Economics
The end of the western rules-based order
In July 1944, even though war was still raging in Europe and Asia, Allied victory was in sight. Delegates of all 44 allied nations gathered at the Mount Washington Hotel in Bretton Woods, New Hampshire, to hammer out a postwar monetary and trade order. There was no way the pre-war gold standard would be restored: it had failed. In its place they intended to fashion a stable exchange rate regime, in order to avoid the beggar-thy-neighbour competitive devaluations and protectionism that had contributed to the economic misery of the 1930s, setting the scene for the ensuing conflicts.
The outcome, which came to be known as the Bretton Woods Order, was an agreement to fix exchange rates in relation to the US Dollar, which in turn was pegged to gold at $35 an ounce. The IMF came into being, and stemming from that agreement a few years later the General Agreement on Tariffs and Trade – GATT – was established.
By most accounts 1973 marked the end of the Bretton Woods order, by which time the fixed exchange rate system had become unsustainable, its collapse resulting from OPEC states raising oil prices and growing participation of “developing” countries in world trade.
That collapse was messy. In the western world the 1970s were years of turmoil, with outbreaks of double-digit inflation, shortages and rapidly rising unemployment, in response to which governments took extraordinary measures. In many ways it was similar to the turmoil around the recent Covid-19 pandemic. In the US, for example, the government implemented price and wage controls. Australia was not immune from these shocks: inflation hit 18 percent and the unemployment rate shot up to around 6 percent, never to return to its 1 to 2 percent range in the postwar era. (As fate would have it, these shocks hit Australia when Labor was in office for the first time in 23 years.)
Although the exchange rate order had gone, GATT and the general principle of free trade endured, and by the 1990s GATT had morphed into the WTO, under which rules and agreements were extended to cover services and other areas of economic cooperation – generally known as the “rules-based order”. Globalization came to mean liberalization not only of trade, but also of finance and investment.
Dollar Dämmerung?
The arrangements of this rules-based order tended to be set by the US and other western powers, and although America’s relative economic strength waned, most international trade and investment is still denominated in US dollars, an arrangement of convenience rather than of ideology. It has suited the US, allowing it to run large fiscal and trade deficits, and has suited other countries, because once a country’s currency becomes heavily traded that country loses control of its money supply. The US has generally been economically strong enough to bear that burden.
That’s all background to the Late Night Live session Satyajit Das on de-globalisation, détente, and decoupling from the American dollar. (35 minutes)
Das explains that the US-dominated rules-based order is giving way to arrangements dominated by others outside the western sphere. That world will be less open and less liberal. It will be a difficult era for a medium-sized open economy such as Australia that has done so well in the order that is now being displaced. Our political institutions and conventions, shaped by a long period of easy prosperity, lack the capacity to deal with the required transformation.
Das is well-known as author of A banquet of consequences reloaded (2021). His most recent work is Fortune’s fool: Australia’s choices (2022).
Real wages are starting to rise, but don’t spend it all at once
At last there is a sign of real wage growth. In the December quarter last year wages, as indicated by the ABS Wage Price Index, rose by 0.9 percent. That’s 0.3 percent above the 0.6 percent rise in the CPI. That makes it the second quarter in which wages have risen a little faster than the CPI: in the September quarter wages rose by 1.3 percent, just clear of the 1.2 percent rise in the CPI, but that’s within the margin of error.
The ABC’s Michael Janda reports in some detail on the ABS data, in an article with the optimistic title Wage increases beat inflation over 2023, ending real pay cuts.
Real wages will have to rise much more to make up for their recent fall. To illustrate what has happened, the graph below is constructed from ABS wage price and CPI data, re-based to December 2020, which is around the end of a period when real wages at least held steady, even if they were not growing.
Since 2020, while the CPI has risen by 16 percent, wages have risen by only 10 percent. In rough figures we can therefore say that real wages have fallen by 6 percent since 2020. But there is a glimmer of good news, because if you look at the graph really closely you will see that the lines are no longer diverging.
Note that the divergence commenced well before the Reserve Bank started to raise interest rates in 2022: it had started at least a year earlier, on the Coalition’s watch.
Note, too, that the CPI does not pick up interest payments. Those with large mortgages will be feeling a much greater loss in real purchasing power in relation to their wages.
Even if the wage price index comes back to track the CPI, as it had been doing between 2000 and 2020, that would be hardly satisfactory, for it would simply indicate a stagnation in real wages – a return to an economy with zero productivity growth.
Tax reform – the issue that won’t go away
Our risk-averse government is extremely cautious on tax reform. It was almost apologetic about minor changes to the taxation of people with more than $3 million in their superannuation accounts, and their recent decision to make a common-sense change to income tax thresholds caused a great deal of anxiety. These changes achieved, the government would like tax reform to disappear from the landscape, at least until after next year’s election.
Because the Opposition raised a hysterical and deceitful scare campaign about these minor changes, tax reform isn’t going away, however. There are now strong voices advocating reform to negative gearing and capital gains tax concessions that have given undeserved and fiscally expensive breaks to people buying so-called “investment” properties – concessions that add to demand-side housing inflation. The ABC’s Ian Verrender asks if another housing price boom will spark a negative gearing policy U-turn. Writing in The Saturday Paper Paul Bongiorno points out that the Greens have linked support for the government’s “Help to Buy” scheme to reforms to negative gearing.[1] The article is paywalled, but Bongiorno covers the same ground in a Schwartz Media 7am podcast: Can Labor be forced to end negative gearing?.
Even if the government were to yield to the Greens’ demands on tax breaks for property speculators, all it would have achieved is the removal of a couple of distortions – on top of its tweaks to superannuation and income taxes. The tax system as a whole, with its inefficiencies and inequities would be unchanged. That’s the emphasis of an article by Brendan Coates and Kate Griffiths of the Grattan Institute with the Dundee-style headline: That’s not tax reform – THIS would be tax reform.
Ken Henry, author of the 2010 Australian Future Tax System Review (which the Rudd government largely ignored), is once again calling for comprehensive tax reform. The ABC’ Gareth Hutchens interviewed Henry on tax reform, summarising his case on the ABC’s website: Australia's tax system is worse than it was 15 years ago, and young people are paying the price, Ken Henry says. There is also a 12-minute interview on RN Drive: Why Australia's tax system is causing tragic intergenerational inequity.
Henry goes back to basic taxation principles, noting that there are three possible sources of taxation revenue – income, wealth and consumption. In relying heavily on income taxes we are disproportionately putting the load on those who depend on work for income, rather than on the proceeds from financial investments. This is in a society where over the last forty years or so there have developed tremendous disparities in the distribution of wealth. Some of the most lightly taxed are well-off retirees, who enjoy virtually tax-free income from accumulated superannuation and don’t even pay much tax on consumption, because our GST rate is so low and has so many exemptions.
Although the public administration texts urge governments to approach reform incrementally (advice the Albanese government seems to have taken on board), Henry and others have been stressing the point that tax reform cannot advance by taking one tax at a time (income tax, GST, etc). That’s because each change would involve some people having to pay more tax. A common pattern in any single tax reform is that many gain a small and possibly unnoticed benefit while a concentrated few experience a noticeable loss. Also, as behavioural economics research confirms, the pain from monetary losses does not offset the enjoyment from equivalent monetary gains.
Therefore those who lose out, or who believe they will lose out, will be motivated to mobilize in opposition, particularly if they are helped by political parties who see politics in terms of combative scaremongering rather than advancing public policy. Also changes in one tax, even if they satisfy particular equity and efficiency criteria, may actually distort the tax system as a whole.
For those reasons tax reform should include all taxes at all levels of government, privatized taxes such as private health insurance, and possible changes to transfers to the social wage, so that what’s achieved can be a bundled win-win outcome – a Pareto outcome in economists’ terms. The public discussion on tax reform also has to put up some sacred tax exemptions for consideration – inheritance taxes, wealth taxes, and taxes on the principal residence.
Far-reaching tax reform was the strategy of the Hawke-Keating government, when it introduced a raft of reforms to taxation, superannuation and the social wage (particularly health and education). It was a period of strong economic growth, and therefore reform was about changing the slices of a growing economic cake. Pareto solutions are harder to find in the present era, when economic growth is sluggish, and when we are carrying the inequities resulting from the Howard government’s policies – policies that wrecked our capital gains tax system and privileged well-off retirees (including those accumulating funds for retirement.). Laura Tingle writes It's delusional to think everyone will always be better off under political policy change. We might now be ready to have that conversation. There can’t be only winners, she warns.
The clear implication is that tax reform will inevitably mean that wealthy retirees will lose some of their privileges and have to pay their fair share of tax. There would be a backlash, but it should not be politically costly for the government, particularly a Labor government. Most older Australians are rusted-on Coalition voters, and not all older people lack a social conscience.
While Henry’s advice to treat tax reform as one big package is generally sound, there may be some opportunity to address some public revenue distortions separately, without having to wait for the big package reform. This applies to situations where “taxes” are actually user charges, ensuring that all costs are brought to account.
One such opportunity is a carbon price. Ross Garnaut, now deputy chair of the Superpower Institute which he and Rod Sims have established, is a passionate advocate for a carbon price. You can hear him outline the Institute’s proposal for a Carbon Solutions Levy in a 10-minute ABC podcast. The CSL would be levied on all CO2-contributing production, at the point of production or import to Australia, at a rate equal to the EU carbon price. It would be more broadly-based than the Gillard government’s Emission Trading Scheme. Note that although some ABC editor used the word “tax” in the podcast headline, it is not a tax: it’s a charge to account for the negative externalities in contributing to CO2 pollution.
For a more thorough description of a CSL and the possibilities it offers the Australian economy there is a transcript of Garnaut’s February 14 address to the Press Club – “Restoring Prosperity by Building the Superpower” – on the Superpower website. It is partly about establishing internationally competitive industries through wise use of our natural resources. It is also about collecting revenue to boost our public finances in a way that does not distort resource allocation. (In time, however, revenue from a carbon price should surely fade away if we are to meet our long-term commitments.)
Another opportunity for a user charge to replace a tax is road user charging. As our vehicle fleet becomes more electrified, revenue from fuel excise will fall away, and we will need to find a better way to fund transport infrastructure. For now road user charging is not on the table: we are using its absence as a de-facto incentive to get EV sales and infrastructure underway. It would be a good idea to start having discussions about road user charging now.
While some tax reform involves dealing with clear distortions, such as negative gearing concessions, the widespread reforms Henry, the Grattan Institute, and others are calling for go into questions of value. To what extent should taxes achieve redistribution? What trade-offs between the present and the future (the discount rate) should be incorporated in our tax measures? Should particular activities be preferenced over others? Should taxes be guided by normative values about “good” and “bad”? At what level of government should particular taxes be collected?
These questions should be the subject of a political debate over ideas and principles, in line with different interpretations of the public interest. But as Garnaut says about tax debates, “public interest doesn’t get much of a look in”.
Our political landscape is corrupted by the Coalition who choose scare campaigns, negativism and lies over argument. We have seen that play out in the Voice campaign, in the spat about tax cuts, and in irresponsible statements about asylum-seekers. In all these matters there are plausible arguments a centre-right opposition party could mount to differentiate itself from the government, and present its own idea of the common good: that’s how the “Westminster” system is supposed to work. But Dutton and his acolytes refuse to engage in this process. That’s why there is a despondent mood among tax-reform advocates.
A way around the Coalition roadblock is for tax reform to be pursued by people and organizations outside the two-party system – by bodies such as the Grattan Institute and the Australia Institute, by retired public servants such as Henry, by independent politicians such as Allegra Spender (who is preparing her own tax green paper), by university researchers, and by indefatigable advocates such as Garnaut and Sims. The media can have a decisive role if they give rein to journalists such as Verrender who write explanatory articles, and if journalists on the front line help politicians advance and defend their arguments, rather than build up their stocks of “gotcha” questions: journalists who ask politicians “will you rule out a change in X tax?” do the public a terrible disservice. Most importantly our public broadcaster must not be entrapped in the moral relativism of partisan balance.
With enough momentum established, and the rules of debate established, even a timid Labor government has to come on board. Maybe even then the Coalition will still not come on board, but if it fails to do so it will be seen as a peripheral player on the political fringe, not to be taken seriously, while the grownups get on with the hard task of developing good public policy.
1. In the same piece he makes strong observations about the poor behaviour of Coalition, Labor and Greens politicians in Parliament – behaviour that impedes the development of good public policy. ↩
Insurance – can its business model deal with climate change?
Insurance premiums rose by 16 percent over the year to December. That rise has contributed materially to CPI inflation over last year: my back-of-the-envelope calculation suggests that had insurance premiums risen only in line with other prices, the CPI for last year would have come in at 3.9 percent, rather than 4.1 percent – a little closer to the Reserve Bank’s two-to-three percent comfort zone, or, to use Peter Costello’s construction “a number with a three in front of it rather than with a four in front of it”.
In view of the damage climate change has inflicted on Australia, we should expect some real (i.e. above general inflation) rise in premiums, but a full 12 percent seems hard to explain.
ABC investigative journalist Adele Ferguson has been looking at two trends in the industry. One is a record number of complaints to the Australian Financial Complaints Authority, mainly about delays (years, not weeks) in settling claims for building damage, shoddy rectification work, and denial of responsibility for cover. The other is a significant rise in the major insurers’ profits. Her account, including case studies of appalling behaviour by insurers, is on the ABC website: General insurers use a variety of dirty tricks to knock back claims. A slew of harrowing stories shows it's getting worse.
You can also hear Ferguson on insurance, followed by her account of dysfunctional behaviour in the Australian Securities and Investment Commission, the body responsible for regulating insurers, in a 6-minute session on ABC Breakfast. A week earlier Ferguson had posted a report on systemic problems in the insurance industry – problems known to and researched by ASIC, but on which they have done nothing in response: The worst practices of the insurance industry on show in government grilling.
Ferguson’s stories are mainly about the ghastly experience of claimants who have lost property as a result of weather-related events. There is also the loss to the community – an opportunity cost in economists’ terms – of events that don’t go ahead because of liability insurance – for example live music. Between them, in jacking up the price of liability cover, lawyers and insurers are behaving like unintelligent parasites and are killing their host.
In view of the uncertainties facing Australia as a result of climate change, one might ask if the private insurance companies are the right means to deal with sharing the costs of climate-related events. Insurers’ business models are developed around dealing with statistically calculable risks – car accidents, minor break-and-enter events and so on. There are no models to deal with uncalculable uncertainties – the events thrown up by climate change.
Their business model is to exploit consumers’ behavioural biases, particularly their misunderstanding of risk, to sell a lot of cover people do not need – such as “first dollar” content policies – while leaving people exposed for contingencies they cannot cover themselves. It’s entirely the wrong way around, according to a 1988 paper with the provocative title Over-insurance – why it matters.
Dissatisfied with your job? Get a new one, for Australia’s sake
Australians are changing jobs less often than they were thirty years ago.
Aaron Wong, of the public policy research institute E61, reveals this in a well-researched paper Climbing the wage ladder: linking job mobility and wages.
His general finding is that people who switch jobs enjoy significant pay increases – $5700 on average, and there are even larger gains for younger workers.
It’s an important revelation, because in a comparatively static economy, where people don’t move around, wages and productivity tend to stagnate. A basic principle of economics is that resources, including people, should be allocated to where they are most productive. If workers are stuck in low-pay-low-productivity jobs, there are missed opportunities for the workers and for the economy as a whole.
Mobility of workers is a basic feature that distinguishes capitalism from feudalism. The dynamics of capitalism are such that productivity gains are more likely to be found in new, growing, businesses than in old established ones. Old established businesses are always seeking greater productivity, but those gains are generally subject to diminishing returns. More significant gains in wages and productivity are more likely to be found in newer businesses.
Wong identifies several impediments to worker mobility, including non-compete clauses, occupational licensing restrictions, and in cases rigidity in the way pay is set. He also mentions the costs of moving house – stamp duties and selling fees. (The real-estate market has some high-cost practices embedded in governments, real estate agents and lawyers.) Earlier this month Wong and his colleagues Gianna La Cava and Angus Moore produced a paper Stepped on by stamp duty covering this same issue.
Those advocating tax reform point out that stamp duty is particularly tough on young first-home buyers, and call for a fairer way for state governments to raise revenue. Wong adds the benefits of higher wages and productivity as arguments in support of its abolition.