how the economy fared over the three months to the end of June. The Australian Bureau of Statistics’ “national accounts” show it continuing just to limp along.

Real gross domestic product – the value of the nation’s production of goods and services – grew by only 0.4 per cent – the same as it grew in the previous, March quarter. Looking back, this means annual growth slowed from 2.4 per cent to 2.1 per cent.

If you know that annual growth usually averages about 2.5 per cent, that doesn’t sound too bad. But if you take a more up-to-date view, the economy’s been growing at an annualised (made annual) rate of about 1.6 per cent for the past six months. That’s just limping along.

And it’s not as good as it looks. More than all the 0.4 per cent growth in GDP during the June quarter was explained by the 0.7 per cent growth in the population as immigration recovers.

So when you allow for population growth, you find that GDP per person actually fell by 0.3 per cent. The same was true in the previous quarter – hence all the people saying we’re suffering a “per capita recession”.

As my colleague Shane Wright so aptly puts it, the economic pie is still growing but, with more people to share it, the slices are thinner.

It’s possible that continuing population growth will stop GDP from actually contracting, helping conceal from the headline writers how tough so many households are faring.

But the media’s notion that we’re not in recession unless GDP falls for two quarters in a row has always been silly. What makes recessions such terrible things is not what happens to GDP, but what happens to workers’ jobs.

It’s when unemployment starts shooting up – because workers are being laid off and because young people finishing their education can’t find their first proper job – that you know you’re in recession.

In the month of July, the rate of unemployment ticked up from 3.5 per cent to 3.7 per cent, leaving an extra 35,000 people out of a job. If we see a lot more of that, there will be no doubt we’re in recession.

But why has the economy’s growth become so weak? Because households account for about half the total spending in the economy, and they’ve slashed how much they spend.

Although consumer spending grew by 0.8 per cent in the September quarter of last year, in each of the following two quarters it grew by just 0.3 per cent, and in the June quarter it slowed to a mere 0.1 per cent.

Households’ disposable (after-tax) income rose by 1.1 per during the latest quarter but, after allowing for inflation, it actually fell by 0.2 per cent – by no means the first quarter it’s done so.

What’s more, it fell even though more people were working more hours than ever before. People worked 6.8 per cent more hours than a year earlier.

So why did real disposable income fall? Because consumer prices rose faster than wage rates did. Over the year to June, prices rose by 6 per cent, whereas wage rates rose by 3.6 per cent.

Understandably, people make a big fuss over the way households with big mortgages have been squeezed by the huge rise in interest rates. But they say a lot less about the way those same households plus the far greater number of working households without mortgages have been squeezed a second way: by their wage rates failing to rise in line with prices.​

This is why I say the nation’s households are paying the price for fixing an inflation problem they didn’t cause. It’s the nation’s businesses that put up their prices by a lot more than they’ve been prepared to raise their wage rates.

Businesses have acted to protect their profits and – in more than a few cases – actually increase their rate of profitability. In the process, they risk maiming the golden geese (aka customers) that lay the golden eggs they so greatly covet.

If you think that’s unfair, you’re right – it is. But that’s the way governments and central banks have long gone about controlling inflation once it’s got away. It was easier for them to justify in the olden days – late last century – when it was often the unions that caused the problem by extracting excessive wage rises.

But those days are long gone. These days, evidence is accumulating that the underlying problem is the increased pricing power so many of our big businesses have acquired as they’ve been allowed to take over their competitors and prevent new businesses from entering their industry.

The name Qantas springs to mind for some reason, but I’m sure I could think of others.

Read more >>

Murray-Darling basin: farmers’ friends are helping them self-harm

Not only in America. If you think the United States has become dysfunctional and incapable of solving its pressing problems, I have three words to say to you: Murray-Darling Basin. Last week, federal Environment and Water Minister Tanya Plibersek announced a brave new plan to rescue the Murray-Darling rescue plan, which the feds, NSW and Victoria had agreed to give up as all too hard.

Since the issue’s unlikely to be front of mind, let me tell this sorry story from the beginning. I’ll do so with much help from Professor Jamie Pittock of the Australian National University, an environmental scientist who’s been studying it for most of his career. (His many articles are on the universities’ The Conversation website.)

The Murray-Darling Basin covers about a seventh of Australia’s land mass: most of NSW, all the Australian Capital Territory, much of Victoria, and parts of Queensland and South Australia. It covers the Murray and Darling rivers, plus all their many tributaries, including the Murrumbidgee.

You could call it the nation’s biggest food bowl, underpinning the livelihoods of 2.6 million people and producing food and fibres worth more than $24 billion a year. Vast amounts of water are extracted from the rivers to supply about 3 million people, including those in Adelaide, but particularly for irrigating farms.

It’s also a living ecosystem that depends on interconnected natural resources. About 5 per cent of the basin consists of floodplain forests, lakes, rivers and other wetland habitats. Like all our rivers, the Murray-Darling is subject to recurring droughts and flooding.

Over the past century, however, the extraction of water, especially for irrigation, has reduced water flows to the point where the system can no longer recover from these extreme events.

Over the past decade, millions of fish have perished in mass die-offs, toxic algae have bloomed, wildlife and waterbird numbers have declined and wetlands have dried up.

Efforts to reverse the river system’s decline began with big-spending announcements by John Howard and his environment minister Malcolm Turnbull before the election they lost in 2007. It took five years before Julia Gillard and Tony Burke reached agreement with the basin states on a plan to restore the river system.

Under the then $13 billion plan, 3200 billion litres a year would be returned to the rivers, largely by buying back water entitlements from willing farmers. But the plan’s been modified several times and in 2015 the feds decided to cease buying back entitlements. Both the NSW and Victorian governments had been persuaded by their farmers to oppose buybacks.

NSW and Victoria have not delivered on their promise to reach agreements with riverside landowners to allow bought-back water to spill out of river channels onto floodplain wetlands. Another problem has been farmers drawing more water than their entitlement.

The buybacks have stalled at 2100 billion litres a year, even though the planned 3200 billion litres is probably too little to counter the evaporation caused by global warming. The plan had been due to be completed by June next year, with a new agreement in 2026.

But, in the 2022 election campaign, Anthony Albanese promised to revive the scheme and buy back the remaining water needed to meet the 3200 billion-litre target, and last week Plibersek announced a new deal with all the states, bar Victoria.

She agreed to another two or three years to deliver the remaining water, more options to deliver it, more funding to pay for it and more accountability by the feds and other governments to deliver on their obligations.

But she will need the support of the Greens and independents to get the new deal through the Senate. The opposition won’t support the resumption of buybacks, whereas the Greens don’t like the extra time to be taken.

Of course, even if the legislation goes through, there’s no guarantee the various governments will do what they’ve committed to. The feds are doing what the feds always have to do to get the states’ co-operation – offer them more money – but Victoria and NSW will always be tempted to keep their own farmers and river towns on side, which remain strongly opposed to buybacks.

How can it be so hard to ensure the continued survival of such an important river system? To say that, without remedial action, the rivers could shrink to a chain of billabongs is no great exaggeration. That might not happen for 50 years but, the way climate change seems to be accelerating, it could be a lot sooner.

You’d think the people who’d see this most clearly were those who stand to lose most as the rivers continue to shrivel. But, no, myopia prevails.

Take some pain now to avoid catastrophe later? No way! You can keep all the city-slickers’ tax money you want to pay us to help us adjust. We’re betting it will never happen. In any case, I’ll be dead by then.

And politicians who will take the votes of people who’d prefer to self-destruct aren’t hard to find. Reminds me of the way things are in the Land of the Free.

Read more >>

How to make sense of Treasury's latest intergenerational report

Our sixth intergenerational report envisages an Australia of fewer young people and more elderly, with slower improvement in living standards, climate change causing economic and social upheaval, aged and disability care becoming our fastest-growing industry, and home ownership declining, while we spend more defending ourselves from the threat of a rising China, real or imagined.

That does sound like fun, but remember this: just as I hope many of the predictions I make will be self-defeating prophecies – because people act to ensure they don’t happen – so it is with Treasury’s regular intergenerational reports.

They say, here’s the pencil sketch of the next four decades that we get when we assume present economic and demographic trends keep rolling on for 40 years, and that present government policies are never changed.

Get it? Intergenerational reports are Treasury’s memo to the government of the day, saying things will have to change. The memo to you and me says: you may hate change, but unless you let our political masters make changes, this is how crappy life may become.

Every intergenerational report comes to the same bottom line: if you think you won’t be paying more tax in future you must have rocks in your head.

The media can’t stop themselves from referring to the report’s findings as “forecasts”. Nonsense. Forecasts purport to tell you what will happen. These reports are “projections”: if we make a host of key assumptions about what will happen, plug them in the machine and turn the handle 40 times, this is what comes out.

Remembering that Treasury demonstrates almost annually its inability to forecast in late April what its own budget balance will be in just two months’ time, June 30, let’s not imagine that anything it tells us today about 2063 could prove close to the truth, except by chance.

This is no attack on Treasury. No one’s forecasts are less wrong than theirs. It’s just saying don’t let the false confidence of the economics profession fool you. Only God knows what the world will look like in 2063 – and she’s not telling.

We’re all peering through a glass darkly, doing the best we can to guess what’s coming around the corner. How many pandemics in the next 40 years? Treasury’s best guess: none. How many global financial crises? Best guess: none.

We know from experience that the economy rarely moves in straight lines for long, but the nature of Treasury’s mechanical projections is that most curves stay straight for 40 years. Unexpected things are bound to happen. Some will knock us off course only briefly; some may change our direction forever. Some will be bad; some will be good.

The report’s single most important assumption is the rate at which the productivity of labour will improve. Until now, Treasury has avoided argument by assuming that the average rate of improvement over the next 40 years will be its rate over past 30 years.

The first report in 2002 assumed a rate of 1.75 per cent, but in later reports it was cut to 1.5 per cent. Now it’s been cut to the seemingly less unrealistic 20-year average of 1.2 per cent.

This shift makes a big difference. The first report had living standards – measured as real gross domestic product per person – climbing 90 per cent in 40 years. This report has them climbing by only 57 per cent in the next 40.

Since this is only the second of the six intergenerational reports produced under a Labor government, it’s only the second that takes climate change seriously. The other four looked into the coming 40 years and didn’t see any consequences of climate change worth taking into account.

Labor’s first report, in 2010, had a lot to say about climate change, but this report attempts to measure its effect on the economy and the budget. It estimates that climate change will cause the level of real GDP in 2063 to be between $135 billion and $423 billion less than it would overwise have been, in today’s dollars.

The report’s title has always been a misnomer. If it lived up to its name, it would deal with the intergenerational transfer of income and wealth from the young to the old – an issue that deserves much more attention than it gets.

It would talk about the way our treatment of housing favours the elderly, and how the tax, spending and superannuation decisions of the Howard government, in particular, shifted income from the young to the old.

But no. The real reason it’s called the intergenerational report is that its main purpose is to bang on about the huge effect the ageing of the population – the rise in the population’s average age – will have on the federal budget (while ignoring any effects on the states’ budgets).

It’s here, however, that Rafal Chomik, of the ACR Centre of Excellence in Population Ageing Research at the University of NSW, has noted this overhyped story being toned down over the six reports. In 2002, the first report projected that, by 2023, the share of the population aged 65 and over would climb from 12.5 per cent to nearly 19 per cent.

Actually, it’s only up to 17.3 per cent. And the projection for 2063 is 23.4 per cent, less than the 24.5 per cent originally projected for 2042.

Another factor on which the report was too pessimistic at the start is the effect of ageing on participation in the labour force (by having a job or actively seeking one). Whereas it was expected to dive as the Baby Boomers retired, it’s now expected just to glide down.

Participation actually reached a record high of 66.6 per cent this year – who knew our response to a pandemic would return us to full employment for the first time in 50 years? – and is now projected to have fallen only to 63.8 per cent by 2063. If so, that would be higher than it was in 2002.

Chomik says the first report projected government spending on health care to reach more than 8 per cent of GDP by 2042. Now it’s projected to reach just 6.2 per cent by 2063. But, thanks to the royal commission, the cost of aged care is now expected to grow faster, to 2.5 per cent of GDP by 2063.

Which brings us to Treasury’s bottom line, the federal budget. Treasury projects that, as a percentage of GDP, the budget deficit will decline steadily until 2049, before ageing causes it to start heading back up.

Note, however, that while government spending is projected to rise by almost 4 per cent of GDP, tax collections are assumed, as always, to be unchanged.

Get the (unchanged) commercial message from Treasury? Taxes will have to rise.

Read more >>

Albanese's big chance to improve inflation, productivity and wages

Are Anthony Albanese and his ministers a bunch of nice guys lacking the grit to do much about their good intentions? Maybe. But this week’s announcement of a review of competition policy raises hope that the nice guys intend to make real improvements.

The review, which will provide continuous advice to the government over the next two years, has been set up because “greater competition [between Australia’s businesses] is critical for lifting dynamism, productivity and wages growth [and] putting downward pressure on prices”, Treasurer Jim Chalmers says.

As I wrote on Monday, the great weakness in our efforts to reduce high inflation has been our assumption that its causes are purely macroeconomic – aggregate demand versus aggregate supply – with no role for microeconomics: whether businesses in particular industries have gained the power to push their prices higher than needed to cover their increased costs.

But it seems Chalmers understands that. “Australia’s productivity growth has slowed over the past decade, and reduced competition has contributed to this – with evidence of increased market concentration [fewer businesses coming to dominate an industry], a rise in markups [profit margins] and a reduction in dynamism [ability to change and improve] across many parts of the economy,” he says.

The former boss of the Australian Competition and Consumer Commission, Rod Sims, had some pertinent comments to make about all this at a private business function last week.

He observes that “companies worked out long ago that the essence of corporate strategy is to gain market power and erect entry barriers. Profits from ‘outrunning’ many competitors from a common starting point are generally small; profits from gaining market power are usually large.

“Businesspeople know that when the number of competitors gets too large, price competition is often the result, and that this ‘destroys shareholder value’ or, alternatively put, helps consumers.”

Sims says the goals of growing and sharing the economic pie are being damaged in Western economies, and in Australia, by inadequate competition leading to market power. But, aside from the specialists, the economics profession more broadly has been slow to realise this and factor it into policy responses.

Australia has an extremely concentrated economy, Sims says. We have one dominant rail freight company operating on the east coast, one dominant airline with two-thirds of the market, two beer companies, two ice-cream sellers and two ticketing companies, all with a 90 per cent share of their markets.

We have two supermarkets with a combined market share of about 70 per cent. We have three dominant energy retailers and three dominant telecommunications companies. We have four major banks, with a 75 per cent share of the home mortgage market.

This is much greater concentration than in other developed countries. And, as you’d expect, the profit margins of these companies generally exceed those of comparable companies overseas.

The centuries that businesses have spent pursuing economies of scale explain why we don’t have – and shouldn’t want - the huge number of small firms assumed by the economic theory burnt on the brains of most economists.

But, Sims argues, our relatively small population doesn’t justify the much greater concentration of our industries. For one thing, studies of Australian industry sectors show that the returns to scale stop increasing well before market shares are anything like as high as they are in Australia.

For another, Australia’s modest size doesn’t explain why our industries are getting ever more concentrated, so that our key players are less likely to be challenged by competitors.

And it’s not just our high concentration, it’s also that we see large asset-managing institutions with big shareholdings in most of the firms dominating an industry. Thus, asset managers have an interest in keeping the whole industry’s profits high by limiting price competition between the companies.

One study, of 70,000 firms in 134 countries, found that the average prices charged by our listed companies were 40 per cent above the companies’ marginal cost of production in 1980, and about the same in the late 1990s. But by the early 2000s, average prices were 40 per cent above marginal cost. By 2010, they’d risen to 50 per cent above, and by 2016 it was nearly 60 per cent.

Analysis by federal Treasury has found that our companies’ markups increased over the 13 years to 2017.

The evidence in Australia and overseas is that in concentrated industries we see less dynamism, lower investment and lower productivity, Sims says. Our productivity performance has been very poor at a time when our focus on pro-competition public policy appears to have been lost.

It’s not hard to believe that the latter explains the former. “We run harder when competing versus when we run alone,” Sims says.

Our Treasury’s research also shows that firms in concentrated markets are further from the productivity frontier as there’s less incentive to keep up.

And market concentration also has implications for wage levels. Where labour mobility – the ease with which people move between employers – is reduced, wage levels are lower.

But high industry concentration means fewer firms that workers can move to, bringing relevant skills, and fewer new firms entering the industry. Less competition for workers means lower wages.

“Non-compete clauses” make the problem worse. Recent Australian studies have shown that more than one in five employees are prevented from working for competitors under such contract terms, often even in fairly low-skilled jobs.

Another finding is that the benefits of improved productivity are less shared with workers in concentrated industries. The share of productivity gains going to workers has declined by 25 per cent in the last 15 years, Sims says.

So next time some business person, politician, Reserve Bank governor or other economists tells you higher productivity automatically increases everyone’s wage, don’t fall for it. Used to be true; isn’t any more.

All this says that if the Albanese government is fair dinkum about getting inflation down and productivity and wages up, it will at least ban non-compete clauses and tighten up our merger laws.

Read more >>

Why Albanese's housing solution will help, but only a bit

If you rank our many economic problems in order of importance, the affordability of housing comes second – admittedly, a distant second – only to the need to limit climate change. And the good news is that Anthony Albanese’s latest deal with the premiers represents progress. The feds have made a start by offering the premiers a bag of money if they do the right thing.

What climate change and housing have in common is their great effect on the future wellbeing of our children. With housing, the fundamental problem is that our present arrangements favour those who already own a home (or two) at the expense of those who’d like to own one.

Those who are well set up in the property department love seeing the inexorable rise in their wealth. The more unaffordable their home becomes, the happier they are. Because there are double the number of home owners to would-be home owners and other renters, politicians on both sides have gone for decades professing great concern about the plight of would-be first home buyers while doing little or nothing to help them.

This means housing is becoming hereditary. Young people can afford to buy a home only with help from their parents, but parents can help only if they’re well-established home owners. Without so much help from parents, home prices would have to fall to make homes affordable.

So, the Bank of Mum and Dad has become an essential part of the system, but it works to keep home prices unaffordable to those without access to that bank.

Renting used to be seen as a temporary, transitory state. This is why state governments have never worried much about the treatment of tenants and have easily yielded to pressure from landlords to give them the upper hand.

It’s always been the case that poor people rented all their lives, but now the poor and the students are being joined by middle-class couples who’ve got on with having kids rather than waiting until they can afford a place. We’re acquiring a large underclass of people who’ll never manage to afford a ticket in the home owners’ club.

Until now, the problem of “housing affordability” has been seen as a problem for would-be home owners. Last week, the focus shifted to rent affordability and the poor treatment often dished out to renters.

Economically, this has happened because, at a time when the price of everything we buy is rising faster than our wages, rents have been positively shooting up. Why? Because, suddenly, there are so few vacancies; because the number of people needing to rent almost exceeds the number of properties for rent.

Politically, the spotlight has turned on renters because the Greens have been taking votes from the two majors by billing themselves as the party for renters.

Meanwhile, the nation’s economists, whose usual focus has been on the way tax and pension rules have pushed up home prices by adding unduly to the demand for homes, have reached a new consensus that it’s really the inadequate supply of homes that’s the problem.

Right now, that’s obviously true – especially in the supply of rental accommodation. But if you look at our record over recent decades, supply hasn’t had much trouble keeping up with demand, so it’s not the main thing that’s pushed prices so high.

So, on the face of it, Albanese’s new agreement with the premiers to facilitate the building of 200,000 more homes than the previous target of 1 million extra homes, over the five years from next July, doesn’t seem such a big deal. Most of those probably would have been built anyway.

What’s different is that they have to be new “well-located” homes. Well-located means “close to existing public transport connections, amenities and employment”.

Get it? “Well-located” is code for medium- and high-density housing. Most people want to live close to the centre of capital cities – or at least close to good public transport to the city – and economists now believe it’s council zoning restrictions on high-rise that’s done most to drive up home prices “where people want to live”.

So, premiers Daniel Andrews and Chris Minns have signed up to more high-rise. But agreeing to targets is one thing; delivering them is quite another. The premiers will meet plenty of objections, obstructions and foot-dragging.

That’s the other thing that’s different about Albanese’s new deal. He’s offering $3.5 billion in “performance-based funding” to those states that achieve more than their share of the original 1 million target. Each of the further well-located 200,000 homes their state’s builders produce will bring the premier a $15,000 bonus.

You’ve heard what they say about getting between a premier and a bag of money, so let’s hope it works. Ditto the premiers’ promises to reach a national agreement requiring landlords to have reasonable grounds for eviction, limiting rent increases to once a year, and phasing in minimum quality standards for rental properties.

When it comes to getting premiers to agree on harmonising regulations, I wouldn’t hold my breath – unless there’s more money on the table, of course.

Read more >>

We won't fix inflation while economists stay in denial about causes

Led on by crusading Reserve Bank governors, the nation’s economists are determined to protect us from the scourge of inflation, no matter the cost in jobs lost.

But there’s a black hole in their thinking about the causes of inflation, only some of which must be stamped on. Others can be ignored. Meanwhile, here’s another sermon demanding the government act to raise productivity.

In your naivety, you may think that inflation is caused by businesses putting up their prices. But economists know that’s not the problem. Businesses raise their prices only in response to “market forces”. When demand for their products exceeds the supply, businesses seize the chance to raise their prices.

In your ignorance, you may think they do this out of greed, a desire to increase “shareholder value” at the expense of their customers. But that’s the wrong way to look at it.

In raising their prices, businesses aren’t being opportunistic, they’re only doing what comes naturally, playing their allotted role in allowing the “price mechanism” to bring demand and supply back into balance.

As balance is restored, the price will fall back, pretty much to where it was before. What? You hadn’t noticed? Funny that, neither had I.

No, what causes prices to keep rising at a rapid rate is when the greedy workers and their unions force businesses to increase their wages in line with the rise in the cost of living. Can’t the fools see that this merely perpetuates the rapid rise in prices?

So, what we need to get inflation down quickly is for workers to take it on the chin. They can have a bit of a pay rise – say, 2.5 per cent – but nothing more, especially when there’s been no increase in the productivity of their labour.

This will cut the workers’ real incomes and lower their standard of living, of course, but that can’t be helped. It’s the only way we can make them stop spending as much, so businesses won’t be able to get away with continuing to raise their prices by more than 2.5 per cent.

But cutting real wages probably won’t be enough to stop businesses raising their prices so high, so we’ll need to raise interest rates and really put the squeeze on workers with big mortgages. Sorry, nothing else we could do.

Yet another worry is our return to full employment. If the demand for labour exceeds its supply, that would allow the suppliers of labour – aka workers – to raise their prices – aka wages – and that would never do.

Indeed, our history-based calculations say the unemployment rate has already fallen below the level that causes wage and price inflation to take off. It hasn’t yet, but it will.

But not to worry. As incoming Reserve Bank governor Michele Bullock explained in a speech extolling full employment, the Reserve estimates it should only be necessary to raise the rate of unemployment by 1 percentage point to 4.5 per cent to get inflation back down to where we want it.

What! Cried the punters in stunned amazement. To get inflation down you will knowingly put about 140,000 workers out of work? How could you be so utterly inhuman?

What stunned and amazed the nation’s economists is that anyone should be surprised or offended by this. Don’t they know that’s the way we always do it? And 140,000 job losses would be getting off lightly.

Just so. When, as now, the Reserve Bank and the government accidentally overstimulate the economy, allowing businesses to increase their prices by more than they need to, what we always do to stop businesses raising their prices is bash up their customers until the fall-off in households’ spending – caused partly by people losing their jobs – makes it impossible for businesses to keep increasing their prices.

Problem solved. Standard practice is to put a stop to businesses’ opportunism – their “rent-seeking” as economists say – by bashing up their workers and customers until the businesses desist.

But what never happens is that the level of prices falls back to about where it was before the econocrats stuffed up – as the economists’ price-mechanism theory promises it will.

Why doesn’t the theory work? Because what’s required to make it work is intense competition between many small firms. When one firm decides to raise its prices and fatten its profit margin, the others undercut it and it either pulls its head in or goes out backwards.

In the real world, industries are increasingly dominated by just a few huge firms – firms that have become so mainly by taking over their smaller competitors. This is true in all the rich economies, but none more so than ours.

Economists know that “oligopolies” form because it’s easier for a few big firms to gain a degree of control over the prices they charge (whereas the price-mechanism theory assumes they’re too small to have any control).

The few big players compete on marketing and advertising, and using minor product differentiation, but never on price. When prices rise, they rise together – and rarely come back down.

Economists know all this – it’s knowledge gained and taught by economists – but it’s classed as “microeconomics”, whereas the econocrats seeking to manage the economy and keep inflation low specialise in “macroeconomics”. And they never join the dots – though that’s changing in other countries.

This year the European Central Bank, the International Monetary Fund and the Organisation for Economic Co-operation and Development have delved into the national accounts and determined that rising profit margins explain a high proportion of the recent inflation surge.

But when the Australia Institute replicated this analysis for Australia, both Treasury and the Reserve Bank used dodgy graphs and dubious arguments to dismiss its work as “flawed”.

Entrenched inflation only emerged as a problem in the 1970s. After much debate, the world’s economists decided the problem was caused by powerful unions, whose expectations of continuing high inflation caused a “wage-price spiral”, which could only be broken by using high interest rates to put the economy into recession.

This is the thinking we’ve had full strength from the Reserve for the past year or more. Since the 1970s, however, multiple developments have weakened the unions’ bargaining power, while decades of takeovers have increased our big businesses’ pricing power – without the econocrats noticing.

And despite their unceasing sermons about the need for governments to increase national productivity, it’s never occurred to them that the primary driver of productivity improvement is intense competition between businesses.

The calls by successive heads of the Australian Competition and Consumer Commission for stronger powers to block mergers that would “substantially lessen competition” have gained no support from the Reserve, Treasury or economists generally.

But we won’t fix inflation until we have stronger laws defending competition.

Read more >>

RBA's double whammy: hit wages and raise interest rates

If the sharp increase in interest rates we’ve seen leads to a recession, it will be the recession we didn’t have to have. The judgment of hindsight will be that the Reserve Bank’s mistake was to worry about wage growth being too high, when it should have worried about it being too low.

The underrated economic news this week was the Australian Bureau of Statistics’ announcement that its wage price index grew by 0.8 per cent over the three months to the end of June, and by 3.6 per cent over the year to June.

This was the third quarter in a row that wages had risen by 0.8 per cent, but annual growth was down a fraction from 3.7 per cent over the year to March. It was a slowdown the Reserve hadn’t expected.

So, the obvious question arises: is it good news or bad? Short answer: depends on your perspective. Long answer: keep reading.

The Reserve would have regarded the modest fall as good news because its focus is on getting the rate of inflation down to its 2 to 3 per cent target range as soon as reasonably possible. The slight lowering in wage growth will help in two ways.

First, it means a slightly smaller increase in businesses’ wage costs, which should mean they increase their prices by a little less.

Second, the slight fall in wage growth slightly increases the squeeze on households’ incomes, making it a little harder for them to keep spending as much on goods and services. The less the demand for their products, the less the scope for businesses to raise their prices.

It’s hardly a big change, obviously, but it’s in the right direction. It’s a sign the Reserve’s anti-inflation strategy is working and that the return to low inflation may happen a little earlier.

But what if you’re just a worker – is it good news or bad, from your perspective? Well, Treasurer Jim Chalmers would like to remind you that wage growth of 3.7 or 3.6 per cent is the highest we’ve had since mid-2012.

Not bad, eh? Trust Labor to get your wages up.

I trust you’re sufficiently economically literate to see through that one. Back then, the annual rate of inflation was about 2 per cent, whereas in June quarter this year it was 6 per cent – not long down from a peak of 7.8 per cent.

So wage growth of 3.6 per cent is hardly anything to boast about. Wages might be up, but prices are up by a lot more. Take account of inflation, and “real” wages actually fell by 2.4 per cent over the year to June.

Over the 11 years to June, consumer prices rose by 33 per cent, whereas the wage price index rose by 29 per cent. If you’re a worker, that’s hardly something to celebrate.

Why do ordinary people put up with the capitalist system, in which big business people are revered like Greek gods, permitted to lecture us on our many failings, and allowed to pay themselves maybe 40 times what an ordinary worker gets?

Because the punters get their cut. Because enough of the benefits trickle down to ordinary workers to give them a steadily improving standard of living. Because wages almost always rise a bit faster than prices do.

This is the “social contract” the rich and powerful have made with the rest of us for letting them call the shots. But for the past decade or more we’ve got nothing from the deal. Indeed, our standard of living has slipped back.

Don’t worry, say Chalmers and his boss Anthony Albanese, it won’t be more than a year or three before inflation’s down lower than wage growth and real wages are back to growing a bit each year.

Yeah, maybe. It’s certainly what should happen, it happened in the past, so maybe it will happen again. But one thing we can be sure of: we’re unlikely ever to catch up for the losing decade.

Throughout the Reserve’s response to the post-pandemic period, it’s had next to nothing to say about the abandon with which businesses have been whacking up their prices, while always on about the need for wage growth to be restrained.

It’s tempting to think that, in the mind of the Reserve, the only function wages serve is to help it achieve its inflation target. When inflation’s below the target, the Reserve wants bigger pay rises to get inflation up. When inflation’s above the target, it wants lower pay rises to get inflation down.

The truth is, the Reserve’s been mesmerised by the threat that roaring wages would pose to lower inflation. Its limited understanding of the forces bearing on wages is revealed by its persistent over-forecasting of how fast they will grow.

Once the unemployment rate began falling towards 3.5 per cent and the jobs market became so tight – with job vacancies far exceeding the number of unemployed workers – it has lived in fear of surging wages as employers bid up wages in their frantic efforts to hang on to or recruit skilled workers.

It just hasn’t happened. As we’ve seen, wages haven’t risen enough merely to keep up with prices, much less soar above them.

The Reserve has worried unceasingly that the price surge would adversely affect people’s expectations about inflation, leading to a wage-price spiral that would keep inflation high forever. This is why it’s kept raising interest rates and been rushing to see inflation fall back.

Again, it just hasn’t happened.

Normally, when inflation’s been surging and the Reserve has been raising interest rates to slow down our spending, real wages have been growing strongly. But not this time. This time, falling real wages have greatly contributed to the squeeze on households and their spending.

That’s why, if this week’s falling employment and rising unemployment continue to the point of recession, people will realise the Reserve’s mistake was to worry about wage growth being too high, when it should have worried about it being too low.

Read more >>

Fixing inflation doesn't have to hurt this much

They say that the most important speeches politicians make are their first and their last. Certainly, I’ve learnt a lot from the last thoughts of departing Reserve Bank governors. And, although Dr Philip Lowe still has one big speech to go, he’s already moved to a more reflective mode.

Whenever smarty-pants like me have drawn attention to the many drawbacks of using higher interest rates to bash inflation out of the economy, Lowe’s stock response has been: “Sorry, interest rates are the only lever I’ve got.”

But, in his last appearance before a parliamentary committee on Friday, he was more expansive. He readily acknowledged that interest rates – “monetary policy” – are a blunt instrument. They hurt, they’re not well-targeted and do much collateral damage.

“Monetary policy is effective, but it also has quite significant distributional effects,” he said. “Some people in the community are finding things really difficult from higher interest rates, and other people are benefiting from it.”

Higher interest rates don’t have much effect on the behaviour of businesses – except, perhaps, landlords who’ve borrowed heavily to buy investment properties – but they do have a big effect on people with mortgages, increasing their monthly payments and so leaving them with less to spend on everything else.

That’s the object of the exercise, of course. Prices – the cost of living – rise when households’ spending on goods and services exceeds the economy’s ability to produce those goods and services. So economists’ standard solution is to use higher interest rates to squeeze people’s ability to keep spending. Weaker demand makes it harder for businesses to keep raising their prices.

Trouble is, only about a third of households have mortgages, with another third renting and the last third having paid off their mortgage. This is what makes using interest rates to slow inflation so unfair. Some people get really squeezed, others don’t. (Rents have been rising rapidly, but this is partly because the vacancy rate is so low.) What’s more, some long-standing home buyers don’t owe all that much, so haven’t felt as much pain as younger people who’ve bought recently and have a huge debt.

Who are the people Lowe says are actually benefiting from higher interest rates? Mainly oldies who’ve paid off their mortgages and have a lot of money in savings accounts.

In theory, the higher rates banks can charge their borrowers are passed through to the savers from whom the banks must borrow. Some of it has indeed been passed on to depositors, but the limited competition between the big four banks has allowed them to drag their feet.

So the “significant distributional effects” Lowe refers to are partly that the young tend to be squeezed hard, while the old get let off lightly and may even be ahead on the deal. And the banks always do better when rates are rising.

All this makes the use of interest rates to control inflation unfair in the way it affects different households. And note this: how is it fair to screw around with the income of the retired and other savers? They do well at times like this but pay for it when the Reserve is cutting interest rates to get the economy back up off the floor.

But as well as being unfair, relying on interest rates to slow the economy is a less effective way to discourage spending. Because raising interest rates directly affects such a small proportion of all households – the ones with big mortgages – the Reserve has to squeeze those households all the harder to bring about the desired slowdown in total spending by all households.

In other words, if the squeeze was spread more evenly between households, we wouldn’t need to put such extreme pressure on people with big mortgages.

Lowe has been right in saying, “Sorry, interest rates are the only lever I’ve got.” What he hasn’t acknowledged until now is that the central bank isn’t the only game in town. The government’s budget contains several potential levers that could be used to slow the economy.

We could set up an arrangement where a temporary rise in the rate of the goods and services tax reduced the spending ability of all households. Then, when we needed to achieve more spending by households, we could make a temporary cut in the GST.

If we didn’t like that, we could arrange for temporary increases or decreases in the Medicare levy on taxable income.

Either way of making it harder for people to keep spending would still involve pain, but would spread the pain more fairly – and, by affecting all or most households, be more effective in achieving the required slowdown in spending.

The least painful way would be to impose a temporary increase or decrease in employees’ compulsory superannuation contributions. That way, no one would lose any of their money, just be temporarily prevented from spending it at times when too much spending was worsening the cost of living.

Our politicians and their economic advisers need to find a better way to skin the cat.

Read more >>

Hate rising prices? Please blame supply and demand, not me

Have you noticed how, to many economists, everything gets back to the interaction of supply and demand? Understand this simple truth and you know all you need to know. Except that you don’t. It leaves much to be explained.

Why has the cost of living suddenly got much worse? Because the demand for goods and services has been growing faster than the economy’s ability to supply those goods and services, causing businesses to put their prices up.

Since there is little governments can do to increase supply in the short term, the answer is to use higher interest rates to discourage spending. Weaker demand will make businesses much less keen to keep raising their prices. If you hit demand really hard, you may even oblige businesses to lower their prices a little.

But, as someone observed to me recently, saying that everything in the economy is explained by supply and demand is a bit like saying every plane crash is explained by gravity. It’s perfectly true, but it doesn’t actually tell you much.

Consider this. After rising only modestly for about a decade, rents are now shooting up. Why? Well, some people will tell you it’s because almost half of all rental accommodation has been bought by mum and dad investors using borrowed money (“negative gearing” and all that).

The sharp rise in interest rates over the past year or so has left many property investors badly out of pocket, so they’ve whacked up the rent they’re charging.

Ah no, say many economists (including a departing central bank governor), that’s not the reason. With vacancy rates unusually low, it means that the demand for places to rent is very close to the supply available, and landlords are taking advantage of this to put up their prices.

So, what’s it to be? I think it’s some combination of the two. Had the vacancy rate been high, mortgaged landlords would have felt the pain of higher interest rates but been much less game to whack up the rent for fear of losing their tenants.

But, by the same token, it’s likely that the coincidence of a tight housing market with a rise in interest rates has made the rise in rents faster and bigger than it would have been. It would be interesting to know whether landlords with no debt have increased their prices as fast and as far as indebted landlords have.

The point is that knowing how the demand and supply mechanism works doesn’t tell you much. It doesn’t allow you to predict what will happen to either supply or demand, nor tell you why they’ve moved as they have.

It’s mainly useful for what economists call “ex-post rationalisation” – aka the wisdom of hindsight.

Economic theory assumes that all businesses – including landlords – are “profit-maximising”. But in their landmark book, Radical Uncertainty, leading British economists John Kay and Mervyn King make the heretical point that, in practice rather than in textbooks, firms don’t maximise their profits.

Why not? Well, not because they wouldn’t like to, but because they don’t know how to. There is a “price point” that would maximise their profits, but they don’t know what it is.

To economists, when you’re just selling widgets, it’s a matter of finding the right combination of “p” (the price charged) and “q” (the quantity demanded). Raising p should increase your profit – but only if what you gain from the higher p is greater than what you lose from the reduction in q as some customers refuse to pay the higher price.

What you need to know to get the best combination of p and q is “the price elasticity of demand” – the customers’ sensitivity to changes in price. In textbooks or mathematical models, the elasticity is either assumed or estimated via some empirical study conducted in America 30 years ago.

In real life, you just don’t know, so you feel your way gently, always standing ready to start discounting the price if you realise you’ve gone too far. And the judgments you make end up being influenced by the way you feel, the way your fellow traders feel, what you think the customers are feeling and how they’d react to a price rise.

How flesh-and-blood people behave in real markets is affected by mood, emotion, sentiment, norms of socially acceptable behaviour and other herding behaviour – all the factors that economists knowingly exclude from their models and know little about.

Keynes called all this “animal spirits”. Youngsters would call it “the vibe of the thing”. It’s psychology, not economics. And it’s because conventional economics attempts to predict what will happen in the economy without taking account of airy-fairy psychology that economists’ forecasts are so often wrong.

They may know more about how the economy works than the rest of us, but there’s still a lot they don’t know. Worse, many of them don’t think they need to know it.

It’s clear to me that psychology has played a big part in the great post-pandemic price surge. It didn’t cause it, but it certainly caused it to be bigger than it might have been.

The pandemic’s temporary disruptions to supply and the Ukraine war’s disruption to fossil fuels and food supply provided a cast-iron justification for big price rises, and it was a simple matter for businesses to add a bit extra for the shareholders.

It was clear to the media that big price rises were on the way, so they went overboard holding a microphone in front of every industry lobbyist willing to make blood-curdling predictions about price rises on the way. (I’m still waiting to see the ABC’s prediction of the price of coffee rising to $8 a cup.)

Thus did recognition that the time for margin-fattening had arrived spread from the big oligopolists to every corner store. One factor that constrains the prices of small retailers is push-back from customers – both verbal and by foot.

All the media’s fuss about imminent price rises softened up customers and told the nation’s shopkeepers there would be little push-back to worry about.

In the home rental market, dominated as it is by amateur small investors, who rightly worry about losing a tenant and having their property unoccupied for more than a week or two, it’s the commission-motivated estate agents who know when’s the right time to urge landlords to raise the rent, and how big an increase they can be confident of getting away with. 

Read more >>

Don't be so sure we'll soon have inflation back to normal

Right now, we’re focused on getting inflation back under control and on the pain it’s causing. But it’s started slowing, with luck we’ll avoid a recession, and before long the cost of living won’t be such a worry. All will be back to normal. Is that what you think? Don’t be so sure.

There are reasons to expect that various factors will be disrupting the economy and causing prices to jump, making it hard for the Reserve Bank to keep inflation steady in its 2 per cent to 3 per cent target range.

Departing RBA governor Dr Philip Lowe warned about this late last year, and the Nobel Laureate Michael Spence, of Stanford University, has given a similar warning.

A big part of the recent surge in prices came from disruptions caused by the pandemic and the invasion of Ukraine. Such disruptions to the supply (production) side of the economy are unusual.

But Lowe and Spence warn that they’re likely to become much more common.

For about the past three decades, it was relatively easy for the Reserve and other rich-country central banks to keep the rate of inflation low and reasonably stable.

You could assume that the supply side of the economy was just sitting in the background, producing a few percentage points more goods and services each year, in line with the growth in the working population, business investment and productivity improvement.

So it was just a matter of using interest rates to manage the demand for goods and services through the undulations of the business cycle.

When households’ demand grew a bit faster than the growth in supply, you raised interest rates to discourage spending. When households’ demand was weaker than supply, you cut interest rates to encourage spending.

It was all so easy that central banks congratulated themselves for the mastery with which they’d been able to keep things on an even keel.

In truth, they were getting more help than they knew from a structural change – the growing globalisation of the world’s economies as reduced barriers to trade and foreign investment increased the trade and money flows between the developed and developing economies.

The steady growth in trade in raw materials, components and manufactured goods added to the production capacity available to the rich economies. Oversimplifying, China (and, in truth, the many emerging economies it traded with) became the global centre of manufacturing.

This huge increase in the world’s production capacity – supply – kept downward pressure on the prices of goods around the world, thus making it easy to keep inflation low.

Over time, however – and rightly so – the spare capacity was reduced as the workers in developing countries became better paid and able to consume a bigger share of world production.

Then came the pandemic and its almost instantaneous spread around the world – itself a product of globalisation. But no sooner did the threat from the virus recede than we – and the other rich countries – were hit by the worst bout of inflation in 30 years or so.

Why? Ostensibly, because of the pandemic and the consequences of our efforts to limit the spread of the virus by locking down the economy.

People all over the world, locked in their homes, spent like mad on goods they could buy online. Pretty soon there was a shortage of many goods, and a shortage of ships and shipping containers to move those goods from where they were made to where the customers were.

Then there were the price rises caused by Russia’s war on Ukraine and by the rich economies’ trade sanctions on Russia’s oil and gas. So, unusually, disruptions to supply – temporary, we hope – are a big part of the recent inflation surge.

But, the central bankers insist, the excessive zeal with which we used government spending and interest-rate cuts to protect the economy and employment during the lockdowns has left us also with excess demand for goods and services.

Not to worry. The budget surplus and dramatic reversal of interest rates will soon fix that. Whatever damage we end up doing to households, workers and businesses, demand will be back in its box and not pushing up prices.

Which brings us to the point. It’s clear to Lowe, Spence and others that disruptions to the supply side of the economy won’t be going away.

For a start, the process of globalisation, which did so much to keep inflation low, is now reversing. The disruption to supply chains during the pandemic is prompting countries to move to arrangements that are more flexible, but more costly.

The United States’ rivalry with China, and the increasing imposition of trade sanctions on countries of whose behaviour we disapprove, may move us in the direction of trading with countries we like, not those offering the best deal. If so, the costs of supply increase.

Next, the ageing of the population, which is continuing in the rich countries and spreading to China and elsewhere. This reduction in the share of the population of working age reduces the supply of people able to produce goods and services while the demand for goods and services keeps growing. Result: another source of upward pressure on prices.

And not forgetting climate change. One source of higher prices will be hiccups in the transition to renewable energy. No new coal and gas-fired power stations are being built, but the existing generators may wear out before we’ve got enough renewable energy, battery storage and expanded grid to take their place.

More directly, the greater frequency of extreme weather events is already regularly disrupting the production of fruit and vegetables, sending prices shooting up.

Drought prompts graziers to send more animals to market, causing meat prices to fall, but when the drought breaks, and they start rebuilding their herds, prices shoot up.

Put this together and it suggests we’ll have the supply side exerting steady underlying – “structural” – pressure on prices, as well as frequent adverse shocks to supply. Keeping inflation in the target range is likely to be a continuing struggle.

Read more >>