Economics
Hockey sticks and creative destruction – the Nobel Prize in Economics
How economic growth took off 200 years ago, how to sustain economic growth, and what can threaten it.
Imagine a world where there is an abundance of scientists with PhDs in physics, but a shortage of mechanics who can build and repair machines. Or conversely a world where there are plenty of electricians, proficient in vacuum tube technology, but where there are no engineers developing semiconductors. The former world would be one lacking all but the most basic practical technical skills, and the latter would be frozen at a basic stage of development without progress.
The three whose work earned this year’s Nobel Prize in Economics, Joel Mokyr, Philippe Aghion and Peter Howitt, were curious about the drivers of economic progress. Why was it that for most of human history living standards hardly moved, until some time around the eighteenth century economic growth suddenly took off, in a pattern known as a “hockey stick” function.
This brings us to the scenarios in the first paragraph. Although politicians talk loosely about STEM, as if it is all one class, Mokyr distinguished between two types of knowledge – propositional knowledge and prescriptive knowledge. Propositional knowledge is about why things work. It’s the knowledge of scientists and engineers, who understand the principles of natural phenomena. Prescriptive knowledge is about how things work. It’s the knowledge of practical mechanics and craftspeople. Writing in Economic Forces about the Nobel Prize, Brian Albrecht describes the distinction in more detail. Leonardo da Vinci was able to use scientific principles to design a helicopter but there weren’t many aircraft mechanics in fifteenth century Florence.
Mokyr realized that these two forms of knowledge had a long history, but they existed in separate domains, and the pre-Enlightenment world lacked the institutions and the channels of communication that would bring them together. But happenstance did bring them together, initially in Britain, where there was a pool of “skilled craftsmen, artisans, and tinkerers”, who exchanged ideas with thinkers from mainland Europe, many of whom had been forced to move by religious and political upheavals.
Albrecht goes on to describe the work of the other two winners, Aghion and Howitt, whose work on economic growth was based on refining Joseph Schumpeter’s idea of creative destruction. Schumpeter pointed out that turnover of firms – processes of creation, growth and destruction – is a feature of successful capitalism.
Aghion and Howitt realized that these processes play out in different ways in different industries, and that they require a certain level of competition, but there seems to be an optimal level of competition for the Schumpeterian outcomes of innovation and economic progress to be realized.
Two other articles provide additional insights into the prize winners’ work. John Hawkins of the University of Canberra, writing in The Conversation, describes their work on creative destruction and how it plays out at the corporate level in driving (or suppressing) innovation. The ABC website has a Reuters summary of the prize winners’ work, including their warnings that economic progress cannot be taken for granted. In a clear warning about Trump’s policies Aghion is quoted, pointing out that tariffs and retreat from globalization are obstacles to growth.
On a more positive note, both streams of the prize winners’ work offer guidance for public policy. A clear implication of Mokyr’s findings is the need for public support of institutions of learning, particularly where people from all disciplines from liberal arts through to trades can come together to exchange and share ideas.
The implication of Aghion’s and Howitt’s work is that there can be a reconciliation of competition and industry policy. It can be read as an endorsement for programs such as A Future Made in Australia, co-existing with strong competition policy, while there is recognition that competition can be pushed to a point of diminishing returns. It’s a way of thinking that would have been seen as heretical in recent times when the ideas of neoliberalism were dominant.
It is inevitable that people will question the basic proposition that economic growth is desirable. It’s an important question, but it raises a further question about the natural resource intensity of growth. To return to the example about vacuum technology, we might contrast the material bulk and power requirements of valve operated radios, televisions and early computers, and compare them with their current equivalents. There can be growth in entertainment, arts and education making very few demands on natural resources. The idea of economic growth can be decoupled from the idea of natural resource depletion.
Our expensive and brutal child-care system
Child care is back in the news, for the wrong reasons.
Paedophiles exploiting Australia’s broken childcare system as safeguards crumble is the headline of the ABC website drawing attention to Monday night’s Four Corners program – Hunting ground – described by the program’s presenters as “a system so broken it has created a perfect storm for abuse”.
Ferguson and her colleagues have presented a deeply disturbing account of our child care system. Their description of organized networks challenges the stereotype of the lone individual who quietly and secretly acts out his weird sexual fantasies, burdened by fear of exposure and possibly a sense of shame. Those who operate with the support of such networks have resources, including supportive feedback, unavailable to the lone operator. They expose a menace that we hardly knew existed.
To suggest the system is “broken”, however, suggests it was once functioning well.
It wasn’t.
Andrew Scott of Deakin University, well-known for his enthusiasm for Nordic-style universalist human services, takes us back twenty years to the rise and collapse of ABC Learning, an expensive lesson in the folly of allowing the for-profit sector to become involved in child care.
In his speech Boosting equity and safety for Australia’s children, Scott points out that successive governments have not learned from that early experiment in for-profit child care. The present government is still “wastefully spraying more than fifteen billion dollars of public money a year into this brutal, profit dominated system”. He reports that “early childhood education and care in Australia is now the most privatised in the developed world for three and four year olds, and the second most expensive for parents”.
Paedophilia is the starkest manifestation of the for-profit system’s failure, a system driven by cost-cutting and the greed of those who see the industry as an easy way to get their fingers into the public till. Child care is not amenable to a for-profit mode. It is an industry in which, for many reasons to do with misalignment of incentives and what economists call “market failure”, the for-profit market model does not work.
It's all very well to have supervisory bodies, but the real need is to rid the sector of for-profit providers. Properly structured, as government services or as privately-owned cooperative ventures, child care can work, with tremendous immediate and long-term returns to society.
Scott summarises the economic benefits of well-resourced and affordable child care. In the short term they are about allowing more women to contribute in the paid workforce, and in the long term they are about laying down the crucial foundations for lifelong learning.
Fundamental reform, involving investment in and support for not-for-profit care should come easily to an economically responsible government guided by social democratic principles. But Scott fears that the government is backing away from even modest reforms aimed at making care more affordable, and it seems to have no zeal for driving out the for-profit operators.
It’s another chapter of the dismal performance of the Albanese government, so strong on announcement, but so terrified to do anything that may differentiate itself from the Coalition.
Inflation
We get excited about CPI inflation, while ignoring or even valorising house price inflation.
CPI inflation – the case for higher taxes
Whichever way we look at it, the rise in the September quarter CPI was a shock.
The media (including the ABC) tend to use the “all groups” and the “trimmed mean” estimates over the last 12 months, which came in at 3.2 percent and 3.0 percent respectively – one just above the RBA two-to-three percent comfort zone and the other just on the top of the zone.
But these are understatements, because they relate to CPI inflation over the last twelve months. The September quarter CPI, a closer indicator of what inflation is now, was 1.7 percent, a figure which, if annualized, would indicate CPI inflation of around 7.0 percent.
The most defensible measure in terms of orthodox statistical analysis, is to use the ABS’s seasonally-adjusted series as a basis for annualization. This shows the “all groups” CPI rising at 4.9 percent a year, while the “trimmed mean” is 4.0 percent. The graph below shows that both have broken out of the RBA’s comfort zone.
The CPI figures reduce the odds for an interest rate cut next week somewhere down to the odds of Barnaby Joyce joining the Greens.
The partisan media will inevitably portray the CPI as a failure by the Labor government to rein in spending and its tolerance of letting wages run out of control. But the services component of the CPI, which is most affected by wages, is continuing its downward trend, while the goods component is on the way up.
Steep rises in health and education prices suggest that consumers’ out-of-pocket costs for these services are rising. This could be a reflection of Commonwealth and state government austerity. Similarly there has been a large rise in local government rates and charges, maybe as a result of state governments squeezing their contributions to local government.
That’s all speculative, but it could point to a failure by the current government to collect enough revenue to fund these services. If it were to collect more tax, from well-off retirees, from tradies avoiding tax through family trusts, from heavily-geared property speculators, and from foreign-owned gas companies, it could reduce inflation resulting from excess demand, while reducing households’ burden of the costs of health care, education, and local government services.
But don’t expect to hear that criticism from the opposition, who are still committed to the idea that we somehow benefit if we have to pay $1.10 or $1.50 for a privatized service in order to save $1.00 in tax.
Understanding the CPI
The CPI has been vested with an undeserved sense of precision, but like all statistics it is subject to sampling errors, and even more significantly it is an estimate of movements on the price of a metaphorical “basket” of household goods and services in our capital cities, even though household consumption is only around a half of our economy. It’s an indicator of inflation, but it would be rash to call it a measure of inflation.
Peter Martin, Amy Auster of the Policy Institute and Kevin Fox of the University of New South Wales, on The Economy Stupid, discuss and describe conceptual issues around estimating the CPI and the ways the ABS has used data capture to refine its estimates: Why the official inflation rate feels wrong. It seems that the ABS has been able to eliminate what was once considered an unavoidable bias known as the “substitution effect” that tended to overstate the CPI. They also explain why mortgage repayments are not included in the CPI basket, even though they comprise a large part of many households’ outlays.
Housing price inflation
“’I think everyone can get into the property market’: Aussie man reveals how he bought 50 properties” was the headline of a news.com story that came to my attention.
A moment’s thought reveals the fallacy in those few words. There are 10.9 million dwellings in Australia. If everyone tried to emulate this young man’s practice, only the first 214 000 would succeed, because the other 10 686 000 wannabe “investors” would be tenants of the first 214 000. It’s as absurd as the advice, offered by some educational experts, that all boys should go to mixed-sex schools and that all girls should go to single-sex schools.
That fallacy (known as the fallacy of composition) exemplifies the way our ideas about property have become so detached from the processes of cool, rational thinking about markets, not only among individuals, but also among property spruikers and among politicians.
Another example of weird thinking is the idea that everyone who owns and lives in their own house somehow becomes better off when their house appreciates in value. When Coles raises the price of Oreo cookies we recognize it as inflation, but when the market value of the house we live in rises we see it as a gain – the “wealth effect” in economists’ terms, better expressed as the “wealth illusion”.
And perhaps the greatest fallacy affecting own-home buyers and “investors” alike is the idea that because prices have been rising strongly in the past, they will go on rising. Have these people never read about the way speculative bubbles always end in tears?
In time we should be thankful that this week’s CPI figures have almost certainly dissuaded the Reserve Bank from cutting interest rates. Writing just before the CPI figures came out Ian Verrender expressed his fear that an interest cut would add fuel to an already overheated speculative housing market in his article Why the RBA should put a handbrake on property prices.
As Verrender points out, even if the RBA doesn’t care about property prices, the Australian Prudential Regulatory Authority (APRA) has the power to limit demand-side price inflation through its capacity to regulate minimum deposits and to set prudential borrowing limits based on people’s capacity to repay loans.
But as Saul Eslake points out in a 15-minute interview with journalist Daniel James about the government’s 5 percent deposit scheme, the arithmetic of political strategy does not support such rational thinking. Eslake explains, with evidence, that APRA controls have worked in the past, and that they should be able to work again. But policies that stimulate demand, increasing the pool of people who believe they can get into the housing market, have their attraction, as do policies that have the effect of increasing house prices because of the wealth illusion.
Fortunately there is evidence from the Macquarie University Survey on housing and the 2025 election that voters, particularly young voters, are becoming less likely to see rising house prices as positive.
Eslake notes however, that such clear thinking has not influenced Labor and Coalition politicians, who have openly expressed their hope that house prices keep rising.
Could you imagine the political reaction if, in response to Wednesday’s CPI figures, Albanese or Ley were to express their hope that the CPI keeps on rising strongly?
But housing in Australia enjoys a special exemption from the rules of rational thinking.
Public sector capability
The Australian Public Service is a good employer, but do our public servants have a sense of its important function?
Mariana Mazzucato of University College London can be counted on to put the case for a strong and productive public sector. With her colleague Rainer Kattel she writes on Social Europe about restoring public sector capability. That means:
… rendering [government] more capable, strategic, outcomes-oriented, and a good partner in solving the greatest problems of our time: providing adequate housing for all, strengthening climate resilience, and ensuring that technology makes our lives better, not just a few “bros” richer.
Explaining their work at the Institute for Innovation and Public Purpose they write:
Through our engagement with governments globally, we have learned that the old economics of correcting market failure leaves governments reactive, fragmented, and risk-averse. Today’s intertwined crises demand a new public-sector economics that regards the state as a proactive market shaper, co-creating innovation, public services, and socio-technical systems for inclusive, sustainable, and resilient futures. We have also learned that the way to transform governments legitimately is not by wielding chainsaws, Elon Musk-style, but by building trust and aligning with citizen needs.
Even though these messages align with ideas of sound governance and standard economic theory on the role of government, they have to be repeated and brought to the fore because the view that government is some unproductive overhead borne by the productive private economy is so common in our societies.
Related to the idea of public sector capability the Commonwealth has published its 2025 APS Employee Census, reporting on public servants’ perceptions of and attitudes towards their work. The ratings are mostly positive – the only statement to receive a positive response below 50 percent is “Change is managed well in my agency” (48 percent). But for almost every statement there is an improvement on last year’s ratings.
They work hard, but are they focussed on the public purpose? (John Gorton Building Canberra)
Most statements in the employee census are about working conditions, rather than the public service as a profession serving the public. The public who vote, who through Parliament authorise their salaries and program costs, and who expect them to deliver public value. There are only two statements under the heading “working in the APS” which touch upon professional issues. One is the statement “I am supported to use my expertise to provide frank and fearless advice” which has a 70 percent positive response, and the other is the statement “My workgroup considers the people and businesses affected by what we do” which has a 78 percent positive response.
The message from the survey is that the Commonwealth public service is a well-managed organization, where people are committed to high standards of administrative efficiency.
But the almost complete emphasis on working conditions, rather than the task of public service, suggests that the idea of public sector capability as Mazzucato and Kattel describe – the idea that public servants can contribute to Australians’ wellbeing in ways that the private sector cannot – does not seem to be at the forefront of those who designed the survey.
How to score a cheap flight
AI gives us an incentive to look financially irresponsible.
After a couple of drinks frequent travellers are bound to offer advice on how to get a cheap flight. Book many months ahead, rock up to the check-in desk ten minutes before the gate closes, choose an airline that has recently had bad publicity …
All such “beat the system” advice is prone to the logical problem of the “fallacy of composition”. The more people who try to follow it, the more likely it is to fail.
Here’s another piece of advice: work on your personal profile, but not in the way you normally would.
The next time you buy something online, choose Afterpay and miss one of the payments. Steal something from an op shop, or from a bargain counter in a regular store, making sure that you are caught so that you can tell the magistrate how poor you are. When your car’s tank is near empty, limit your purchase at the pump to $10, and do this often enough so that your bank account suggests you are really poor. Never let your personal bank balance exceed $200.
It may work – if you want to fly Delta Airlines (and if you could be enticed to fly on any airline in the USA), according to Aradhna Krishna, Professor of Marketing at the University of Michigan, who writes in The Conversation In defense of “surveillance pricing”: Why personalized prices could be an unexpected force for equity.
“Surveillance pricing” is the latest form of price discrimination, now made possible by the tools of artificial intelligence which can harvest data to assess each individual’s capacity to pay.
Price discrimination is an established and common practice in “bums on seats” industries, such as airlines, where the fixed costs are high and the cost per extra customer, the “variable cost”, is low. For an airline it’s better to have someone paying at least a small amount rather than have a seat go empty. We observe price discrimination in many industries – the cheap cinema ticket on Tuesday night for example. It’s often associated with minor variations in service such as first class, business class, premium economy and economy class in airlines, with the cost of the difference in service at each step being far less than the fare difference. Price discrimination even applies to products such as automobiles, where a couple of hundred dollars of extra electronics can command a price of several thousand dollars above the standard price. In economists’ terms price discrimination is about harvesting the largest possible consumer surplus from each customer.
Is price discrimination bad? The textbook answer is “it depends”. An industry with strong market power can try to set prices just below the level that customers are willing to pay. If you have to travel at short notice, for example on learning of a friend’s unexpected death and funeral, expect to pay a high price for your fare. But if you’re browsing on the internet for a cheap flight to Europe sometime next year, expect to see plenty of bargains on offer. Many point out that price discrimination is simply a form of price gouging. On the other hand, when we book an economy seat, we can be quite pleased that there are people at the other end of the plane contributing to the airline’s fixed costs.
Aradhna Krishna describes this new form of price discrimination based on AI, which builds up profiles on potential customers, to make reliable estimates of how much each customer can afford to pay. Krishna sees the good side of it, drawing attention to its similarity to progressive taxation.
That may be a particularly American interpretation, because it’s almost an article of faith in that country that anything that helps match customers to suppliers is an unmitigated good. But that’s a perspective with a corporate bias, which essentially involves consumers revealing their capacity to pay – a weakened position in any negotiation. We’re better off if our financial means can be kept to ourselves, which suggests that we need much better protection from banks and other agencies not only against outright theft (where there has been some progress), but also from data harvesting that weakens our power in markets.