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The case for a consumption-based carbon tax

Coal is Australia’s second largest export – over 10% of total exports. These will not end soon and the coal lobby is a politically powerful obstruction to taking measures to effectively address climate change. The suggestion by Geoff Carmody – one I have also long endorsed and written about – is to impose a destination-based carbon tax which exempts all coal exports but which taxes coal consumption locally as well as all other forms of carbon pollution locally. Imports of carbon-based products should be taxed at the border by means of border tax adjustments reflecting the excess of our carbon tax over those of exporting countries. This removes a significant first constraint on Australian actions to address climate change and costs little – criticizing the coal exports will not end them – they will continue anyway and even if you could, substitute production will enter the market from elsewhere in the world. Coal is an abundant resource – Australia alone cannot stop its use.

The destination accounting proposal has recently been endorsed for the US by Janet Yellin, Ben Bernanke and Alan Greenspan but has long been rejected by the mafia who control climate policy discussions in Australia by wrong claims of lack of policy practicality: See the AFR editorial this week.

The policy is simple to implement – the border taxes are WTO compliant and would be concentrated in a handful of industries. These adjustments would deal with the often-exaggerated concerns about carbon leakages and import competing industries being put at a competitive disadvantage because of carbon pricing. This gets rid of a second major constraint to introducing effective carbon pricing in Australia – the unfair competition argument. This no longer arises.

In addition, this type of tax regime establishes the right types of incentives for other countries to levy production-based taxes. If they don’t levy carbon taxes we impose a tax on them ourselves and we keep the money. If they impose comprehensive carbon taxes they get to keep the money. Obviously this type of argument is of greater force for large countries such as the US and China but also for Australia too.

Finally, the advantage of this type of proposal is that it gets Australian discussions on climate back to be where they should be. We omit a tiny part of global carbon emissions and restricting our emissions won’t make much difference to anything. Our focus should be on setting a good example, on playing a proportionate part in addressing climate and on developing pricing mechanisms that will be robust and which will help to foster international agreement on effective climate action.

Most importantly we will not put ourselves in the silly position of trying to stop carbon pollution in the rest of the world by restricting our exports. We cannot do that because the substitution possibilities are too great.

Black-throated finches to possibly stop Adani

Not completely sure of the conservation logic here but it will be a good outcome if it occurs. I photographed these Black-throated finches inland from Port Douglas last year – specifically about 20 klm west of Mount Carbine. It is the second time I have seen them there. It is near a dam site on a cattle property. Great spot – we also saw Great bowerbirds and some Comb-crested jacana. The following photos are an embed from my FB page:

The case for retaining franking credits

The Labor Party policy for not refunding franking credits when an individual pays little or no income tax is poor policy. The policy is easily revealed to be a fraud that misrepresents the character of imputation credits but which gains community support because of widespread misunderstanding of the character of company tax and the imputation credits system: This misunderstanding I dealt with in an earlier post. The policy also provides an intellectually unsatisfactory appeal to “soak-the-rich” ideology – unsatisfactory because, if that is the policy objective, there are fairer and more efficient means of achieving it.

Two wrong arguments for the proposed policy

Consider two arguments that have been used to defend Labor’s policy stance but which are irrelevant. 

First, there is the social media argument that any tax involves gainers and losers and that this is just an instance of that situation – this is an argument often advanced by those who well understand the weakness of the Labor policy but who defend the party line at all costs.  This is a weak argument since it can be used to justify any tax.  For example exempting all individuals who earn more than $50,000 income from paying income tax but taxing everyone else, benefits people earning more than $50,000 but harms those earning less than $50,000. Clearly no one would sensibly advocate such a regressive tax even though it is justified on the basis that one group loses while another gains.  The example chosen is unrealistic but has a point: The abolition of imputation credits at low incomes, as is argued below, also has regressive implications since this policy falls heavily on those with low outside incomes and small shareholdings – they get no imputation credit – whereas wealthier citizens with high outside incomes get the credit.

Second, there is the more superficially credible argument that many people with huge wealth may get benefits from substantial franking benefits even though they are wealthy because they are income-poor.  This can be so but this would sensibly be an argument for taxing their wealth – or perhaps their superannuation holdings – rather than for restricting access to imputation benefits across-the-board to include those who may only enjoy low incomes with small shareholdings.

Background on corporate taxation

Corporate taxes are levied on the net earnings of a firm after all costs (staff, management, inputs) have been deducted from revenues gained.

Economists distinguish between the nominal and the effective incidence of corporate taxes and it is known that corporate taxes fall heavily on labour. Without going at length into the theory, firms typically employ labour and capital as complementary inputs – each of these inputs boosts the productivity of the other. One argument proposed – and favorably tested empirically by such entities as the Australian Treasury – is that lower corporate taxes mean that firms will employ more capital so that complementary inputs such as labour become more productive. Hence lower corporate taxes mean that more labour will be required increasing employment and bidding up wages. Hence there has been pressure from many economists to cut corporate taxes primarily to benefit labour.

Most other countries, including most recently the United States, have in fact cut corporate taxes and Australia remains with one of the highest corporate taxes anywhere. Because Australia relies heavily on international capital markets it is also often argued that, by having high corporate taxes, we discourage foreign investment and hence limit prosperity and the wages we need to pay workers here. There is something to this argument but I don’t want to consider it here. Foreign investment has been relatively strong into Australia for two centuries – we invariably run current account deficits that signify this – and this substantial foreign investment has persisted in the face of apparently high corporate taxes. In addition, the imputation system that is the basic concern of this article, does not include foreign indirect investments (investments in equities) in Australia as giving rise to refundable imputation credits. Hence a major benefit of levying taxes on foreign shareholdings in Australia is that it draws in revenues that would otherwise be lost to the Australian taxation net.

In short, the arguments to follow do not rely on standard arguments for cutting taxes to boost wages or to attract foreign investment. We are only concern with the implications of corporate taxes for Australian resident investors.

Even then it is worth noting there have been many other reasons advanced in the economics literature for abolishing the corporate tax altogether.  Corporate profits can be held as retained earnings or distributed as dividends.  Since dividends are taxed in the hands of shareholders and because retained earnings will eventually be paid out as higher dividends on the resulting capital investment or enjoyed as capital gains, both of which are taxed, so a reasonable question is why we should tax profits at all within a corporation.   It seems, at first sight, unnecessary. However most economists reject this line of argument because capital gains are generally taxed at concessionary rates and, in any event, deferring tax liability on retained earnings by only incurring taxes on future dividends would provides a source of tax avoidance within firms. Indeed it is claimed any tax liability can be postponed almost indefinitely.  So let us agree that we should tax corporate earnings, if only to capture the tax benefits that would otherwise be lost by firms channeling profits into retained earnings. The basic idea behind the imputation system is to avoid double taxing dividends while levying a tax on the profits that are retained within firms.


Dividends themselves are a form of income and there seems little reason to tax them in a different way than other income – a horizontal equity principle. Hence it would be unwise to double tax dividends (once in the firm and once when the shareholder receives them as income) since this does not happen to other forms of income. Hence there is a case for dividend imputation which prevents the double taxation from occurring. Effectively these dividends will be taxed at the marginal tax rate (MRT) of the dividend recipient but will be subject to no further tax.

This is achieved by appointing the corporation as a tax collection agent for the government – this is, as the excellent article by Tony Dillon points out, analogous to the PAYE function of firms who collect income taxes for their employees which are directed straight to the ATO. 

With respect to income that will be dispensed as dividends, firms collect a withholding tax on behalf of the dividend earners equal to the corporate tax rate, often 30%.  If firms pay this tax on their behalf then shareholders are only required to pay as tax the difference between their MRT and the 30% company tax rate. If a shareholder’s MRT is 45% the shareholder must pay 15% tax on their dividends since 30% has already been paid by the firm as a type of withholding tax.

This is, as mentioned, exactly analogous to a PAYE deduction which is also a withholding tax. With PAYE deductions firms collect an estimate of the tax liability of the workers they employ and send it directly to the ATO. The individual worker tax liability is then assessed by the ATO and the worker contributes only the difference between the tax they are liable for and the tax collected by their employer. If these items match they pay no tax. If the employer has deducted more tax than is required by their overall income level then the worker gets a refund.

With respect to dividend income the situation addressed by the proposed Labor Party policy is to alter the way dividends received by a shareholder should be viewed by the ATO. Under current policy if the shareholder is not liable to pay tax because their income is low they receive a rebate on the imputed tax on dividends that was withheld by the firm. This is the current issue of controversy. In Australia when the MRT of a shareholder is zero – the case when individuals earn taxable incomes less than $18,200 – the firm issuing dividends to that shareholder have withheld tax that the individual would not be obliged to pay at all because $18,200 is the no-tax threshold. More generally, for reasons of progressivity, if workers earn little income they will pay less tax than workers who pay higher incomes.

This seems a sensible policy for exactly the same reason that PAYE deductions should be returned to workers when the value of taxes withheld exceeds an agent’s tax liability. The appropriate policy is to return to that individual over-extracted corporate tax withheld by the corporation. Indeed if it is not returned then the income tax schedule becomes regressive in the range of low incomes. Those earning $18,200 or less get no imputation benefit while those above $18,200 receive a benefit.  A progressive tax system, with a minimum positive level of income at which tax cuts in, must provide negative taxes over this range – money must be paid to the taxpayer from the government. This is essential if the income tax schedule is to remain progressive but there exists some minimum threshold level of income at which no tax is payable.

Case study

Suppose I am a retiree (very realistic!) with a part-time job at KFC that yields me my total gross income for the year of $18,000. KFC acting as an agent for the ATO collects $6000 in PAYE tax for me each year but, at the end of each financial year, I claim this entire deduction back because my gross income is below the no-tax threshold of $18,200. My refund-inclusive income is the gross figure of $18,000 made up of post-tax income of $12,000 and the refunded PAYE deductions of $6000.

Suppose instead that, as a retiree I don’t work but hold shares in the Commonwealth Bank that yield me a total annual income of $12,000. On this dividend the firm has withheld $6000 as an imputation credit it has forwarded to the ATO. At present what I do each year, as with the KFC case outlined, is to apply for a rebate of the withheld tax of $6000 that was held deducted from my income by the CBA as a withholding tax and sent to the ATO. Currently I will receive back, as in the PAYE case, an extra $6000, my imputation credit, returning my total income to $18,000.

The Labor Party policy would limit the last rebate leaving me with only an income of $12,000. This seems unjustified on the grounds of horizontal equity – the principle that people in the same tax situation and with the same economic circumstances should be treated the same.

If one argues that economic circumstances are not the same because the asset holder possesses an asset that can be disposed of to support their income then that suggests a case for taxing the asset and redistributing it. Not doing so creates an injustice since a citizen holding the same quantity of assets but earning considerable outside income – a wealthier person than the retiree mentioned – will gain the full imputation credit on this shareholding and the extra outside after-tax income.

Final comments

At this stage of the argument supporters of the Labor reforms become characteristically angry and claim that many people who get this return of incorrectly withheld tax are “very wealthy” and it isn’t “fair” that the progressive income tax law applies to them.  But that issue has been addressed above in paragraph 1. If people believe that wealth is excessive then the correct policy approach is to tax wealth, including even perhaps superannuation.  (I do not support such moves – the savings that generate wealth has come from income that in many cases been already taxed. However if the argument is that wealth is socially excessive that is what you supporters of this argument should advocate). 

The difficulty with wrongly targeting imputation credits, when wealth is your concern, is that byproduct injustices are created. Many in the community have relatively small shareholdings of fully or partially franked shares.  For example, the Commonwealth Bank of Australia reveals in its 2018 Annual Report that it had 809,805 shareholders in total, of whom 591,209 owned less than 1,000 shares.  These are small shareholders.  This story would be replicated in many of our large public companies – BHP, Telstra, Westpac, NAB and the various licensed investment companies – that tend to pay close to fully-franked dividends. All of these shareholders would have claimed imputation benefits and yet, many of these people would be retirees earning modest or close to zero incomes and so would be adversely affected by the Labor policy. It is wrong to lump half a million shareholders into the “very rich” basket simply because they are shareholders.  Some are wealthy but many are not and mistakenly targeting imputation credits rather than wealth obscures this.

Indeed, as mentioned, abandoning the return of this wrongly extracted withheld tax is a reversion to a more regressive income tax since, while more income rich asset owners get the withholding tax recognized as tax that has been pre-paid, those on low incomes do not.

Independent of these arguments are other concerns over the lack of fairness of the proposed Labor policy move.  Since 1987, when this policy was introduced, equities that were sold in companies with fully or partially franked dividends have been sold on an “effective yield” (or “grossed up” yield) basis – the dividend paid was quoted and the effective yield calculated as the nominal dividend plus the franking credit that would be rebated.  For a fully franked share the effective yield was (100/70)*(the nominal yield) – the 70 reflecting the fact that a tax imputation benefit of 30% would accrue along with the nominal yield.    This determined the price that would be paid for securities in equity markets.  The price of a security yielding franked dividends would therefore increase to reflect the prepayment of company tax by the firm.  Thus shareholders who purchased such shares after 1987 paid for this tax benefit in markets – it was not given away free.  Changing the law to obliterate this benefit means that shareholders on incomes of less than $18,200 have paid too much for such securities and will experience capital; losses as the market comes to understand that these benefits will not always be provided.  One can justify such moves by the “some lose some gain” argument cited in paragraph 1 but this is a poor case for the proposed change.  It is rather a recognition of the adverse effects of the change but with the weak counterargument that, never-mind, some recipients of these wrongly deducted taxes from within firms will gain a benefit as discussed in paragraph 1.

Arguments for eco-centrism & deep ecology: draft subject to revision

The conventional view of economists and others is that nature and biodiversity have instrumental value as a consumption good (broadly defined to include conservation, aesthetic and altruistic motives as well as standard uses) and as a factor of production (e.g. transport or dairy. Thus we stop species from going extinct because it offends the convexity of our preferences – humans value diversity. This is an inadequate view for almost all conservation biologists and many philosophers who espouse eco-centrist or bio-centrist ethics. Their claim is that while. of course we should limit extinctions by having conservation reserves, zoos and perhaps native species as pets that this is entirely inadequate as an ethic for thinking about nature – its a “last resort” ethic. We should instead assign an intrinsic value to nature and biodiversity irrespective of what we might want as humans. As argued earlier there are logical arguments – such as the “last person argument” (see Richard Routley, 1974) – which suggest this is reasonable.

Instead of viewing nature instrumentally we should recognise that we share the world with non-human species and generally seek to minimise our impact on such species by conserving ecosystems. To the eco-centrists we can (humanely) kill a duck for the pot are not allowed to destroy its environment. This focus takes us away from the paradoxes of “animal liberation” because it now makes sense to destroy feral species which damage environmental sustainability. The suggestion is that in all human activities we should seek to preserve local environments by restricting human populations and their activities so that we have minimal adverse impacts. This also means conserving or restoring soils and waterways that sustain natural populations.

The “zoo mentality” (just keep enough nature so our human preferences for variety are satiated) needs to go. We need to conserve natural populations everywhere by not irreversibly destroying them but drawing on them only in a minimal way. Human activities should enhance degrade environments not further destroy them. The idea of preserving species (or sub-species) alone is inadequate, anyway, from a long-term viewpoint anyway since we need to preserve local populations which provide the basis for speciation – the creation of new species. All we are doing at preserve is wiping out global biodiversity and substantially limiting its regeneration.

The practical ways of achieving this change in attitude are suggested in Tim Jackson’s, Prosperity Without Growth, viz by fostering education and cultural activities as a substitute for resource-depleting activities and, controversially, from the viewpoint of “deep ecology” by substantially reducing global human populations.

Fish wars

It is important to understand the basic economics of conflicts over fishing rights as discussed in this article.  The problem arises from the difficulty or impossibility of enforcing property rights over access to fishing rights.   With open access exploitation of fisheries – a free for all grab for available fish – there is excessive exploitation of fish  and total fish yields decline.  It is important for these last 4 words to be understood.  Total fish yields decline – it is not just that certain nations are grabbing the fish that “rightfully” belong to others.  It is not only a distributional issue – who gets what – but also an efficiency issue – what fish are available in total. Economists say that the open access fish stock is too small and yields an excessively low rate of natural regeneration. By reducing effort fisher-people can gain access to a higher level of sustainable self-reproducing fish yield.  In this case practicing fishing conservation – perhaps by maintaining moratoria in certain fisheries – fish will become more plentiful.  The problem here is the standard strategic one of deriving and enforcing a cooperative agreement to restrict fishing so that fish stocks can recover.

This policy issue is analogous to the task of generating a global cooperative climate agreement to cut emissions.  Such an agreement benefits us all by producing a lower level of a public “bad” – global CO2 levels.

The Chinese model, as discussed in the article,  is to send its fishing boats into any region where fish are available and then to defend this illegal fishing with a naval threat.  This policy might give China extra fish for its 1.3 billion people over the situation where it does not engage in such illegal fishing – with most other countries being too weak militarily to combat this threat – but again leads to an excessively low reproducible stock of fish globally.   In fact, it is doubly inefficient since there is waste involved in using the navy to enforce the illegal fishing rights.

The difficulty these days is that we have global environmental problems – over-fishing, climate deterioration, excessive CFCs – but nation governments pursuing individual national self-interest.  Cooperation can make us all better-off.


Driverless car technology and congestion

A traffic engineer told me the other day that driverless car technology would largely replace the need for expanding road systems in urban centers.   The general idea is that if car travel can be automated that there is plenty of road space for cars to make synchronized journeys on so congestion will just disappear.  There are, however, now many studies that question the claim that driverless cars will reduce congestion – the latest is in today’s AFR.   Let’s back up a bit and sort out the basic logic here.

Roads should be expanded, if congestion and other costs are appropriately priced,  whenever roads display appropriate profitability – the exact definition of “appropriate” here depends on the “returns-to-scale of the road technology. Simply expanding roads, when they are unpriced, is unlikely to be sensible because the effort reflects the attempt to meet an excess demand for travel that is being sold at a zero financial price.  Intuitively what happens here is that there are latent, unrealized demands for travel – people leave their cars at home simply because car travel is too time expensive and inconvenient/uncomfortable. When a new road is constructed these latent demands are released and congestion tends to return to its original level.  There is a small welfare gain – new commuters get to travel from the pool of latent demands – but the level of congestion itself is unaddressed.  Anthony Downs (“Stuck in Traffic”, Brookings, 1992) described this release of latent demands as “triple convergence”.  The only way of avoiding this offset and dealing effectively with congestion is to appropriately price car travel to reflect as marginal congestion costs and, if the road makes an appropriate profit, then just as with a private firm, its scale should be expanded.

With driverless cars two things happen to a car journey.  First it becomes more pleasant – the opportunity cost of the time involved goes down because the commuter does not have to drive and can read, work or indeed, watch a Lady Gaga video if they like.  This stimulates the demand for journeys since the disutility cost of a journey declines.  Second, the immediate time taken for travel will itself decline and more cars will be released onto the road on this account.   This stimulation of the demand for travel will be quite strong because the time savings are also accompanied by an improvement in the convenience of the journey.  Indeed, accounting for this latter effect equilibrium levels of congestion might be expected to increase beyond initial levels because commuters will ensure a bit more congestion given that their journeys are more pleasant.

As with an unpriced road expansion, there is a welfare gain – more people will get to travel and their journeys will be more convenient but the effect on congestion will be to worsen it.  The net welfare effect is plausibly positive (and therefore welfare-increasing) but from the viewpoint of an individual driver that will not appear to be the case.  His/her journeys may take longer but he/she can spend more time working or recreating in the car on these longer journeys.

The upshot: Even with driverless cars the best solution to urban congestion problems is to price it at marginal cost.  Then desired road expansions and the development of driverless car technologies will avoid triple convergence issues and make commuting more convenient and pleasant in our large cities.


Comments on corporate taxes

Most people don’t seem to understand* what company tax is intended to do in Australia’s tax imputation system. The idea of imputation is to avoid taxing the same income twice. When a firm earns profits it is taxed on those profits at the company tax rate of 30%. If some of the after-tax profits are distributed as dividends to shareholders then the intention is not to tax this income a second time when it reaches the shareholder. Hence, if the shareholder’s marginal tax rate is 49%, they get a tax credit equal to the tax paid by the company of 30% and hence only pay 19% tax. The income is overall taxed at the taxpayer’s marginal tax rate it is just that the firm is regarded as “pre-paying” the taxpayer’s liability of 30% with the individual making up any excess of their marginal tax rate over 30%. Under John Howard’s sensible and consistent, ruling if the taxpayer’s marginal tax rate was only 20% then they can claim a rebate of 10% since the tax on that amount of dividends was already paid by the company. Continue reading Comments on corporate taxes

Investment advice

I am often asked to give financial advice to friends and colleagues partly on the grounds that I am an economist and partly because, it is supposed, I have a fair bit of experience in investing. My response is that I have no special expertise in making investment choices although I do have strong views on what should be avoided. 
Generally, I support a version of the efficient markets hypothesis in financial markets. So, I do not generally believe that activist investors can, on average, outperform the market in the longer-term. Of course, there are thousands of funds out there making stock selections so that, purely by chance, some will make above-average returns short-term and sell themselves as stock-picking superstars. However ex-ante it is impossible to pick which of the investment funds are going to be the winners so that you can’t usefully exploit the benefits of using a superstar. 
I agree with Warren Buffett that investment funds that charge high fees are a pure con. They typically take a fixed percentage of your assets – usually around 2% per year but some take even more than that. In addition, if they should be lucky enough to earn above-average returns they will hit you with performance fees of between 15-50% of an “excess” return. Effectively, then, you are paying them with a fixed fee for giving them the chance to gamble with your money and possibly earn themselves more but not to share in any losses that may impact on you. This no-loss proposition is the core reason finance courses are so popular in universities. The courses themselves generally (there are important exceptions) have little or no academic content. Most of the run-of-the-mill courses feed off the fantasy of sitting in front of a computer and raking in millions.
Some people do need financial advice to develop their savings and to manage such things as their retirement. That such people are regularly cheated of their life savings is a testament to this. The best source of advice is commission-free, fee-for-service advisers, examples include the large superannuation funds, that are used for their advice but not as vehicles for investment. If Mr. Bluesky, the smiling accountant, tips you to invest in his best mate’s olive oil plantation (“it can’t lose”) give him a big miss. And try to learn a bit about investment yourself. Burton Malkiel’s “A Random Walk Down Wall Street” is a great start as are older classics such as Benjamin Graham’s, “The Intelligent Investor” which dates from 1949. Both of these books can be purchased for less than $100 and they will give you far more information than any paid investment advisor (or myself) can give. 
Like Malkiel, I strongly favor investment in “no” or “low”-load mutual funds (including index funds and ETFs) that are publicly listed on the stock market. Management costs are tiny and accessing your funds is a snack. The key to realizing great wealth is to start investing early in your life, to develop a reasonably diversified portfolio and then exhibiting patience, thereby allowing the effects of compound interest to grow your wealth.  The key problem facing investors lies in their naive personal psychologies that are almost always tuned in to the rantings of the “get-rich-quick” school.  People who retire without much wealth have asked me what to do to guarantee themselves a high rate of return on their limited wealth.  Of course, I cannot advise in this situation other than to offer them commiserations, to advise on the need for careful budgeting and the possibility of getting the Age Pension.  Their “needs” do not create the opportunities for above-average returns but their desperation can drive them into the arms of get-rich-quick spivs who will destroy the little wealth they have. 

Abbott on immigration

Not everything that Tony Abbott says is nonsense.  A fair bit of his verbal output is suspect but his views on immigration make sense. The claims of his critics, in relation to this, do not.  Particularly when they are related to unwarranted claims of an anti-multicultural bias.

Abbott wants a substantial cut in the immigration intake from 190,000 to 110,000.  The reasons are to limit pressure on house prices and to encourage wage growth.  Both of these claims are correct. Immigrants comprise at least half of housing demands in Australia because they comprise more than half of population growth. Moreover, typically immigrants enter Australia with the need for somewhere to live and without any existing dwelling here. Restricting immigration will reduce demand pressures on house prices.  Likewise, net additions to the workforce are more than half related to immigration for the same reasons.  Unless you believe the cloud-cuckoo view that wages are unrelated to the supply of labour, pouring huge numbers of immigrants into Australia will limit wage growth.  The current immigration intake is 190,000 annually which is at close to record levels – almost double the level of the Howard years.

ANU academic Liz Allen is quoted as saying”evidence shows that the optimal rate of immigration is 160,000 to 210,000 per year”. What evidence?  I’d like to see it.  Having worked in the area of population economics for 30 years I know of no practical way of determining “the” optimal population and that is what is implied here.  The issue is not whether these additional people provide tax benefits and “much needed” skills but whether we are better off net having such a high rate of population growth.

Allen claims that people in Melbourne and Sydney want an expanded population.  Where is the evidence for that claim too?  Massively increased congestion over recent years and with each of these cities destined to be mega-cities by 2050 are an unattractive prospect to many.  Allen further claims that infrastructure funding has failed not the immigration program.  But this additional infrastructure funding is a consequence of (a cost of) pursuing high rates of population growth.  Moreover, it is paid for, in the main, by original residents of these cities not by the newcomers.  These infrastructure costs, that are in the order of tens of billions of dollars in Melbourne alone, are driven by the needs of cities exploding at their boundaries. They dominate any claims that Australians derive net benefits from immigration.

Claims that immigrants increase the size of the economy are true but irrelevant piffle.  The immigrants want to come here so they can be judged better off – they reveal themselves to be so. The relevant criterion for accepting such high rates of immigration is whether preexisting people derive advantage or not from such immigrations.  To see whether this is the case note that immigrants do increase the value of the economy but some of that increase is paid to them as wages as factor returns. The residual – higher profits and other returns to original resource owners must exceed the value of the increased congestion costs that are imposed and the massive infrastructure bills that are being expended by state governments to accommodate a much bigger population.  These infrastructure bills relate not only to roads and public transport systems but also to the exploding costs of water provision – there are now hugely expensive desalination plants in every state capital city. In addition part of the reason for rapidly-growing energy costs is population growth. The net return to the preexisting residents of our community is most plausibly negative. These preexisting people lose because the efficiency gains they enjoy from a larger population are dominated by negative environmental externalities and surging infrastructure costs of roads, water and energy.

We are losing as a community by pursuing such mindless, “endless expansion”, population targets.  Australian cities that have in the past been ranked as among the world’s most liveable are already becoming much less so.  Tony Abbott is right. We should substantially restrict our immigration intake.


Rational expectations?

A penny dreadful mining exploration company that I have followed in the past (to my regret) has made losses for each of the past 10 years.  It has several exploration sites that it owns or co-owns,  but none is anything close to a producing mine – indeed at some “promising” sites, only a single drill sample has been analyzed. Several of the sites are in Africa.   The firm is capitalized at about $40m but has cash at the bank of only about $500,000.  Over the past 6 months, it spent $1.7m on “administrative and corporate costs” (it pays its CEO $700,000 annually) and it spent about $900,000 on “exploration and evaluation” activities.  It is scheduled to spend about another million over the next quarter on “exploration and evaluation”.

To me, it isn’t just Bitcoin that raises questions about the rationality of investor expectations.  Of course, the firm might strike it rich  – I might win Tattslotto too –  but a market capitalization of $40m suggests more than a little exuberant optimism.   A reasonable question can be raised as to whether it is a going concern – but new issues of stock to credulous investors can keep it ticking over I suppose.  It has 700 million shares out there now. A few more hundred million will not make too much difference and once the amount of script gets to a billion or so the board can decide on a 10 for 1 share consolidation and start off the money-mining operation again.

The Vietnam War

I watched the ten-part series,  “The Vietnam War” (TVW), now made available at SBS online.  This is a powerful analysis of this almost grotesque tragedy that influenced my own thinking greatly as a young man. It changed me into a person who thought politically. I opposed the American-run war and Australia’s participation in it during my final high school years and most of my years of study at university.  I was an active participant in the Vietnam Moratorium movement and faced the real prospect of being drafted to fight in Vietnam. The war changed my politics simply by forcing me to question basic assumptions about supposed democratic governments.   I came to reject the naive, adolescent notion that citizens can rely on central governments to behave honestly and decently.  They cannot because they do stupid things. Governments tell lies on important issues of life and death and take monumentally foolish decisions that reflect their own selfish interests.

Generally, my view as a youth was that Australia had no business in fighting in this war and that by doing so we were increasing human suffering not improving things.  I don’t seek to revise these views at all but one new aspect of the war did become clear to me as a consequence of viewing this excellent documentary: A  sound and sensible pragmatic reason for opposing participation in this conflict was that there was no possible way the Americans could “win” this non-conventional civil war. Given the anonymity of the respective sides and the negative spillovers from wrongly persecuting the innocent this was a hopeless military task. Indeed,  the difficulties were understood by all three of the US presidents who were concerned with operating most of the war – John F. Kennedy,   Lyndon B. Johnson and Richard M. Nixon.  All were repeatedly advised on the low probability of anything approximating a reasonable outcome from US military efforts. Moreover, this advice came from advisors who were, initially at least, hawkish on the war. Robert McNamara for example argued that even with a massive buildup of US forces in Vietnam, the chances of victory were very low.  John F. Kennedy had the same understanding – at least as a young politician. The American people and the unfortunate troops sent to fight in Vietnam were sold lies by their presidents simply because of electoral considerations and the need to avoid being the “first US president to lose a war”.  This splendid speech by returned marine, John Kerry, makes it clear that this selfish ethic was in force right up to the final point where Nixon did withdraw US forces. Nixon’s dishonest role in extending this conflict is well-documented in this series. The final rapid US withdrawal and the subsequent collapse of US military equipment support to the South Vietnamese army did seem cowardly given the past actions of the US, but given the sunk costs it probably minimized the consequent very considerable suffering experienced by those who opposed the northern communists. Given past US mistakes there was no simple way to extract itself from this quagmire without imposing huge costs on the South.

The  TWV documentary certainly makes it clear that this war was, on both sides, a savage conflict that was immensely costly in terms of loss of life and human suffering.  More generally, it is a powerful anti-war film.  It also reminded me of the links between this war and the racial divides and of the militarization of security services inside the United States.  The killings at Kent State University by US National Guardsmen and the brutality of their attacks on protesters in Chicago’s Democratic Convention in 1968 drove ongoing and, as yet, unresolved social changes that changed America. Cops in the US are still killing innocent black people and cops still patrol US cities like paramilitary forces.

The interviews with Vietnamese war participants and their families were a key part of this documentary.  There was both savagery and a great deal of intelligent compassion on the part of the Vietnamese. Both sides of the conflict incurred huge human costs but, in terms of aggregated loss of life and suffering, most of the pain was experienced by the people of Vietnam. Also valuable was the discussion of the moderating role that Ho Chi Minh played in the northern communist movement and, of course, his early impassioned plea to the Americans to help Vietnam secure its independence from the French after WW2.  The beginning of the Cold War thwarted that initiative that could otherwise have saved several million lives.

The tragedy of the Vietnam war obviously devastated Vietnam but also changed the west.  It changed me.

The series is available on SBS online for the next few weeks.  Well worth viewing.

Fire and Fury

Michael Wolff’s “Fire and Fury” is a sustained attack on the Donald Trump presidency. Trump is revealed as a narcissist bumbler who repeats himself. A buffoon who is out of his depth for the job of being President. The White House staff he has surrounded himself with are a barely competent collection of factions competing for his attention but all of whom are individually aware of the extent of the Trump inadequacies. Organizationally the White House is a shambles partly because of the “crash through” philosophy of Steve Bannon and partly through the competing family versus the rest factions. “Fire and Fury” is a sustained attack on the Donald Trump presidency.

There have been so many scandals and incidents during the Trump Presidency that putting them all together is confronting. It is also oddly repetitious. A major flaw in the book it seems is the failure to appreciate the Trump cunning and the more positive aspects of his personality. Those who read this and who encounter Trump publicly or privately are likely to think that he is not as bad as portrayed here. The unrelenting attack, as several reviewers point out, probably helps Trump.

What did I find interesting in the book? The following claims surprised me:

  1. The claim that Trump never wanted or expected to win the Presidential election. He wanted to be a runner-up to the evil Hilary and to make a publicity splash. But once he did win he promptly reversed gear and claimed a great victory.
  2. The key role of a few rich Republican-supporting families (particular that of Rebekah Mercer) in driving a Trump victory. Trump didn’t back himself since he saw his candidacy as inevitably failing.
  3. The extent to which Trump sees himself as a performer on a stage. It is a continuation of his ethic of putting the name “Trump” on buildings he has built for him. Trump is obsessed by the media.
  4. The role of Rupert Murdoch as an advisory to Presidents and as a key part of the American political scene. Apparently, he is still on good terms with Trump even though he is claimed to regard him as a “fucking idiot”. Generally, Trump adores financial celebrities such as Murdoch and Carl Icahn.
  5. The role of the US power elites and particularly of New York’s Jews. For example, on of a billionaire Jewish family, Jared Kusher is a White House employee, is married to Trump’s daughter, Ivanka, and is a friend of Netanyahu. His primary policy concern in the White House is US Middle East policy.   It’s a tight group of financial celebrities. Ivanka, for example, is a close friend of Rupert Murdoch and Murdoch’s previous wife Wendy Deng.
  6. Steve Bannon is no masterful Machiavellian figure. He is just a small time right-wing flog with a much-exaggerated view of his own intelligence. Bannon is a flash in the pan figure who will soon be forgotten. On the other hand, Bannon did drive much of Trump’s early policy craziness.
  7. Everything is ultra personal to Trump. Who likes or who criticises him seems to matter more than any policy stance.  His immediate family (daughter Ivanka and her husband Jarod Kushner) have a central role and are the possible weak link in the Rusian investigations. None seem to have much political intelligence.  The role of Jarod Kushner, raised an orthodox Jew, in driving Trump’s Middle East policies seemed to me astounding.

To Wolff, and of course to Steve Bannon, the Trump presidency seems unlikely to continue. Trump is an ignorant child who seeks approval from those around him but who has neither intellect nor discipline. He is a “fucking idiot”, not only to Rex Tillerson,, but to all those around him. No one is fooled. Nor can some of the considerable talent around him compensate for his stupidity since Trump refuses to be upstaged. I am unsure myself even after reading this book. Trump’s stupidity and lack of suitability for the presidential role seems to be a major asset that keeps 35% of the American people loyal to him.  Those who fume at him seem to derive a “guilty pleasure” from listening to and from exposing this fraud.

The possibility of a crash

The arguments by Willem Buiter on the possibility of an exuberance-induced global recession seem reasonable to me.  Stock and property markets are exuberant, particularly in the US  while bond markets are moving into recession because we all know that interest rates are rising and will continue to rise.  There has been a prolonged US expansion since 2009 and Donald Trump’s inappropriately-timed tax cuts will lead to additional exuberance that, given almost full employment in the US, will likely need to be trimmed by even tighter monetary policy than currently envisaged.  Tighter future monetary policies are a risk that create the possibility of recession and a stock and property market crash.  The poorly timed US fiscal expansion will create a huge US fiscal deficit of 5.5% of GDP  that may raise questions about US financial solvency and the possible monetization of the US deficit.  There could well be a Trump-induced recession.

All these thoughts are possibilities only but possibilities that need to be accounted for in making current investment decisions. For Australia the fear is one of contagion.  A US recession inducing a recession in China and new challenges for our paper-thin energy and commodity price revival.

Merry Christmas to All

Christmas is a celebration of what is guessed to be the approximate birth date of Jesus Christ. It is an important occasion in almost all civilized societies for both Christians and Non-Christians alike.
In Australia, the number of people who describe themselves as Christians has fallen from 71% of the population in 1996 to only 52% twenty years later in 2016. I have been a non-believer – although an increasingly much more tolerant one – for my entire adult life so I am gradually acquiring more companions. Christianity, in fact, faces the prospect of being a minority belief – part of the ‘counter-culture’ – in Australian society. But while formal adherence to Christianity may be fading the ideas that underlie it remain, by-in-large, an important positive force in our society. Christmas remains important to many of us – both the secular and the religious.
I lack empathy with multiculturalists and those from other religions who see the widespread respect paid to Christmas as something offensive to atheists and non-Christians. Given my early Christian upbringing, I still feel comfortable celebrating the message of hope, forgiveness, friendship and kindness that Christmas brings to us. I have a long-standing respect for the values that the man Jesus Christ espoused. The birth of a baby indicates the hoped-for possibility of living in a better world. The materialism associated with Christmas does make me reflect. Do  we devote to much time to the emotional impact of Christ’s birth and not enough to the thinking and reasoning part of his life as John Carroll claims? Most of us enjoy giving and receiving gifts. One can be too puritanical about such matters. Most of us enjoy some of the incidentals of Christmas – carols being sung, food and wine being imbibed and homes being brightly decorated. At the very least these are a valued part of our cultural traditions.
The idea of hope associated with Christmas and the belief that the world can be a better place because of the birth of a boy is a beautiful parable. I do not believe that to appreciate the beauty of this notion that one, in fact, needs to accept the idea that the young boy is the ‘son of God’ or our ‘saviour’. It is enough to think about our prospects for renewal and for trying to live a life that reflects Christian values of kindness and forgiveness even if not of Christian theology. It is these values that Jesus taught throughout his life that are important to us as well as the symbolism of his birth.
No religion – Christianity included – should ever be seen as having the last word on anything. One of the great advantages of living in Australia is its openness and the freedom of choice it offers with respect to religion. But the wisdom of many religions, freed from their bigotry, can guide us towards living happier, more fulfilled lives. Whether you are thinking about what job you should take, what partner you should live with or how you should deal with the neighbors and with outsiders, the message of Christianity has something to teach us all. God might be irrelevant in all this – we are after all human beings – but the core message of Christians and the hope of Christmas is not.

North East Link

The North-East Link Project in Melbourne seeks to connect the Western Distributor with the Eastern Freeway. There is much to this project – including a widening of the already-jammed Eastern Freeway – but the biggest feature of this project is its cost. Namely, $16.5b. Some claim the price could go as high as $21b.
This is, by far, the most expensive road transport project in Victorian history. Like most major recent transport infrastructure proposals, there seems to be no cost-benefit analysis that supports the project. If I am wrong please point me in the direction of one.
Arguments for the project include the fact that (i) there is currently heavy congestion due to trucks in local roads around Heidelberg (I live nearby and can verify this), that trucking demands are forecast to grow strongly over future decades (also true) and that the planned 5 km tunnel under the Yarra River will avoid major environmental damages. There have been some qualitative estimates of time savings.
I like the last point but don’t like the huge associated costs being incurred without any overall cost-benefit analysis. It is just hard to get your head around a $16b cost. If I capitalize it at a 4% discount rate over an unending time horizon that is $640m annually forever. The time and inconvenience costs that the project seeks to avoid must be large. Moreover, will the project remain viable for long. The Eastern Freeway and even the link to Eastlink are now already heavily congestion as is the Western Distributor. Even with widening works completed and set to be initiated, there are doubts about whether this project will be an effective one longer-term.
If the project is “essential” then the primary reason for it must be the massive population growth that Melbourne is forecast top experience up to 2050. The immigration-driven population by that time will be something north of 10 million. I think it is important to recognize these costs as an implication of trying to derive benefits from a larger policy-driven population.

The case for enhanced Australian company tax cuts: Modified re-post of an April 2016 post

This issue is again on the agenda because of the US decision to massively cut corporate taxes from 35 to 20% of corporate profits.  It is not the same intellectual case as for the US economy but many of the same issues arise.  The growth in the US deficit as a result of these cuts will be large and there are questions about the extent to which investment will increase given the relatively low level of US unemployment.  As with the US, there is a case for reducing corporate taxes to induce less effort to transfer price profits out of the country.  Australia has already agreed to cut corporate taxes on small companies but should the cuts be extended to all firms including large corporations?

It is important that people take the time to understand what is really at stake here and not just fall into the simplistic and incorrect line that increased profits will only go to increase dividends paid to the rich and salaries paid to corporate bosses.  There is much more to it than that. Continue reading The case for enhanced Australian company tax cuts: Modified re-post of an April 2016 post

Skidelsky on the case against liberal migration policies

I agree with parts of the Robert Skidelsky argument supporting restrictions on immigration but not with others. I agree that the value of diversity are overstated (we want some but shared values also of value and we do not want ISIS) and that public sector tax benefits from immigration are like a Ponzi scheme. But I disagree with the Skidelsky analysis of labour market effects.
Skidelsky says that more migrants mean lower wages but that, in time, the benefits to capital owners will encourage more investment thereby offsetting the initial wage decline. Skidelsky argues that the lag between the initial wage and the final investment effects is likely to be excessively long.
This is generally a wrong view of standard immigration arguments. Wages do fall and profits do increase but the standard economic argument is that gains to capital exceed losses to workers. It is a trivial bit of microeconomics to show this. Thus the argument against migration is that while it realises efficiency gains – total incomes rise – it worsens the functional distribution of income. Thus the argument against immigration is a distributional argument.
I have neglected capital flows and the easiest assumption is that there is perfect capital mobility internationally. Then the initial wage fall creates a boost to the marginal product of capital that creates a capital inflow. Theis occurs until wages are driven back to their initial levels. Then wages for the original workers are as before but the economy has a larger capital stock. All gains from the initial migration accrue to the new migrant arrivals.
If capital is imperfectly mobile – the realistic situation – then the outcome is as somewhere between the situation of zero international capital flows and perfect capital mobility so that economic outcomes are, again, on balance, bad for local workers.
The economy gets bigger in this latter case and the new arrivals as well as local capitalists gain advantage but workers in the original pre-immigration economy lose out.

Australia’s migration and humanitarian programs

Australia’s population growth rate is rocketing along primarily because of our migration and humanitarian programs.  These make up 54% of our total population growth.  Our migration program in 2015/16 took in 189,770 people gross and about 20,000 less than that allowing for permanent emigration.   The gross figure is within a smidgeon of the highest level ever recorded (190,000 a couple of years back) while the humanitarian program intake was 17,555 entrants which is the highest level of intake for 30 years.  The total gross intake was 207,325 people. Useful source documents are here (for migration) and here (for the separate humanitarian program).

Most of our regular immigrants come from India and China while about half of the humanitarian program come from the Middle East  (in 2015/16 4358 from Iraq, 461 from Syria, 1714 from Afghanistan, 337 from Iran).

The migration program for 2016/17 and the planned program for 2017/18 is basically a replication of recent trends with an intake of 190,000 being targeted (here). The humanitarian program will increase through to 2018/19 when it will amount to an intake of 18,750 which will create a new record intake over the past 30 years (here).  The bulk of this increase will reflect the 2014 commitment by the Australian Government to refugees from Syria and Iraq.

Australia is growing its population using the migration and humanitarian programs at the greatest rate for decades.

Advising investors not to believe in active investment strategies

Some of the fees charged by local investment advisors, such as local accountants, seem more than hefty. Particularly when investments are in equities. Often there is a fixed fee of around $300 per month or $3600 per year. There is also often a trailing fee of 1% of the value of the portfolio. Thus on a $1m investment with gross earnings of 5% the total annual fees would be $13,600 which, ignoring taxes, would be 25% of the total return. A big slab since it would now take about 20 years for your investment to double if all returns were reinvested whereas it would take only 14 years without the fees.
An alternative might be to charge clients $50 for a copy of Burton Malkiel’s A Random Walk Down Wall Street*, and a once-and-for-all $500 fee for assistance in opening up, for example, an efficient CommSec account**, along with a brief introduction to the Vanguard no-load mutual funds, exchange traded funds or to the low-load mutual funds such as Argo Investments or Milton Corporation. Capitalized over 20 years the transactions cost of doing this would fall from 25% of the investor’s total return to a tiny fraction of 1%. Moreover, this move is consistent with almost all evidence on equity markets that passive investment strategies outperform active management.  Should re-tool as a low-cost financial advisor and do this? Probably not although anyone else is free to pursue this approach. 
I mention this because, as an economist, I am often asked for financial advice.  My response is that I have no investment advice to give beyond reading Burton Malkiel’s book.  Generally, I believe in “efficient markets”***. In particular, if you have limited assets when you retire there are no miracle ways of accessing high-income returns. You need to learn to be frugal and budget to live within your means and can claim the aged pension.
*Malkiel is an enlightened believer in “efficient markets”. With a few exceptions, he does not believe in “stock picking” but prefers “no-load” mutual funds.  Malkiel is excellent on retirement planning where he favors a major proportion of investments being in REITs and fixed interest securities.
** One which includes direct debit of dividends or their reinvestment in dividend investment schemes.
*** Again following Malkiel I occasionally punt on investments about which “bubble-like” dreams can be built. But this is a risky business and I limit it to 1-3% of my portfolio.

Policy proposal on North Korea

The best deal offered so far in the ongoing conflict with North Korea comes from China. It is:  Abandon your nukes and we will offer you protection. This gives the North what it wants, namely,  protection from externally-imposed regime change. The North’s nuclear capacities are primarily defensive.Moreover, the policy is credible since China does want a buffer between itself and the “west” (the US allies of South Korea and Japan) and, most importantly, helps prevent huge possible loss of life in the North and South and in Japan. It gives time and incentives for internal reform of the wayward North. It addresses the core concern with North Korea which is their ownership of nuclear weapons and their ability to use and sell these weapons.

Moreover, the Chinese policy is credible since China does want a buffer between itself and the “west” (the US allies of South Korea and Japan) and, most importantly, this policy helps prevent the huge possible loss of life in the North and South and in Japan were there to be an armed conflict. It gives time and incentives for internal reform of the wayward North. It addresses the core concern with North Korea which is their ownership of nuclear weapons and their ability to use and sell these weapons. In time the Pyongyang regime may be bribed or induced to voluntarily surrender power.  A pre-emptive strike runs the risk of the regime seeking to go out with a bang rather than a whimper.

Moreover the Chinese policy package is not purely passive – it has ended coal imports from the North (a major source of foreign exchange) and is considering further sanctions.

The US approach is the brinkmanship game of ramping up threats against the bully regime (which is using nukes entirely to protect itself) while leaving the US with the option of a pre-emptive strike. This policy will either not work because the incentives are misaligned or will likely end in a bloodbath.   Every nation party seeks eventual regime change in the North but the slow and steady policy path proposed by the Chinese is plausibly less costly than the impulsive militarism of Trump and his generals.

On this foreign policy issue, China is showing leadership whereas the US is moving to antagonize further the obnoxious Great Leader.