Basic Economics for Australia

This is the best article I have read on the economics of recent policy changes for quite some time. All students (and perhaps Coalition politicians) should read it.

Jessica Irvine

Economics by book not for Abbott

October 14, 2011


Economics textbooks are hefty objects. Many a kinked neck and curved spine have resulted from children being forced to lug such weighty tomes between school and home.

Whether many students manage to read and absorb the often turgid contents of such books remains an open question.

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.

Read more: http://www.smh.com.au/opinion/politics/economics-by-book-not-for-abbott-20111013-1ln1b.html#ixzz1ajjutopH

Surprise, surprise ... the rich have got richer

Today the ABS reported that

Richest households 15% richer

The wealthiest 20% of households have increased their average net worth 15% since 2005-06 (CPI adjusted), while the poorest 20% of households saw only a 4% rise, according to the Australian Bureau of Statistics (ABS).

These wealthy households had an average net worth of $2.2 million per household, and accounted for around two-thirds of total household wealth. The poorest 20% of households had an average net worth of $32,000 per household, which accounted for 1% of total household wealth.

The average wealth of an Australian household in 2009-10 was $720,000, up 14% (CPI adjusted) since 2005-06.

There were differences in the average levels of wealth between the states and territories. Average net worth in Queensland, South Australia and Tasmania were below the national average.

Household wealth was more concentrated in metropolitan areas. The average net worth of households located in capital cities was $772,000 as compared with $629,000 in areas outside of capital cities.

Owner-occupied homes were the main asset held by Australians. Mortgages on them were the main liability, with over two-thirds of Australian households owning their own home either outright or with a mortgage.

For households who owned their home outright (2.7 million households), the average value of the home was $541,000. For those households with a mortgage on their home (3 million households), the average value of the home was $521,000, and the average mortgage outstanding was $188,000, giving a net home equity of $333,000.

One in five households owned property other than their own home, including holiday homes and rental properties.

Superannuation was the main financial asset held by households, with three-quarters of all households having some superannuation assets.

For households with superannuation, the average value of their superannuation was $154,000, but for half of these, the value was less than $60,000.

More information can be found in Household Wealth and Wealth Distribution, Australia, 2005-06 (cat. no. 6554.0).

Other interesting stats

"Sixty-nine percent of households own their own home either outright or with a mortgage"

It also notes the important distinction between means and medians

DISTRIBUTION OF WEALTH


While the mean household net worth of all households in Australia in 2009-10 was $720,000, the median (i.e. the mid-point when all households are ranked in ascending order of net worth) was substantially lower at $426,000 (table 7). This difference reflects the asymmetric distribution of wealth between households, where a relatively small proportion of households had high net worth and a relatively large number of households had low net worth, as illustrated in the following frequency distribution graph (S1).

As shown in table 2, over 1.2 million households (16%) had net worth less than $50,000, with 77,000 of these households having negative net worth (1% of all households).

S1. DISTRIBUTION OF HOUSEHOLD NET WORTH, 2009-10

Another measure of wealth distribution is provided by the net worth shares of groups of households at different points in the wealth distribution. The following graph (S2) shows that, in 2009-10, households in the highest net worth quintile held 62% of the total net worth of all households, while a further 20% was held by households in the 4th quintile. By comparison, the lowest three quintiles held, in total, 18% of total net worth.
S2. Net worth, Percentage share of total

 

It also notes the distinctions between WEALTH and INCOME [for example while I might have a reasonable income, I have no wealth :-( ]

Wealth is distributed between households somewhat differently to income. While the 20% of households comprising the lowest net worth quintile accounted for only 1% of total household net worth, they accounted for 12% of total gross household income. The 20% of households comprising the lowest gross household income quintile accounted for 4% of total gross household income but 13% of total net worth (table S4).

The differences in the distribution of wealth and income partly reflect the common pattern of wealth being accumulated during a person's working life and then being utilised during retirement. Therefore many households with relatively low wealth have relatively high income, especially if they are younger households. Conversely older households may have accumulated relatively high net worth over their lifetimes, but have relatively low income in their retirement.

In addition, some households have low or even negative incomes due to business or investment losses, but still have relatively high levels of net worth. ...

The lowest equivalised income decile had a higher mean equivalised net worth ($309,000) than the second to fifth equivalised income deciles. Average equivalised net worth of households in the highest (tenth) income decile was more than double that of households in the ninth income decile ($1,158,000 and $477,000 respectively).

Of course the stage of life you are in matters considerably as well

Life cycle stages


A typical life cycle includes childhood, early adulthood and the forming and maturing of families. ...

Of the selected life cycle groups, the group with the highest mean household net worth was couple only, reference person aged 55 to 64 ($1,317,000). Many of these people are either nearing the end of their time in the labour force or have recently retired, that is, they are at the end of the main wealth accumulation period. People over 65 had lower net worth on average ($1,111,000 for couples and $572,000 for lone persons), at least partly reflecting a run-down of assets to support consumption in retirement. These older cohorts may also have had less opportunity for capital accumulation in earlier decades, for example, because women had lower participation rates in the paid work force. 

Lone persons aged under 35 had the lowest mean household net worth, at $151,000. The mean household net worth of couple only households with a reference person aged under 35 was $237,000 (or $119,000 per person). These couple only households had almost twice the level of mean gross household income of the young lone person household ($2,128 per week compared with $1,152 per week). The mean age of the household reference person in both household types was 28, that is, they had had the same amount of time on average to accumulate wealth.

One parent, one family households with dependent children had a mean net worth of $276,000, compared to $827,000 for couple family households with dependent children. Differences in relative age did not contribute significantly to this substantial difference in net worth, since the average age of parent was 41 years for the one parent families and 42 years for couple families. Home ownership for the one parent family households was about half that of the couple family households (40% and 77% respectively)

Interesting stuff.

Cartoons of the Week

More to the point ... here's my workspace where it all happens

Dreams and Nightmares

I've recently written a very long paper on Australian-Asian relations called Dreams and Nightmares: Australia's Past, Present and Future in Asia. It was written for the Institut français des relations internationales (it's in English).


 

Cartoons of the Week

China's Steel Industry

A Reserve Bank of Australia paper from 2010 by James Holloway, Ivan Roberts and Anthony Rush on China's steel industry makes interesting reading in the light of the problems of the Australian steel industry.

Some of the main points:

Growth has been rapid with the period from the mid-90s to the mid-2000s most significant. Growth fell during the financial crisis and recovered on the back of extensive fiscal stimulus by the Chinese government. My guess is that it will slow over the next few years.

Since the introduction of market-based economic reforms in 1978, the Chinese economy has grown strongly, recording an average annual growth rate of around 10 per cent. Over this period, Chinese steel production has also expanded rapidly, growing at an average annual rate of 7 per cent during the 1980s, 10 per cent during the 1990s and close to 20 per cent in the 2000s (Graph 1).

China's percentage of global production has increased rapidly.

China now accounts for around 45 per cent of global steel production, which is significantly higher than its share of 15 per cent at the start of the decade

The Chinese government has attempted to consolidate the industry increasing the percentage of production by the large state-owned firms.

In 2008, there were more than 660 companies producing crude steel, with thousands of other firms producing finished steel and steel-related products. The top 10 producers accounted for less than 50 per cent of crude steel output, with the next 75 companies accounting for an additional 30 per cent (State Council 2009, CISA 2009). Most of the larger Chinese steel producers are state-owned, while a significant proportion of the smaller producers are private companies. Geographically, the industry is widely dispersed. The coastal provinces account for around 65 per cent of crude steel production, with the concentration of steel production in the north-east of the country partly reflecting proximity to major iron ore mines, particularly in Hebei and Inner Mongolia ... 

In July 2005, the National Development and Reform Commission issued a formal policy on steel that sought to spur consolidation by increasing the concentration of steel production among large producers, and to protect the environment by reducing energy consumption and eliminating obsolete production capacity. Targets for industry consolidation through mergers and acquisitions or closures of small- to medium-sized firms were outlined. In June 2010, the State Council updated these targets, announcing that the production share of the 10 largest steelmakers was to rise from 44 per cent in 2009 to 60 per cent by 2015, with a goal of cultivating three to five very large, internationally competitive iron and steel conglomerates (State Council 2010). 

Steel can produced from iron ore and coking coal or from scrap. In Western countries a good deal - about a half to two-thirds - is produced from scrap. In China it is mostly produced from scratch.

Crude (or unprocessed) steel can be produced either directly from iron ore and coking coal using the blast furnace/basic oxygen converter method, or from scrap steel (and other inputs) using the electric arc furnace method. In the United States and Europe, where the electric arc furnace technology is commonly used, between one-half and two-thirds of steel is produced using scrap. In contrast, in China more than 90 per cent of crude steel is produced by steelworks using blast furnaces and basic oxygen converters (World Steel Association 2010). This reflects difficulties with the supply of electricity in some parts of China and low domestic availability of ferrous scrap, due to relatively low household consumption of steel-intensive manufactures and limited scrap collection and processing systems. The prevalence of the converter method has important implications for resource demand: on average, each tonne of Chinese steel requires around 1.7 tonnes of iron ore and more than half a tonne of coking coal as inputs. This helps explain the significant increase in China's demand for these resources over the past decade.

China has significant iron ore reserves but they have lower iron content than ore from Australia (62 per cent), Brazil and India (both 65 per cent). Not only is Chinese ore more expensive to process, but much of it is located "inland in the north and west of China. While steel mills in the north-east are close to major iron ore mining precincts, it is costly to transport ore to steel mills located elsewhere in the country."

Increased iron ore shipments have benefited Australian iron ore producers enormously

Strong demand for steel has seen the imported share of iron ore supply increase from around 10 per cent in the late 1980s to more than 50 per cent currently, although over the past five years China's iron ore output has generally kept pace with growth in steel production. This reflects a number of factors, including the high price of imported iron ore and the temporary downturn in steel demand associated with the global financial crisis. More recently, iron ore imports have remained at a high level, having picked up sharply as the Chinese economy recovered from the downturn in late 2008 and early 2009 aided by the substantial fiscal stimulus, although domestic production has also been strong.

 

In recent years, more than 80 per cent of China's iron ore imports have come from Australia, Brazil and India. In an effort to diversify supply, Chinese policymakers have encouraged direct investment by Chinese companies in iron ore exploration and iron ore mines abroad. To date, numerous investments have been made in West Africa, South America, Central Asia, Russia, Australia and Canada, many of which are large in scale. While efforts to diversify supply may have implications for the Chinese steel industry's sourcing of raw materials in the future, the likelihood of continued high rates of economic growth suggests that China's imports of raw materials will remain high.

China has also become more dependent on coking coal imports.

[I]n the first half of 2009, coking coal imports surged, with a pronounced effect on Australian coking coal exports to China. This surge reflected a combination of factors, including a strong rise in steel production, a significant decline in international freight rates, and lower Chinese production of coal owing to efforts to consolidate the coal sector and mine closures or renovations for safety reasons. While China has extensive reserves of coking coal, many of its existing deposits are relatively inaccessible and therefore costly to mine. Many of these deposits are also far from major steel-producing areas.

Steel is mainly used in the development of buildings, structures and machinery, with the construction industry accounting for "more than one-half of steel consumption".

Worryingly for steel exporters, China's steel exports have increased since 2006, although they have varied.

Since 2006, China has been a net exporter of steel products. The early 2000s saw a large increase in steelmaking capacity, partly reflecting an increase in the number of small- and medium-sized firms; this growth in capacity translated into higher production, some of which flowed onto the international market. Since China's accession to the World Trade Organization in 2001, the volume of steel exports has increased noticeably; however, steel exports have not recorded sustained growth, and over the past few years have been declining as a share of total domestic production. At times when steel production has risen faster than domestic demand for steel, such as during the 2008 slowdown, China's steel exports have surged, only to decline again when domestic demand for steel has recovered, as was the case during 2009.

Note that these are net exports, China still imports higher quality steel from abroad.

There may be continuing opportunities for developed countries to push their credentials for higher quality steel products.  The Australian government could assist the industry especially for steel use within Australia by insisting on rigorous quality testing for imported steel and for restricting contracts that lock out Australian producers. But protecting the industry by tariffs or insisting that projects must use a quota of Australian steel would be a backward step for the Australian economy.

Zealous economic liberals pronounce any suggestion that governments should assist industries as closet protectionism and ironically put their faith in the Chinese Communist Party to keep  the Chinese economy growing at 10 per cent or so until the 2030s, I have less faith.

The CCP will need to rebalance the Chinese economy away from excessive investment and when the inevitable adjustment occurs the Australian resource sector will be negatively affected.

Australia needs to debate continuing economic vulnerabilities and consider the potential problems of a less diverse, resource dependent economy.