Market failure in Australia – what is happening to structural change?

Market failure in Australia – what is happening to structural change?

Adam Fforde

Two things are important, one is obvious, the other is not.

What is obvious is that the Australian economy is undergoing structural change.

During the 20 year boom, when export prices were high, we learnt to cope with rapid increases in tax revenue, a high exchange rate and an economy oriented structurally towards commodity exports. 

Before the 1990s, after the ALP reforms, we were using market signals to re-orient towards sustainable ways of earning our living internationally such as exports of high-value added manufactures, services and high unit value foods. With the boom, our markets told us, partly through a high exchange rate but also because of the income effects of the divvy-up of exports revenues, to shift towards retail, domestic non-traded services and construction. Construction did not keep up with demand, but money was made, employment created and profits earned.

The boom started to end with the Global Financial Crisis, but had an Indian Summer due to Chinese nation-building economic stimulus, which kept our mineral export prices high until they started to fall sharply, hammering our tax receipts and causing Australians to prepare for what has happened so many times before, ‘no Boom’. We know that tax receipts are down, we know that the dollar has fallen to the 70-80 cent range, and most people think the economic weather will continue in this direction. Australians are very good at living ‘off the sheep’s back’ which means boom and no boom. 

It is obvious that the Australian economy is changing as this happens. Factors of production: our business capital and entrepreneurial skills, our labour and its capacity to apply and learn skills, and our land – must all be reorienting to the new economic conditions. This is obvious.

But it is 2015, already (the Global Financial Crisis started in 2007), and what is not obvious is, concretely, where this is heading. Despite having good economists, journalists and out own brains it is not obvious to us where to put our money, what to encourage out children to study, and what and where land prices will change. Our markets are not telling us what the central aspects of the structural change are. You can find predictions, encouraging tales, stories that dishearten and the rest of it, but these are not market signals. Our markets are failing us.

A very good example of this is the non-University tertiary sector.  Labor campaigned promising improvements, to ‘re-open Greensborough TAFE’. After the introduction of ‘contestability’ it is not yet clear, in the market, whether and how the balance between the public and private sectors will be struck. But it is clear that our labour market is not telling us what is changing, with the structural reorientation, what, now, we should train in what, now, we should avoid. It used to be IT, where strong market signals pointed to opportunities. What now? It is not clear.

Labour needs capital and investment decisions drive structural change, though employers will factor in expected labour costs and labour quality. Entrepreneurial decisions are fundamental; public support, ideally, targets spending on public goods production partly to improve welfare directly and also to leverage by supporting good private investment decisions. Trying to lead the market, for governments, is risky: entrepreneurs are paid in part to bear risk. So, where is the money going and does this tell us what we need to know about the nature of the ongoing structural reorientation of our economy? If we know, we can adapt, as suppliers of land, labour and capital.

I don’t think we do know. The stories we hear and read about investment in Victoria are largely about real estate (Fisherman’s Bend) and infrastructure (railway crossings, the East-West link). These are not guides to how we exploit the shift away from high value commodities exports and a high $: if you like from being the quarry of Asia to being Asia’s deli.

Why?

I think there are two reasons.

The first is that, whilst we can know if we want to, it takes rather a lot of effort to find out where the money is going and why. And part of the shift away from the commodity export boom years is to enjoy that effort, to like reading  about export successes that are real and authentic, and to value such studies (and give time to them). Finnish papers are different from ours – they make their living differently.

The second is that our capital markets are not working well. A friend of mine used to be a bank manager, 30 years ago, and at that time lending decisions were decentralised and he was paid to know about the branch’s commercial client base and take decisions about the banks’ business with them. He left as decision-making was moved upwards and information became standardised, reducing bank transaction costs but destroying much information. A good banker has in their head much accumulated knowledge about their clients, and, if you asked them to write it all down, it would cover a lot of paper. Judgement of risk is then an art, and that does not suit centralisation of power and reliance on statistics that summarise and so ignore detail. What I hear from our banks is a push to large state support for infrastructural investments to tide us over. This does not generate a narrative where it is clear what the structural reorientation that, obviously, is happening, and which, equally obvious (at least to me) is unclear.

Our markets should tell us what to do, and it is clear that they are failing to do so.

Adam Fforde

Tertiary institutions as rent-seeking, but un-owned, businesses

Who profits from Universities, if you believe in markets? 

Standard economic theory would suggest that Universities are not the same as, say, companies that produce baked beans. Their outputs have strong elements of public goods, and, since students cannot know in advance what their studies will be nor what they will lead to, they are also marked by powerful information asymmetries. Under such situations lack of strong regulation leads to shouting and screaming, as was found early in their history: shonky 19^th century teachers promised that their courses were good, and they were not, and that they would lead to good jobs, and they did not. Thus, though in practice for many other reasons, tight regulation surrounds any attempt to set up a private university.

Personally, if I wanted to set up a Masters course, and had access to a private university, the real costs involved are very low. If it had 8 subjects - a two semester course - and I could hire who I wanted to teach them, a ball park estimate would put direct costs at, high end of the range, $100,000, with some more for class teachers. Service companies that have to carry marketing and other costs usually require a mark-up of 2.1:1 or so – to pay somebody $1000 you need to bring in $2100. Round up and that gives a total cost of say $250,000 - if there are 50 students that gives a fee of $5,000. Modern Universities can and do charge far more than this. But their authentic costs are far less than a private company: their borrowing costs are lower and their real estate is far cheaper too, and anyway they do not have to pay dividends to shareholders. So who gets the profit? A good Masters is profitable for the student at far higher fees, so, as economic theory would tell us, as it Is not easy to set up a private university the resulting restriction in supply creates rents. Price control is one way of controlling this, but that is not what current policy is saying – rather, that fees should be uncontrolled.

So who profits?

If we look for pork, which is the technical term the best economists use in the bar to discuss such things, the answer is obvious. A man a friend of mine knows somebody was hired as head of an economics department in the UK in the late 1960s, and the Dean asked him if he thought he needed a Secretary. He replied that he did, but he could have managed without one. Management structures meant that he could do this, as reporting and other requirements, to managers who managed managers and on up, were far less. The system was far more efficient than nowadays, less costly and probably better in administrative terms too. He had fewer equity compliance responsibilities, as this was managed culturally, through trust, though of course sexism was an issue. So if we look for well-paid powerful people in modern Universities, and in structures associated with them, where do we find them? In University bureaucracies and in the political structures (mainly in the Federal Government) that mirror them. Measurement is of course contentious, as this state of affairs is clearly not what the tax-payer wants, and is therefore hidden, but it is normal for the % of total revenues that is actually spent on teaching to be well below 50%. More tellingly, and this reflects the question of who are the superior people who get to eat pork and who are the inferiors who get to eat pig-meat, it has become quite normal over the past couple of decades for cost-cutting to be borne by the academic staff rather than the management, especially in areas that are not attractive (Arts brings in lower value $ grants than other sectors, and since the Federal bureaucracy bases itself on money volumes so does the University bureaucracy, so Arts generates less pork and so its staff, eaters of pig-meat, get hammered).

So if one believes in markets, one can expect the freeing up of fees to create major problems, as the resulting profits accrue to those who are powerful and so eat pork (not pig-meat). Souls have no gender, no class and no race, so the natural tendency for good Christian thinking is to dislike pork and enable a level playing field. Many of our national political leaders are good Christians. And in a sector such as tertiary education, that means regulation as market failure is large and the stakes are high. Will the penny drop? So far, it has not.

So what can we expect? It depends on how good the economists are. Good regulation will reduce rent-creation and cut pork. We can see this already in the treatment of coming cuts at some Universities and TAFEs – but how much of this is actually designed to protect core pork? Have power relations changed? It does not look as though they have. Watch Arts and watch the TAFE system, for they are weak, which is why they have suffered. Does it mean closing down conference organising sections and preserving the entourage and management levels that preserve in turn the structures in Canberra? The answer is, probably, as there is not fundamental rethinking going on. A senior University manager, with entourage, costs maybe $1m a year. Compare that with the teaching costs of running a good Masters. So what is happening, with no shift in thinking, instead feels like a classic Yes Minister response. It helps but does not solve the problem. The key indicator here will be use of political power, driven in part by good Christian ethics, and fundamental reorienting of the Federal bureaucracy, and what it thinks it is meant to do. And this requires a shift away from current philosophies of service delivery and a return to simple service, with far higher levels of trust required and far fewer levels of bureaucracy. But that means turf and Ministers are Ministers. But as pork increases in volume as fees increase (is it really likely that the tax-payer will get the proceeds in terms of reduced budget costs for tertiary education?), this could get interesting.

A second phenomenon could be the rise of private colleges and Universities. It is striking how few these are in Australia. Like many things, it is not in the interests of regulators to encourage their formation, as, unlike the state-funded tertiary sector, they do not need such profitable managing, though they do offer chance of jobs for public servants when and if they decide to cash in their relationship capital.  The possibility of large political contributions, or their reality, does not seem to have been very successful here.

So what seems most likely is that those who control Universities (various bureaucrats), rather than those that own them (tax-payers) will be the ones who profit. That is what economics tells us. Oh, and students who, even after paying off their loans, will, obviously as they have been able to do so, earned more because they are graduates. But those incomes will have come from the labour market, and in Australia on the whole that is relatively competitive. I cannot easily set up a private teaching Institute and offer degrees, but I can easily choose what to study and what to do with that degree. Under the current set-up, with weak democratisation, what I cannot do is stop rent-creation from adding a very large padding to what I have to pay for my degree. 

The economic fallacy in austerity economics

Austerity economics argues that restoration of economic growth requires fiscal stabilisation - usually, from a position of fiscal deficits, this means reducing fiscal deficits. This can be done by either cutting spending (including the cost of debt servicing) or increasing taxes. Both are influenced by the rate and quality of changes in GDP.

As austerity policies came in during 'stage 2' of the GFC, they almost always involved - large spending cuts, minimal tax hikes (in some places - the UK is an example) taxes were actually reduced, and various monetary measures to reduce interest rates and so the cost of servicing government debt. There are generally no narratives that explain why the centre of gravity of fiscal policy was so regressive - why the changes tended to push far more of a load onto state spending than upon the revenue side.

As would be expected, the effects were to cut effective demand, and quickly economic forecasts were revised downwards, with lower tax revenue accompanying lower GDP levels and high spending (for example as unemployment rose), and this increased the forecasts for fiscal deficits. In general, whilst one can expect this outcome to have been clear from the modelling made when the original austerity forecasts were made, these were massaged to give better outcomes, and then this proved hard to continue as GDP slowed.

Given this, is it clear that $1 for $1 transfers from rich to poor will increase effective demand. In Australia, removal of the effective 'flat tax' of 15% charged on contributions to superannuation funds in a way that increased income tax revenues by, say, $10 bn, and reductions of proposed spending cuts by the same amount would increase effective demand, slow unemployment gains and in a series of second-round effects reduce the forecast, and actual, fiscal deficits. In the old Keynesian language, with unemployment above the minimal level variations in the marginal propensity to consume will (in any decent macro model) have such effects.

But, what is happening? In Australia, neither the ALP nor the Coalition are offering the population a vote on tax increases. Like old issues such as immigration and the death penalty, if such policies are not in the manifesto of a party that can be elected to govern, you cannot vote for them.

But has the ALP been cunning? Instead of tax hikes, ex Treasurer Swan talks about adjustments to the taxation of contributions to superannuation funds for those with high incomes, about changes to the conditions that allow negative gearing, and taxation of mineral companies. Unless the Treasury has been completely bought by its political masters, such policy changes, which can be said not to be income tax hikes, must have positive effects on the forecasts for the fiscal position, and upon the real economy.

Which takes us back to the lack of a narrative as to why, when all those people sat around tables in those EU capitals now implementing austerity policies, these issues were not discussed enough for them to become part of the historical narrative. Of maybe this has been written up somewhere?

4/2/2015