My article in today’s Fin argues that while suggestions for cuts in petrol excise are silly, removing GST completely from food would relieve household budgets while improving economic efficiency.
Category: Economic policy
Peak car
Today’s Fin (paywalled unfortunately) includes the neat neologism “Peak Car” from transport consultant John Cox, making the point that car travel in developed countries is unlikely to increase further. I’ve tended to disagree with Cox in the past: for example, with this 2006 piece, which stated that public transport is in terminal decline. This was just at the beginning of the recent resurgence in public transport use, particularly noticeable in Brisbane. Still he’s right about the peak, or more precisely plateau in car travel, matching what’s happening to oils supplies. I’d take it further and say that the inevitable (given no growth in supplies and increased demand from China and India) decline has probably already begun.
Calculated Risk points to this report from the US Dept of Transportation, showing the first yearly decline in several decades, and includes a graph which shows that the recent decline follows several years of flattening
Don’t sell water down river
That’s the headline for my article in today’s Fin. It’s a nice pun (sub-editors love this kind of thing) but I should clarify that in fact, I am in favour of upstream irrigators selling water to flow down the river to restore natural flows and provide drinking water for Adelaide.
You can read the full article here on the RSMG blog.
Instant budget reaction
First up, I have to say that it was good to watch a budget without having to put up with Peter Costello. Unlike Howard, I never regarded Costello as having any real substance. Even after 11 years on the job, his mastery of his portfolio was a clever barrister’s mastery of his brief, not a serious understanding of economics. Despite his nervous start in the job, and a delivery of the Budget that wasn’t notable for rhetorical flair, Swan impresses me more as knowing what he is talking about. Turning again to the Opposition for contrast, I didn’t think much of Malcolm Turnbull’s response, claiming (on a basis he never made quite clear) that this was a “high-taxing, high-spending budget”, and edging perilously close to attacking the government for closing the alco-pops tax loophole his own side had created. Clearly the Liberals are still trying to work out what they stand for.
Coming to the main point, the government did a good job in keeping its promises, even if households on incomes over $150 000 may feel picked on. The means-testing of Family Payment B was announced before the election, and the threshold could scarcely have been higher than it was.
IIRC, the Howard tax cuts, largely copied by Labor were announced in nominal terms (without allowing for inflation). If so, the higher than expected inflation bequeathed to Swan is actually something of a gift, since it means that bracket creep will pay for (and justify) much of the promised cuts. Looking at the parameter revisions, most of which have been attributed to “the mining boom” it’s hard to believe that the $12 billion or so the government has gained from this source is all due to real increases in revenue, so I think bracket creep is playing a role here.
I was disappointed, if not very surprised, that the budget savings were made up almost entirely of odds and ends, with big targets like the dependent spouse rebate and the FBT exemption for cars left pretty much untouched (the rebate was subjected to the 150K means test). That said, there was enough fat left over from the previous government that it was possible to cut $7 billion or so without causing any obvious pain. It won’t be so easy next time, and I think it would have been better to take some pain this time around. Still with a surplus of 1.8 per cent of GDP, it’s unsurprising that they didn’t feel the need to cut further.
The one big new thing in the Budget (new in magnitude, but not in concept) was the announcement of $40 billion in infrastructure funds, building on the Future Fund and the Higher Education Endowment Fund. This seems promising, especially as the money seems likely to be invested in a mixture of equity and other assets, allowing the government to keep on issuing at least some debt.
Overall, this Budget is reasonable as regards its macroeconomic settings, cautious but reasonably sensible in fiscal terms, and likely to be politically successful (first budgets usually are). But it’s left some hard decisions to be taken later and, with a three-year term, there will only be one more chance before the next election year budget.
The one-hoss shay
The Fed’s bailout of Wall Street investment bank Bear Stearns has, unsurprisingly, been discussed in terms of the domino theory. A more appropriate metaphor is The Wonderful One-Hoss Shay . This was a carriage constructed on the theory that a system always fails at its weakest spot.
he way t’ fix it, uz I maintain, Is only jest T’ make that place uz strong uz the rest”.
On the Fed’s current approach, the system is unbreakable, provided that “too big to fail” protection is extended to every significant firm in the system. The result of this protection is that the kind of crisis where the failure of one firm leads to a cascade of failures elsewhere is prevented. But then
First a shiver, and then a thrill, Then something decidedly like a spill,– And the parson was sitting upon a rock, At half-past nine by the meet’n’-house clock,– Just the hour of the Earthquake shock!
–What do you think the parson found, When he got up and stared around? The poor old chaise in a heap or mound, As if it had been to the mill and ground! You see, of course, if you ‘re not a dunce, How it went to pieces all at once,– All at once, and nothing first,– Just as bubbles do when they burst.
A lot or a little, part 2
This CT post on Stiglitz and the cost of the Iraq war reminded me to get going on one I’ve had planned for some time, as a follow-up to this one where I pointed out that the $500 billion in aid given to Africa over the past fifty years or so is not, as is usually implied, a very large sum, but rather a pitifully small one, when considered in relation to the number of people involved, and the time over which the aggregate is taken.
What are the sums of money worth paying attention to in terms of economic magnitude. I’d say the relevant order of magnitude is around 1 per cent of national income[1], say from 0.5 per cent to 5 per cent. Smaller amounts are important if you’re directly concerned with the issue at hand, but are impossible detect amid the general background noise of fluctuations in income and expenditure. Anything larger than 5 per cent will force itself on our attention, whether we will it or not.
To get an idea of the amounts we’re talking about, US national income is currently about 12 trillion a year, so 1 per cent is $120 billion a year. A permanent flow of $120 billion a year can service around $6 trillion in debt at an interest rate of 4 per cent, so a permanent 1 per cent loss in income is equivalent to a reduction in wealth by $6 trillion.
For the world as a whole, income is around $50 trillion, so the corresponding figures are $500 billion and $25 trillion.
What kinds of policies and events fit into this scale?
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Lowering the NAIRU
Among the relatively few points the opposition has scored in this Parliament has involved the unwillingness (or, in the Opposition’s telling, inability) of Treasurer Wayne Swan to respond substantively to a question from Malcolm Turnbull about the level of the NAIRU (non-accelerating inflation rate of unemployment), AKA “the concept formerly known as the natural rate”.
At this point I was going to refer readers to Wikipedia but, as with quite a few economics articles, it’s not entirely satisfactory. However, rather than complain, I’ve edited it to include a slightly better explanation.
Coming back to Australia, the fact that inflation is rising suggests that, if the NAIRU exists, we are now below it. It doesn’t seem as if there is much scope for fiscal and monetary policy to be tightened further. Given the risk of a breakdown in global credit markets, raising interest rates any further seems very dangerous. And the tax cut promises (which should be kept – the credibility of political processes is more important than the risk of inflation) mean that the scope to tighten fiscal policy is limited.
What remains is the possibility of reducing the NAIRU by improving the performance of labour markets. Education and training will help in the long term, but not so much in the short run. What is needed is to take advantage of the tight labour market to reduce long-term unemployment and to bring discouraged workers back into the labour market. At this phase of the cycle, the best policy instrument to achieve this goal is a targeted wage subsidy. Employers who take on workers moving off unemployment and disability benefits, or re-entering the labour force after a long absence should receive a subsidy for a period of say, three to six months. I’ll try to post a bit more on this, and why it’s superior to suggested alternatives like cutting minimum wages, before too long.
Reviewing the Stern Review
The Productivity Commission has just released a paper called The Stern Review: an assessment of its methodology (the full paper is a 1.3Mb PDF). It’s very good, I think, giving a balanced presentation to the Review, its supporters and critics and those who fit into neither category. Here’s the summary:
The Productivity Commission today released a staff working paper titled The Stern Review: an assessment of its methodology. This technical paper contains a detailed examination of key elements of the Review’s analytical approach. Originally prepared as an internal research memorandum following release of the Stern Review’s report, the paper is being made more widely available given its ongoing relevance in light of Australia’s Garnaut Review.
The staff paper finds that the Stern Review made some important analytical advances. The Review sought to move beyond analysis based on the mean expected outcome to one that incorporates low probability, but potentially catastrophic, events at the tail of probability distributions. The Review also attempted a more comprehensive coverage of damage costs than most previous studies.
The paper also finds that value judgements and ethical perspectives in key parts of the Stern Review’s analysis led to estimates of future economic damages being substantially higher, and abatement costs lower, than most previous studies. The paper notes that the report could usefully have included more sensitivity analysis to highlight to decisionmakers the consequences of alternative assumptions or judgements.
Looking at the way debate has evolved both within and outside the economics profession, a few points have emerged
* No-one credible now disputes the view that a well-designed set of policies could greatly reduce CO2 emissions at very low cost. The Stern Review is marginally lower than average at 1 per cent of GDP, but it would be hard to find any serious analyst claiming costs much higher than 3 per cent. These are once off changes in levels corresponding to a once-off loss of between a few months and one year of improvements in material living standards. It’s intuitively hard to see how risking the worst case outcomes of climate change to avoid such a small economic cost could possibly be justified.
* While there is still plenty of dispute about the economic costs of doing nothing, relative to stabilisation, the median estimate has been revised sharply upwards following the Stern Review. On the issue of discount rates, the (still controversial) choice of a low rate by the Stern Review pointed up the dependence of earlier estimates on rates that now look implausibly high. And on the treatment of risk and damage to the natural environment, Stern’s look at these issues points up how badly neglected they were in the past. If anything, subsequent discussion has suggested that Stern was too conservative.
The speed with which the economic debate has evolved has left the political advocates of doing little or nothing stranded. Most of them had no qualifications in climate science, and embraced delusionist arguments against the science because they were opposed on political, economic or culture-war grounds to the kinds of policies needed to stabilise climate. Many of them clearly envisaged a campaign in which they would fight as long as possible on the science before turning to the economics. But the speed of change has left them flatfooted. Rather than being able to make a graceful retreat to a prepared position, they are trying to argue against what is now the mainstream economics position, while still being lumbered with their now-discredited attacks on mainstream science.
Ergas v Quiggin on risk and social democracy
A while ago, I wrote a piece for the Centre for Policy Development (PDF) , making the case that risk and its management, in various forms, would be the central policy issue of the 21st century. The central idea of the piece was to show how an improved understanding of risk could contribute to a modernised social democratic model.
The piece got a bit of attention, and has now been paid the compliment of a full length reply in Quadrant by Henry Ergas . Ergas raises some good points, and usefully extends the discussion in important respects. Unfortunately, he misses the point of the article fairly thoroughly, to the point where he often seems to be arguing against an imaginary opponent. His repeated claims that the paper is unclear reflect the problems he is having matching my paper to the one he thinks he is reading. The debate isn’t helped by the fact that, although Quadrant is now at least partly online, the idea of hyperlinks is too new for its editor, with the result that most of Ergas readers will probably not have read the piece he is criticising.
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Iemma’s power failure
Over the fold, my column from yesterday’s Fin, on NSW electricity privatisation, which ran under the title above
John Quiggin 