Other economics
What’s driving wealth inequality
There’s a big difference between income inequality and wealth inequality. One’s income can rise and fall over time, but once someone reaches a certain level of financial wealth, unless he or she is reckless, their wealth grows over time, and can be passed on through generations. Provided the return on financial wealth exceeds the growth in a nation’s economy, wealth inequality, once established, will widen over time. That’s the simple message in Thomas Piketty’s work Capital in the twenty-first century.
David Richardson and Frank Stilwell, in a research project for The Australia Institute, point out how the tax system is turbocharging wealth inequality in Australia.
They point out that wealth inequality in Australia is much greater than income inequality, and that it’s becoming more marked. Just twenty years ago the wealth of the richest 200 Australians was equivalent to 8 percent of GDP: it is now equivalent to 24 percent of GDP.
This widening of wealth inequality has been boosted by the way capital gains are taxed. In 1986 the Hawke-Keating government re-shaped our capital gains tax system to ensure that the income from realized capital gains was treated in the same way as income from other sources, with indexation to compensate for the effect of inflation. In 1999, under pressure from the finance sector, the Howard government abolished that way to tax capital gains, replacing it with a system that taxed only 50 percent of capital gains, while abolishing indexation. That change gave an incentive for short-term turnover of assets (anything over a year), while relatively penalizing patient long-term investment.
How the Reserve Bank works
Physicist Neils Bohr once warned “Never make predictions, particularly about the future”.
But we do have to make predictions, about everything from tomorrow’s weather through to the funds we need for retirement, and that’s just in our personal lives. In government and in corporations reliable forecasting is crucial.
The trouble is that we’re not very good at forecasting. Our forecasts are usually subject to a bias of overconfidence. Think of the number of times you have promised to have a job completed by a certain time. Of times when you failed to use known information about probabilities. Of times when your forecasts were based on what you wanted to happen rather than what was most likely to happen.
The Reserve Bank board has to make forecasts, because their task of setting interest rates is based not on their estimate of the present rate of inflation (although they often convey that impression), but on what they believe inflation will be in the medium term. That task is subject to an extra complication because people’s behaviour in markets is influenced, in part, by what they believe will be the rate of inflation. The bank has to take into account other people’s biased forecasts.
In a speech to the Economic Society of Australia – Beware false prophets – RBA Deputy Governor Andrew Hauser describes how the bank goes about making its estimates of coming inflation. In what would be considered a well-presented lecture in a university, he covers the theories of uncertainty (not to be confused with risk) and the bias of overconfidence – important content missing in many economics courses.
He moves on to display the inflation forecasts that have been made by financial markets and by the RBA, comparing those forecasts with outcomes. Both the financial markets and the RBA have underestimated the level of future inflation, although the RBA seems to have been a little more accurate than the markets.
He considers possible reasons for that underestimation bias, and considers three reasons why inflation might be higher than experts estimate – inflationary expectations, excess demand, and supply side shortages.
Relax – inflationary expectations are low
If people were expecting inflation to be high, that expectation, in itself, would be a driver of inflation. Hauser finds no evidence, however, that Australians have come to expect higher inflation. (If there were such an expectation the bias would probably be towards overestimation.)
That is an important finding. Ross Gittins believes that the RBA worries too much about expectations of further high inflation. There is no wage-price spiral and there isn’t a risk of one breaking out, because Australia has strong mechanisms for suppressing excess wage demands. Gittins concludes:
My point is, there’s no reason for the Reserve to live in fear of an imminent worsening in inflation expectations if workers and their unions’ ability to turn their expectations into higher wages is greatly constrained. That being so, we shouldn’t allow impatience to get the inflation rate back to target to worsen the risk we’ll end up in a recession, the depth and length of which could greatly impair our return to full employment.
No, there isn’t excess demand
A time-honoured explanation of inflation is the presence of excess demand in the economy. It’s a theory with an ideological dimension, because that excess demand is often supposed to come from reckless government spending, even when, as is the case in Australia, the government has a conservative fiscal policy. But Hauser finds no evidence of excess demand, which would show up in a high growth of nominal GDP.
He also goes into detail about the drivers of consumer demand. Simple economic models link demand closely to income, but the world is more complex, because some people finance their consumption from accumulated wealth. That means policies to suppress demand through suppressing incomes – the shared characteristic of monetary and fiscal policy – are of limited effect when the wealthy are sitting on piles of liquidity.
But there are supply constraints
Haser concludes (tentatively) that excessively-optimistic expectations of falling inflation result from people over-estimating the economy’s supply capacity.
That conclusion helps explain why firms are facing labour shortages. It is also consistent with what’s been happening in the labour market, where labour shortages seem to be met by an increasing labour participation rate (a record high by some measures), and higher employment without a wages breakout. But according to the August Deloitte Access Economics employment forecast, this growth in employment may be coming to an end, particularly for “white collar” jobs. Between the lines of that report is the hint that the Reserve Bank may be too rigid in its idea that interest rates should stay on hold for the rest of the year.
Stiglitz on the drivers of inflation
Joseph Stiglitz summarizes the causes of inflation in a 3-minute videoclip that the Australia Institute has taken from an ABC Q+A program. There are many drivers he explains: the Ukraine war, the market power of firms in industries with little competition (“greedflation”), and supply side bottlenecks resulting from just-in-time production systems.
Stiglitz’s explanations are generally consistent with Hauser’s analysis. They confirm that use of the heavy-handed single instrument of setting interest rates is of limited effect in suppressing these drivers of inflation.
Should policies promote manufacturing? That may be the wrong question
Let’s stop thinking about “manufacturing”
Writing in the New Daily Simon Kuestenmacher – “the stats guy” – presents a spirited case for expanding our manufacturing capability: Nation goes backwards as middle-class shrinks.
He acknowledges that while we are, and should remain, a country with high labour costs, we can compete internationally, using our low-cost renewable energy to secure a competitive advantage in processing raw materials.
That aligns with conventional economics, and with the investment plans of Australian entrepreneurs. (But not with the Coalition’s ideas, whose understanding of economics and of engineering are rather weak, and who dismiss industry policy out of hand.)
He cites the Atlas of Economic Complexity, produced by Harvard’s Growth Lab. Australia doesn’t look too flash on that index, coming in at position #93 out of the 133 countries surveyed, just behind Uganda. There is some criticism of use of that index, because it is based on the complexity of a nation’s exports, and because we’re such a huge exporter of basic commodities, even a reasonable volume of complex products is overwhelmed by the weight of commodities. Nevertheless, that’s a limited excuse: Norway, another country with a “resource curse”, comes in at #44, and even Kuwait is well ahead of us at #55.
That leaves the question, raised in his article, whether we should have policies aimed at favouring manufacturing.
The idea of prioritizing manufacturing is too easily put down by an assertion that we don’t want to return to the days of high-cost Pelaco shirts and Holden cars, produced behind a tariff wall.
The problem with the question is that the term “manufacturing” is too broad to be useful as a guide for public policy. Economists may say we shouldn’t produce “footwear” for example, but it’s a term that covers everything from plastic flip-flops through to chemical-resistant firefighting boots and mountaineering boots. Everything from a generic small car through to a Bushmaster is a “motor vehicle”. Production statistics tell us we don’t make much furniture anymore, but for the last 50 years or more built-in furniture has been made by joiners classified to the building industry.
Rather than thinking about what comes out a factory door, policymakers should be thinking about what people in factories and workshops are doing. Are they employed in high-paid jobs, making the best use of their skills and capabilities?
In fact the transformation of materials – the “manufacturing” processes themselves – may be only a small part of a value chain involving assessing customers’ needs, design, transportation and provision of customer support.
Even though statisticians and customs officers have invested heavily over a hundred years or more into classifying economic activity as “manufacturing”, “construction”, “services” and so on, perhaps it’s time we dropped those classifications from our policy thinking. They belong to a different age.
Don’t be apologetic about picking winners
The easiest way to put down industry policy advocates is to assert that governments cannot pick winners.
Rebutting that idea, Llewelyn Hughes of ANU writes in The Conversation Yes, it’s difficult for governments to pick green industry winners – but it’s essential Australia tries.
One reason we need an industry policy is that we live in a world where other countries have industry policies, particularly around their transitions to renewable energy. Industry policies of past times, which relied on trade barriers, stifled entrepreneurship. The industry policies of today operate on different mechanisms, designed to encourage innovation, adaptation and trade in complementary products.
Many aspects of industry policies are addressed at basic market failures, such as the disadvantages faced by early movers in areas with rapidly-changing technologies, and the need for public goods, particularly R&D.
Hughes sees information as one of the public goods governments can provide. Successful corporations develop a tremendous amount of knowledge and expertise in understanding their own technologies and markets. Public service agencies tend to have a broader understanding of economic and political developments, and can help shape public policy to remove barriers to industrial development. That’s why sound industry policy involves public-private cooperation, with mechanisms to protect against favouritism and corruption.
How your next pizza will be delivered
In a short Conversation contribution, Juan Diaz-Granados of the Australian Catholic University and Benedict Sheehy of ANU describe what will happen from Monday, 26 August, when the government’s updated fair work legislation comes into force: “Gig workers” get minimum standards from Monday. Here’s what will change.
You will still get your pizza, but the person delivering it will have more protection around payment terms, record-keeping and insurance. He or she will be able to be covered by certain standards specified by the Fair Work Commission, but those standards will not cover overtime rates ad rostering arrangements.
These are probably not the final version of provisions around gig workers. It’s still a work in progress.
Will your pizza cost more? It shouldn’t, if you have been buying your takeout food from an ethical supplier, because the legislation simplify codifies what reasonable companies have been doing all along.