Puzzles with the Henry Tax Review

You can find the full Henry Report here. The Government's promotional web site here.

At the moment, we are dealing with two very different things. The first is the Henry review itself, the second with things that the Government has accepted, rejected or left up in the air.

With taxation matters, the devil always lies in the detail. You also have to look very carefully at the language involved.

I simply don't have a view on much of this at the moment. My assessment of the Resource Rent tax as proposed strikes me as a bit gimmicky with a complicated and still unknown pattern of winners and losers. Further, I am not sure that the proposed Commonwealth investment of 40% in new mining infrastructure makes a lot of policy sense.

I am sure that details will change as consultation proceeds. I don't think that the use of the Government bond rate as a benchmark from which to calculate "super profits" is in any way sustainable, ignoring risk among other things.

We can be sure that the various interest groups will pick over the entrails. I will read with interest.   

Australian house prices rise further

While there is anecdotal evidence that the boil may be coming off, the rise in house prices in Australia has been quite remarkable by world standards.

This graph from the Australian Bureau Statistics shows the weighted quarterly average increase in house prices in Australia's capital cities.

You can see how prices came of the boil during the global financial crisis, only to start ramping up again. Average weighted prices in the March quarter 2010 were up no less than 20% from 12 months before.

The biggest increase came in Melbourne (27.7%), followed by Sydney (21%).

According to ABS, both the Melbourne and Sydney increases in the most recent quarter came especially at the high end of the marketplace.

ABS does not give non-metropolitan figures. However, while not rigorous, the numbers I have seen suggest significant rises in regional Australia as well.   

Non-tradable's and the Australian CPI

At 0.9% for the March quarter, 2.9% for the full year, the Consumer Price Index figures released today by the Australian Bureau of statistics were a little higher than forecasters had expected.

One thing that interested me was the difference in price performance between the traded and non-traded sectors.

The tradable component where prices are largely set on the world market makes up around 42% of the CPI basket. Prices here rose by 0.2% in the March quarter, up 1.1% over the year. This compares to 1.4% in the year ending in the December quarter 2009.

By contrast, the non-tradable component (58% of the CPI basket) rose by 1.5% in the March quarter, up 4.2% over the year. The equivalent figure for the year ending in the December quarter 2009 was 2.6%.

As you might expect given Australia's relatively good growth, the price pressures are presently on the non-traded side. This can be expected to continue.

Leaving aside issues associated with the definition of core inflation, the CPI is now very close to the Australian Reserve Bank's target range of 2-3%, above it in some capital cities and in non-tradable goods.

The Bank may or may not raise interest rates at its next meeting, but the raw numbers do suggest that Australia is facing inflationary pressures. The real sleeper is the tradable side since world economic growth is accelerating.            

Hawke report into Australia's home insulation program

One of the problems that the Rudd Government has faced in Australia, one that I have commented on before, is simply that of delivery. In this context, the troubled home insulation program has finally been axed. 

The Australian has provided an on-line copy of the Hawke report into the program. The report is worth a browse for those interested in the practical processes involved in program delivery. 

Conundrums in the Australian economy

The release of the minutes of the Reserve Bank Board monetary policy meeting of 2 February 2010 contained no real surprises.

In terms of the economic outlook, the global economy was strengthening, if with some downside risks; underling Australian inflation was declining; while the medium term outlook for the Australian economy was good, the immediate picture was still mixed. In these circumstances, the Board felt under no immediate pressure to shift the official cash rate.

While the minutes are interesting and provide a useful summary of the current economic position, the 16 February speech by the Bank's Guy Debelle (Assistant Governor (Financial Markets)) is far more interesting.

In that speech Guy Debelle discusses the unfolding of the global financial crisis and the Bank's response. Certainly the Bank had a far easier time of it than its overseas counterparts simply because the crisis was less here. However, it also appears that the Bank's operating mechanisms - its experience, policies and processes - proved to be more robust. Crisis it may have been, but it could still be managed.

I found the description quite fascinating.

Looking to the longer term, Debelle made a clear distinction between the financial markets in the major Northern Hemisphere economies and those in Asia. To his mind, To his mind, there was still some distance to go before the effects of the asset bubble (my words) were fully unwound. This was likely to affect the US financial system outside the major banks. By contrast, Asian was expanding faster, while bank balance sheets were better there.

This brings me to the first conundrum in the Australian economy, China.

Reading Michael Pettis, I get the strong impression that Chinese banks are by no means as secure as Guy Debelle's analysis would suggest. The huge expansion in bank credit has been associated with something of an asset bubble, especially in real estate much loved by so many Chinese. The numbers I have seen quoted are staggering.

I just don't feel confident about China.

The second conundrum lies in the Australian data itself. Some economic data is good, some not. What does seem clear, but subject to China, is that a two stream economy is re-emerging again.

Management Perspectives - most popular posts 6

It is again a number of months since I looked at the most popular posts on this blog. Then the economics posts dominated because of the global downturn.

Looking at the last 100 visits, the most popular post by a considerable margin was Problems with computer lock-in, an economics/management post explaining what I meant by computer lock-in and its implications.

A way behind came two equal posts:

• The Importance of Demography and Demographic Change - update, a post from February 2007 now badly in need of updating.
• Common Management Problems Series 1 - managing up, always a reasonably popular post.

Then came three equal posts, again a bit behind:

• December quarter 08 - Australia's real net disposable income increases by 1%
• Australia's financial outlook February 09
• Rudd Government's problems with green policies

In all, a reasonably mixed bag combining economics, management and public policy.

Friday Economics and Management Review 12 Feb 09.

This post reviews some of the economics, management and professional issues that have interested me over the last week.

The announcement of the opening in Australia of UK law firm (here and here) interested me because of the sheer size of the raid (14 partners) on Australian national firm Clayton Utz. While I don't expect A&O's opening to have the same impact on the Australian marketplace for legal services as some of the breathless commentary would suggest (the story made the front page of Australia's Financial Review, for example, with supporting material later), it is still an interesting development.

I spoke of the troubles affecting Australian environment minister Garrett in Insulation, pressure cookers and Minister Garrett.

While the problems that have arisen in the national home insulation scheme are in fact an example of the type of systemic problems that I have been talking about in current public administration, I am more sympathetic to Minister Garrett than you might expect. The genesis of the trouble lay in the pressure cooker atmosphere of Canberra at the time the scheme was developed, decided and first rolled out, a time when people feared an economic Armageddon.

Just looking at the economic stimulus side of the package, this one pumped money into employment far more quickly than any of us (me included) expected. The very speed of take-up was central to later problems.

Unfortunately, one outcome is likely to be a reinforcement of concerns about risk as opposed to risk management. I still see this as a major impediment to improved management, especially in the fish-bowl world of the public sector.

This links to the post I wrote on Will proposed international bank regulations cost all Australians?.

Most business people are worried about the increasing burden of regulatory compliance. There are two different types of costs here. One are the transaction costs directly associated with compliance. Apart from costs to individual firms, the higher the proportion of national resources tied up in this, the lower the proportion available for directly productive activities. The net result is reduced growth. The second costs are those that flow from distortions to the market place and economic activity more generally.

My problem with the proposed international bank regulations lay in the possibility that they might increase interest rates, while actually increasing sector vulnerability, I accept that this was based on very simple, some may say simplistic, analysis. Still, it at least there is a basis there for further thought.

Monday in Problems with computer lock-in I looked at some of the effects of what I call computer lock-in, the way in which past investment in IT and all the systems based on It could adversely affect economic performance. This discussion was triggered by question on an earlier post by one of my old Commonwealth Public Service colleagues Winton Bates, formerly a senior official with the Australian Productivity Commission.

Winton suggested that I should look at some of the later material on institutional economics for another economic explanation of some of the things that I have been talking about. As I admitted to Winton, I am very out of touch here, but he has given me some leads to follow up to re-educate myself.

One of the points I made about IT and communications technology is the way they could facilitate cost shifting as compared to cost reduction. Your costs go down, but this is actually at the expense of someone else, often the customer. Measured by cash and opportunity costs for all, overall system costs may not fall at all and may even increase. 

In the commercial case, this type of cost shifting may yield immediate profits after taking into account any adjustment costs. However, the sustainability of the profit then depends upon customer and competitor response. Where customers make some gain, then they are more likely to accept the costs and frustrations involved.

A related problem is that one set of costs can be seen and measured, the other less so. This can be a significant public policy problem, for in cost shifting associated with the delivery of centralised services you have defined gains to the taxpayer on one side, sometimes hidden if unmeasured costs to taxpayers on the other. The issue is further complicated.

I became interested in the Bellingen Hospital case because I noticed a new Facebook page Tuesday this week. I have been interested for quite some time in the way that different social networking tools can be used and the dynamics associated with them. In this case, an un-official Save Bellingen Hospital Page was started Tuesday morning asking people to say why the Hospital should be saved. By the time I noticed it later that day,  it had already gathered over 200 fans.

To provide some background information, Bellingen is a small town on the New South Mid North coast with a population a bit under 3,000. Health authorities are considering closing certain service there requiring people to travel instead to the bigger Coffs Harbour hospital. This is a bit over half an hour away from Bellingen by road.

I know Bellingen quite well, was sympathetic and very interested in the comments. So on Thursday morning I wrote a sympathetic supporting story about it on my New England Australia regional blog, Bellingen organises to save hospital. By this morning, the Facebook page had 812 fans, and I followed up with a second story,  Bellingen Hospital, Facebook and the costs to the community, looking at some of the community cost issues.

These are the type of cost issues that are generally not measured. One side effect - and this is not unique to Australia -  is the way that service centralisation has in fact had a quite devastating on the economic and social life of many smaller communities.

    As I finish, the number of fans on the Save Bellingen Hospital Facebook Page has just reached 1,046.

Australian unemployment falls to 5.3% in January 10

Figures released today by the Australian Bureau of Statistics show a fall in the Australian seasonally adjusted rate of unemployment to 5.3% on a steady participation rate. Aggregate hours worked also increased slightly.

The numbers suggest a continued strengthening in the Australian economy. The Treasury November forecast of 6¾ peak unemployment that I mentioned yesterday in  Australia's financial outlook February 09 sure looks a long way away!

Postscript::

A number of commentators have suggested that aggregate hours worked have fallen, whereas I said they have increased. The reason lies in the difference between the trend numbers (just up) and the seasonally adjusted numbers (down).

Overall, commentators appear to be correct when they suggest that average hours worked had declined slightly (no of jobs worked, aggregate hours much the same).

Will proposed international bank regulations cost all Australians?

There have been several things that have caught my eye over the last day when it comes to interpreting the economic entrails. This post deals with one.

Jaime Caruana, general manager of the Swiss-based Bank for International Settlements, is reported as saying that Australian banks could not expect to be quarantined from changes taking place across the global system.The thing that really caught my eye is the requirement that mortgage lending be funded using long-term debt.

Now depending on the meaning attached to this, this would actually lead to a fundamental change in Australian banking. Older Australians will remember the Australian savings banks, banks who used generally short term deposits to fund housing. This is actually the Australian pattern.

In system terms, short term funds withdrawn from one bank simply went into another, so there was no system wide risk associated with short term lending. There could, however, be risks for individual institutions that might then translate into system wide risks if everybody tried to store their money under the bed. We saw this in the 1890s' crash and the associated asset bubble.

Now looking at the implications for Australia from the proposed change and working just from first principles. I stand to be corrected, of course, if I get things wrong.

If Bank A cannot use its retail deposits for mortgage activity including housing and has to borrow longer term, then on the surface it will pay more for funds, a cost that will have to be passed on.

Given the banks control over deposits, and excluding international borrowing, Bank A will actually need to access funds held by other banks, say Bank B, directly or indirectly. Bank B also wants to lend for housing, but also cannot use its deposit base. So Bank B will, directly or indirectly, lend Bank A money on a longer term basis, in turn borrowing from Bank A. We have a round robin in which interest rates go up, inter-bank dependency increased.

I accept that this may be simplistic, so please correct me if I have got things wrong.     

Australia's financial outlook February 09

In November 2009 in its mid year estimates, the Australian Treasury was forced to alter its its projections to take into account better than expected economic performance. Even then, Treasury was forecasting that unemployment would still peak at at 6¾ per cent in the June quarter 2010.

Since then, the economy has continued to strengthen. As a consequence, the Australian Government financial statements for December 2009 show  a further strengthening in the Government's financial position with expenses lower, revenue higher than expected. That's good.

There were two especially interesting things in all this.

The first was the increasing probability that the Government would run up against the 2% real spending cap far sooner than anyone had expected. As I understand it, once Australian economic growth returns to trend, then the Government has committed to capping increases in real Government spend at 2% to speed the return of the budget to surplus. Given other pressures, this is going to be interesting to say the least!

Quoting Peter Martin from the Sydney Morning Herald:

Speaking to central bankers from around the world gathered to celebrate the Reserve's 50th birthday Happy Birthday RBA), Mr Stevens speculated about how monetary policy should be handled if governments restrained spending to pay off debts, creating a drag on economic growth. ''The straightforward answer is presumably that it would remain more accommodative than otherwise,'' he said.

Apparently in this speech, the RBA's Stevens mused about the problems that might arise should the combination of Government fiscal restraint, low inflation and consequent low interest rates encourage future asset bubbles. Perhaps the RBA should take this into account in setting rates, taking pre-emptive action?

I remember a speech a number of years ago from Australian economist Don Stammer in which he suggested that now we had entered a period of sustained low inflation, we could no longer expect the increased asset values of the past. Ha!

Don's arguments actually made a lot of sense. It was a bit hard to forecast the way in which plentiful liquidity in combination with low interest rates might lead instead to asset bubbles. Mr Stevens' comments make a degree of sense.