A high-level group within cabinet, chaired by the Treasurer, Wayne Swan, called the expenditure review committee, last week signed off on a range of budget savings measures to ensure the surplus target. They will be revealed in the coming week with the regular end-of-year federal budget update, known as the Mid Year Economic and Fiscal Outlook. MYEFO, to those in the know.

This year’s update will reveal a downgrade to the Treasury’s economic growth forecasts since the May budget, but still show the economy growing at about trend, not falling off a cliff.

However, smaller-than-expected revenue collections mean that, left alone, the budget would still be in deficit by a billion or two in 2012-13. And make no mistake, by hook or by crook, Gillard, Swan and Co are getting their surplus (intervening dramatic European events permitting, of course).

The government says that by pulling on the fiscal reins it is giving the Reserve Bank more room to cut interest rates. Picture Gillard as razor maiden, the Reserve Bank governor, Glenn Stevens, as Santa Claus.

This is significant, representing a continuing shift in what economists call Australia’s “policy mix”: the relative responsibility of fiscal policy (government’s spend and tax decisions) and monetary policy (interest rates) in influencing the level of aggregate demand in the economy.

In previous episodes – think mining boom mark one under Howard – puritanical economists were always complaining that the two arms of economic policymaking were working against each other. By lifting interest rates in 2007, the Reserve Bank had its hand on the brake, trying to reduce aggregate demand in the economy, and hence control price rises.

At the same time, the Howard government was merrily spending on cash handouts for pensioners and tax cuts for all before the 2007 election (cuts that Labor also adopted and implemented), effectively putting its foot on the economic accelerator by adding to demand.

When the global financial crisis hit, the policy mix changed dramatically. The government and the Reserve Bank acted in concert to stimulate demand, delivering multibillion-dollar fiscal spending and interest rate cuts. In a speech in late 2009, senior Treasury official David Gruen hailed “the return of fiscal policy”.

Since early 2010, the government has in fact been quietly putting its foot on the brake. Because the government went from stimulating activity a lot to stimulating it by less, this change in stance means government budget decisions have actually been subtracting from the rate of economic growth.

These new spending cuts indicate the government wants fiscal policy to continue to be contractionary. The advantage of running tight fiscal policy rather than tight monetary policy – that is, high interest rates – is that it limits upward pressure on the dollar, in turn relieving some pressure on struggling manufacturers and tourism operators.

The same puritanical economists are now running around arguing the government is putting its foot on the brake while the Reserve Bank is, if anything, tapping the accelerator with its interest rate cut last month.

But let’s keep this in perspective.

The estimates are that the government will need about $4 billion in savings to secure a surplus in 2012-13. Out of total spending of $381 billion forecast for that year, that’s not huge. Europe may well fall over the edge, triggering another economic downturn, but it hasn’t yet. With Australian economic growth at trend, it remains prudent for the government to keep a firm hand on the purse strings.

Moreover, let’s not look this gift-horse in the mouth. How often do you get politicians desperate to cut spending rather than squander it on appealing to special interests (like pre-election handouts for old people). Let them go for it, I say.

In the long term, the budget faces a significant shortfall in revenues due to the ageing of the population. In the shorter term, money must also be found for a $2 billion pay rise for low-paid social and community service workers and to fund a comprehensive national disability insurance scheme.

As always, it’s the quality of the spending cuts that matters, not their size. It would be quite possible to fudge the figures to create a surplus in 2012-13 by simply pulling forward spending into earlier deficit years, or delaying spending until the out-years of the budget.

But the government has also indicated “structural” spending cuts to the big budget items of welfare, health, education and defence are in the offing. Specifically, the ballooning cost of pharmaceutical subsidies and dentists who over-claim under a limited publicly funded dental scheme are reportedly in the firing line.

Will it be enough to convince the Reserve Bank it could step in with another cut in interest rates next month? That, of course, depends on the size of the cuts the government unveils. But at $4 billion – or roughly 0.3 per cent of GDP – it’s unlikely.

Dramatic events in Europe could well convince the Reserve board of the need for another pre-Christmas interest rate cut, as could any signals in economic reports that Australian consumers and businesses are more worried about Europe than they had previously been letting on.

For the time being, however, the bank is sitting pretty, having returned interest rates to “neutral” – their historic average. It continues to watch for a sign that it needs to flick the monetary policy switch to stimulatory by cutting interest rates to below neutral. But it hasn’t happened yet.

Dad, can I have a pay rise?

Should a woman tending to personal care needs of an elderly person be paid more or less than a male garbage disposal worker? The government’s decision to support a pay rise for 150,000 social and community services workers delivers a well-earned boost to the pay packets of some of our most under-appreciated workers. But Fair Work Australia’s new powers to assess pay discrimination cases based on “equal or comparable work” open a can of worms.

What constitutes comparable work? Traditional economics struggles to explain the continuing gender pay gap, in large part because of the concentration of women in non-market, public-sector jobs where pay is set by decree, rather than by the forces of supply and demand. The historic undervaluation of “women’s work” – the caring responsibilities once carried out for free in the home – continues to dog women’s pay.

Men working in private-sector waste management, for example, traditionally demand and receive “compensatory pay” – extra for the unpleasantness of the job. But when women care for the elderly, handle bed pans and change soiled sheets, society says they should do it as a labour of love and respect.

Women continue to earn just 82 per cent of their male counterparts working in full-time jobs. Much of this gap – about 8 percentage points – is due to a combination of factors, including that men tend to work in higher-status jobs and work longer hours in them.

A better measure of the pay gap – that of full-time, adult, ordinary time, non-managerial, average cash earnings – puts it at a somewhat narrower 90 per cent. But how do we explain the remaining 10 percentage point gap?

Much of this is due to the different industries in which men and women work, their individual willingness to negotiate pay rises, the interrupted career paths of women as they have children, and outright discrimination.

Standard economic theory also struggles with the concept of discrimination. A firm that excluded women on the basis of sex, rather than productivity, would reduce the size of its potential labour pool by half. As a result, it would have to pay more for its male workers. Female workers – less in demand – could only sell their labour for a lower price. A firm that seized the opportunity to hire cheaper, but similarly productive, female workers would soon get a profit advantage over its discriminating rivals.

And yet, discrimination exists. Some economists say employers discriminate against women to appeal to the innate sex preferences of customers. Families would rather have a male financial adviser, or a male barrister in court. Hmm. Maybe.

A fascinating piece of research highlighting the importance of discrimination in pay setting came across my Twitter feed this week. Like Daughter, Like Father: How Women’s Wages Change When CEOs Have Daughters reflects on data from 6321 Danish firms which found male CEOs with daughters closed the workforce earnings gap by 0.5 per cent in the year after a daughter’s birth. If she was also their first born, the gap narrowed by 2.8 per cent.

The researchers said: “The first daughter ‘flips a switch’ in the mind of a male CEO, causing him to attend more to equity in gender-related wage policies.” The effect was strongest for highly educated employees – suggesting CEOs relate more to their highly educated female employees – and in firms with a smaller number of employees – where the CEO would have greater power over wage setting.

Until we begin to truly tackle society’s deep-seated attitudes towards women in work, closing the gender pay gap will remain a work in progress.

THE IRVINE INDEX

82%
Female full-time, adult, ordinary-time, averageweekly earnings as a percentage of
male earnings.

90%
Female full-time, adult, ordinarytime, non-managerial average hourly cash earnings as a
percentage of male earnings.

$53.60
Average ordinary-time hourly cash earnings of full-time, non-managerial financial brokers,
dealers and investment advisers.

0.5%
Reduction of the gender pay gap in a company when a male chief executive has a daughter.

$40.30
Average ordinary-time hourly cash earnings of full-time, non-managerial midwives and nursing professionals.

$213 million
Cost of administering passport services in 2012-13.

$27.10
Average ordinary-time hourly cash earnings of full-time, non-managerial prison and security officers.

$170 million
Cost to the federal budget in 2012-13 of granting a pay rise to social and community services workers.

$20.10
Average ordinary-time hourly cash earnings of full-time, non-managerial child carers.

Sources: Bureau of Statistics Employee Earnings and Hours, May 2010′ and Average Weekly Earnings, May 2011; Like Daughter, Like Father: How Women’s Wages Change When CEOs Have Daughters paper by Michael S. Dahl, Cristian L. Dezso and David Gaddis Ross, published March 2011; budget.gov.au.

Speaking of cholesterol...

SHOULD we worry about rising inequality? Protests across the United States under the Occupy Wall Street banner are in part a spontaneous outcry at the outrageous post-crisis salaries of Wall Street “bailoutees”. But they also find roots in a deeper, multi-decade trend of rising inequality in the US. As the stunningly successful catch cry “we are the 99 per cent” shows, this is a movement based on statistics as much as slogans.

Since the late 1970s, the share of US pre-tax income going to the top 1 per cent of American wage earners has grown from 8 per cent to 18 per cent, the online World Top Incomes Database shows.

Inequality of wealth is even more pronounced, with the top 1 per cent sitting on 35 per cent of the country’s net household worth, that is, assets, including housing, shares, trusts, deposits and pension accounts, minus debts.

Sympathetic Australians occupying Martin Place and Melbourne’s City Square have less cause for complaint, but inequality here is rising, too. Tax Office statistics show the share of taxable income earned by the top 1 per cent of Australian wage earners doubled from 5 per cent to 10 per cent over the past three decades.

But as long as incomes are growing for all, why should we care?

Some economists think we shouldn’t. So long as there is equality of opportunity and redistribution to alleviate poverty, they argue inequality is simply a fact of life, reflecting the disparate market value of the output of workers with varying levels of skill and ability.

This theory of wages does well to explain the pay gap between, say, computer software developers and retail assistants, but it struggles to explain the excessive multi-billion dollar salaries awarded to some chief executives.

Most economists also defend some degree of inequality on the basis that it provides useful incentives for all workers. We need to see that others are earning more than us to drive us to work harder, improve our skills and aspire to greater things.

But how much inequality is enough?

In a recently released book, The Haves and the Have-Nots, the World Bank economist and inequality expert Branko Milanovic argues that inequality is like cholesterol: “There is ‘good’ and ‘bad’ inequality, just as there is good and bad cholesterol. ‘Good’ inequality is needed to create incentives for people to study, work hard, or start risky entrepreneurial projects.”

But, he argues, economic efficiency is eventually undermined when a group of super rich devote their considerable resources to ensuring they get to keep all the best jobs and opposing economic reforms that would endanger their privileged positions. “Bad inequality starts at a point – one not easy to define – where, rather than providing the motivation to excel, inequality provides the means to preserve acquired position.”

Milanovic argues the global financial crisis is a direct result of this kind of “bad” inequality taking hold in the US. An excessive build-up of wealth and income in the hands of the financial elite meant they soon ran out of ways to consume it in caviar and champagne, meaning it needed to be invested in ever riskier vehicles.

Meanwhile, US politicians sought to hide the uncomfortable truth of declining middle and lower class wealth by turning a blind eye to a massive loosening of credit standards, which enabled people to borrow and feel rich, even as their incomes stagnated. A more equitable path of development “would have spared the United States and the world an unnecessary crisis”.

So, worth keeping an eye on, then.

THE IRVINE INDEX

$197,112
Minimum income you needed to earn in 2007-08 to make it into the top 1 per cent of Australians by income.

18%
Share of pre-tax income earned by the top 1 per cent of American workers in 2007, up from 8 per cent in 1977.

10%
Share of pre-tax income earned by the top 1 per cent of Australian workers in 2007, up from 5 per cent in 1977.

85%
Share of net worth owned by the top 20 per cent of US households.

35%
Share of net worth, including housing, shares, trusts, deposits and pension accounts, owned by top 1 per cent of US households

0.9%
Share of net worth owned by the bottom 20 per cent of Australian households.

62%
Share of net worth owned by the top 20 per cent of households in Australia.

9
Gross household income of the top 10 per cent of Australia’s top income-earning households as a multiple of the bottom 10 per cent.

49
Net worth of the top 10 per cent of Australia’s wealthiest households as a multiple of the bottom 10 per cent.

Sources: Facundo Alvaredo, Anthony B. Atkinson, Thomas Piketty and Emmanuel Saez, The World Top Incomes Database, g-mond.parisschoolofeconomics.eu/topincomes, accessed 21/09/2011; sociology.ucsc.edu/whorulesamerica/power/wealth.html; ABS Household Wealth and Wealth Distribution 2009-10; andrewleigh.org/pdf/TopIncomesAustralia.xls.

Put simply, the only possible explanation for the steep rise in house prices over the past few decades, both in outright terms and compared to incomes, is that demand has outstripped supply. The real question is why?

Even those troubled souls who think Australian house prices are in a bubble waiting to burst accept that house prices are the result of supply and demand. They just think demand has been artificially boosted (for example through unrealistic expectations of future price growth), or supply artificially constrained (through developer land banking and the like), and that one day one or both of these forces will quickly reverse.

Much of the recent debate about Australia’s home affordability crisis has focused on the demand side of the equation. Freer availability of credit and lower interest rates have enabled borrowers to spend more on home purchases.

Population growth and the rise of single-person households have also increased the demand for housing, although both these forces have slowed recently.

The tax treatment of housing also influences demand. For instance, the exemption of the family home from capital gains tax increases demand, forcing prices up. But arguably some tax breaks for investor housing also encourage new home supply.

The less well-understood side of the housing equation is what determines the supply of new homes.

A new paper from a team of researchers in the Reserve Bank’s economics group, titled Urban structure and housing prices: some evidence from Australian cities shines new light on why we live in the types of homes we live in and why they cost what they do.

Through a combination of empirical research and new economic modelling, the authors Mariano Kulish, Anthony Richards and Christian Gillitzer highlight some factors that contribute to Australians living in more expensive, smaller and lower density housing than we would if the housing market was not constrained by a number of structural factors, including high transport costs, restrictions on density and costs imposed on new housing supply.

We all suffer as a result, paying higher home prices (if we can afford to buy at all), being unable to live where we prefer and increasingly squashed into smaller homes than we would like.

The urban structure of our cities is obviously a product of history. But what if we could start anew? What would our cities look like if we could build them from scratch to suit our current needs?

To find out, the researchers created a theoretical model of a city with 2 million people, situated on the coastline and with one central business district where most people worked. Of course, real cities are more complex, often with satellite centres such as Parramatta and North Sydney. But some simplification is unavoidable.

The most telling finding from this model is that such a city would be far more densely populated in inner-city areas than all of Australia’s five major cities are today. About half the population would live within 10 kilometres of the central business district.

When the model was changed to produce a city for a population of 4 million, interestingly the footprint of the city only expanded a couple of kilometres, from about 35 kilometres to 38 kilometres. Although there were 2 million extra people in the new city, just 1 per cent of them lived outside the borders of the alternative, lower-population city.

Unrestrained, the market’s natural response to a higher population would be rising densities in inner-city areas. But in the real world, because we’ve constrained new supply in various ways, housing costs have risen.

Indeed, the researchers found Australian cities today are much less dense than European cities of comparable size and more on par, in people-per-square-kilometre, with US cities.
Zoning restrictions are one culprit. In Australian cities, local councils make the ultimate decision on what developments to allow. The Reserve Bank researchers note they found it very hard getting good information on land zoning in the major cities, calling for better data in this area. But by modelling the impact of just one imaginary restriction – say, a cap of four storeys permitted per building – the researchers found it changed the urban structure, increasing housing prices, lowering average home size, decreasing density and decreasing the population in inner-city areas, pushing city limits further out. Sound familiar?

Similarly, a lack of investment in public transport and roads was also found to have an impact on urban structure, increasing house prices in the inner city and lowering them in outer areas, where residents must set aside more of their income to pay for transport costs.

Unsurprisingly, the researchers conclude more investment in transport would reduce the average cost of housing in cities.

Lengthy delays and hurdles in the urban planning process, along with upfront developer and infrastructure charges, also add to the upfront costs of new developments, dampening the supply of new housing. Higher costs are passed on to buyers through higher home purchase prices and ultimately people live in smaller houses than they would like.

It is the ultimate deceit of NIMBYism. Policies which enable existing homeowners in well-located areas to protect their own patch of turf come at the expense of others who are forced to live in smaller homes, further out from the city than they would like and to pay more for the displeasure.

Interestingly, the Reserve Bank researchers found evidence that Sydney’s population density has increased in recent years. But more needs to be done.

If we want to solve the housing affordability crisis it’s clear we’ll have to tackle the supply side. And the only way is up.

People making stuff

Do you sometimes worry about Australia becoming a place that doesn’t “make things” any more? Let me lighten your load. Kevin Rudd used to worry about such things. In his first press conference as opposition leader in 2006, Rudd stressed he wanted to be the prime minister of “a country that actually makes things”.

Today a high dollar is putting extra pressure on manufacturers while also making it cheaper for us to import things that other countries have made.

It is undoubtedly true that only a small proportion of us are engaged in making “things”. Just 8 per cent of working Australians are employed in manufacturing, down from 26 per cent in 1966. Meanwhile, the proportion working in the services sector has risen from 54 per cent to 77 per cent.

More broadly, the proportion of employees working in what the Bureau of Statistics classes “production industries”, including agriculture, forestry, mining, manufacturing, electricity, gas and construction, has halved from 46 per cent to 23 per cent.

In between we’ve largely outsourced the making of things to nimble hands abroad who will do it for less. Is that such a bad thing?

An increasingly globalised economy has not only given Australian consumers access to cheaper products, but to a wider variety of goods for purchase – Japanese cars, Korean TVs, Belgian chocolates, you name it.

The benefits to consumers of increasing trade and specialisation are often overlooked. Millions of consumers have less in common and less cause to rally than smaller groups of people employed in declining industries.

It is understandable and entirely predictable that manufacturers and the people they employ should lobby hard to save their jobs. And they have powerful representatives in unions and Federal Parliament to make their case.

But perhaps part of the reason we’re not making things as much is that we’re not buying things as much. Retail spending here is growing at its slowest annual pace in decades. National accounts figures show annual spending on recreation and culture is up 7 per cent and spending on hotels, cafes and restaurants up 6 per cent. We’re spending more on experiences and less on stuff.

Why? Partly it’s a symptom of our success. Recreation and household services are what economists call “normal goods”; that is, we tend to buy more of them when incomes rise and they come to make up a higher proportion of our total spending. Overseas holidays are normal goods, while bus tickets are “inferior goods”; we tend to buy them less when incomes rise.

The growing role of women in the workforce, while initially boosting demand for manufactured, labour-saving devices such as fridges and washing machines, has also boosted demand for domestic service employees, such as cleaners and childcare workers. These jobs are not so easily sent offshore.

When the Bureau of Statistics began conducting household surveys about people’s employment in the 1960s, the most commonly reported occupation sector was “tradesman, production process workers and labourers”. Today, it’s “professionals”. Now, more than ever, Australians make a living from the agility of our minds rather than the nimbleness of our bodies.

If you want to worry about the future of jobs growth, spend less time worrying about protecting declining industries and more time worrying about the fact that Australian government spending on higher education as a proportion of gross domestic product is one of the lowest of all member countries of the Organisation for Economic Co-operation and Development.

THE IRVINE INDEX

26%
Manufacturing’s share of total employment in 1966.

8%
Manufacturing’s share of
employment today*. *Today means August, 2011.

23%
Percentage of employed people working in production industries today.

12%
Percentage of Australian jobs in the healthcare and social assistance industry the biggest employer nationwide.

54%
Percentage of employed people working in the service sector in 1966.

2% Percentage of Australian jobs accounted for by mining. Agriculture only slightly ahead on 3 per cent.

77%
Percentage of employed people working in the service sector today.

46%
Percentage of employed people working in ‘‘production industries’’ in 1966, including agriculture, forestry, mining and manufacturing.

77%
Increase in the number of people working in the childcare industry over the past decade.

Sources: Bureau of Statistics Australian Labour Market Statistics, October 2011 Feature Article “Fifty Years of Labour Force: Now and then”; Reserve Bank speech by Philip Lowe September, 22 “Changing Patterns in Household Saving and Spending”.

Lamborghini on fire... Italy?

You know how most of the traffic created by a car crash is not the crash itself, but everyone slowing down to have a rubberneck? Well, the same thing can happen with economies. And fair enough, the unfolding car crash that is the euro zone is a pretty horrific sight. It’s hard to look away.

While the past two years have seen a collection of pile-ups of smallish European economies – think Portugal, Ireland, Greece and Spain (the PIGS) – the spectacle unfolding over Italy’s public debt is of an entirely different magnitude – think head-on collision between a road train and a B-double.

Italy is the world’s eighth largest economy, with government debt of $2.6 trillion, exceeding the debts of all the PIGS combined. The markets seem unimpressed by the Italian Prime Minister, Silvio Berlusconi, finally falling on his sword.

On Wednesday night, investors pushed the market interest rate for Italian sovereign debt to 7.48 per cent, crucially above the 7 per cent rate that eventually forced the PIGS to seek bailout funding.

It’s also roughly the same rate Australian banks are charging homebuyers. Yep, in a rough sense, markets now think Australian households have about as much chance of making good on their debts as the sovereign government of the world’s eighth largest economy.

The markets are now trapped in a self-fulfilling prophecy, one in which their action of pushing up the cost of Italian borrowing increases the likelihood that their worst fear will come to pass – the Italian government being unable to make payments on its debts.

The potential ripple effects of such a default are much larger than a Greek default, with French banks sitting on an exposure to Italian debt of more than $400 billion, and German banks more than $150 billion.

What really scares the pants off investors is that Italy, although clearly too big to fail, may also be too big to save. The entire European Financial Stability Facility – the kitty euro countries have set up to bail out indebted nations – stands at only €1 trillion ($1.334 trillion) even after the last tin rattle around the European Council. Pressure is now building up on the European Central Bank to step in as a lender of last resort, a role it has so far shirked.

Whatever the precise outcome, it is likely this crash will scatter debris over the global economy. But what will it mean for Australia? As with all car crashes, the best thing to do is just grip the wheel, focus on the road and keep driving. Australians should remember we are a few steps removed from this euro crisis.

Broadly, there are only three channels through which the crisis in Europe can have an impact on us, and there is indeed cause for optimism on all three.

First, a collapse in commodity prices following slower world growth would affect our exports. But it matters which commodities we’re talking about. Although prices for hard metals such as steel and copper have fallen dramatically, declines in bulk commodity prices – for the coal and iron ore we ship to China – have been more muted.

While Chinese demand for our bulk commodity exports remains robust, we have a buffer. It is true Europe is a leading destination for US exports, and the US is in turn the main destination for Chinese exports, which have have already dropped off.

However, lower-than-expected Chinese inflation figures released this week also mean there is room for the Chinese government to stimulate the economy with lower interest rates. And there remains plenty of stimulus spending power in its kitty. Just as China acted as a shock absorber for the Australian economy in the first global financial crisis, so is it likely to act in any renewed financial crisis.

The second way Australia could be affected by the euro crisis is through the world banking system. Fears about sovereign defaults could conceivably lead to another near complete seizing up of the global banking system, with banks unable or unwilling to lend, except at exorbitant interest rates reflecting the perceived risk the money may never be repaid.

Depending, of course, on the depth and duration of any such seizing up, there is also good ground for optimism in the healthy state of Australian banks’ balance sheets.

Apart from making multibillion-dollar record profits, they have learnt the lessons of the first global financial crisis, when they were forced to pay high interest rates on their foreign borrowings, which made up more than half of their funding sources. Since then, the banks have amassed a bigger base of domestic deposits and moved ahead of the game in securing long-term international funding.

If funding costs did rise significantly, there would be room for many banks to hold off, for a period, on rolling over foreign debts. And even if banks did pass on higher borrowing costs to mortgage holders, the Reserve Bank stands willing and able to cut its interest rate dramatically to keep the rates paid by borrowers down. Australia comes into this turmoil with one of the highest cash rates in the world.

The third, and perhaps least predictable, way that European troubles could impact on the economy is through consumer and business confidence. If consumers become unnecessarily spooked about the euro crisis, they could delay spending decisions, harming businesses. Business, in turn, could delay investments and stop hiring. Yesterday’s jobs figures showing the unemployment rate remaining at near historic lows of 5.2 per cent are encouraging in that regard. A lower Australian dollar, as investors seek the safe haven of the US dollar, while bad news for holidaymakers to the US, would also provide relief for embattled manufacturers and domestic tourism companies.

It’s hard to look away from the car crash that is the euro zone, but Australians would do well to remember our strengths.

“Hey,” I hear you ask, “didn’t those guys sort all this out last week?” Well, yes. And a couple of months before that, and once early last year. Greece is now onto its second of two €110 billion ($146 billion) bailouts arranged by the European Central Bank and International Monetary Fund. The first was approved in May last year, the second in July this year. Greek and European officials have been locked in furious negotiations ever since about the size of Greek budget cuts required in return for the money Greece needs to keep paying its bills.

In June, Greek protesters and police clashed violently in the streets outside the Greek Parliament as members voted in favour of a radical five-year austerity plan. Euro ministers are now insisting on another pound of flesh from Greek government spending in return for a bailout package to write down 50 per cent of its debts. This latest package also includes euro countries stumping up hundreds of billions to beef up the euro zone’s rescue fund – the European Financial Stability Facility – to €1 trillion, up from an original €440 billion.

How did the shining jewel of the Mediterranean become such an international touch point?

The Greek economy itself is small. At about $US300 billion its annual economic output is about a quarter the size of Australia’s. About one in five Greeks are employed in tourism, with shipping and food processing other big employers. Greece is one of the euro area’s biggest producers of cotton, rice and olives.

It is the potential ripple effects of a Greek default – if Greece is unable to keep making payments on its loans – that worry international investors. Losses would fan out across Europe, particularly to the predominantly French and German banks, and their shareholders, who bankroll Greece’s debts. Greek banks are also heavily exposed to Greek government debt, creating the potential for a run on the nation’s entire banking system should it default or exit the euro in a messy way. Either of these events would have a devastating impact on global investor confidence, pushing up the cost of all international borrowing, which could in turn make it hard for indebted Italy – Europe’s third-largest economy – to continue funding its debts.

European leaders refuse to countenance such a possibility. And so the citizens of Greece, already suffering double-digit unemployment, must accept more public sector job cuts and pension cuts.

There are two problems with this approach. The first is a political one. Such austerity is likely to continue fuelling civil unrest, meaning continued political instability and potential for future default.

The second is economic. Austerity policies, by removing demand from the economy, cripple the very growth needed to generate the revenues to keep meeting debt repayments. Bailouts are arguably a Band-Aid solution to keep an essentially insolvent nation lurching from one budget crisis to the next trying to make ends meet. The Greek economy could be on the ropes for decades to come and that is hardly a recipe for stability.

Having trouble keeping up with the euro crisis? Get used to it.

THE IRVINE INDEX

18.5 per cent
Projected jobless rate in Greece next year, according to the International Monetary Fund, second in the euro zone only to Spain’s projected 19.7 per cent.

5%
Percentage by which the Greek economy is expected to shrink this year after shrinking 4.4 per cent last year.

29th
Greece’s rank on the UN Human Development Index, putting it in the ‘‘very high’’ group of countries. Australia ranks second only to Norway on this global index.

$US306 billion
Greek gross domestic product last year.

11.3 million
Population of Greece.

23%
Interest rate on 10-year Greek government debt, up from about 5 per cent before the Greek debt crisis began in early 2010.

60%
Percentage of Greeks who oppose the harsh austerity terms of the latest bailout plan.

166%
Greek government gross debt as a percentage of gross domestic product.

70%
Percentage of Greeks who want to stay in the euro zone.

Source: International Monetary Fund’s World Economic Outlook and Fiscal Monitor; Economist Intelligence Unit; United Nations Human Development Index.

Australia’s top 10 biggest companies, by the value of their shares listed on the ASX, comprise four banks, three mining companies, a telecommunications company, a shopping centre owner and a grocery store.

All of these companies derive their value, in some way, from the presence of a degree of monopoly power. Miners have monopoly power over particular mines, awarded by exploration licences. Telstra has a monopoly over the copper wire network for telecommunications. Westfield controls land and land has scarcity power. Woolworths owns stores in prime locations all over Australia. And the banks exist as a cosy club of four, locking customers into 25-year loans that are a hassle to transfer.

Monopolistic companies possess a power that is envied by every business person: the ability to set their prices above their costs of production.

In a truly competitive market, consisting of many sellers selling a similar product, firms don’t actually control their prices. They are “price takers”. Prices are determined by the intersection of supply and demand, and because no one seller has enough market power, they can’t influence the price. They just keep producing until their cost of producing one extra unit equals the market price.

If this all sounds a bit foreign, that’s because many of the markets for the products we consume are tainted by a degree of market power. Girt by sea, Australia has proved a breeding ground for monopolies, or oligopolies.

Pure monopolies, where one firm is the sole seller of a product without close substitutes, are quite rare. They arise when a key resource is owned by one firm, the government gives a single firm exclusive rights to produce a product, or the costs of production make a single producer more efficient than a large number of producers.

Oligopolies, however, abound. Think of groceries and you see the market dominated by two players – Woolworths and Coles. Think petrol and you get Caltex, BP, Shell and Mobil. Think banks: Commonwealth, Westpac, NAB and ANZ. Think telecommunications: Telstra and Optus. And of course, think airlines and you get Qantas and Virgin.

It’s hard to turn around without seeing the corporate logo of some oligopolist. No wonder we Australians so often feel like we’re getting ripped off, either paying more than we should in a truly competitive market or simply not getting the service that we deserve.

Trade liberalisation has opened up opportunities for cheaper imports of many everyday items such as TVs, fridges, couches and cars. When goods are internationally traded it is harder for monopolies to survive.

But many of our big purchases, groceries, electricity and home loans continue to be supplied by a limited number of domestic companies and so we need to be constantly vigilant to the presence of monopoly power.

One of the main jobs of an Australian government, then, is to stand up against these oligopolists and try as much as possible to expose them to the rigours of competition.
Banks must be bashed, telecommunication monopolies dismantled and cosy monopolists forced to provide a good product, not just for shareholders but also customers.

The Rudd government ran several inquiries into the concentration of power in the grocery and petrol markets. The problem is, once an oligopoly exists, it’s hard to unscramble the egg. Without creating new companies, like turning Australia Post into a bank, the best that can be done is to ensure barriers to entry are as low as possible. Market power is lessened if participants are opened to competition from foreign competitors. But where the product sold is a key strategic resource, such as the telecommunication or electricity networks or mines, opportunities for opening up the industry to foreign competition are limited.

Oligopolistic competition is, then, an enduring feature of the Australian business landscape. And the rewards can be handsome.

Alan Joyce, the CEO of Qantas, which has a near-monopoly over air travel in Australia, has hit the headlines with his $5 million pay packet. But he is far from the highest paid CEO in Australia.

Top of the list for 2010 was the outgoing Commonwealth Bank boss Ralph Norris, on $16.2 million. ANZ’s Mike Smith also makes the top 10, as does Westpac’s Gail Kelly on $9.6 million and Macquarie Group’s Nick Moore (an unfortunate name) on $9.6 million. In fact, of the 10 largest companies in Australia, eight also have CEOs in the top 10 of highest paid executives.

Economic theory says workers are paid according to the value of their marginal product. But what are the bank CEOs adding?

It is hard to escape the conclusion that many of their salaries derive not from the value added by the CEOs but the monopolistic power those companies exert over the prices paid by the Australian consumer.

Australian CEOs say they must be remunerated so as not to be tempted away by jobs as international CEOs. But running a company is a tougher gig in the big, deeper pools of larger economies. Better to be a big fish in a small pond.

CEOs also say they need to be compensated for the risks involved in running these very large companies. But what risk? Running a big bank in Australia is about as risky as running a large bureaucracy, and we don’t pay public servants anything like these guys get.

The membership of the top 10 companies in Australia is remarkably stable. These are not companies that fall over. In fact, the big four banks have an all but explicit guarantee they will not be allowed to fail.

Sitting in a CEO chair at the top of the ASX food chain is a great gig. These companies are simply not at risk of going under and their CEOs simply don’t deserve what they get.

He forgot to do his tax return

IT’S around this time every year I get a jolting reminder of how short life is. Yep, tax returns are due on Monday, people. Have you done yours yet? So while some of you laze about reading newspapers this weekend, think of me sitting at home sifting through receipts and cursing the Tax Office for not creating an Apple compatible etax portal. Seriously fellas, get on to it. If not for me, do it for Steve.

Just so we’re clear, it can make perfect sense to leave filling out your tax return to the very last minute, as I do. It all depends on whether you think you’ll get a tax refund or be issued a tax bill. Remember the time value of money? Give me a dollar today and I can invest it. Give it to me tomorrow and it’s not worth as much.

So if you think you’ll get a tax bill, leave it to the last minute. But if you are likely to get a tax refund, you really should have submitted months ago and had that money sitting in a uBank online savings account earning 6.51 per cent (payable only if you make regular deposits).

As an economics journalist, I feel a sense of responsibility to be among the select minority of taxpayers who still persevere each year in doing their own tax return.

But let’s face it, three in four taxpayers this year will use a tax agent to do their dirty work for them (and earn an extension on lodgement). And who could blame them?

According to a review of the Australian tax architecture for the Ken Henry tax review: “The time and resources individuals devote to complying with the requirements of the law could be allocated to more productive or satisfying activities and therefore represent a significant cost to the economy.” Amen to that.

Estimates put the cost of taxpayer compliance with the tax system as high as 2.1 per cent of gross domestic product. That’s as much as 12 per cent of tax revenue collected. The complexity of the system contributes to 1.2 to 1.5 million taxpayers every year failing to lodge. A report in 2009 by the Inspector-General of Taxation found the chances of being penalised are low: only 98,700 penalties are imposed a year for non-lodgement.

The annual drudgery of tax returns is a missed opportunity to engage people with where their tax dollars go. A small thank you note on lodgement would go a long way …

“Thank you, madam, for your completing your annual tax return. Personal income taxes account for about 45 per cent of total federal government revenue and assist us greatly in the work that we do. Business chips in another 20 per cent through the corporate tax rate and another 15 per cent comes from the GST, so thanks for that too. The rest we get from a bunch of customs duties, excises on fuel, alcohol, tobacco and some other itty bitty taxes too small to mention here.

You might be wondering where it all goes. Rest assured we usually spend every dollar we get (sometimes less, sometimes a bit more). By far our biggest expense is in welfare payments to individuals and families. Of every dollar we collect in tax this year, we expect to spend about a third on social security and welfare. About 16 per cent will be spent on health, 8 per cent on education and 6 per cent on defence.

We hope you think that’s money well spent. If not, please alert us at the earliest possible election. Many thanks for your time. Now please do go sit in the sunshine and read a newspaper.”

THE IRVINE INDEX

1.2 million
Australian taxpayers fail to lodge a tax return each year (this is a lower estimate by the Inspector-General of Taxation – the upper estimate is 1.5 million).

98,700
Number of ‘‘failure to lodge’’ penalties applied by the Tax Office in 2007-08.

$366b
Total estimated government spending in 2011-12.

88
Pages of Australian income tax law in 1936.

$122b
Federal government spending on social security and welfare in 2011-12.

5743
Pages of income tax law at the time Ken Henry began his tax review in 2008.

$34b
Cost of the age pension in 2011-12 paid to 2.2 million people.

20,000
Public servants at the Tax Office, the second largest government agency, employing 15 per cent of the Australian Public Service.

Sources: Inspector-General of Taxation, Review into the non-lodgement of individual income tax returns, June 11, 2009; Architecture of Australia’s Tax and Transfer System, by Australia’s Future Tax Review, accessible at taxreview.treasury.gov.au; 2011-12 federal budget documents accessible at budget.gov.au; FaHCSIA Facts and Figures, October 2011.

But the Prime Minister, Julia Gillard, and the Treasurer, Wayne Swan, have proven diligent students. Many of the hallmark economic policies of this Labor government – pricing carbon, the mining tax, fiscal stimulus and even efforts to cap middle-class welfare – could be torn straight from the pages of your typical HSC economics textbook.

Forcing big polluters to pay for the pollution they emit is economics 101. To an economist’s mind, pollution is the ultimate example of an “externality”. Externalities arise when the total costs or benefits of an activity are not borne entirely by the producer of that activity, but are imposed, in part, upon the rest of society. This can be a good thing. Investments in new technologies can produce “positive externalities”, or “technology spillovers”, if the resulting new technology is of potentially wider application.

That is why economists often support government subsidies for research and development. Without such subsidies, the market would produce less investment in this new technology than would be socially optimal. Any economics textbook will tell you such externalities are a case of market failure, where the level of activity produced by the free market is not socially optimal. Society is better off when governments intervene to promote the activities that generate positive externalities, or to discourage activities with negative externalities.

When your neighbour strikes up her lawnmower at 7am on a Saturday, no doubt she is doing it because it is the best use of her time. But her actions create a negative externality – noise – which affects all within earshot. The neighbourhood as a whole would be better off – enjoying more sleep and harmony – if she did not engage in such industrious activity so early in the morning. That is why local councils commonly impose curfews on the use of loud machinery, to control the noise externality.

Pollution is the textbook example of such a negative externality. If producers are not forced to pay for the pollution they emit as part of their production process, they tend to do more of it than would be socially optimal. Pollution imposes a cost on the rest of society – through global warming, increased severe weather events and drought – that is not borne by the producers themselves. Making polluters pay, even if they pass some of this cost on to consumers, corrects for this externality and gives them an incentive to pollute less.

The economic theory behind the government’s proposed minerals resource rent tax is similarly standard economics fare. Economists are always looking for ways to raise tax in a way that interferes with economic activity as little as possible. Land, being immoveable, is the ultimate example of something good to tax – land can’t move to avoid the tax. Natural resources are also largely immoveable, making them an obvious target for taxation.

But instead of setting an arbitrary annual tax based on the volume of mineral extraction – like state mining royalties – economists consider it far more efficient to tax natural resource producers as a percentage of their profits. In particular, it makes sense to tax mining companies on their “above normal profits”, that is, not just the reasonable rate of return required to tempt them into extracting resources in the first place, but the return they receive in excess of that due to the scarcity of the resource and the monopoly power they have over production at a particular mine. This is the essence of the mining tax.

The government’s multibillion-dollar stimulus program unleashed at the beginning of the global financial crisis was also by the book. It is no overstatement to say it represents perhaps the finest example of Keynesian fiscal stimulus employed by any country to date. With private demand in retreat, the government stepped forward quickly with public demand to prop up growth and employment, helping Australia to avoid recession. Crucially, the stimulus was designed to be temporary, so when the economy was on the mend the withdrawal of stimulus ensured government policy was Keynesian on the upside, too.

Carbon tax, mining tax and fiscal stimulus: a holy trinity of good economic policies that, instead of earning Labor a reputation for fine economic management, have somehow bred only discontent and fear.

Because while Labor has proved a good economics student, it has proved a woeful economics teacher, failing to impress upon voters the important and prudent nature of its reforms.

It has no doubt faced fierce opposition in building the case for good economic policy. Labor swallowed the economics textbook whole, but choked politically in the process.

But in Tony Abbott’s hands, the economic textbook seems little more than a handy blunt object with which to whack one’s opposition. The Opposition Leader appears hell-bent on styling himself as some sort of economic Antichrist.

Where Labor seeks a market-based solution to the problem of climate change, Abbott wants a multibillion-dollar system of grants, where the government will pick winners for funding to reduce emissions.

Where Labor seeks a minerals resource rent tax in line with Ken Henry’s recommendation, Abbott wants to axe the tax, meaning a return to inefficient state mining royalties.

Abbott lampooned the government’s fiscal stimulus to such a degree that it is not at all clear he would attempt any such action should global economic conditions deteriorate.

I was at the lunch earlier this year at Melbourne University when Abbott slapped down a roomful (outdoor tentful, actually) of Australia’s most respected economists for their advocacy of a price on carbon. “Maybe that’s a comment on the quality of our economists,” the Rhodes scholar and Sydney University economics graduate chided his audience.

Certainly, the comment raised some eyebrows. But mostly, the reaction seemed one of “well, he would say that wouldn’t he?”

Tony Abbott has made it abundantly clear that the arguments set out in economists’ textbooks do not impress or interest him.