The Sydney Morning Herald has an editorial praising the expenditure cuts introduced by the Hawke-Keating government in 1986 and 1987, and suggesting that Abbott should copy this example. Apparently, according to the Oz, Hawke and Keating themselves have endorsed this view (I haven’t gone behind the paywall for the full article).

This argument carries a great deal of force, because, as we know, the Hawke-Keating cuts restored the budget to surplus, leading to Keating’s famous declaration that the 1988-89 Budget was “the one that brings home the bacon”. Leading scholars like Alesina and Ardagna have pointed to this exercise as one of the great success stories of “expansionary austerity”.

What’s that you say? The economy fell in a heap in 1989, leading to a decade of deficits and fifteen years of high unemployment? To quote another Keating aphorism, that was “the recession we had to have”. I guess we are about due for another.

With the closure of GMH locked in, it seems virtually certain that Toyota will follow the same path in the end, along with most of the supporting components industry. It’s possible that a well-designed policy, combined with a sustained depreciation of the $A, could keep the industry alive (the fact that it survived the end of the high tariff era was largely due to the Button Plan in the 1980s), but this is the Abbott government we’re talking about, so it seems unlikely.

The impending end of the car industry constitutes the effective end of large scale manufacturing in Australia, at least as the term is ordinarily understood. The remaining manufacturing sector consists mainly of basic processing of agricultural and mineral products for export, along with food and beverages for the domestic market. Elaborately transformed manufactures, on which such high hopes were pinned in the 1980s and 1990s have been declining for years, and will be confined to niche markets once we stop exporting automotive products.

An immediate policy implication of the end of car production is that it’s time to drop a bunch of policies whose rationale was to support the domestic industry. The most obvious candidate is the FBT concession, just reinstated by the Abbott government. But there’s also the maintenance of some of the worlds weakest fuel efficiency standards, driven by the desire not to tilt the playing field against Falcons and Commodores. More generally, a whole range of pro-car policies will need to be reassessed, given that they increase our dependence on imports and therefore our vulnerability to terms of trade shocks.

There are direct implications for employment policy, arising from the job losses that are about to take place, and longer term implications for education and training. More on these soon, I hope.

I’ve been asked a few times about the Grattan Institute’s new report Balancing budgets: tough choices we need. It’s a substantial piece of work, and isn’t driven by a partisan agenda or special interest lobbying. On the other hand, I disagree strongly with the implicit criterion for policy design. This is nowhere spelt out, but the analysis is clearly driven by the following rule: seek policies that maximize GDP growth, subject to the constraint that the poorest (bottom 20 per cent of) households should not be made worse off.

This is most evident in the recommendation to remove the GST exemption for fresh food and use some of the proceeds to compensate the poorest 20 per cent of households. Let’s compare this with the alternative of raising income tax rates for high income earners (say, the top 20 per cent). By design, neither proposal has much net effect on the poorest 20 per cent. But the food tax falls mostly on the middle 60 per cent of households, since the top 20 per cent don’t spend much more on fresh food than the middle income group. It’s true that the cost of raising money through income tax is higher (Grattan uses an estimated cost of 25 per cent of the gross revenue) than for a food tax (5-10 per cent). But let’s spell this out a bit. Suppose you need to raise $500 in net revenue (roughly speaking what you’d get from the food tax for a household spending $100 a week). Would it be better to impose the tax on Gina Rinehart (in which case, taking account of the economic costs of collecting the tax, you’d have to raise an extra $100 or so compared to the food tax) or on one of her employees. If you regard Rinehart as an extreme example, take the choice between taxing a university professor (definitely in the top 20 per cent) or a campus worker such as a gardener or cleaner (not in the top 20 per cent, but normally not in the bottom 20 either, since this group consists almost entirely of people on pensions and benefits).

The fact is that Howard’s tax cuts, mostly carried on by Labor, used the temporary proceeds of the mining boom to permanently increase the after-tax income of the top 20 per cent. That’s the biggest single cause of the budget problems identified by the Grattan Institute, and the first thing that needs to change if we are to fix those problems.

Following on from my previous post on productivity and the eponymous Commission, I have a piece in the Guardian with the stated objective of killing the productivity/micro reform zombie once and for all. Of course, that’s impossible: as watchers of the genre know, there are always more zombies, then sequels and new seasons, then reruns. But I’ll keep on trying.

As regular readers will know, I’ve had a long debate[1] with the Productivity Commission on the sources of the supposed ‘productivity surge’ of the 1990s, which, I’ve suggested was primarily the result of increased work intensity and unmeasured increases in working hours at a time of high job insecurity. I was looking back at some of these discussions when Google turned up a Hansard transcript of hearings of the Senate Standing Committee on Economics in 2012. It turns out that the Commission now agrees with me, and has done so for some time. To quote the Commission’s expert witness, Dr Jenny Gordon[2]

There was a very big debate with the former branch head, Dean Parham, who did a lot of work on productivity. He looked at the effect of the reforms and ICT, which is one of the points that Professor Quiggin made, in trying to explain the productivity boom of the 1990s in terms of what actually happened. Professor Quiggin’s main point is that work intensity is important, which is quite hard to measure but, in fact, is a major source of productivity growth. If people work smarter and work harder while they are at work, that will improve productivity. So it is cutting the fat of organisations, I suppose you could call it. The other point is that people are working longer hours. But the way the productivity measurement is done takes account of the hours of work. That is actually data collected through ABS surveys of individuals reporting the hours that they work. So we could measures hours properly. It is hard to measure work intensity. It does appear and it is a source of productivity growth … So we were in full agreement with that. So the debate was settled back in the mid-2000s.

It’s good that we are in agreement this far. I would add though that productivity growth achieved by working harder does not, in general, improve economic welfare. As for “working smarter”, if this is a reference to technological progress, it’s fine. In my experience, however, it’s usually management-speak for “do the same job with less resources, and work out for yourself how to do it”.

More importantly, the key implication of my analysis is that, to achieve sustainable improvements in living standards, we ought to be focusing on getting the macro issues right rather than lining up for another round of microeconomic reform. Increases in work intensity don’t last, as experience since the 1990s has shown. Genuine long-term improvements in the productivity of the economy can be gained only through educating the workforce to take account of improvements in technology (only a small proportion of which are generated domestically) and through macroeconomic and labour market policies that avoid wasting human potential through unemployment and other forms of social exclusion.

fn1. In the same hearing I cite here, PC Chairman Gary Banks described it as a ‘rich’ and ‘ongoing’ dialogue. I’ve certainly learned a lot from it, and I hope the same for the Commission and any onlookers patient enough to follow it.
fn2. Not particularly germane, but interesting to this post is that Dr Gordon is married to Brian Schmidt, winner of the 2011 Nobel Prize for Physics

Reports that the NSW Liberal government is planning to buy back the Cross-City tunnel, following the bankruptcy of the second set of private owners mark an important step in the failure of the private infrastructure program launched in the 1980s with the Sydney Harbour Tunnel[1].

The interesting failure here is not the bankruptcy of the operators but the recognition that the whole idea of imposing tolls on a road designed to divert traffic from the city is nonsense. The most sensible plan, after buying the tunnel is to remove the toll and free road space in the CBD for a variety of initiatives including light rail and cycleways.

Unfortunately, the lessons have not been learned. The new WestConnex project in Sydney is to be a largely private tollway. The proposed East-West link in Melbourne is also a toll road but “is being procured as an Availability Public Private Partnership (PPP), with the State initially retaining tolling and traffic risk.” Whether or not these projects are economically and socially justified, there is no doubt that the use of toll funding will greatly reduce the benefits, leaving more traffic on congested, but untolled, roads.

fn1. A sham deal, which was eventually reconstructed as a publicly owned tunnel with a private operating contract.

The Abbott government is faced with its first big economic policy decision, a bit sooner than I expected. Going into the election Abbott promised to reverse the Rudd government’s tightening of FBT rules for motor vehicles, at a cost of $1.2 billion over the forward estimates period of 4 years. This was to be funded in part by scrapping $500 million of assistance to the domestic car industry.

Since the great majority of cars in Australia are imported, and since much of the benefit of FBT rorts is dissipated through the inefficiency of the required structuring of salary packages, the reversal of the FBT decision yields only a minimal benefit to the domestic industry. It’s unsurprising therefore, that Holden has announced that, unless the government restores Labor’s assistance policy by Christmas, the company will close down. The general assumption is that the resulting contraction of the supply chain would force Toyota out of domestic production as well, so that the entire industry would shut down.

All of this would be comprehensible if the government was pursuing a consistent free-market line. But no one has tried to pretend that the FBT treatment of cars is anything other than a rort. LNP advertising during the election was all about the damage removing the rort would do to jobs in the salary packaging industry and to employers who depended on the rort to reduce their wage bills. Those employers notably include charities and NGOs which could be aided more efficiently with grants – of course, the LNP is going to cut those grants.

Assuming the government is unwilling to see the car industry close down within its first year of office, the sensible thing would be a double backflip, restoring Labor’s policy. That seems highly unlikely. I’ll also be surprised if the government holds its nerve and lets Holden close. So, I suspect we are going to see a half-baked partial solution which will increase the structural budget deficit relative to any consistent policy, and still only defer the end by a few years.

But, even if we don’t make cars any more, we will, at least, have a salary packaging industry that is the envy of the world.