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Guest post from Adrian Pagan

November 16th, 2007

Last week the Prime Minister is reported to have said that economist Richard Blandy had estimated Labor’s plan to abolish Work Choices would destroy between 200,000 and 400,000 jobs. This claim has provoked a response from Australia’s (and one of the world’s) leading econometrician, Adrian Pagan. My one line summary: Blandy has derived this estimate by comparing levels, but has ignored the pre-existing upward trend in employment.

The full piece is over the fold – if there are any opinion editors among my readers, this would make a great contribution for the final week of the campaign.

Economic tricks: A comment by Adrian Pagan

Many years ago a visiting econometrician from the U.S. gave a public lecture in which he mentioned that a secretary who was typing his material thought that “econometricsâ€? should be typed as “economic tricksâ€?. Last week the Prime Minister is reported to have said that economist Richard Blandy had estimated Labor’s plan to abolish Work Choices would destroy between 200,000 and 400,000 jobs. This was apparently based on an econometric model that was reported on in the AFR of 29/8/07. It needs to be appreciated that the conclusion is indeed a type of “trickâ€?.

Blandy claimed that Work Choices has added something like 290,000 jobs. When teaching econometrics to students one always argues that they should plot the data to get some idea of what they are trying to explain. Later, after they have finished the modeling, it is a good idea to see what the model did explain.

Following this advice one would get the figure below.

200711160942

The quite volatile dashed line is the variable Blandy was explaining – deviations from employment after trend – and the solid line called “fitâ€? are the predictions of his model. Work Choices was introduced in May 2006 where the jump in the solid line takes place.

Now the first observation is that there was a high growth in employment before Work Choices. Moreover, the model looks singularly unimpressive as a model of employment over that period. Things seem to change after the advent of Work Choices. Such marked differences inevitably makes one suspicious.

There is a simple explanation of the “improved fitâ€?. It is a consequence of the way in which Blandy allows for Work Choices in his regression – through a so-called “dummy variableâ€?. This variable goes from zero before the introduction of Work Choices to the value of one when Work Choices comes in during March 2006. No matter what the effect of Work Choices is one will find that the amount attributed to it by Blandy’s regression will be very close to the average of the employment change after its introduction. This is simply an artifact of the way in which the analysis is done and has no causal significance whatever.

Obviously there was some other factor (or factors) – X – that caused the big rise in employment before Work Choices. If X is still operating after March 2006 then its effects will be attributed in Blandy’s regression to Work Choices. Unless an attempt is made to control for X, there can be no confidence that Work Choices has had any effect.

To emphasize the foolishness of all this I replaced the Work Choices dummy with a Rudd dummy. It is constructed in the same way as the Work Choices dummy – zero until Rudd took over as leader of the ALP in December 2006 and then unity. Interpreted in the same way as Blandy interprets the Work Choices results it would imply that Rudd has added many jobs- in fact 10% more jobs per month than Work Choices did.

This type of work is akin to the famous quote from Wallace Irwin that “Statistics show that of those who contract the habit of eating, very few survive�

Adrian Pagan

Professor of Economics, UNSW
Processor of Economics, QUT
Chair, National Centre for Econometric Research

Categories: Economic policy, Oz Politics Tags:
  1. wilful
    November 16th, 2007 at 11:12 | #1

    In simple terms, the analysis is useless and Howard’s a liar.

  2. November 16th, 2007 at 11:20 | #2

    Abolition of workchoices may cause some problems at my place. If we have to return to the previously used awards that is.

    Existing staff, whose AWA’s will be current until expiry, and new hires who (perhaps) will be on the old award, working alongside each other.

    Except the new hires do not have access to the pay & conditions of those on the AWA’s.

  3. Peter Davidson
    November 16th, 2007 at 11:41 | #3

    There is a brief mention of the failings of this analysis in a piece in the business section of the Oz – http://www.theaustralian.news.com.au/story/0,25197,22741023-16965,00.html

    It points out that one problem may be the variable used to measure the mining boom – the trade weighted exchange rate.

  4. derrida derider
    November 16th, 2007 at 12:06 | #4

    Yeah, Blandy’s analysis is well below the standard one would expect of a respected professor of economics – I can only think his judgement has been clouded by ideology. In essence he fails to heed something that is hammered into every first-year undergraduate – “correlation does not imply causality”.

    After all, looking at that graph you would be likely to find that employment Granger-caused Workchoices rather than vice versa. In one sense that’s even true – without a booming economy this government would not have won well enough to get control of the Senate and introduce the legislation.

    The irony is that Workchoices probably *would* reduce unemployment in the long run simply by reducing wages and conditions amongst the low-skilled. Whether that is enough to increase total employment, though, is a separate question – reduced wages and conditions will tend to reduce the number of people wanting such jobs (ie participation).

    But then Workchoices proponents generally (a) aren’t game to publicly admit the reductions will occur and (b) make ridiculous claims about its short term effects (only a small proportion of lower-skilled jobs are currently under AWAs).

  5. al loomis
    November 16th, 2007 at 12:32 | #5

    so, are we agreed, that awa’s are a mixed blessing, and howard is a: a liar or b: confused by econometric ‘science’ or c: just trying to hold on to his job?

    perhaps we can agree on this: none of this matters in the slightest, as rudd will get in ’cause howard is oppressing single mums and going to ring in costello anyway, or, howard will get back ‘cuz those union thugs must be kept in line.

    that’s all of politics in oz: choose between hagar and attilla, then let them loose in the treasury and the army, and the justice system.

    what, me worry?

  6. November 16th, 2007 at 12:32 | #6

    It is the low-motivated who have the most to fear from Workchoices. Far more than the low-skilled.

    To date the low-motivated have been piggy-backing (via the award system) on their industrious co-workers.

  7. 2 tanners
    November 16th, 2007 at 13:24 | #7

    SATP,

    I think you may not have it right. The unselfconfident are the ones most at threat, followed by those who can afford a small cut in wages and conditions, but cannot afford the risk of unemployment, especially of quitting. The motivation that will play the largest role is that of employers, not employees.

    And don’t tell me otherwise. I have worked in a large, AWA only organisation where a decision is handed down on pay scales and no discussion is brooked. Those who are ambitious and motivated don’t dispute it, as they want to advance which is hard if you’re tagged a troublemaker.

    You may operate as a just boss – I believe you run a small business. Others, who are managers assessed on their budgets only, or who are remote from the floor and take a ‘labour component’ view of people may be less interested in either justice or for that matter rewarding or punishing individual performance.

  8. November 16th, 2007 at 13:32 | #8

    In regard of WorkChoices it was the greatest deception pulled of by the high Court of Australia. SEE ALSO MY BLOG AT http://au.360.yahoo.com/profile-ijpxwMQ4dbXm0BMADq1lv8AYHknTV_QH
    .
    Interest rates did continue to go up despite WorkChoices and therefore hardly a indication that WorkChoices is better for the limiting of inflation.
    .
    The deception portrayed by many is also that the Commonwealth has no debt. That it paid off all debt. The truth is that constitutionally (as a “CONSTITUTIONALIST� this is my primary basis to consider issues from) that Telstra actually never was sold, but pretended having been sold as without a Section 128 referendum it was beyond powers for the Commonwealth to sell it. Hence, the Commonwealth has a debt to all so called shareholders to refund their monies.
    .
    It is the same as with being obligated to vote. Well on 19 July 2006 the County Court of Victoria upheld my claims that there is no constitutional powers to force anyone to enrol and/or to vote in federal elections, as I refused to vote. Now I am BOYCOTTING the purported federal election altogether.
    .
    If Kevin Rudd simply insist to pursue the “RULE OF LAW� (as constitutionally permissible) we all be better off without any need for bogus hand outs of political parties.

  9. Tosca
    November 16th, 2007 at 14:16 | #9

    How do econometricians account for the change in the definition of employment under Howard. Surely that change has had the biggest impact on employment numbers & statistics. In claiming the lowest unemployment in 30 years we need to know whether apples are being compared with apples or with a fruit salad.

  10. November 16th, 2007 at 15:31 | #10

    Adrian’s reasoning is correct. This is not a correct way of interpreting the impact of WorkChoices since the dummy captures a large reduction in unemployment that occurred before WorkChoices came into effect.

    But dd’s claim is preposterous – higher wages won’t reduce jobs because higher wages encourage people into the workforce. The difficulty dd is that there will be fewer people wanting to employ them – employment. If there initially is an excess supply of labour then a reduction in the wage will reduce that excess supply and an increase in wages will increase it.

    And Al there is nothing in this analysis that condemns WorkChoices. The Pagan argument shows that accounting for its impact on unemployment as Howard has done is incorrect. With enough competition for workers – and there is plenty at close to full employment – removing restrictions between employers and employees should provide social benefits because it offers the potential for more labour market deals.

    Lowering union-imposed restrictions on employing unskilled workers will reduce unskilled worker wages but leave unskilled people better-off overall.

  11. November 16th, 2007 at 17:01 | #11

    #7 – 2 tanners. I agree with you. Big business and Unions deserve each other.

  12. melanie
    November 16th, 2007 at 18:27 | #12

    According to the Workplace Authority’s data, 9.3% of workers are currently on AWAs.

  13. SJ
    November 16th, 2007 at 20:22 | #13

    Good work, Adrian. You’ve got Harry Clark agreeing with you, so it should be a bullet-proof piece for any of the newspapers.

  14. Don Harding
    November 16th, 2007 at 23:15 | #14

    Adrian, I agree that Blandy’s work is poor econometrics and I agree that its pretty hard to justify any type of conclusion on the basis of such work. But I don’t agree with your statement that “Obviously there was some other factor (or factors) – X – that caused the big rise in employment before Work Choices.” The reason is that after the Coalition won the Senate majority in October 2004 it was evident that they would get rid of unfair dismissal laws and change labour laws in a way that reduced the cost to business. Since businesses are forward looking it makes sense for them to increase hiring in advance of the detail of the laws and their introduction. If one looks at the data the increased employment growth started about November 2004.

    We see this feature regularly where, because people are forward looking, a pre-announced event causes something to happen before the date of the event. One such pre announced event (Christmas) is coming up shortly presumably it will continue to cause the arival of Christmas cards in the usual way rather than Christmas cards causing Christmas.

    I agree with your general point that one would need to control for other possible explanations before attributing some part of the post Oct 2004 employment growth to WorkChoices.

    John, I think your one line summary is a bit quick for the reasons outlined above.

  15. Ian Gould
    November 16th, 2007 at 23:18 | #15

    “The reason is that after the Coalition won the Senate majority in October 2004 it was evident that they would get rid of unfair dismissal laws and change labour laws in a way that reduced the cost to business. Since businesses are forward looking it makes sense for them to increase hiring in advance of the detail of the laws and their introduction. If one looks at the data the increased employment growth started about November 2004.”

    So logically given the current polls, employers should currently be shedding labor in anticipation of a Labour victory, right?

  16. Don Harding
    November 16th, 2007 at 23:59 | #16

    In response to Ian Gould, the answer is not necesiarily. Assuming nothing big happens on world markets over the next year the effect of a Labor win on future employment will depend on several things.

    1. Will Labor also gain effective control of the Senate. If it does what sort of labour laws will it bring in. My guess is that they will be pretty reasonable from the point of view of business and could, from an economic perspective, be an improvement over WorkChoices. (Many economists, including myself, think that WorkChoices is a very poor set of labour laws). I don’t read the business community as having any great fear of Labor in this area. So, I don’t see why one should expect to see a big adverse employment effect because of what the polls are saying.

    2. If Labor doesn’t gain effective control of the Senate then it is stuck with the WorkChoices laws.

    3. Shedding labour isn’t the reverse of hiring. There are much bigger fixed costs in shedding workers. In the event that Labor introduced IR laws that raised business costs it is highly likely that the adverse effects of that on employment would be delayed until the next recession.

  17. November 17th, 2007 at 00:02 | #17

    Agree Ian, it is a most implausible explanation for increased hiring.

    Though at the moment plenty of small businesses are switching their interest rates from variable to fixed.

  18. Tony Hughes
    November 17th, 2007 at 04:38 | #18

    Maybe Blandy’s just a Bayesian with a very strong prior.

    Or a prior that doesn’t have much support.

  19. mugwump
    November 17th, 2007 at 05:00 | #19

    So logically given the current polls, employers should currently be shedding labor in anticipation of a Labour victory, right?

    Anecdotally, yes. At least two small business owner friends have fired underperformers sooner than they may otherwise have in anticipation of a Labor victory and reinstatement of unfair dismissal laws.

    I wonder how often Adrian Pagan feels compelled to comment on misguided econometric analyses that support opposition policies?

    The use of statistics to sell a message rather than tell the truth knows no political boundaries, but the efforts of academics dispelling such messages are curiously one-way.

  20. Spiros
    November 17th, 2007 at 06:02 | #20

    Good one, Mugwump. You can’t touch Pagan on the substance of what he says, so you resort to an ad hominem attack.

    Yet another rush to occupy the low moral ground by the Right. No wonder these people are about to get the drubbing of a lifetime. They are intellectually and morally bankrupt.

  21. November 17th, 2007 at 06:24 | #21

    The forward-looking hypothesis of economic fears in relation to a Labor victory is not borne out where you would expect it to be most obvious – namely the stock market. It has continued to grow strongly this year.

    Don, The forward-looking hypothesis in relation to a once-off event like the removal of unfair dismissal laws seems impossible to test. How would you ever reject it? More plausibly business will defer hiring more workers until they become cheaper rather than in expectation that they might.

  22. mugwump
    November 17th, 2007 at 08:27 | #22

    Spiros, it was JQ that touted Pagan’s credentials to bolster the import of his criticism. But given that politicians of all stripes abuse statistics, the relevance of Pagan’s reputation in this particular case depends on his impartiality. I doubt the frequency with which Pagan questions the left side of politics differs significantly from the background frequency amongst Australian academics, which to a first-order approximation is zero.

  23. Mark U
    November 17th, 2007 at 08:54 | #23

    mugwump,

    Pagan’s criticism depends on its content, which as other commenters have agreed is “spot on”. His article deals purely with the analytical approach that Blandy has adopted. So what have his political views got to do with it?

  24. Katz
    November 17th, 2007 at 08:56 | #24

    Mugwump, Blandy’s critics on this thread have accused him of incompetence, not corruption.

    Perhaps you should start with showing how your favourite leftist whipping boys are incompetent before moving on to your ambitious pet project of proving the existence of a vast left wing conspiracy to subvert the truth.

    In short, learn how to crawl before you take on the challenge of bipedalism.

  25. jquiggin
    November 17th, 2007 at 08:57 | #25

    Mugwump displays his statistical brilliance yet again. Responding to a criticism by one academic of work by another academic, he concludes “I doubt the frequency with which Pagan questions the left side of politics differs significantly from the background frequency amongst Australian academics, which to a first-order approximation is zero.”

    Similarly, when reanalysed through the Mugwump Filter, the evidence for the proposition that human activity is causing global warming yields a probability of zero (to a first-order approximation, of course).

  26. Don Harding
    November 17th, 2007 at 10:32 | #26

    Can I reiterate what John Quiggin says in response to Mugwump. Adrian was my Phd supervisor and we have coauthored several papers over about 11 years. I don’t know what his personal politics are. Nor do I care. But what I do know is that I have never seen a shred of evidence that personal politics have affected his analysis. On the contrary, one of the most enduring lessons that I have learnt from Adrian is to focus on the idea rather than any other feature such as the person. The other lesson is to have the personal courage (of which he has heaps) to be willing to debate ideas irrespective of who you are debating.

    Australia would be a much better place if more academics were willing to debate things in public. One reason they are reluctant to do that is the noise created by people who have no ideas themselves but are all too willing to shout “political bias” drowns out the content of the debate.

  27. Don Harding
    November 17th, 2007 at 10:49 | #27

    Harry Clarke, raises two questions.

    The answer to the first is that if you read what I said it was that I didn’t see Labor’s IR laws as being particularly threatening to business and it could even be favourable. So I don’t see why there would necessarily be noticeable stock market reaction.

    The answer to the second is that econometricians conduct structural break tests for single breaks all of the time so I don’t see the problem. Moreover, in finance event studies are widely used to assess the effectof say a takeover on the value of a company. One can do the same thing here except that it is employment that is of interest. The only tricky thing is that one needs a forecast of employment that is independent of Workchoices. Back in June 2006 in the Fin Review I suggested using the Treasury budget employment forecasts because Treasury was forebidden to do any modelling of WorkChoices and so they could not affect its forecasts. Its a bit rough but it remains the best approach I have seen to date.

  28. Sam
    November 17th, 2007 at 12:48 | #28

    Mugwump, your claim that ‘The use of statistics to sell a message rather than tell the truth knows no political boundaries, but the efforts of academics dispelling such messages are curiously one-way.’

    The first part of this claim has already been completely demolished by other folks, so I won’t bother commenting any further on this. But I will take issue with your claim regarding academics.

    This silly claim about academic bias, so often trotted out by the likes of you, is as offensive as it is pathetic. Do you and your ideological amigos really believe this tripe? Throughout this election there has been bucket loads of other academic opinions being trotted out that are very supportive of Coalition policies (e.g. a number of folks from the Melbourne Institute in the Oz). And while Richard Blandy might have to go back to econometrics 101, he is still an academic (adjunct professor of economics at the University of South Australia). Can anyone else smell the irony?

    What you’ve jumped into is a debate BETWEEN academics: there is nothing ‘one-way’ about that. In the future, how about trying to play the ball and not the man.

  29. davidp
    November 17th, 2007 at 13:18 | #29

    Hi Don (et al)

    Is there another way to characterise aggregate demand so we could compare the response of employment in this boom to the response of employment in another earlier boom. The microeconometric equivalent of this is using propensity scores to match your treated and controls – this seems to be one way to sort out the effect of Work Choices.

    cheers

  30. davidp
    November 17th, 2007 at 13:21 | #30

    P.S.
    Alternatively if we had firm or plant level data and an argument could be made for differential impacts of work choices on different types of firms (like we did for the Workplace Relations Act) this might be another way to get the same thing. I don’t know enough about Work Choices to do this (and don’t have the data!)

  31. November 17th, 2007 at 15:33 | #31

    Don you said:

    ‘Since businesses are forward looking it makes sense for them to increase hiring in advance of the detail of the laws and their introduction.’

    I am saying that if this was true in labour markets it is even more likely to be true in equity markets and so far it has not been.

    I cannot see how Treasury forecasts of employment (ignoring policy effects) have much to do with the employment decisions of firms anticipating policy changes. If the shocks were repeated you might get away with it but a once off shock I don’t see how. That it is done all the time does not neceesarily make it sensible.

  32. sdfc
    November 17th, 2007 at 23:08 | #32

    Gee and here was I thinking that our strong employment growth was due to the terms of trade boom and easy monetary policy.

    Let’s face it in the current climate Workchoices effects only the most vulnerable members of our society.

  33. mugwump
    November 18th, 2007 at 04:33 | #33

    Mugwump, your claim that ‘The use of statistics to sell a message rather than tell the truth knows no political boundaries, but the efforts of academics dispelling such messages are curiously one-way.’
    The first part of this claim has already been completely demolished by other folks.

    You claim Labor or the green left are pure in their use of statistics yet the Coalition are corrupt? Good luck with that – I look forward to your thesis.

    But I will take issue with your claim regarding academics. This silly claim about academic bias, so often trotted out by the likes of you, is as offensive as it is pathetic…

    as it is true.

    I was once an academic. Worked in two Australian Universities, including the IAS at ANU. I’d guess less than 10% of my fellow academics at either institution were of the right.

    If I am so off the mark, where are the references to Pagan’s myriad attacks on poor applications of econometrics by the left?

  34. Ian Gould
    November 18th, 2007 at 12:03 | #34

    “You claim Labor or the green left are pure in their use of statistics yet the Coalition are corrupt? Good luck with that – I look forward to your thesis.”

    No, I believe the claim is that all statistics should be viewed with a degree of skepticism.

    But when one individual is shown to be misusing statistics, the proper response isn’t “everybody’s doing it”.

    As I’ve noted before, most of us here are interested in establishing the facts, you on the other hand seem primarily driven by a desire to defend your pre-existing ideological prejudices.

    Personally, I take the view that if my position need to be defended by distorting or ignoring the facts, that means I need to re-examine my position.

  35. Thomas Walker
    November 19th, 2007 at 05:11 | #35

    Great work. I was thrilled to read this article, and Gittins’ discussion of it in SMH. The underlying data say it all – Blandy’s model is just a level shift plus noise. I will be interested to see Adrian’s estimate of the effect on jobs of Howard’s exit in about a week.

    I am glad to see Australia’s academics playing a key role in this election. It is so easy for politicians to make glib claims about policy effects, yet those of us who spend our lives estimating these things know how perilous it can be. I can only wonder how the Liberals would have got the econometric result they wanted had the legislation been introduced in a downswing. Howard is a clever politician indeed.

  36. Lukas
    November 19th, 2007 at 08:21 | #36

    @14 Don Harding says:

    “I don’t agree with your statement that “Obviously there was some other factor (or factors) – X – that caused the big rise in employment before Work Choices.â€? The reason is that after the Coalition won the Senate majority in October 2004 it was evident that they would get rid of unfair dismissal laws and change labour laws in a way that reduced the cost to business. Since businesses are forward looking it makes sense for them to increase hiring in advance of the detail of the laws and their introduction. If one looks at the data the increased employment growth started about November 2004.”

    The extent of the changes to unfair dismissal and other laws was not apparent in November 2004. Howard’s announcement that the unfair dismissal laws would be removed for firms with less than 100 employees (as opposed to the 20 employees they had promised) was not made until the end of May 2005 and came as a considerable surprise. Businesses would not have factored such a change into their decision making in November 2004.

    @2 SATP says:

    “Abolition of workchoices may cause some problems at my place. If we have to return to the previously used awards that is.”

    Of course SATP you won’t have to go back to awards after a change of government. You can make overaward payments, like the majority of businesses did. If you want to reduce penalty rates and the like you can just use an employee collective agreement, provided that you can get the majority of employees to agree to it. If you can’t, then it’s probably not a good idea anyway.

    @12 Melanie says:
    “According to the Workplace Authority’s data, 9.3% of workers are currently on AWAs.”

    The Workplace Authority estimates of AWA coverage are grossly exaggerated, as they assume that every worker who signs an AWA remains in their job for a minimum of three years.

  37. m.p.
    November 19th, 2007 at 09:34 | #37

    davidp
    Treasury actually did a comparison of the current boom with the boom of the 1970s, and they (unsurprisingly) found that Australia has performed much better in the current boom than in the 70s. Reason: the economy is much more flexible now.
    See: http://www.treasury.gov.au/documents/1087/PDF/03_Gruen_speech.pdf

  38. m.p.
    November 19th, 2007 at 09:40 | #38

    Ian Gould, Sam et al
    While Pagan may not be biased, there are plenty of others in the IR field who are. A classic is David Peetz, who (for example) argued that IR reform in New Zealand reduced productivity whereas various researchers have shown that productivity in NZ improved after they did IR reform.
    See: Diewert & Lawrence (1999) “Measuring New Zealand’s Productivity� Treasury Working Paper Series 99/5-1 reach the conclusion that “After 1993 there was a productivity surge. This is likely to have been aided by the effects of the labour market reforms of the early 1990s, among other things� (p xx)
    Also see ). Conway & Hunt (1998) “Productivity Growth in New Zealand: Economic reform and the Convergence Hypothesisâ€? Reserve Bank of New Zealand Discussion Paper G98/2 and Perry (2006) “Do Workplace Contracts Harm Labour Productivity Growth – a reconsideration of the macroeconomic evidence from New Zealandâ€? Australian Economic Review 39(4)

  39. davidp
    November 19th, 2007 at 09:58 | #39

    Thanks m.p., will take a look at this – will be interested to see how they did it

  40. derrida derider
    November 19th, 2007 at 12:12 | #40

    Harry, read what I said carefully. I never said that Workchoices *will* reduce jobs in the long run – I said it was “another question”.

    You’re balancing two effects that work in differing directions – more people will be in low-skill jobs because they’re easier to get, fewer people will be in such jobs because they pay less. The result on total employment is theoretically ambiguous, and given where we’re starting from (ie essentially full employment, so unemployment can’t be reduced much) you’d be brave to predict the empiric outcome.

    Of course, to the extent that Workchoices delivers increased employment of marginal workers it will tend to *reduce* average productivity by a simple compositional effect.

  41. Bruce
    November 19th, 2007 at 15:14 | #41

    How did Blandy become a Professor? I can do a better analysis of the impact of work choices than that!

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