Economics
Australia’s innovation report card – could do better
In comparison with other prosperous countries Australia scores poorly on innovation. We may have the right policy settings, but our corporations aren’t meeting the challenge.
If you want to make a point about Australia’s technological backwardness you can draw on the Kennedy School’s Country and product complexity ranking, which puts Australia at rank 105 out of the 145 countries surveyed – a rank that’s slipped two places since 2018. We now come in just below Botswana, but just ahead of Côte d’Ivoire.
That ranking makes a point, but because it is based on the composition of countries’ exports, the point is about the dominance of unprocessed and simply-processed commodities in our exports, which contrasts with the comparatively technically advanced nature of our domestic economy.
A more informative index is the Global Innovation Index, put together by the World Intellectual Property Organization. This index looks at countries’ innovative capacity and its use of technologies, pulling together 80 indicators, including patent data, education expenditure and the strength of countries’ public institutions. (From its website you can see a short video explaining the index. It’s overhyped but it explains WIPO’s basic approach.)
On its rankings of 139 countries, Australia comes in at #22, significantly below northern European countries and high-income Asian countries. The chart below, which plots WIPO’s scores against countries’ incomes, confirms that innovation and prosperity are linked, but it is no simple straight-line relationship. And notably, standing out on the left of the chart is China, occupying position #10.
Our score isn’t too impressive. We show up poorly in comparison with much smaller countries, such as the Nordic countries.
Turning to individual country details in WIPO’s main document we see a mixed report card for Australia. By WIPO’s criteria our regulatory environment is positive for business and we score well on education at both school and university level. Our openness to trade, indicated by our low tariffs, is an asset (they wouldn’t have said that 40 years ago). But we score poorly on “ecological sustainability”, as indicated by the carbon-intensity of our industries. While we are turning out many university graduates, particularly women with degrees, there is a deficit in science and engineering degrees. Labor productivity growth is poor, and this is reflected in low use of advanced technologies in our industries.
It’s as if our broad policy settings favour innovation, but we are burdened by a culture of complacency and a technological conservatism in our corporate sector. An index such as WIPO’s does not go further into causes for our poor ranking. It may be because we have gone 30 years without a clear industry policy. It may reflect our historical dependence on foreign investment, which saw product and process development retained in foreign countries. Or it may be an outcome of our economic structure, with a bloated finance sector and a dominance of small business in certain industries such as construction.
Western Australia’s dirty GST deal
The Coalition government’s deal with Western Australia broke an 85-year old arrangement for achieving fiscal equality with the states. Unwinding it will be politically tricky.
In 2018, with the 2019 election looming and opinion polls looking bad for the Coalition, the Commonwealth government was desperate to shore up support for the Coalition in Western Australia, which was on the verge of seeing a sharp cut-back in its share of Commonwealth grants.
Up to that point, since 1933 general-purpose Commonwealth grants to the states (grants now linked to GST revenue) had been distributed on the basis of states’ needs and their revenue-raising capacity, as determined by the Grants Commission. Unsurprisingly, in view of Western Australia’s mineral endowments, by 2018 analysts at the Grants Commission had worked out that Western Australia had plenty of revenue-raising capacity and should have its allocation of funding cut.
That finding, although it was reasonably predictable, was not welcomed by the Coalition. Breaking with the 85-year-old tradition of going along with the Commission’s findings, Treasurer Morrison, with support from the Labor opposition, placed a floor on Commonwealth funding for Western Australia. Saul Eslake described it as the “worst policy decision of the 21st century (so far)”.
It paid off for the Coalition, which held 11 of the state’s 15 seats in the 2019 election. But in the 2022 and 2025 elections Western Australia did very well for Labor, which now holds 11 of that state’s 16 seats.
The amounts involved are significant. Under the 2018 changes, Western Australia will get $6.2 billion more next year than it would have under the pre-2018 arrangements. That’s about $2000 a head, allowing for a low level of state taxation and generously-funded state services.
Last week the Commonwealth announced that it is sending a reference to the Productivity Commission. Such a review is required in the 2018 legislation, and while the government could have framed the review in a way that precludes any cut to Western Australia’s revenue, the Commission’s terms of reference are reasonably open. On a short (4 minute) clip on Radio National – WA’s GST deal to be scrutinised by Productivity Commission – you can hear Rita Saffioti, the state’s treasurer, pleading for special treatment, and Saul Eslake praising the government for its political courage.
Maybe it’s not so much political courage as financial necessity, because Eslake estimates that the cost of the deal has been getting higher and higher because the Commonwealth has had to boost payments to other states in order to maintain a semblance of fairness, or the principle of “horizontal fiscal equalization” to use the long-standing official term. That boost is estimated to cost the Commonwealth $60 billion over 11 years.
The Commission is due to report by the end of next year. Whatever it reports nothing will happen to Western Australia’s share in the short term, because the 2018 arrangement is legislated to hold until 2030, but assuming the Commission recommends a cut to those generous arrangements, the issue will be a live one for the 2028 election.
You can hear Greg Jericho and Elinor Johnston-Leek of the Australia Institute discuss the Western Australian deal, in the full context of revenue-sharing, in an Australia Institute Podcast How ScoMo stuffed the GST. (The first 12 minutes are speculation about interest rates, now history.)
The problem is not only that some states, specifically New South Wales and Victoria, get back less of the GST than their citizens pay. The other is the GST’s failure to keep up with economic growth. This problem and some means of covering the shortfall, are covered in an Australia Institute paper by Matt Grundhoff: The cost of slow growth in GST revenue: the growing problem of short-changing the states.
It is curious that the Liberal Party is generally classified as “conservative”, because Morrison’s decision to override the Grants Commission was a dangerously radical move. Horizontal fiscal equalization is one of the basic principles established in the early years after federation, and has helped Australia avoid the sharp and enduring regional disparities that have caused so many political and economic problems in other countries. It should be a government priority to see it re-established.
The many drivers of housing price inflation
For many, housing has become a financial instrument rather than a basic right, but when it is looked at through a financier’s lens it looks like a dangerously over- priced investment: John Howard and the Reserve Bank share the blame.
Have you noticed that while there are long queues around houses or apartments to rent, there are not similar queues around Mercedes Benz dealerships?
The quick answer is that while we need housing we don’t need Mercedes Benz cars. But an economist would suggest that the presence of a queue suggests that the pricing system is failing. Just as the Mercedes dealer sets a price that clears the market, so too should the property owner (the “landlord” to use the feudal-era term) set a price that’s high enough to clear the market. A win for the landlord, a win for the people who can stay in bed (probably couch surfing) on a Saturday morning, and a deal (albeit expensive) for the renter.
Fortunately economists do not run the world (though many would like to). Rents, on average, tend to track the CPI, which means that over the long term they tend to be constant in real terms. That explains the queues.
The graph below shows that from around 1987 housing prices started to rise faster than the CPI.[1] They stayed stable for a few years until the turn of the century when the Howard government decided to let a financier determine housing policy. As so many have pointed out, the Howard government’s abolition of the previously well-functioning capital gains tax system, and its permissive treatment of negative gearing, defined housing as a speculative commodity like gold or bitcoin, providing capital gains into the indefinite future.
To an extent housing reflects what has been happening in all asset prices. Because there is so much money sloshing around the world, share prices have risen much faster than the earnings from those same companies. A stockbroker would say that the Price:Earnings ratio (the P:E ratio) of houses has done the same as has happened in all asset classes. But while on share markets P:E ratios have at most doubled, the equivalent for Australian housing – the ratio of capital value to rents – has at least trebled. Larry Elliott sees high P:E ratios on share markets as leading indicators of a coming financial crash, while Marxists see them as current indicators of the decay of capitalism. The high P:E ratio in the Australian housing market suggests that it is even more fragile than the share market.
Regarding asset prices generally, including house prices, the Reserve Bank has issued a warning in its Financial Stability Review, in language that would have a negative rating on the Flesch Reading Score:
Despite rising geopolitical tension, and fiscal sustainability challenges in a number of large advanced economies, risk premiums in global equity and credit markets remain low, and sovereign bond term premia are only around long-term averages. Forward-looking measures of financial market volatility are also generally subdued. A reassessment of the likelihood or consequences of key risks materialising would therefore make international financial markets vulnerable to sharp corrections. Highly leveraged trading strategies employed by hedge funds, liquidity mismatches among bond funds, concentration in equity markets, and interlinkages across the global financial system, have the potential to amplify an adverse shock.
In Australian English that means “Asset prices are too high; we could be heading for a bloody big crash.”
Nick Garvin of e61 has looked at the inexplicable disconnection of house prices from rents in house prices in his article Should housing home people or money? It seems that so-called “investors” are somewhat indifferent about rental yields, because they see housing as a means of accumulating financial wealth. (“Naïve speculators” is a better term than “investors”, because most are simply buying established properties, rather than investing in new assets.)
Note particularly how housing prices started to rise even more quickly after 2008, which corresponds to the time, after the global financial crisis, when the RBA started to drop nominal interest rates. It was a bumpy ride, but the trend was downwards, as is shown in the graph below which marks the RBA cash rate decisions. Many may be disappointed that on Tuesday the RBA board kept the cash rate at 3.6 percent, but it’s not long ago that people would have thought a rate below 5 percent to be adventurous.
By now many economists believe that the RBA’s low rates in the years leading up to the pandemic are one of the factors to blame for stimulating house price inflation, and for people taking on too much mortgage debt. Control of asset prices is not in the RBA’s duty statement, but their decisions, and the decisions of the world’s central bankers, certainly have an effect on the amount of money available for investment/speculation (pick your word).
Gareth Hutchens draws attention to this situation in an article The RBA has never known what to do about property prices, former deputy governor says. He’s quoting from a 2023 oral history interview of former RBA Deputy Governor Stephen Grenville which the RBA has recently posted on its website. The interview is largely about the destabilizing effects of large capital flows, but Grenville also mentions his unease at seeing interest rates being brought to low levels and its effect on housing:
A low interest rate does very little for activity, for real GDP growth, but it has a big effect on asset prices like houses and shares. [Asset inflation] may make people feel good and for house owners, it gives them something to talk about at the dinner parties about how their house price has gone up, [and that] makes everyone feel good; maybe that would stimulate the economy a bit, but I just regard that as such a weird way of stimulating the economy by giving people a big hit to their asset prices.
He goes on to state that he sees the impact of low interest rates on house prices and personal indebtedness as “an unresolved issue of the inflation targeting framework”.
As in financial markets generally, it’s not only the actual interest rate that influences people’s decisions: it’s also expectations about future interest rates, and all the talk is still about two or three further cuts over the next six months.
Expectations of lower rates reinforce speculators’ FOMO instinct. There is nothing in the RBA’s press release to suggest that it sees a 3.6 cash rate as a ceiling, even though that 3.6 percent rate implies a real interest rate of somewhere between 0.6 percent and 1.6 percent, when matched with the 2 to 3 percent band.
Even if the RBA were to sound a cautionary note, the property spruikers are still talking about a 2026 property price boom, which provides the speculator “a roadmap to wealth”.
When investment advisors show they do not know the difference between wealth and money, and that they believe asset price inflation represents an increase in wealth, it all portends hard times ahead, when the housing bubble eventually bursts.
The political debate around housing suffers from the tendency by the commentariat to focus on one cause of a problem. Many are blaming demand-side incentives, particularly the government’s five percent deposit scheme that came into effect on Wednesday. Economists tend to blame the supply-demand imbalance. Others blame the Howard government’s changes. But the other driver, conveniently overlooked, is the long-term fall in nominal interest rates, which has encouraged home buyers and “investors” alike to blow air into a speculative bubble, becoming dangerously indebted in the process.
We know how that story ends, but we don’t know when.
1. There are qualifications around these figures: there have been changes in the mix of houses and apartments, there have been quality changes in housing, the figures relate only to capital cities and they are heavily influenced by Sydney prices. Rental prices in the CPI include established, ongoing rents, which are generally lower than rent prices offered to new tenants. But the general finding is clear: the rental yield on housing is much lower than the capital gain in housing. ↩