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Wider economic benefits of infrastructure projects – EP136

Jakarta Mass Rapid Transit system (under construction), an example of a public transport program which could deliver wider economic benefits.

Wider economic benefits are increasingly being estimated in the economic assessments of infrastructure projects. In Episode 136 of Economics Explored, show host Gene Tunny and his colleague Arturo Espinoza Bocangel chat about how some infrastructure projects, particularly transport projects, can stimulate new economic development, increasing the density of businesses and workers in an area. This can boost innovation and productivity through knowledge transfer and greater specialisation, among other mechanisms. The expected wider economic benefits of the Cross River Rail subway project in Brisbane, Australia are discussed.

You can listen to the conversation using the embedded player below or via Google PodcastsApple PodcastsSpotify, and Stitcher, among other podcast apps. A transcript and relevant links are also available below.

Transcript of EP136: Wider economic benefits of infrastructure projects

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny  00:01

Coming up on Economics Explored. The more we engage with each other the more knowledge is shared, the more we learn from other people. And this actually helps us in an economic sense.

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene Tunny. I’m a professional economist based in Brisbane, Australia and I’m a former Australian Treasury official. This is Episode 136, on wider economic benefits. I’m joined this episode by my Adept Economics colleague, Arturo Espinoza Bocangel. Arturo and I chat about how some infrastructure projects can stimulate new economic development, increasing the density of businesses and workers in an area. We talk about how this can boost innovation and productivity, through knowledge transfer, and greater specialisation among other mechanisms. Please check out the show notes for relevant links, clarifications and details of how you can get in touch with any comments or suggestions. I’d love to hear from you. Also, check out our website economicsexplored.com. If you sign up as an email subscriber, you can download my e-book, Top 10 Insights from Economics. Righto, now for my conversation with Arturo on wider economic benefits. Thanks to my audio engineer, Josh Crotts, for his assistance in producing this episode. I hope you enjoy it. Arturo, good to be chatting with you again.

Arturo Espinoza Bocangel  01:33

How are you? It’s my pleasure to be here.

Gene Tunny  01:36

Excellent. Yes, keen to chat with you about wider economic benefits. So you helped me out regarding that presentation I gave last month in March to the Indonesian government officials. So as part of a short course, through University of Queensland international development, so you helped me get ready for that. And yeah, that was great. And you dug up some really interesting studies on wider economic benefits, and it helped me understand what they are and how you might measure them. So I thought that was really useful. I thought it could make a good conversation. And hence, I thought, well, let’s chat about it on the programme.

So yes, I guess where we should begin is just this. What is this idea of wider economic benefits? It’s benefits that are additional to the standard ones that you estimate in a cost-benefit analysis, isn’t it?

Arturo Espinoza Bocangel  02:41

Yes, that’s true.

Gene Tunny  02:42

It’s benefits that are in addition to the travel time savings, for example, or the reduction in greenhouse gas emissions that you might get, or the reduction in vehicle operating costs that you would get if you invest in public transport, for example, or if you make the roads more efficient, if you build a new road, you increase road… Actually, that’s probably going to… Yes, that would. That should reduce greenhouse gas emissions to an extent if people aren’t stuck in traffic as long. But yeah, it’s something additional to those normal benefits that are counted in a cost-benefit analysis. And it’s things like an improvement in productivity that comes from what they call agglomeration effects, that sort of thing, isn’t it, and having more people in a region, a thicker labour market? I think that’s how they refer to it. There are all these benefits that they try to estimate, in addition to the standard benefits, is that right?

Arturo Espinoza Bocangel  03:55

Yes, that’s right, Gene. And also, those wider economic benefits can involve some potential impacts on the market, the labour market. They can create more jobs in terms of supply and demand. So that is another WEB that we can consider too.

Gene Tunny  04:17

Right. So yeah, the idea is that there’s some sort of development or infrastructure investment, typically a transport infrastructure investment, and it opens up a new area, or it increases the access to a particular area. And we know that there’s been a bit of focus on what’s called transit-oriented developments, the TODs, whereby if you have a new railway station or subway stops, so you have a new subway system, then the idea is that this can activate new parts of the city. It can create little hubs, little clusters of activity and we see that with what is called the Cross River Rail project here in Brisbane. So this is a subway system.

Now, I’ve questioned in the past the economic viability of it, but they did manage to produce a cost-benefit analysis which had a positive benefit-cost ratio of over 1.4. And they also looked at, well, what could the wider economic benefits of this project be. And if you look at what the government says about the project, a lot of how it sells the project relates to what you might call wider economic benefits. So it talks about revitalised inner city precincts ready to connect, create and advance the region globally for generations, connect industry talent and major facilities, create communities employment and economic value, advance global competitiveness, livability and visitation.

So these are really sort of high level, or these are ambitious benefits, and not just your standard, oh we’re building a new subway system, and people will be able to get to work faster. And so they won’t be wasting time on a congested train network anymore. So that’s one of the ideas of Cross River Rail. Their concern was that there was a bottleneck at this railway bridge in Brisbane, the Merivale Street Bridge. Do you know that one? It connects South Brisbane and the city, so via Roma Street Station. I don’t know if you know that railway bridge.

Arturo Espinoza Bocangel  06:45

Probably yes, I pass by that bridge, but I’m not sure.

Gene Tunny  06:51

That’s okay. That’s okay. But apparently there’s some congestion issue there. And they needed to build this subway system to take pressure off of that. And there’s a bit of a debate to what extent that’s actually the case and whether that is such a serious issue. But anyway, let’s just take their word for it. Let’s just accept that that’s the case for now.

And it’s interesting that in selling this project, probably because perhaps they realise that the actual benefits in terms of travel time aren’t really that great. They have to make this bigger case for Cross River Rail. And it’s all about… Well, it seems to me a lot of it is about the wider economic benefits. And it’s about activating or revitalising some of these inner-city precincts, and they’ve got an interesting document, and I’ll put this in the show notes about Cross River Rail.

And they talk about their Boggo Road precinct. So that’s out near the… There’s an old jail that they’re no longer using, or an old prison at Annerley called Boggo Road. There’s no Boggo Road. Boggo Road was Annerley Road. And because once upon a time, it didn’t have any bitumen on it, it would just get muddy if it rained. And people would get bogged in the road, you know, in their horse and cart or their horse and buggy. And so they call the Boggo Road.

Arturo Espinoza Bocangel  08:30

That’s funny.

Gene Tunny  08:31

We’ve got this area of Brisbane now called Boggo Road, even though there actually is no such thing as an actual Boggo Road. But anyway, and what the government’s tried to do there is it’s tried to create, they call it a world class innovation precinct specialising in health science and education jobs of the future.

So I guess this is consistent with this idea of agglomeration effects, because if you make it easier to get to this Boggo Road precinct where you’ve got this cluster, this health sciences or biotech cluster, then that might encourage biotech firms to locate there or suppliers to biotech firms to locate there. And then you get these conglomeration benefits these efficiency benefits from colocation of businesses that can benefit from being near each other, the synergies so to speak. Economists talk about increasing returns to scale from having more economic activity and having the sum of the parts, sorry, the actual outcome being greater than the sum of the parts, so you get more than the components. Does that make sense? I probably didn’t explain that very well. You get more than the actual sum of the parts. That’s the idea, isn’t it? You get all these synergies.

Arturo Espinoza Bocangel  10:01

Under economic theory, when we talk about economies of scale, that mean a firm or an industry is operating under decreasing cost per unit. So as soon as you use more input, could be labour, capital, etc, that mean, as you increase in that proportion, let’s say a given proportion of those inputs, your return is going to be rather than that. So that is when we talk about when we are under economies of scale.

Gene Tunny  10:42

Yeah, yeah. Yep. So, there’s this idea that you get these benefits from greater density, this clustering. And I mean, we’ve got it to some extent in our cities. I mean, all cities have clusters of some kind, or many cities do, and they’re talking about this health sciences cluster at Boggo Road. They’ve got some other examples. Wooloongabba they want that to be a vibrant world class centre for community sport and health. So that’s centred around the Gabba Stadium, the Wooloongabba Stadium, which is a cricket ground. They play Australian rules football there, Aussie rules as well. And it’s going to be where the opening ceremony of the Olympics is going to be held in 2032. So there’s going to be a lot of investment there. I think they’re going to spend over a billion dollars upgrading that stadium. Yeah. Again, whether that’s economic or not, who knows? But let’s put that aside for now.

Yeah, so this idea that we sort of have all of these clusters, and we’re going to get similar firms locating with each other, and there are all these stories about what benefits this brings. And so as part of getting ready for this and getting ready for the short course presentation, I mean, we had a look at how do you explain these wider economic benefits, these agglomeration effects, these benefits from greater density? We know they exist. I mean, we know there are regions such as Silicon Valley, which specialises in tech, and you get the benefits from having firms and, you know, co-located near each other, you’ve got the workers from the firms talking to each other. They’re learning from each other informally. Yeah, there could be more formal learning between, say, a business and its suppliers. I mean, businesses could be learning from suppliers who are helping them out on something. But there’s informal learning, there’s the watercooler effect that they talk about. And so we had a look at what are some of these wider economic benefits, how do you explain them, and there are some really great articles out there.

There’s one I found by Gerald Carlino, Gerry Carlino. This is one of the best ones I’ve found. He was an economic adviser in the research department of the Philadelphia Fed, so the Philadelphia Federal Reserve Bank. He’s still got some emeritus professor there now, but I don’t think he’s active as he was when he wrote this article in 2001. Knowledge Spillovers: City’s Role in the New Economy. So this is terrific. I’ll put it in the show notes. And I mean, he gives some great examples, particularly from tech because a lot of the really good examples are from that technology industry.

And he refers to a book by AnnaLee Saxenian. In the 1994 book, I’ll have to look that up, she described her gathering places such as the Wagon Wheel bar, located only a block from Intel, Raytheon, and Fairchild Semiconductor. This is in Silicon Valley. She wrote about how they served as informal recruiting centres as well as listening posts. “Job information flowed freely along with shop talk.” So that’s what she wrote. And then other examples of high-tech hotspots include the Route 128 Corridor in Massachusetts, the Research Triangle in North Carolina, and suburban Philadelphia’s biotechnology research and medical technology industry.

And then Gerry Carlino goes into some other examples and he talks about Los Angeles he talks about Hollywood. “The geographic concentration of the motion picture industry in LA offers a network of specialists, directors, producers, script writers, set designers, each of whom focuses on a narrow aspect of moviemaking. The network allows easier collaboration, experimentation and shared learning among individuals and firms.” And then he gives some other examples. Talks about medical research, facilities and teaching institutions having concentrated along York Avenue on Manhattan’s Upper East Side. And so he goes into these different examples. So that’s a great article.

And that’s an example of where you’ve got benefits from firms and workers in the same industry clustering together. So that’s a particular type of agglomeration benefit or knowledge spillover. So there’s a knowledge spillover. The knowledge spillover is driving the benefit there, isn’t it? It’s the fact that there’s this knowledge being transferred from people who have the knowledge to people who don’t have it, obviously. And so what Carlino, how he describes this, he calls it an MAR spillover, and he names it after three famous economists, Alfred Marshall, Kenneth Arrow. Can you guess who R is, Arturo? It’s Paul Romer. Sorry, that was a…

Arturo Espinoza Bocangel  16:39

I am not sure.

Gene Tunny  16:40

It’s all right. I was just wondering if it was obvious, but it’s… You know Paul Romer, did all that work on endogenous growth theory?

Arturo Espinoza Bocangel  16:49

Oh Paul Romer.

Gene Tunny 16:50

Yeah, Paul Romer.

Arturo Espinoza Bocangel 16:51

Definitely, yeah, I know him.

Gene Tunny  16:53

Yeah.

Arturo Espinoza Bocangel  16:54

Thanks to him I learned about endogenous growth, economic growth.

Gene Tunny  17:00

Oh, right. Yeah, yeah. So he’s one of the big names in that literature. Love to cover that in another episode. I guess this is related to it. I mean, this is about increasing returns to scale. In part, so, I mean, that’s relevant to endogenous growth. So that’s what we’ve been talking about here. So Carlino, what he writes is in 1890, Alfred Marshall… So Alfred Marshall was one of the great British economists at Cambridge University at Trinity College at Cambridge. He was a teacher of John Maynard Keynes. So he developed a theory of knowledge spillovers that was later extended by Kenneth Arrow and Paul Romer, hence the name MAR spillovers. According to this view, the concentration of firms in the same industry in a city helps knowledge travel among firms and facilitates innovation and growth. Employees from different firms in an industry exchange ideas about new products and new ways to produce goods. The denser the concentration of employees in a common industry in a given location, the greater the opportunity to exchange ideas that lead to key innovations. And that’s what we were talking about just before. There were these common places that people would get together such as this Wagon Wheel bar in Silicon Valley, and that was a source of knowledge exchange, people learning from each other.

Arturo Espinoza Bocangel  18:31

That’s interesting.

Gene Tunny  18:34

Okay, we’ll take a short break here for a word from our sponsor.

Female speaker  18:39

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Gene Tunny  19:08

Now back to the show. So we’ve talked about the MAR or MAR spillovers. There’s another concept of spillovers, which is called Jacobs spillovers, which is named after Jane Jacobs and this is the idea that you get benefits when people from different industries are different sectors clustered together or are co-located and you get synergies in that way. So that’s another concept. And just because you’ve got that flowing of ideas, so of things that people may not have thought about before. And one of the one of the points that Carlino makes in his article is that refers to some other authors here. As John MacDonald points out, both Jane Jacobs and John Jackson… So Jane Jacobs is the – I think she was a journalist, but she became famous for writing that book The Life and Death of American Cities. And she had a really interesting take on what made for a good city and she was very much into the medium density type of city you want to have. You don’t want to have tall towers, because they’re really lifeless. You want to have some intensity, some density. So it’s medium density. So similar to what you see in the apartment buildings in New York City, but not the really tall ones, not the Trump Tower. But you want people to have eyes on the street. So you want enough people that it’s vibrant, and exciting, but you don’t want too many that it just becomes lifeless and soulless. So she’s got a really interesting take on the life of cities.

But anyway, as John McDonald points out, “Both Jane Jacobs and John Jackson have noted that Detroit’s shipbuilding industry was the critical antecedent, leading to the development of the auto industry in Detroit. In the 1920s, Detroit exported mainly flour. So Detroit exported flour because of the industry was located north of Lake Erie along the Detroit River, small shipyards developed to build ships for the flour trade. The shipbuilding industry refined and adapted the internal combustion gasoline engine to power boats on Michigan’s rivers and lakes. As it turned out the gasoline engine rather than the steam engine was best suited for powering the automobile.” Okay, and so that’s interesting. And so because they had that sort of knowledge to begin with, and that sort of led on to the motor industry. So that’s an interesting example.

And there’s another great example in this book by Cal Newport, Deep Work. So Cal Newport’s got a great podcast, Deep Questions, which I thoroughly recommend to anyone is interested in productivity and working on the right things. So doing the things that matter. And he’s got this great example of building 20 at MIT, which was this temporary structure that they built during the Second World War. It was meant to house the overflow from the school’s bustling Radiation Laboratory. It wasn’t a very well made building. And they just put all of these different departments in it, people who couldn’t fit it in another building. And this is how Cal Newport describes it. “The result was a mismatch of different departments from nuclear science to linguistics to electronics. They shared the low-slung building alongside more esoteric tenants, such as machine shop and a piano repair facility. Because the building was cheaply constructed, these groups felt free to rearrange space as needed. Walls and floors could be shifted and equipment bolted to the beams.” And there was an article in The New Yorker where the author pointed out regarding the scientist Gerald Zacharias, his work on the first atomic clock, it was important that he was able to remove two floors from his building 20 lab, so he could install the three-storey cylinder needed for his experimental apparatus. So that’s pretty interesting.

But in MIT law, so in the stories they tell at MIT, it’s generally believed that this haphazard combination of different disciplines thrown together in a large reconfigurable building, so this is the important bit, that led to chance encounters in a spirit of inventiveness that generated breakthroughs at a fast pace, innovating topics, as diverse as Chomsky grammars, so that’s what Noam Chomsky contributed to linguistics, the Loran navigational radars. I think that’s how you pronounce it or Loran, and video games all within the same productive postwar decades. So he’s saying that this sort of odd mix of people from different disciplines led to these breakthroughs because people were talking to different people, perhaps that that encouraged them to think differently. Does that make sense? That sort of thing?

Arturo Espinoza Bocangel  24:35

Yeah, that makes sense? Yeah. That’s a very interesting point. I think the most popular example is all the technology developed in the military side was then, for example, in the case of microwave, that is a technology developed by the military side on military technology. And then that was applied for civil life. So I think that is the most popular example that we can use. But it’s true. You enrich your thoughts, your knowledge, when you have information from other fields, for example, in this case rather than economy.

Gene Tunny  25:28

So guess what all these stories are trying to show is that there are benefits from having people interact. I mean, it sounds obvious, doesn’t it when you think about it? Well, yeah, I guess that that makes sense, doesn’t it? I mean, the more we engage with each other, the more knowledge is shared, the more we learn from other people. And, you know, this actually helps us in an economic sense. And I mean, this is very difficult for… Well, you can’t really model this or predict this, but it’s something that occurs. And so hence, there can be benefits from getting people in the same place, making investments that can create these hubs, so improve the density, increase the density of particular areas. I mean, we know that density does matter to an extent because we know that cities develop central business districts and over the decades firms have found it advantageous to be in the CBD. I mean, it used to be more obvious that there was a benefit from being in a CBD, or a major activity centre somewhere in the city. It used to be more obvious than it is now. We can chat about that in a moment.

But I guess, if we’re talking 20 or 30 years ago, you could say, well, if you want to be in the CBD, or in an activity centre, say in Brisbane, Toowong or if you’re in Melbourne, it could be Box Hill or wherever, or if you’re in Sydney could be Parramatta. So you want to be in a place like that, because then you’re close to the bank, you’re close to the post office, you’re close to the stationery shop, you might be close to your clients. And so therefore, you’re going to get benefits that way, it’s going to make your life, your business easier to run.

Arturo Espinoza Bocangel  27:28

Exactly.

Gene Tunny  27:29

Yeah. And so that’ll make you more productive. Now, of course, now, we’ve discovered with COVID that, and this is one of the questions that one of the course participants asked, well, what do you think’s gonna happen with everyone’s working from home now? I mean, are these agglomeration benefits as big a deal now that we’ve discovered that we can work virtually and, you know, maybe there aren’t the same benefits to colocation as there once were? And I think that’s an interesting question. I mean, I think that’s something we probably do need to explore and look at what the evidence is over the next couple of decades or so. So I thought that was a good question. I mean, I don’t have the answer to that at the moment. All I know is that pre-COVID It did appear that regions which were denser, where there was a greater concentration of workers, and businesses seem to be more productive. And there were real benefits from this colocation. Do you have any thoughts on that, Arturo?

Arturo Espinoza Bocangel  28:37

Yeah, I remember that. I heard something about that, how it will be the impact of working from home in terms of productivity. I remember that. The results were positive, some cases, and the people now is more productive than before. So definitely, that topic is very interesting and it should be studied.

Gene Tunny  29:11

I think where we’ll end up is that it’ll turn out that that hybrid mix is probably optimal. I mean, you want the best of both worlds in a way. Now, I found this write-up of a study on the Vox EU website so Working From Home: Too Much of a Good Thing. So this is by Kristian Behrens and some of his coauthors. And this is on 13th February 2021. So Kristian Behrens, he’s a professor of economics at the University of Quebec in Montreal. And their abstract of this article, “Containing COVID 19 has required more people to work from home accelerating the trend towards telecommuting. This column uses a general equilibrium model to analyse the long-term effects of this trend, and finds that it may prove to be a mixed blessing.” I think that sounds right. So they go on. “Working from home saves time that would be spent commuting, but deprives firms of the benefits from information and knowledge spillovers. Firms use less office space, but workers require more space at home. Overall GDP will likely be maximised when working from home occurs one or two days per week.” Okay, so I think that sounds pretty much what I would expect. So I’ll put a link to that in the show notes. Do you have any reactions to that, Arturo?

Arturo Espinoza Bocangel  30:55

I need to check that papers in detail.

Gene Tunny  31:00

Yeah, of course. Yeah, it’d be worth having a look at. This one I just found preparing for this conversation today. But yeah, I’ll send that to you. And I’ll put a link in the show notes. So if you’re listening, and you want to check that out. But that sounds fairly sensible to me. So there will still be benefits of agglomeration, there are, but you may not need to be in the office five days a week. You’ll get a benefit if you come in three days a week or something and you’re mixing with your colleagues. You want some mixing with your colleagues. But you don’t need to be mixing with them all the time.

Arturo Espinoza Bocangel  31:45

That’s right.

Gene Tunny  31:47

And that’s what we’re finding, people are just, you know, they’re coming in for a few days a week. And it seems to be that the days people don’t come in… And I think this is replicated in cities across the world, or at least Australian cities. I’ve seen a study of this. People don’t come in Fridays. I mean, there are always fewer people coming in Fridays anyway. But that was because people tended not to… They wouldn’t have a part-time work day on a Friday. But now we’ve got a lot of people working from home on a Friday or Monday too.  People who want to have those days that adjacent to the weekend. So you can have a long weekend. Yeah. So that’s increasingly popular. But I guess there is still that recognition that you need to be working together for some time. There are these benefits from colocating. And so yeah, I don’t think the pandemic has wiped out the argument in favour of wider economic benefits. I think that’s still there. And this is what these authors, Kristian Behrens and his coauthors are arguing that you wouldn’t want people working from home all the time, because then you will lose these benefits. Yeah.

Okay. So, what I thought we should chat about… What else? Oh, what are actually these benefits from agglomeration? I mean, how substantial are they? And there was this great paper by Peter Abelson where he reported that the average elasticity of output to employment density, so this is the percentage by which output… So the value added, the percentage by which that changes for every percentage point increase in employment density. So he reported the average elasticity of output to employment density appears to be in the order of 0.02. Doubling employment would increase output per worker by 2%. So if you have twice as many people in an area, so, say a square kilometre, or say a pocket of the city, precinct of the city, you have twice as many people, then you can increase your output by worker by 2%. So that was the empirical finding.

And it appears that the most important mechanisms, so this is from our presentation, from our slides, the most important mechanism is that both scale and density created an environment where firms and workers can develop highly specialised products, services and skills, e.g. these typically are inputs to firms from specialised  suppliers. Okay, so more firms, more businesses, specialisation and you get efficiencies from that specialisation. So that’s the general idea, isn’t it?

Arturo Espinoza Bocangel  35:15

Yep, that’s the general idea.

Gene Tunny 35:17

Good one. Okay. And then we also note that a further mechanism arises as competition is likely to be intense in a large and dense cluster. So monopolistic pockets of inefficiency are less likely to survive. Okay, so there’s that idea that you get more people in an area, it’s a bit of a hothouse, isn’t it? There’s more competition. Everyone’s striving, everyone’s working harder to compete against the others. And then that benefits everyone through greater efficiency and productivity. So I think that’s a good point. What did you think of the whole agglomeration economies argument and these estimates such as what Abelson reported, that if you double the amount of people in an area, you’re going to increase output per worker by 2%? Do you think that sounds reasonable?

Arturo Espinoza Bocangel  36:08

Yeah, I think so. Isn’t that depend on which area you going to study? Right? Each country, each city has its own features. And you need to take into account that. Of course, you will have different electricity from each cities or areas.

Gene Tunny  36:33

You need to take into account the specific circumstances. But I think generally, it sounds reasonable. It’s not over the top. I mean, if he was saying that it increased productivity by 10%, maybe I’d be sceptical. But there certainly are some benefits from increasing density.

Cost-benefit analysis studies, one way they estimate a dollar value for wider economic benefits is through looking at how density and productivity for particular industries appear to be related across the city or across different cities. And that’s what they did in that cost benefit analysis of Cross River Rail. So I’ll put a link to that in the show notes. They’ve got a bit of a discussion, not as much detail as I would have liked on wider economic benefits, but they do mention that they’ve estimated these wider economic benefits by looking at how much Cross River Rail could increase the density, the effective employment density, or the business to business effective density, they call it, how it could increase that in those particular clusters. So places like Dutton Park, or the Boggo Road precinct there, or RNA or in other places, and it looks at well what could that… It makes some assumptions as to what that could do to productivity, and then estimates a dollar value based on that. So that’s an interesting approach.

They estimate that that if you take that into account, then that increases the benefit-cost ratio of Cross River Rail from something like 1.4 to 2.2. That’s one of the major benefits. And I think there are a couple of other types of benefits they estimate in their wider economic benefit analysis, but it’s something that’s on top of the standard cost-benefit analysis. They report the normal cost-benefit analysis. And then they say, well, okay, there are these other things you could take into account. They’re not standard. They’re additional lists. They’re a supplement to this. They bolster the case. They enhance the case. That’s the idea with wider economic benefits. They’re not your standard benefits you include in a cost-benefit analysis. But you can estimate them. Your estimates of your wider economic benefits are probably more… Would you say they’re more speculative, more of a guess? You could say they’re a guess. They probably aren’t as robust or reliable as your normal estimates of travel time savings, because what they’ll be doing with the travel time savings is they’ll have a detailed transportation model for the city. So they’ve probably got more confidence in our estimates of what it means for travel time savings. If you build a new road or you have a new subway system, they probably got more idea what that means for travel and how much time people save than they do of what is this actual benefit from creating this new activity centre.

Look, to some extent, what happens is you open up a new regional, you make it easy to travel to one particular part of the city. You’ll just have firms moving from another part of the city to that part of the city, right. So, you know, the benefit has to come from this increased density, so a greater density than you’d get otherwise, because these… I mean, how much benefit is that really? Like, it’s hard to know. I mean, you can tell stories about knowledge transfer, but I mean, does that always happen? I don’t know. I often wonder how much confidence we can place in these wider economic benefits. I would say you’d probably have a very wide confidence interval, a very wide gap between the lower and the upper bound of the estimates.

Arturo Espinoza Bocangel  41:05

Yeah. Those are estimates. You need to take into account some source of potential benefit that perhaps they’re not going to accrue.

Gene Tunny  41:18

Yeah. Yes. Right. So yeah, wider economic benefits. And the one other thing I wanted to mention was that you discovered this great paper from the World Bank on wider economic benefits of transport corridors. And this is something that the world, the World Bank, has been interested in these wider economic benefits, because the World Bank has a mandate to improve developing economies, emerging economies to promote economic development. And they’re looking at well, are there investments, we can finance transport projects that can increase economic growth opportunities. And one way you can possibly do that is building railroads or building ports or building roads.

And they’ve done this great study where they looked at a few dozen, or maybe it was over 40 transport corridor projects in developing economies. And they looked at the nightlight data from satellites, and they use that to assess how successful these different projects were. And then they determined Well, what are the markers of success, what actually contributes to the success of a project? And in a way, what they found was, I guess a little bit obvious. I mean, if there’s a project that connects with the sea, then that actually is more likely to lead to additional economic activity as measured by the nightlights, more nightlights. And that’s probably obvious, I guess, in a way because, well, if you’ve got that port, then what you produce, you can easily export. And that’s one way that we know that export led development. That’s been important for quite a few developing economies that ended up going into middle income or advanced economy status around the world.

And another thing that mattered a lot was the actual logic behind the investments. So did they have a real theory of how this would deliver benefits? And in a way, that’s just the rationale. Was this a sensible thing to invest in to begin with? And so I guess that shows that you got to do the thinking about, okay, do we actually have a legitimate reason for building this project? Does it make sense? It’s not just if we build it, they will come. You need to think about are we actually providing something that is delivering real value. This transport corridor is, say, connecting important city centres or it’s connecting a hinterland to an urban area to a port where the products can be exported. I mean, is it actually delivering some real benefit like that?

So I think this is a really great paper. And it begins by talking about how there’s a number of ongoing and proposed initiatives for transport corridors. One ambitious proposal is to revive the Grand Trunk Road from Kabul, Afghanistan to Chittagong, Bangladesh, connecting areas that are home to a significant share of the world’s poor. That’s probably on hold now that you know what’s happened in Afghanistan with the US pullout and Taliban taking over. An even more ambitious initiative is the Belt and Road Initiative proposed by China.

Okay, now, again, look, there are all these geopolitical issues related to these projects we can’t go into. But it’s interesting that the World Bank, they’re examining it, they’re thinking about these wider economic benefits. Can we develop new roads, new railways that open up regions, that encourage investment, foreign direct investment, for example, that create jobs, that lead to additional economic activity, and, you know, help these economies grow? So I thought that was a really great paper, and I’ll put a link to the show notes. So yeah. Well, that’s me having rabbeted on a little bit about wider economic benefits. Is there anything we should add before we wrap up, Arturo?

Arturo Espinoza Bocangel  45:54

Well, I think you have covered the most important WEBs, the wider economic benefits related to [unclear 46:02] and productivity. Also, you mentioned some positive impacts on labour markets. Also, you should have mentioned some important things related to land. In the case of, for example, when you improve on infrastructure, for example, this case, a corridor, the land use, for example of some bar or close to that in infrastructure improvement, possibly that will cause more investment. For example, new households, new unit can be built after improving that corridor, let’s say. So I think that is another thing that we need to take into account, some potential effects in terms of change of land.

Gene Tunny  47:04

Yeah, right. I think that matters a lot in developing economies in particular, so if you’ve got land that’s being used for agriculture, and maybe not used very productively, and then suddenly you open up this new… You’ve got this new road, or this new rail line, and then that encourages industrial development and urban development. And that’s a higher value use. And you mentioned the labour market. So this is this idea of a thicker labour market, or say, for example, Silicon Valley, if you’ve got Silicon Valley as a cluster, and then you’ve got, you know, all the specialised tech firms, all the people who are interested in tech or have got the qualifications in tech or experience, they move to Silicon Valley. And so it’s easier for the firms to find the people they need. That’s that sort of thing. That helps with the firm’s finding the people. You could have a transport investment that makes it easier to get to a particular area, or a particular cluster or an activity centre. And that increases the supply of labour. People might be more willing to work because it’s easier for them to get to work, to travel. So I think that’s an important benefit.

Okay, that was a bit of a whirlwind tour of wider economic benefits, agglomeration effects, increasing returns to scale. I think we’ll have to come back to this again, because there’s so many… There are a lot of different economic concepts here. And they’re important ones, and I think probably need to cover this again, to really do it justice and get that conceptual framework right. These are very important concepts, very important issues. And I think I might have to come back to really explore this again. So any final words, Arturo?

Arturo Espinoza Bocangel  49:14

No. Thank you again for having me here. Was a pleasure again. Thank you.

Gene Tunny  49:19

Very good. Thanks, Arturo. Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to contact@economicsexplored.com and we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.

Links relevant to the conversation

Cross River Rail business case

Cross River Rail project benefits

Knowledge Spillovers: – Cities’ Role in the New Economy – article by Jerry Carlino Gene quotes from in the episode

The wider economic benefits of transport infrastructure paper by Peter Abelson 

Working from home: Too much of a good thing – article by Kristian Behrens and others

Wider Economic Benefits of Transport Corridors : Evidence from International Development Organizations – World Bank paper using nighttime lights data

Clarification

In the episode Gene didn’t get the title of Jane Jacobs’s famous book on cities right. The correct title is The Death and Life of Great American Cities

Credits

Big thanks to EP136 guest Arturo Espinoza Bocangel and to the show’s audio engineer Josh Crotts for his assistance in producing the episode. 

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. Economics Explored is available via Apple PodcastsGoogle Podcast, and other podcasting platforms.

Categories
Podcast episode

Nominal GDP targeting w/ Stephen Kirchner – EP135

Market monetarists such as Stephen Kirchner argue nominal GDP targeting would be better than inflation targeting and could help central banks such as the RBA and the US Federal Reserve get back on track. Stephen is Director of the International Economy Program at the United States Studies Centre at the University of Sydney. 

Stephen spoke about nominal GDP targeting with Economics Explored host Gene Tunny in episode 135 of the show, recorded in April 2022. Among other details of nominal GDP targeting, Stephen discussed the potential role of a nominal GDP futures market and for blockchain and Ethereum in such a market and in financial markets more broadly. You can listen to the conversation using the embedded player below or via Google PodcastsApple PodcastsSpotify, and Stitcher, among other podcast apps.

About this episode’s guest – Dr Stephen Kirchner

Dr Stephen Kirchner is Director of the International Economy Program at the United States Studies Centre at the University of Sydney. He is also a senior fellow at the Fraser Institute in Canada, where he has contributed to research projects comparing public policies in Australia, Canada and New Zealand.

Previously, he was an economist with the Australian Financial Markets Association, where he worked on public policy issues relating to the efficient and effective functioning of Australian financial markets and Australia’s position as a regional and international financial centre.

Stephen has been a research fellow at the Centre for Independent Studies, a senior lecturer in economics at the University of Technology Sydney Business School and an economist with Standard & Poor’s Institutional Market Services based in both Sydney and Singapore. He has also worked as an advisor to members of the Australian House of Representatives and Senate.

He has published in leading academic and think-tank journals, including Public Choice, The Australian Economic Review, Australian Journal of Political Science and The Cato Journal.

His op-eds have appeared in publications including The Wall Street Journal, Straits Times, Businessweek, The Australian Financial Review, The Australian, and Sydney Morning Herald.

Stephen holds a BA (Hons) from the Australian National University, where he was awarded the L. F. Crisp Prize for Political Science, a Master of Economics (Hons) from Macquarie University, and a PhD in Economics from the University of New South Wales.

Stephen posts regularly on his substack: 

https://stephenkirchner.substack.com/

Links relevant to the conversation

Stephen’s papers on nominal GDP targeting:

Reforming Australian Monetary Policy: How Nominal Income Targeting Can Help Get the Reserve Bank Back on Track

The RBA’s pandemic response and the New Keynesian trap

Transcript of EP135: Nominal GDP targeting w/ Stephen Kirchner

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny  00:01

Coming up on Economics Explored.

Stephen Kirchner  00:04

If you want to avoid, you know hitting the zero lower bound or expanding your balance sheet by a significant amount, the way to do that is to respond quickly and aggressively upfront. If you don’t do that, then you fall behind the curve and then monetary policy has to work a lot harder to stabilise the economy.

Gene Tunny  00:23

Welcome to the Economics Explored podcast, a frank and fearless exploration of the important economic issues. I’m your host, Gene Tunny. I’m a professional economist based in Brisbane, Australia and I’m a former Australian Treasury official. This is Episode 135 on nominal GDP targeting. My guest this episode is Dr. Stephen Kirchner, who is Director of the International Economy Programme at the United States Studies Centre at the University of Sydney in Australia. In this episode, Stephen tells us why nominal GDP targeting would be better than inflation targeting and how central banks such as the Reserve Bank of Australia and the US Federal Reserve can get back on track. Please check out the show notes for relevant links and for details of how you can get in touch with any comments or suggestions. I’d love to hear from you. Righto, now for my conversation with Dr. Steven Kirschner on nominal GDP targeting. Thanks to my audio engineer Josh Crotts for his assistance in producing this episode. I hope you enjoy it. Dr. Steven Kirchner of the US Studies Centre. Welcome to the programme.

Stephen Kirchner  01:36

Thanks for having me, Gene.

Gene Tunny  01:37

It’s a pleasure, Stephen, keen to chat with you about a paper you wrote last year on Reforming Australian Monetary Policy: How Nominal Income Targeting Can Help Get the Reserve Bank Back on Track. So there’s a lot to talk about here. And I think this is of general interest to people in other countries, as well, other than Australia, because this idea of nominal income targeting, it’s been raised in other countries, I know that you’ve appeared on David Beckworth’s podcast, Macro Musings, and I know that David Beckworth is a proponent of this in the United States. So I’d like to ask about, essentially, what is this nominal income targeting compared with how we normally, or how central banks have been running monetary policy? Would you be able to give us an overview of that, please?

Stephen Kirchner  02:38

Sure. I think nominal income targeting is actually not a huge change from where we are at the moment. So most central banks do what they call inflation targeting. And as part of an inflation targeting regime, they’re typically adjusting their monetary policy instrument, usually an official interest rate in response to deviations in inflation from target. But also responding to deviations in output from its full employment, or potential level. And the reason you have output as part of your reaction function is the output gap is predictive of future inflation outcomes. So if you’re running an inflation targeting regime, you want to respond to both deviations inflation from target, and output from potential.

Well, if you think about those two things, inflation on the one hand, and output on the other, if you put those two things together, then you’ve got nominal income, or nominal GDP. So in some respects, nominal GDP targeting or nominal income targeting is just a really weighting of that standard central bank reaction function. So if you think about a Taylor rule, which is just an empirical description of how the interest rate responds to deviations and inflation from target, and output from potential, all nominal GDP targeting is doing is saying you want to put inflation output together and weight them equally in terms of the interest rate response.

Gene Tunny  04:14

Ah, right. Okay. Yeah, that’s a good way of describing it. Yeah, please go on.

Stephen Kirchner  04:18

Yeah, so in that sense, it’s not a huge leap from where we are at the moment. But what it does mean is that the central bank is a bit more agnostic about its response to inflation, and deviations in output from potential. So it’s saying really we want to stabilise both, and the reason you want to stabilise both is if you’re just focusing on inflation, one of the problems you face is not all of the deviations in inflation from target are reflective of aggregate demand shocks. As we know, especially at the moment inflation can deviate from target due to supply shocks. Supply shocks have the effect of lowering output. And so this creates a dilemma for a central bank in how do you respond to a supply-driven inflation shock, or deviation from target. Because if you respond to the deviation in inflation from target and raise interest rates, then that’s going to compound the reduction in output you’d get from a supply shock.

Gene Tunny  05:28

Right. So one example, I’m just thinking, Stephen, is one example of this, did this occur, arguably a policy mistake? Was it 2008 when the European Central Bank put up its policy rate? Not long before the financial crisis? Because there was a supply shock? Or was there an increase in the price of oil? I’m trying to remember, is that one of the examples I give?

Stephen Kirchner  05:55

Well, I think the canonical example here is what happened in the 1970s, when you had very significant increases in oil prices giving rise to higher rates of inflation. And central banks did respond to those oil price shocks through tighter monetary policy. And so there’s an influential paper by Ben Bernanke, Watson and Gertler in 1997, which showed that the propagation of the oil price shock to the US economy was essentially through the monetary policy reaction. And so it was the central bank that actually put the stag into stagflation.

Another example of this would be if you go to September 2008, the FOMC meeting took place a couple of days after the failure of Lehman Brothers. And this was at a time when inflation expectations were collapsing and nominal GDP expectations were collapsing. At that meeting, the FOMC incredibly left the Fed funds rate unchanged, and cited inflation pressures arising from higher oil prices as the reason for keeping monetary policy steady. So this is a very good example of monetary policy being led astray by inflation outcomes that are being driven by supply shocks rather than aggregate demand shocks.

And so what we want is the central bank to respond to inflation pressures to the extent that they’re reflective of aggregate demand shocks, not aggregate supply shocks. And nominal GDP lets you do that without actually having to take a view on what’s driving inflation. So nominal GDP outcomes will tell you the extent to which your inflation issues are being driven by aggregate demand rather than aggregate supply.

Gene Tunny  07:51

Okay, so yeah, a few things to try and explore here. Stephen, inflation targeting. So it’s typically going for something around well, in Australia, it’s 2 to 3%, we’ve got a target band for inflation. And in the US, is it 2%? Or I remember thinking of Bank of England? But the different countries have just slightly different targets.

And what’s fascinating is that when these things were first formulated, we had much higher inflation. And I think no one ever expected we’d be getting consistently, we’d inflation outcomes consistently lower than those targets. And it makes it difficult to think about what’s the appropriate monetary policy response.

I better make sure I understand your argument about why you think the Reserve Bank needs to get back on track. Are you suggesting that the fact that Australia is similar to some other advanced economies, who’ve had inflation outcomes below the target for a substantial amount of time, that would imply that the Reserve Bank, the central bank had scope to expand to have a more expansionary monetary policy which could have pushed the economy closer to full employment? Is that the argument, broadly?

Stephen Kirchner  09:14

Yeah, that’s certainly true of the sort of pre-pandemic period basically, the period in which the RBA was undershooting from approximately 2014 through to the onset of the pandemic and even into the pandemic. So it’s certainly in the last couple of quarters that inflation has returned to target. I mean, I think the specification of the inflation target inevitably is a little bit arbitrary. What matters most is not the exact target range, but the fact that you hit that target more often than not over time and thereby establish your credibility in relation to that target. So ultimately, what you’re trying to do is condition the expectations of price, and wage setters in the economy should be consistent with that target. And so whether it’s a 2% target or 2 to 3% target, it’s less important than the fact that you have one and that you actually stick to it.

But the case for nominal income targeting is to say if you’re only targeting inflation, and this creates a bit of a presentational problem and a sort of implementation problem, which is that what happens in the context of a supply shock when inflation might be above target? How do you explain to people the fact that you’re not hitting your target, even though there’s probably a very good reason why you’d want to look through that supply shock.

If you’re expressing your monetary policy target in terms of nominal GDP, that task becomes a lot simpler, because yes, you may be above target on inflation, but in the context of a supply shock, output is going to be lower. And so you don’t get the same sort of deviation from target under a nominal GDP targeting regime than you would under an inflation targeting regime. Policymakers are less likely to be led astray, because by focusing on nominal GDP, they don’t have this issue of trying to figure out whether inflation outcomes reflect demand shocks or supply shocks.

Gene Tunny  11:23

Okay, so how would this work in practice? So in nominal terms, so by nominal, you’re talking about, we’re not talking about a real GDP measure where we adjust for inflation, we try and get things in consistent dollars, you’re just talking about the total value of the economy, in GDP in nominal terms, so what it is in current dollars, and say that it’s over $2 trillion in Australia annually. And so would the Reserve Bank have a target? They would have an expectation of what that nominal income for Australia should be in 2022, what it should be in 2023. So it should be 2.3 billion by this date or something? Is that Is that how it’s formulated? A trillion I meant, not billion. Sorry,

Stephen Kirchner  12:16

You can’t express it in level terms. So with a nominal GDP target, you can express it both as a growth rate or an implied path for nominal GDP. But I think it’s important to emphasise that, just as with inflation targeting, you don’t target inflation outcomes, necessarily. What you’re targeting is actually the inflation forecast. So what you’re saying is, in future, you’re going to be realising inflation outcomes consistent with target, or with nominal GDP targeting, it’s exactly the same thing. So you want to specify a target path for the future evolution of novel income or novel output. And you want to adjust your monetary policy instruments to be consistent with that target path.

So if in any given quarter, your level of nominal GDP is a little bit above or a little bit below the target path, that’s not necessarily a problem. Again, what you’re trying to do is conditions people’s expectations in relation to what future nominal income will be. And I think that has very useful properties from the point of view of stabilising the economy, because if you think about things like wage and price contracting in the economy, people borrowing and lending, all those activities are conditional on expectations for future normal income. And so if you can stabilise both expectations for that future nominal income path, and by implication, also nominal GDP outcomes, then I think that’s a recipe for macroeconomic stability, more so than if you’re targeting inflation without regard to whether inflation is being driven by demand or supply shocks.

Gene Tunny  14:13

Right. Okay. Might go back to that Taylor rule. So you mentioned the Taylor rule. And you mentioned you can actually think of nominal GDP targeting in a, you call it a reaction function, so how the central bank reacts to the macroeconomic variables. And you said this gives equal weight to deviations of inflation from the target end of real GDP from the target. What does the Taylor rule typically do? Do ou know, what sort of normal parameters there are in that reaction function and what that means?

Stephen Kirchner  14:53

So the Taylor rule was due to John Taylor, who in the early 1990s sat down and said, well empirically, how do we characterise movements in the Fed funds rate. So he regressed the Fed funds rate on various macroeconomic variables. And the empirical description that he came up with for the Feds reaction function was to say, well, the Fed responds to deviations in inflation from target, and had estimated a weight of about 1.5 on that deviation, and also response to deviations and output from potential. And he estimated a weight of .5 on that.

But to sort of round out that empirical description of the Fed funds rate, you also needed an estimate of what the neutral Fed funds rate would be. So in other words, what happens when inflation is a target and output is a potential? What is the Fed funds rate consistent with that? And so that just ends up being a constant regression.

One of the big issues that sort of comes out of that is that’s obviously a historical estimate. What happens if your equilibrium real interest rate changes over time. So you then have the issue of, if you’re responding based on those historical relationships, but the actual equilibrium interest rate changes, and you may end up with monetary policy being miscalibrated. And I think that arguably happens in the United States, and to a certain extent here in recent years, where I think the equilibrium real rate probably fell considerably. And that meant that monetary policy ended up being tighter than central banks intended.

Gene Tunny  16:53

Okay, we might come back to that, I just want to go back to the Taylor rule that you mentioned 1.5. So that means for every percentage point that inflation would be above the target, so if the target’s 2%, and inflation is 3%, the central bank would put up the policy interest rate, the overnight cash rate or the federal funds rate by 1.5 percentage points. And the idea is there that you’re trying to engineer an increase in the real interest rate. So you want to make sure the interest rate increases more than the inflation component of it. Actually, yeah,

Stephen Kirchner  17:41

Yeah, that’s right. So this thing actually has a name, it’s called the Taylor principle. And the Taylor principle says that you want to move your nominal interest rate by more than one for one with the deviation inflation from target, because if you just do a one for one or a less than one point move, then you’re not going to move the real rate, you’re not going to move it in the desired direction. So it has to be a move that is more than the change in inflation. So that’s why you get a parameter estimate of a little bit more than one.

For some central banks, you get higher responses to inflation. So the BOJ, Bank of Japan, the ECB, depending on what sort of model that you look at, sometimes their reactions will be up around two. But yeah, the basic Taylor principle is that you want a response to inflation that is greater than one. But essentially, nominal GDP targeting says that you want to combine inflation and output in the form of nominal GDP, and you want to respond to that.

Gene Tunny  18:46

So I guess one of the points that you make, and I think it is a good point, that to do this Taylor rule properly, you need estimates of these unobservable variables, such as this equilibrium real interest rate. And as you rightly point out, I mean, this is something that… Interest rates are much lower now than we ever expected. You compare historically, it’s quite extraordinary what we’ve seen since the financial crisis in Australia, and the US and UK, and even before then in Japan, since the ‘90s. Absolutely extraordinary.

So I want to make sure I understand the logic again. You mentioned that this means that monetary policy was not as aggressive or as accommodative, or however you describe it, because the equilibrium real interest rate, whatever that is, whether it’s… Say it was 4% and now it’s much lower than that. How does that logically work, Stephen? Can you take us through that logic? I just want to make sure I understand how it would lead a central bank to go astray.

Stephen Kirchner  20:00

Actually, the problem is a bit broader than that. So there are potentially three unobservable variables it would impact. Taylor rule style reaction function, and potentially monetary policy Australia. So one is the real equilibrium interest rate, as we’ve discussed. It’s not directly observable. And it could be higher or lower than we think. But I would say it’s probably been lower than policymakers have thought. In terms of the output gap, then you have the problem that we don’t directly observe potential output either. And so that could be higher or lower than we think. And so policy can be miscalibrated on that basis.

An alternative way of thinking about the output gap is to think in terms of an unemployment gap. So the deviation in unemployment from its full employment level, and this is of course where we get the NAIRU from. So the idea that there’s an unemployment rate that’s consistent with the stable interest rate. And both the Federal Reserve and the RBA have conceded in recent years that the NAIRU has actually been a lot lower than they realised. So they have downwardly revised their estimates of the NAIRU.

And so for much of the post financial crisis period, I think both the Fed and to a lesser extent, the RBA were conditioning monetary policy on a view that the unemployment rate was pretty close to the NAIRU, when in fact, it was probably sitting quite a bit above the NAIRU. And so what that meant was we had monetary policy that was two tight. They could have actually pushed the unemployment rates lower. And done it in a way that would have meant that inflation was more consistent with target as well.

So you can see that the problem with a sort of Taylor rule type approach is that embedded in the Taylor rule, you’ve got at least two unobserved variables.  You’re trying to estimate what those unobservable variables are and condition policy on it. So what nominal income targeting says is well, in fact, you don’t need to take a view on either the equilibrium real rate or the NAIRU or potential output, because nominal GDP in and of itself is a complete description of the stance of monetary policy. And in the long run, nominal GDP is fully determined by the central bank. So the central bank can both influence the long run level of nominal GDP, and the level of nominal GDP tells you whether monetary policy is too easy or too tight at any given time.

You don’t need to do what’s sometimes called navigating by the stars, which is, in macroeconomics, when you write this stuff down in the form of equations, the equilibrium values,  the real interest rate, the NAIRU and potential output, those variables denoted with an asterisk or a star. And so we were first and policy that sort of conditions on those variables as navigating the stars. This is what leads monetary policy astray. It’s the problem that nominal GDP targeting seeks to address

Gene Tunny  23:24

Okay, so by NAIRU, N-A-I-R-U, which stands for non-accelerating inflation rate of unemployment, such a horrible expression. We use it all the time. Okay, we’ll take a short break here for a word from our sponsor.

Female speaker  23:45

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Gene Tunny  24:14

Now back to the show. So how’s this gonna work in practice, Stephen? I’m wondering, and does that mean the main thing the central bank is looking at it in their deliberations, so the board meeting of the Reserve Bank or at the Federal Open Markets Committee, or the Monetary Policy Committee, in the UK, or in the FOMC and in the US, they’re just looking at what the latest data are telling them about GDP, about nominal GDP? They’re trying to forecast that themselves based on a range of indicators, I suppose. Have you thought about how it’s going to work in practice?

Stephen Kirchner  24:55

I think central banks should basically look at all the information that’s available to them in forming a view. So the question is more in terms of what their target is and how they specify that target. And, importantly, also how they describe their policy actions in relation to that target. And so, the purposes of adopting a nominal GDP target, one way to do that is to specify a target path for the future evolution of nominal GDP. So you can do that out a few years in advance. And you would then explain your changes in your operating instrument in terms of an attempt to hit that target path.

So for Australia, for example, it would be a simple matter of rewriting the agreement with the treasurer, what we call a statement on monetary policy, which basically sets out what the RBA is trying to achieve through its conduct of monetary policy. And you would specify that in terms of a path, the future path for nominal GDP.

One of the things I do in my paper for the Mercatus Centre is to estimate an implicit forward-looking nominal GDP targeting rule for the Reserve Bank. So I basically do for the RBA, what John Taylor did for the fed back in the early 1990s, and say, How would an empirical description is nominal GDP targeting of how the RBA has actually changed the cash rate in the past?

And as it turns out, it’s actually not a bad empirical model of what they’ve been doing historically, because even if you’re thinking of monetary policy material type framework, you know, you’re still trying to stabilise nominal GDP. You’re just putting different weights on those two components of inflation output. But if you think of monetary policy as just responding to the nominal GDP, well, to some extent, the RBA is already doing that. Where I think nominal GDP targeting is helpful is, at the margin, I think it would lead to better monetary policy decisions, for the reasons that we’ve already talked about that. At the margin, they would be focusing more squarely on nominal demand shocks and looking through supply shocks, which I think is where monetary policy has run off track in the past.

Gene Tunny  27:34

Okay, so I want to ask about the RBA. So you want to get the RBA back on track. And one of the areas or one way you think that it’s off track is that over the last decade or so, or maybe over the last five years, or maybe a bit longer than that, it’s paid too much attention. Am I getting this right? You think it’s paid too much attention to financial stability risks, and this is called leaning against the wind? I think it’s denied that it actually does lean against the wind. Is this one of your criticisms of it, Stephen? And if so, what’s wrong with taking financial stability risks into account when setting monetary policy?

Stephen Kirchner  28:15

So there’s a long running debate about the role of financial stability, inflation targeting framework, and to what extent you should take financial stability concerns into account when doing inflation targeting. And one conception of this is to say that if you are doing inflation targeting, and you’re underpinning nominal stability in the economy, that this in itself is conducive to financial stability. And so, you want to prioritise nominal stability and that is the way you get financial stability.

And to the extent that financial instability becomes a problem, then monetary policy can always address that ex post. So the way the debate is sometimes characterised is between leaners and cleaners. So if your reaction to financial instability is ex post, then you’re cleaning up after you get a financial stability problem. If you’re a leaner, then you’re trying to sort of anticipate those financial instability problems. And to that extent, you’re going to potentially sacrifice your inflation target in order to head off some of those concerns.

So central banks will always obviously have to respond to financial instability after the fact to the extent that it creates problems for the macro economy. The real question is, to what extent do you try to do that preemptively. And I would argue that we don’t have enough information about financial stability risks to really do that successfully, preemptively. And traditionally, that was kind of the view that the RBA took. So if you look at the 2010 statement on monetary policy agreed between the treasurer and the RBA governor, that statement was the first to incorporate financial stability as a consideration. So it was the first statement after the financial crisis. And so it’s no surprise that that statement took on financial stability concerns.

And in that 2010 statement, it says very explicitly that, yes, the Reserve Bank should take account of financial stability, but without compromising the price stability objective. So financial stability concerns were made explicitly subordinate to price stability. And so that reflects the view I talked about before where you view nominal stability as being the most conducive way to address financial stability risks. So that would be the way that I would tend to formulate that relationship between price stability and financial stability.

What happened when Philip Lowe became governor in 2016 is there was a change in the wording on the statement on the conduct of monetary policy, which essentially turned that relationship on its head. So that statement explicitly provided for short-term deviations in inflation from target in order to address financial stability risks. So that agreement was essentially saying that there may be times when in the short run, we’re going to allow inflation to deviate from target in order to address financial stability concerns. And those concerns were explicitly nominated as a reason why you might look at the inflation target.

Gene Tunny  31:51

They might accept lower than the target inflation, because they don’t want monetary policy so stimulatory that it means that there’s a big growth in housing credit and house prices. Is one of the criticisms of what the RBA is doing now. I mean, I’m interested in your views on what it’s done during the pandemic, because we’ve had very aggressive monetary policy response. And this has arguably contributed to the boom in housing credit and house prices where we’ve got double digit, we’ve had house prices increase by over 20% In some cities. And I mean, to me, I mean, it looks like monetary policy has been too aggressive during this period. But yeah, I’m interested in your view on that, Stephen. And I mean, how does what they’ve done, how do you assess that given you’re an advocate of this nominal income targeting? How compatible is what they’ve done with that, please?

Stephen Kirchner  32:58

So if you look at the period from 2016, through to the onset of the pandemic, that changed, and the wording of the statement in the conduct of monetary policy ended up then being a very good description of monetary policy under Governor Lowe. So, through that period, the RBA very explicitly traded off concerns around, in particular the household debt-to-income ratio, and said, Well, the reason why we’re letting inflation run below target is we’re worried that if we provide more stimulatory monetary policy settings, then that would trigger more household borrowing, and potentially create risks in in the housing market. And the concern was that by the household sector taking on increased leverage, that this would increase the household sector’s exposure to a shock. So essentially, you’re trying to fight the last war in terms of the 2008 financial crisis. They were trying to mitigate what they saw as the risks that led to that particular event.

Now, one of the criticisms of leaning against the wind, I think, and this is a criticism that’s been made very persuasively, I think, by Lars Svensson, Swedish economist, is to say, well, if you’re conducting monetary policy on the basis of an apprehended financial stability, its annual trading off inflation and output against those risks, then in a sense, what you’re doing is you’re setting yourself up to have a weaker starting point if and when a financial crisis does occur. So the starting point for the economy is actually going to be weaker because you’ve been running monetary policy, it’s been too tight. And so this is a mistake that the Swedish central bank made In the early 2010s, and which led Lars to sort of formally model leaning against the wind and coming up with that characterization.

Peter Tulip who was a former Reserve Bank economists, when he was at the bank. He also did some work, basically applying Svensson’s framework to Australia and showing that in terms of the trade-off between the central bank’s objectives and financial stability risks, the RBA was basically incurring costs anywhere from three to eight times the benefit in terms of mitigating financial stability risks. So the cost in terms of having unemployment, for example, higher than would have been otherwise, you know, more than offset any gain in terms of reducing financial stability risk.

So essentially, I think this is a hierarchy in knowledge problem that the central bank really does not have enough knowledge about the economy to be able to successfully lean against the wind. This explains why the RBA undershot its inflation target for the better part of seven years. And it was an explicit policy choice, you know. This wasn’t an accident.

Going into the pandemic, I would say that the initial monetary policy response was inadequate. And this was essentially a function of the RBA trying to conduct monetary policy within its traditional operating framework. So they were still trying to use the cash rate as their main operating instrument, even though the cash rate was constrained by the zero lower bound on a nominal interest rates.

Gene Tunny  36:43

So we had a cash rate of, was it .25% going into the pandemic?

Stephen Kirchner  36:49

Going into the pandemic, it was point .75.

Gene Tunny  36:52

Oh, right. Yeah, sorry.

Stephen Kirchner  36:54

In March of 2020 they lowered it by 50 basis points in 2 increments of .25. And that took it down to a quarter of a point, which they argued at the time was an effective lower bound inasmuch as the RBA operates a corridor system around that target cash rate. And so the bottom of the corridor would have normally been at zero, if they had maintained that system. Subsequently, of course, the RBA did lower the cash rate below .25. So it turned out that it wasn’t a lower bound after all. It was very much a self-imposed constraint.

But going into the pandemic, they tried to conduct monetary policy very much within that conventional operating framework with the cash rate as the main operating instrument. And I think, because they allowed the level of the cash rate to determine how much stimulus they would provide… And initially, monetary policy was way too tight. So even though they had lowered the cash rate, what we saw between March 2020 and November 2020, when they finally adopted QE, was that the Australian dollar appreciated significantly. So the Australian dollar outperformed all of the other G10 currencies over that period. The appreciation on the trade-weighted index was about 10%.

And so what this is telling you is that in relative terms, we were not doing nearly as much as other central banks. And we were paying a penalty for that on the exchange rate. The other element of this, of course, was the macroeconomic policy mix, so the relative weight on monetary and fiscal policy. So our fiscal policy response was one of the strongest in the world. But our monetary policy response wasn’t.

Gene Tunny 38:52

Initially, yeah, gotcha.

Stephen Kirchner 38:54

At least up until November 2020. And so this is a recipe for the open economy crowding out effects that you discussed with Alex Robson, when you talked about Tony Makin’s work on open economy crowding out. So if you have a fiscal policy response, if you’re overweighting on fiscal policy relative to monetary policy, you’ll pay a penalty for that exchange rate. And that’s exactly what happened. And that was a pretty strong indication that monetary policy of this period was too tight. The RBA could have done more but didn’t because it was trying to conduct policy within its traditional operating framework.

Gene Tunny  39:33

Right, and by more you mean quantitative easing or large scale asset purchases, creating new money, printing money electronically and then using it to buy financial securities bonds, for example?

Stephen Kirchner  39:48

Yeah, so there are two alternative operating frameworks that they could have used. One is negative interest rates and the other is large scale asset purchases or QE. And so by November 2020, the RBA conceded that other central banks had done more to expand their balance sheet. And they needed to do the same. They also lowered the cash rate target from .25 to .1. And they lowered the bottom of the cash rate corridor from one to zero. So effectively, they conceded that they could have done more and needed to do more, and they finally delivered. And at that time, they did adopt a very aggressive asset purchase programme because they were playing catch up to other central banks. And so by the time we’ve got to the end of 2021, in fact, the RBA had expanded its balance sheet as a share of GDP by an amount that was broadly equivalent to what the Fed had done.

So one of the ironies here is that the RBA’s attempt not to expand its balance sheet actually ended up being a balance sheet expansion that was comparable to that of the Fed. And I think this is an important lesson for monetary policy generally, that typically, if central bank is using its policy instruments aggressively, and over a very extended period of time, that’s usually an indication that it didn’t do enough upfront. So in fact, if you want to avoid, you know, hitting the zero lower bound or expanding your balance sheet by a significant amount, the way to do that is to respond quickly and aggressively upfront. If you don’t do that, then you fall behind the curve, and then monetary policy has to work a lot harder to stabilise the economy. And I think that’s what ended up happening in Australia in response to the pandemic.

Gene Tunny  41:42

Right, okay. You’ve written another fascinating paper on this, Stephen. The paper’s titled The Reserve Bank of Australia’s Pandemic Response and the New Keynesian Trap. So this was published in Agenda, which is a journal put out by the Australian National University. And I want to ask you what you mean by New Keynesian trap. But I think I sort of know, I think you’re sort of alluding to the fact that a new Keynesian policy approach would be inflation targeting, but you can correct me on that. But the point you make, and I think this is fascinating, you want to explore this and make sure I understand what you mean here, you write, “A monetarist conception of the monetary transmission mechanism would have encouraged more rapid adoption of alternative operating instruments.” So could you explain what you mean there, please?

Stephen Kirchner  42:33

Yeah, so the New Keynesian trap was exactly what I was describing in terms of the monetary policy response to the pandemic. The New Keynesian framework for monetary policy analysis relies excessively on an official interest rate as not just the central bank’s only operating instrument, but also the only way that you get monetary policy into that model. And the problem with this is that if the central bank thinks of monetary policy implementation and monetary policy transmission exclusively in terms of an official interest rate, then that’s going to be a problem when your official interest rate hits the lower bound, because at that point, your model basically blows up, because if you can’t lower the nominal interest rate, in a situation which is calling for easy monetary policy, then that’s a recipe for macroeconomic instability. And in fact, it becomes a downward spiral because the economy deteriorates and you can’t respond through your conventional monetary policy instrument.

And in the sort of New Keynesian literature on monetary policy, there are all sorts of ways in which they try and sort of solve this problem. So in some of that literature, for example, there’s just an assumption that  fiscal policy steps in to bail out the central bank. And to some extent, that’s what we saw with the pandemic response, which was that you might have noticed during the early stages of the pandemic, the Reserve Bank Governor was begging the federal and state governments to do even more with fiscal policy than they were actually doing, even though the fiscal policy response is quite large. And so really what he was saying was, my hands are tied, you need to do more to stabilise the economy.

Now, were the central bank’s hands tied by its operating framework? Well, only in the sense that they perceive that framework to be binding on their decision making. If you go back to November 2019. Governor Lowe gave a speech in which he addressed the issue of negative interest rates and quantitative easing. And he was arguing that it was very unlikely that the central bank would have to go there. And if you read that speech, you can see he’s very reluctant to contemplate using either of those policy instruments. So for me, the New Keynesian trap, it’s a self-imposed constraint on monetary policy. It’s because of the way you’re conceiving both the monetary policy instrument and the monetary policy transmission mechanism, it leads you to pull your punches in an environment where you need to adopt a new operating frame.

And for me, the fact that the RBA walked away from that framework in November of 2020 basically concedes the point, they realised that their traditional operating framework was not adequate in responding to a massive shock when the interest rate was hitting the zero bound, and so they needed to think of monetary policy in an alternative framework. And so this is where an RBA officials started giving speeches about the role of quantitative policy instruments and quantitative transmission mechanisms in the monetary policy implementation. If they had done that back in March of 2020, I think we would have had a more timely, more effective monetary policy response and avoided what I’ve called the New Keynesian trap.

Gene Tunny  46:22

Yeah, yeah. Okay. I mean, I think you’ve been rightly critical of the RBA. If they eventually had to adopt these measures, and arguably, they should have done them earlier. So very good point. I want to make sure I understand why it’s a monetarist conception, why that would have led to more rapid adoption. Is that because a monetarist would have been looking at the monetary aggregates, they would have been thinking about, well, how, how could we make the monetary aggregates grow at the rate that would be optimal? Is that what you’re thinking? And you’re just not thinking in terms of a cash rate? You’re thinking in terms of the money supply?

Stephen Kirchner  47:03

Monetarists have always been very critical of the idea that an official interest rate is both the best characterization of what monetary policy is doing, but also the idea that it’s a complete representation of the role that monetary policy plays in the economy. So it’s true that, you know, in equilibrium, you could say that an official interest rate might be a good representation of the contribution of monetary policy.

The way monetarists tend to think of the long run evolution of the price level is in terms of the long run supply and demand for real money balances. And so they tend to think of the evolution of monetary policy in a quantity framework rather than a price framework, the price being the interest rate. So you can think of monetary policy instruments either working through a price, which is the interest rate, or quantity, which is the supply and demand of real money balances. I think both modes of analysis have their place, and they’ve clearly linked. But the focus on official interest rates, I think has been very misleading, because you know, of itself, the level of the cash rate, tells you very little about the stance of monetary policy.

I think one of the mistakes monetary policymakers have made internationally and in Australia has been to assume that because the nominal cash rate is low, monetary policy must be stimulatory. And one of the points that Milton Friedman made repeatedly was to say, if the nominal interest rate is low, then that’s probably indicative of tight monetary policy because that probably means that inflation is very low as well, if you think of the contribution that inflation makes to the nominal interest rate. So if you’ve got very low nominal interest rates, that’s probably an indication that monetary conditions are too tight, rather than too easy. And I think it’s a mistake that monetary policymakers have repeatedly made.

Milton Friedman warned against it in his 1968 presidential address to the American Economics Association. And throughout his life, he tried to impress upon policymakers the significance of this. But it’s something that’s still eludes policymakers, I think, and you can see it in some of the comments that the RBA and Governor Lowe has made in recent years where they often emphasise the low level of the cash rate as being self-evidently indicative of an easy monetary policy stance when, in fact, if anything, it’s probably an indication that monetary policy is too tight.

By the same token, if you go back to say, the late 1980s, in Australia, when we had double digit inflation rates, well, we had double digit interest rates as well. At that time, very high level of interest rates was in fact indicative of the fact that the RBA had run monetary policy in a way that was way too easy, giving us high inflation.

Gene Tunny  50:34

Yeah. And it was that experience that did prompt the adoption of inflation targeting because we weren’t inflation targeting back then. They had some checklist approach or whatever. This was just after they had the brief experiment with monetarism, and then they had a checklist or something and they didn’t have an explicit inflation target until the early ‘90s. I mean, Stephen, would you agree that arguably, inflation targeting was a good thing to adopt at the time? I mean, did it actually improve? Do we get better monetary policy for a while with inflation targeting? Was it better than what we had before?

Stephen Kirchner  51:09

I think inflation targeting was a very important and helpful innovation. They’ve got central banks focused on nominal stability, which is what you want them to do. And I mean, I’m still a defender of inflation targeting as much as I think you could make the current inflation targeting framework work better. And the way in which you would do that would be to focus on as you’re looking through supply shocks, so in other words, not responding to increases in inflation that are clearly driven by supply side constraints, like some of the inflation pressures that we’re seeing at the moment. Where nominal income targeting is helpful I think is helping you to do that.

So one way of thinking about nominal income targeting is you could think of nominal income as an indicator variable or an inflation variable, which tells you when you need to respond to inflation with monetary policy and when you shouldn’t. So that would be one way in which you could improve an inflation targeting regimen would be to sort of look at both variables and use that to help you sift through what inflation shocks you want to respond to, what inflation shocks you want to look through. I don’t think we have to necessarily give up on inflation targeting but we probably do need to change the way we do it, because I think inflation targeting in recent years has failed on its own terms, because central banks have said, well, we’re targeting inflation, but in fact, they’ve missed the target. So if you’re missing the target, you’re not doing it properly. So clearly, you need to change the way you’re doing it.

Gene Tunny  52:49

So as an implication of what you’ve said, are you implying that there’s a risk of the Reserve Bank could increase the cash rate too much, because it’s reacting to CPI data that partly, the inflation is going to be driven by this supply shock? Is that a concern of yours?

Stephen Kirchner  53:12

Yeah, I mean, we’ve certainly seen that in the past. So we talked before about the Fed, and the ECB in 2008 I think clearly made that error. And I think it’s a risk at the moment. At the moment, we have both supply and demand shocks driving inflation. So there’s been a huge dislocation in the supply side of the global economy due to shifts in demand, so that the speed of the recovery has basically caught the supply side of the world economy short. It’s struggling to keep up. And so there’s a big supply component to existing inflation pressures.

In the United States, I’d say there’s also a demand component inasmuch as one of the things that Mercatus Centre has done has been to develop what they call an NGDP gap, which is basically a measure of the deviation in nominal GDP from long-run expectations. At the moment, we have a positive nominal GDP gap in the United States. And so consistent with the nominal GDP targeting framework, that’s saying that there are excess demand pressures in the US economy. And so you would want monetary policy to respond to that. And so I think this is why the Fed is tightening at the moment. It’s appropriate that they do so because there is excess demand in the US economy, and GDP expectations are a good guide. But at the same time, there’s a very significant supply side component to this. And that is something you probably want to look through.

So one way to think about US monetary policy at the moment is the Feds should be tightening with the views of closing that nominal GDP expectations gap on the Mercatus measure. That would require some tightening of monetary policy but not nearly as aggressive as if you were trying to fully stabilise consumer price inflation.

Gene Tunny  55:13

Right. So nominal GDP in the US by that Mercatus measure, it’s higher than that path that long-run path. Is that right?

Stephen Kirchner  55:25

Yeah, that’s right. So on their measure, the level of nominal GDP is running at about, I think, 3% above the path implied by long-run expectations for nominal income. So from a nominal GDP targeting framework, you would certainly want to respond to that.

Gene Tunny  55:41

Right. Now, this is one thing I’ll want to just make sure I understand. In your paper, you talk about how it’s good to correct for deviations from that target path, that nominal path. Why does a target path in nominal terms? Why is that relevant? I think one of the points you make is that, traditionally, central bankers wouldn’t really worry about the nominal path, or they if you did have low inflation for a period, and that meant that you were below that nominal level, it’s not as if you’re going to ramp up, they wouldn’t have a more stimulatory monetary policy just to try and hit a particular GDP number in nominal terms, say two and a half trillion or something, because well, what does the actual nominal value of it matter? What matters is what’s the real value of it and how many people are employed, that sort of thing? I want to understand that. Are you saying that we should try and get back to some sort of the nominal GDP number that was implied by the path we’re on?

Stephen Kirchner  56:54

Yeah, I would say that nominal GDP stabilisation is still implicit in what the RBA and the Fed do today. So if you’re stabilising inflation around target and output around potential, then that will certainly be conducive to stability in nominal GDP. It’s just that we’re not explicitly framing monetary policy in those terms. So at the moment, we frame it in terms of the cash rate responding to deviations in the inflation target, or deviations in output or the unemployment rate from their assumed equilibrium values. All I’m saying is you want to reframe the way in which you implement monetary policy in terms that are currently implicit, but arguably should be explicit.

So really, I’d say monetary policy is trying to stabilise a path for the future path of nominal GDP. Were just not explicit about it. So it’s really reframing monetary policy in those terms, to bring out those relationships. But I think it does it in a way that’s less conducive to monetary policy running off track, for all the reasons that we’ve talked about, that you’re no longer making guesses about the equilibrium interest rate, the equilibrium unemployment rate, or the equilibrium level of real output. You can abstract from all of those things and just ask the question, How is nominal GDP evolving relative to, A, expectations, or B, in my sort of operating framework, you know, where you want monetary policy to be. So just be explicit about that and nominate a target path.

One of the advantages of doing that is in fact, I think, better financial stability outcomes, reason being if you think about the decisions that lenders and borrowers are taking in credit markets, whether it be in relation to housing or business lending or any other type of credit, the serviceability of those contracts depends entirely on the future flow of nominal income. So putting yourself in the shoes of a holder of a mortgage, for example. The amount I borrow is very much a function of what I think my future nominal income is going to be. And the lender is making the same assessment, right? They’re saying, Does this person have the capacity to service a mortgage? Well, that’s a function of what’s going to happen with their normal income in the future.

So by stabilising both expectations for nominal income and actual outcomes for nominal income, I think that’s conducive to financial stability because then the economy is going to evolve in line with the expectations embedded in those credit contracts. So I think you’re less likely to run into financial stability concerns in that context.

So this is essentially Scott Sumner’s critique of US monetary policy in response to the global financial crisis. So what Scott Sumner argues is that the recession in the United States was made deeper by the fact that nominal GDP and expectations for nominal GDP in the early stages of the crisis were allowed to collapse, and that more than anything affected the ability of people to service their mortgages.

Gene Tunny  1:00:42

That’s an interesting argument. I’ll have to have a look back over his work. I’ve seen it in the past. But have you got time for two more questions or do you have to get going? Because there are a couple –

Stephen Kirchner  1:00:52

Oh no, absolutely. Take all the time in the world.

Gene Tunny  1:00:55

Great. There are a couple other things I want to chat about. On page 27 of your Mercatus Centre paper you write, “There’s a growing empirical literature on the advantages of NGDP targeting relative to inflation targeting and other policy rules. I’m interested what that literature is. What does it comprise of? Is it cross-country regression studies, or how do they determine that, that this actually is superior to what we’re doing at the moment?

Stephen Kirchner  1:01:23

So there’s a long history is who the literature on monetary policy rules. And it really goes back to a Brookings Institution project back in the early 1990s. And it was as part of that project that John Taylor published his Taylor rule estimates. And Warwick McKibbin, the Australian economist, was actually an early contributor to that literature as well. And I mean, one of the things I did, as part of that Brookings Institution project was to just simulate different types of rules. So on one hand, you can estimate empirically what the central bank response to macro variables is . But you can also do simulations, where you say, well, what would happen in a economic model if the central bank responded to nominal GDP or some other specification of the monetary policy reaction function.

And I think it’s fair to say that, in that early literature, both nominal GDP targeting, whether in level or growth rate terms, did not fare well, relative to the sort of more Taylor rule type specification. The problem with that literature was that it wasn’t taking account of the knowledge problems that we talked about earlier, which is the unobservability of some of the key conditioning variables, namely the real equilibrium interest rate, either potential output or an estimate of an error. Once you take account of those knowledge problems, then the Taylor rule literature becomes much less robust. And nominal GDP targeting becomes much more robust. So once you allow for the fact that there’s uncertainty around those assumed equilibrium values, then inflation targeting as it’s currently conducted in a Taylor rule framework looks a lot less attractive. So really, that early literature was conditioning on historical relationships, which, when you’re operating in real time, become much more problematic.

Gene Tunny  1:03:53

Okay. I have to ask you about an NGDP futures market. So this was mentioned in your Mercatus Centre paper. Why would that be useful? And what’s the role of Ethereum, so a cryptocurrency, isn’t it? What’s the role of Ethereum in that?

Stephen Kirchner  1:04:15

So if you’re targeting nominal GDP, then one of the things that would be very helpful in that context would actually be a market-based estimate of where nominal GDP is going. People like myself who call themselves market monetarists, the market part of that expression refers to the fact that we think that markets are in fact the best gauge, financial markets at the best gauge of the stance of monetary policy and also what effect any given policy change is likely to have on the economy.

So if you take that view, then what you want to do is get a market-derived estimate of where nominal GDP is going and then base your monetary policy response on that estimate, because that’s going to be your best guess of where nominal GDP is going. And there are various versions of this. Scott Sumner has a version where the central bank would actually tie its open market operations mechanically to prices in that nominal GDP market. So monetary policy would then basically become market-driven. But you don’t need to go quite that far. I mean, it would be sufficient, I think, just for the central bank to take account of what the nominal GDP market was telling you about the stance of monetary policy.

The beauty of this is that any macroeconomic policy measure that you might implement, the nominal GDP futures market will give you instant and real time information on what the market thought that was going to do to the economy. So for example, if you had a fiscal stimulus package, a nominal GDP futures market would tell you basically on announcement, what it thought the impact of that package would be. And my expectation would be that if we had a nominal GDP futures market and you announced a big fiscal stimulus, we would actually probably see very little movement in the nominal GDP futures market because most of the economy crowding out effects that we discussed before, I suspect that in a small open economy with a floating exchange rate like Australia, fiscal policy actually doesn’t do very much in terms of aggregate demand.

Gene Tunny  1:06:45

Right.

Stephen Kirchner  1:06:46

We see that a little bit already, because although we don’t get sort of very clean or discreet announcements of fiscal policy measures, typically when the budget lands every year, and they announce what the change in the budget balance the share of GDP is going to be, which is your sort of best measure of the impact that fiscal policy is going to have on the economy. The national markets very rarely move in response to that announcement.

So the case for a nominal GDP futures market is you want that market to basically inform monetary policy decision making. And it really goes to the issue of what paradigm do you want for monetary policy? The market monetarist paradigm is essentially to say central bank is a lot smarter than financial markets when it comes to assessing where the economy is going. And we should do away with the fiction that they know more than what’s embodied in financial crises. And so conduct monetary policy on the basis of the best available information, which is what financial markets are telling you about the evolution of the economy,

Gene Tunny  1:08:01

What does this instrument look like? And who sets up the market? Does the central bank set up the market? I mean, people are gambling, or they’re betting on what future nominal GDP is. But how’s the market actually work? Has anyone thought about how it would be designed? Does the central bank have to run out or could it be a privately owned market?

Stephen Kirchner  1:08:26

So this could be a conventional futures markets? So we have at the moment futures contracts available, various financial instruments, so there are futures contracts for 10-year bond yields for the Australian dollar. We effectively have futures contracts on inflation outcomes, which is the difference between the prices on bond yields and index bond yields, so that it’s bond yields adjusted for inflation. So we actually already effectively have a futures market in inflation outcomes. And that’s actually a very important input into monetary policy decision making.

So one of the things that the RBA pays very close attention to is what market prices are saying about the future evolution of inflation? So we already have one half of the equation. What we need is the other half, which is to say, a view on what’s going to happen with real output. But if we combine those two things, and what we’re saying is we want a financial market view on where nominal GDP has gotten. So it’s very straightforward to design a futures market contract that you would list on the Australian Stock Exchange, which would be traded by financial market participants.

And I think another thing that would be useful that comes out of this is it would be a very good hedging instrument. So we think of corporations, their top line revenues are in fact often largely a function of nominal GDP. So one of the things the company will look at when they’re forecasting their revenues is an assumption about what nominal GDP is going to do. So corporates could actually use a nominal GDP futures market as a hedging instrument. And that increases the information content of NGDP futures prices. It becomes highly informative of what decision makers in the economy are expecting in relation to the future evolution of nominal income. That information is very useful for policymaking.

And my argument to the Reserve Bank, when I’ve presented this work to them, is to say, Do you think that would be useful input into monetary policy decision making? And of course, the answer has to be yes. You know, you want more information, not less. And so my argument to them is, well, if that information will be useful, then it’s probably worth incurring some costs in order to get that information. So what I’ve suggested is they need to remove some of the regulatory barriers to the creation of a nominal GDP futures market.

A huge regulatory barrier to any sort of financial innovation in Australia is the fact that the costs of financial system regulation in Australia are paid for by the financial sector. So all of the costs of ASIC and APRA in regulating the Australian financial system is recovered from market participants, economic institutions. But that cost recovery framework has a public interest clause, which basically says you should be able to get relief from cost recovery if there’s a public interest in doing so. And so I like it that the creation of a nominal GDP futures market is a perfect application of the public interest case for relief from cost recovery. So basically, the institutions and the Securities Exchanges that would put together that market should basically get an exemption from regulatory cost recovery. I think that would give a huge boost to making that sort of market commercially viable.

Gene Tunny  1:12:37

It’s a fascinating idea, because occasionally, you do have these new financial instruments. I mean, I know in the US they have a market in… Is there a futures market for house prices based on the Case-Shiller Index?

Stephen Kirchner  1:12:51

Yeah, that’s right. There’s derivatives around house prices in the United States. The NSX tried to get a derivatives market in house prices up and running a few years ago. I would argue that, yes, we should have house price futures as well, for exactly the same reasons. It’s informative for policymakers, t gives them information that they would not otherwise have. It will tell you, for example, when APRA changes its regulation of financial institutions. A house price futures market would tell you straightaway what the implications for that are for house prices. It’d be useful hedging instrument as well. So yeah, ideally, I think we should have both markets.

I think the impediments to those markets, given that they are potentially so useful, are most likely regulatory in nature. And so we need to lower the regulatory barriers to the creation of those markets. And arguably, I think there’s a case for implicit public subsidies for those markets as well, so relief from regulatory cost recovery. I think the RBA could use its balance sheet to become a market maker in those markets. So not with a view to influencing the prices, but just providing, being a liquidity provider, which would lower costs for other people transacting in those markets and would help get them up and running.

Gene Tunny  1:14:25

I was just thinking, I was just trying to think, how would this actually start up? And, I mean, you’d need someone to actually develop the instruments, create the contracts and sell them, so that could be say, an investment bank, for example. It could be a Goldman Sachs or it could be a Morgan Stanley or one of those businesses. It’s a fascinating idea.

Stephen Kirchner  1:14:50

Yeah, I mean, in my Mercatus paper, I make the case that the council of financial regulators should jointly mandate the creation of a nominal GDP futures market. And I mean, when regulators mandate something in financial markets, it usually happens. So it’s not uncommon for the financial regulators to actually come out and say to financial market participants, okay, we’re doing this. If it becomes a regulatory mandate, then the financial market participants will cooperate with that mandate. And you know, I think it would be enthusiastic participants. So I think it’s really incumbent upon the RBA to say this is something that we want and need, would be helpful for policymaking and for hedging, as I’ve described. And so we’re going to sit down with financial market participants and make it happen

Gene Tunny  1:15:46

And just finally, you’ve mentioned that there could be a role for blockchain. So you talk about how US NGDP futures have already been implemented on the Augur blockchain. Did I pronounce that right? And then, Eric Falkenstein has also developed Ethereum-based derivatives contracts. These contracts could provide competitive alternatives to listed securities, okay, on existing exchanges and require little or no public support while still yielding useful information about monetary policy in the economy. So is there anything special about the blockchain in this context?

Stephen Kirchner  1:16:22

Well, the role for blockchain I think is just in terms of lowering the costs of doing it. So as we’ve already discussed, there are significant cost barriers to listing nominal GDP futures on our traditional securities exchange. I’ve argued that we should try and lower some of those costs. But another way of doing this is to implement it in blockchain space. There’s already been some interest in doing this in the US. I think, eventually, almost all financial derivatives will move off exchanges and onto the blockchain at some point, main reason being you can then do instantaneous clearing and settlement. So you no longer have trillions of dollars tied up in collateralizing clearing and settlement of financial derivatives. So if derivatives markets are going to move onto blockchain, then arguably NGDP futures should move on to blockchain as well. But I think there’s more scope for innovation in the blockchain space at the moment, just because it’s a different regulatory environment.

And so I’ve sort of argued for a two-prong approach where on the one hand, you want to go through sort of the conventional channel other listed securities market for NGDP futures. But at the same time, I think there’s scope for entrepreneurs to innovate in the blockchain space and do something similar. And hopefully, what we get out of this is a viable future market, not just in nominal GDP, but [with] other macro variables included. And I think it would not only provide policymakers with useful information, but it would really change the way people think about financial markets and monetary policy, because you can’t beat the sort of real-time financial market verdicts on what policy is doing.

It would eliminate a lot of arguments about the implications of various types of public policy, because let’s say the government is proposing a change in some tax rate, and there’s an argument about what the implications of that tax change is for the economy. Well, a nominal GDP futures market will instantaneously settle that argument, because when the tax change is announced, you can observe what the change in the nominal GDP futures is. And that basically tells you what the economic impact is,

Gene Tunny  1:19:07

Assuming the market expectation is correct.

Stephen Kirchner  1:19:11

It doesn’t have to be correct. It’s probably our best guess.

Gene Tunny  1:19:15

Best guess, gotcha. Yeah. I agree. I was just wanting to –

Stephen Kirchner  1:19:19

Ex post it could be completely wrong. At the time of the announcement, it would be the best guess of everyone who actually has a real-time financial stake in that outcome.

Gene Tunny  1:19:31

Yeah, very good point. Okay, Stephen, this has been terrific. I’ve learned so much and it’s made me think about a lot of a lot of things that hadn’t been thinking about before. I love this idea of futures markets in economic indicators. I think that’s brilliant. So yes, I’ll have to come back and explore that in the future. So Stephen, you’ve got a sub stack, which I’ll put a link to in the show notes. I’ll also put links to your two fascinating papers on monetary policy. Any final words before we wrap up?

Stephen Kirchner  1:20:06

I think this has been a great conversation. I’ve really enjoyed it, Gene.

Gene Tunny  1:20:09

Thank you, Stephen. I’ve really enjoyed it too. I must admit, initially I don’t think I’ve really understood this nominal income targeting idea and its merits and what the problems with inflation targeting were as much as I do now, I think I’ve got a much better understanding. So absolutely, really appreciate that. So, again, thanks so much for coming on to the programme. And yeah, hopefully, I have you on again, sometime in the future. We could chat more about these issues. So thanks so much.

Stephen Kirchner  1:20:46

Thank you, Gene. It’s been a pleasure.

Gene Tunny  1:20:49 Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to contact@economicsexplored.com And we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.

Credits

Big thanks to EP135 guest Stephen Kirchner and to the show’s audio engineer Josh Crotts for his assistance in producing the episode. 

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. Economics Explored is available via Apple PodcastsGoogle Podcast, and other podcasting platforms.

Categories
Podcast episode

The high cost of housing and what to do about it w/ Peter Tulip, CIS – EP134

Property prices have been surging across major cities in advanced economies. In Australia, a parliamentary inquiry has recently investigated housing affordability, and it handed down a report with some compelling policy recommendations in March 2022. Our guest in Economics Explored episode 134 provided an influential submission to that inquiry. His name is Peter Tulip, and he’s the Chief Economist at the Centre for Independent Studies, a leading Australian think tank. Peter explains how town planning and zoning rules can substantially increase the cost of housing.  

You can listen to the conversation using the embedded player below or via Google PodcastsApple PodcastsSpotify, and Stitcher, among other podcast apps.

About this episode’s guest – Peter Tulip

Peter Tulip is the Chief Economist at the Centre for Independent Studies, a leading Australian think tank. Peter has previously worked in the Research Department of the Reserve Bank of Australia and, before that, at the US Federal Reserve Board of Governors. He has a PhD from the University of Pennsylvania.

Links relevant to the conversation

Inquiry into housing affordability and supply in Australia

CIS Submission to the Inquiry into Housing Affordability and Supply in Australia

Gene’s article Untangling the Debate over Negative Gearing

Missing Middle Housing podcast chat with Natalie Rayment of Wolter Consulting

A Model of the Australian Housing Market by Trent Saunders and Peter Tulip

Transcript of EP134 – The high cost of housing and what to do about it w/ Peter Tulip, CIS

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny  00:01

Coming up on Economics Explored,

Peter Tulip  00:04

We know that zoning creates a huge barrier to supply. And it’s not clear that there are any other barriers that can account for distortions of this magnitude.

Gene Tunny  00:17

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host Gene Tunny. I’m a professional economist based in Brisbane, Australia and I’m a former Australian Treasury official. This is Episode 134 on the high cost of housing. Property prices have been surging across major cities in developed economies. In Australia, a parliamentary inquiry has recently investigated housing affordability, and had handed down a report with some interesting policy recommendations in March 2022. My guest this episode provided an influential submission to that inquiry. His name is Peter Tulip. And he’s the chief economist at the Centre for Independent Studies, a leading Australian think tank, which I’ve had a little bit to do with myself, over the years. Peter has previously worked in the research department of the Reserve Bank of Australia, and before that, at the US Federal Reserve Board of Governors. He has a PhD from the University of Pennsylvania.

Incidentally, here in Australia, we had a federal government budget handed down in late March 2022. But it didn’t take up any of the proposals in the housing inquiry report that Peter and I discuss this episode. The budget extended an existing housing guarantee scheme, which helps a limited number of first-time buyers avoid mortgage insurance. But the budget didn’t really do anything substantial to improve housing affordability. So we are still waiting for improved policy settings here in Australia, which would make housing more affordable. In my view, such policy settings would not include some more radical ideas that have been injected into the policy debate, such as the government itself becoming a large-scale property developer. That would be too interventionist and too costly policy for me to support. In contrast, what Peter is suggesting in this episode is a very sensible and well thought out set of measures that deserves serious consideration from decision makers.

Okay, please check out the show notes for links to materials mentioned in this episode, and for any clarifications. Also, check out our website, economicsexplored.com. If you sign up as an email subscriber, you can download my e-book, Top 10 Insights from Economics, so please consider getting on the mailing list. If you have any thoughts on what Peter or I have to say about housing affordability in this episode, then please let me know. You can either record a voice message via SpeakPipe, see the link in the show notes, or you can email me via contact@economicsexplored.com. I’d love to hear from you. Righto, now for my conversation with Peter Tulip on the high cost of housing. Thanks to my audio engineer Josh Crotts for his assistance in producing this episode. I hope you enjoy it. Dr. Peter Tulip, chief economist at the Centre for Independent Studies, welcome to the programme.

Peter Tulip  03:10

Hi, Gene. Glad to be here.

Gene Tunny  03:12

Excellent, Peter. Peter, I’m pleased to have you on the programme. So earlier this month, an Australian parliamentary inquiry chaired by one of the MPs, one of the members of parliament, Jason Falinski, released a report on housing in Australia. And it quoted you among other economists, and I was very pleased that you actually referred to a paper that I wrote a few years ago on a housing issue here in Australia. And that was in your submission. And yes, you got quite a few mentions in this report, which was titled The Australian Dream: Inquiring into Housing Affordability and Supply in Australia. Now, Peter, would you be able to tell us why is this such an important inquiry, please, and what motivated you to make a submission to the inquiry, please?

Peter Tulip  04:20

Sure. So the report’s huge. It’s 200 pages long. They had hearings for several months. And I think about 200 people or more made submissions to the inquiry. So there’s an enormous amount of information. And it’s motivated by these huge increases in house prices, that the cost of housing has gone up 20% this year, on the back of similar increases in previous years. So you go back a decade or two and the price of housing has tripled. And that’s having all sorts of huge effects throughout Australian society. It’s making housing unaffordable. And that’s reflected in homeowners can’t get into the market, because deposits are incredibly high, renters suffering a lot of stress. There’s an increase in homelessness. Because housing is one of the largest components of spending, the huge increase in housing costs is having a huge effect on household budgets, changing the way we live. 30-year-olds are living with their parents. Tenants are living with flat mates they don’t like. People are having to suffer three-hour commutes to work. Housing affordability is a real problem in Australia.

Oh, sorry. The other huge issue is that inequality dimension is enormous. So society is increasingly divided up into wealthy homeowners who are having very comfortable lives, and renters and future homeowners who are really struggling. And that’s becoming hereditary, because it’s very difficult to get into homeownership without parental assistance. The Bank of Mum and Dad, it’s often called. And so it’s the children of the wealthy that get a ticket, these enormous capital gains. And people without and less privileged, they’re really suffering.

Gene Tunny  06:38

Yeah. Now, you mentioned the big increases in house prices we’ve had in Australia so over 20%, or whatever, since the recovery for the –

Peter Tulip  06:48

Just this year.

Gene Tunny  06:49

Yes, yes. But we’ve seen big increases around the world and in capital cities around the Western world, from what I’ve seen. The Financial Times had a good report on that last year. Was it the case that our house prices were high relative to benchmark? If you look at things like house prices relevant relative to median income, they were high prior to the pandemic. There’s been this big surge since the pandemic with all the monetary policy response. Is that the case that they were already high and they’ve got worse?

Peter Tulip  07:28

Yeah. And there are a lot of different benchmarks. And the benchmark partly depends on the question you’re asking. But Australian house prices are high in international standards. So for example, one think tank, Demographia, put out a league table of housing affordability. And they looked at, what is it, something like, it’s 100 or 200 big international cities around the world. And Australian capital cities have 5 of the top 25 cities in terms of expense, in terms of price-to-income ratios. So that’s one of many possible benchmarks you can use. And by that benchmark, Australian cities have very expensive housing.

Gene Tunny  08:24

Yeah, yeah, exactly. Okay. Now I just want to talk about the inquiry and how it went about its job. I found the preface to it or the foreword written by, I think it was must have been by Jason Falinski, quite fascinating. He talked about two different tribes of people in the housing policy arena in Australia. The first tribe consists mainly of planners and academics who believe that the problem is the tax system, which has turned housing into a speculative asset, thereby leading to price increases. Okay. And then he talks about how the second tribe believes that planning, the administration of the planning system, and government intervention have materially damaged homeownership in Australia. I think I know the answer to this, Peter, but it’d be good if you could tell us which tribe do you fall into? Do you feel fall neatly into one of those tribes?

Peter Tulip  09:30

Yes, I’m in the second tribe, and as in fact, are almost all economists. I mean, this is one of those issues where you get a real division of opinion between economists and non-economists. And a lot of the most vocal of those non-economists are probably town planners. So there have been a lot of economic studies of the effect of planning restrictions on housing prices. And they find very big effects using a whole lot of different approaches. And that’s a result that’s been replicated in city after city around the world there, and dozens and dozens of papers, economics papers showing planning restrictions are a very big factor, explaining why housing is so unaffordable. And town planners don’t like that and complain and they don’t believe that supply and demand is relevant for prices. They will say that in varying degrees of explicitness. The general public doesn’t like to admit that result. They don’t take part in the academic debates.

Gene Tunny  11:04

So we’re talking about restrictions on what you can build in particular areas. So in Brisbane, for example, where I am, we have restrictions on to what extent you can redevelop these old character houses. A lot of these old character houses, these old Queenslanders, the tin and timber houses, they’re protected in the inner-city neighbourhoods. In other state capitals, you have similar restrictions for different types of properties. And so it ends up distorting the development that you see. In Brisbane, we end up with these horrible, tall apartment towers in just small pockets of where there’s some activity allowed because it was formally allied industrial or commercial area. But yeah, it seems logical to me that we are restricting the supply, because if we had fewer restrictions, presumably we’d see more medium density development, or at least that’s what I think. It doesn’t seem controversial to me that supply restrictions would lead to an increase in prices.

Peter Tulip  12:17

Oh, well Gene, now you’re sounding like an economist.

Gene Tunny  12:20

Well, I mean, I read Ed Glaeser’s recent – I think it’s Ed Glaeser.

Peter Tulip  12:25

He’s done a lot of stuff on the issue. In fact, he may be the leading expert in the world on this topic.

Gene Tunny  12:31

Yeah, yeah. He’s very confident in this impact. Now, you’ve done research on this, haven’t you, Peter? You did research at the Reserve Bank.

Peter Tulip  12:43

Before we get to that, Gene, just a comment on what you just said. There are lots of planning restrictions. They come in dozens of different variations. But there are two of them that are especially important, one of which is zoning as it’s strictly and conventionally defined, which is separation of different uses. Most of Australia’s cities, as in fact is the case for a lot of cities around the world, most of our cities are reserved for low-density housing. That’s single-family detached houses. And in most of Australia’s cities, as cities around the world, apartments, townhouses, terraces are prohibited. Where medium or higher density housing is permitted, there are height limits. And so even if flats and apartments were permitted at your local train station, there’ll be a limit on how high that building can go. Brisbane actually, what you mentioned, is not a very bad offender in this, and so particularly around the river in Brisbane, there’s been a lot of tall apartment buildings, and partly reflecting that, apartment prices in Brisbane are pretty moderate. But in Sydney and Melbourne, the height restrictions are really severe. And so as a result, apartment prices are much, much higher.

Gene Tunny  14:28

Yeah, yeah, absolutely. Okay, so you did research a few years ago, didn’t you, when you were at the Reserve Bank, on the magnitude of the impacts? Now these impacts could be even larger now, given prices have increased so much, but do you recall what sort of magnitudes of impacts you were getting, Peter, from these types of restrictions?

Peter Tulip  14:49

Yes, so the effects are huge. The way we looked at it was to compare the price of housing relative to the cost of supply. And in a well-functioning market, the price will equal the cost of supply. But planning operates as a supply restriction, sort of just in the same way as a quota or a licence to supply will. A lot of cities have taxi licences, and it’s the same thing, that you have a restriction on output, so the price goes much higher than the cost of supply.

And we found when you look at detached houses, the effects are huge in Australia’s big capital cities, I think 70%. Around 70% in Sydney, about 60% in Melbourne, was also very large in Brisbane and Perth. I can get into the details of how we actually estimate that. The more important figure for policy is for apartments, because that’s where the real demand for extra housing is. That’s where the big policy debates are. If we do want more dense housing, it will have to come in the form of urban infill. And again, we find very big effects there, especially for Sydney. I think the effect was about 60%, or a bit higher, it raises the cost of housing. In Melbourne, it was moderate, about 20%. And in Brisbane, actually, we didn’t find much of an effect. It was fairly small, just a few percentage points. But as you say, prices have risen very substantially in the, what is it, four years since our data was put together. So those effects will presumably be bigger.

Gene Tunny  16:52

Okay, we’ll take a short break here for a word from our sponsor.

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Gene Tunny  17:26

Now back to the show. Okay, so we’ve talked about the views of one of the tribes, the tribe that you’re a member of. There’s another tribe, which it’s arguing, oh, it’s all to do with tax policy settings. And, look, we’ve got some quirky tax rules here in Australia. Well, to an extent they’re logical, and which is one of the arguments I made, but they’re different from what happens in some other countries. We’ve got this thing called negative gearing whereby if you lose money on your rental property, taking into account your interest costs and depreciation and the whole range of expenses that are eligible, then you can use that to reduce your taxable income. That reduces the amount of tax you have to pay. And that’s outraged many people in the… There are a lot of people who don’t like that as a policy and think that’s a big problem and leading to higher prices. And there’s also rules around capital gains, concessional taxation of capital gains.

Peter Tulip  18:48

So the whole tax of housing is one of the more controversial parts of this. So can we talk about that?

Gene Tunny  18:55

Yeah, go ahead. Yeah. I’m interested in your thoughts. Yeah.

Peter Tulip  18:59

In fact, you’re the expert on this. In fact, as you mentioned earlier, a lot of what I’ve learned on this topic comes from a paper you wrote in 2018, which was published by the Centre for Independent Studies. It might be easier if you give a quick rundown on what the key issues are. Actually, before that your professional background is probably really relevant here. So in the interest of disclosure, do you want to tell the listeners where you learned about all of this and your experience?

Gene Tunny  19:35

I was in the Treasury, so tax was one of the issues we looked at, but the main research I did on this issue, on the issue of negative gearing and capital gains tax, came from a consulting project I did for a financial advisory firm here in Brisbane, Walshs. Walshs, they clients who are – they have investment properties. And so they were very interested in what the potential impacts of the federal opposition’s policies regarding negative gearing, so changes to that. So basically limiting it and not only allowing it on new houses, if I remember correctly, newly bought properties. And they were concerned about what that would mean for their clients and then what it would mean for the market.

So certainly, negative gearing does make investing in a rental property more attractive. It does two things. So it does lead to more rental properties, and it does push down rents. And it also increases the price of houses to an extent because it does increase that demand. So look, there’s no doubt that it is impacting on prices, but it doesn’t seem to be a huge effect. I got something like 4%. Grattan when they looked at it got 2%. Some other market commentators, I think SQM Research, Louis Christopher thinks it could be 10 to 15%. It’s hard to know, It’s not a huge impact. So you’re not going to solve housing affordability by getting rid of negative gearing. At the same time, there are logical reasons why you’d have it.

Peter Tulip  21:43

Can I just butt in there, Gene? You’re underselling your research. What you said is all right. Everything there is correct. But, in fact, since your study, there have been a whole bunch of further empirical studies and academic studies on the effect of negative gearing, and, and they essentially get the same result as you, that these effects are tiny. So there was a bunch of Melbourne University academics. There was a study by Deloitte and a few others. They use actually different approaches. So the Melbourne Uni study is the big structural model micro-founded in assumptions about preferences and technology. And so we now have a range of different studies, all using different approaches. And they’re all finding the results, the effect on housing prices comes in between about 1% and 4%. So I think we can be more confident than you were suggesting about this result. It’s a big important controversial issue. So we need to talk about it. Listeners need to be aware that it just doesn’t actually matter for anything.

Gene Tunny  23:15

Yeah. So I think one of the main points that’s important, I think, in that whole negative gearing debate is that it is quite a logical feature of the tax system, and as the Treasury explained in one of their white papers, on tax issues, it’s important for having the same treatment of debt and equity if you’re buying an investment property. So I thought that made sense. So there’s some logic to it, and it certainly does improve the rental market. Now, look, there was a huge debate. It was all very political. I thought, well, certainly it would impact house prices. And then that ended up becoming a big story. And there was a lot of discussion about that and just what could the impact on the market be.

Peter Tulip  24:15

Is the problem negative gearing or the discount for capital gains tax? Because they interact.

Gene Tunny  24:21

Yeah, I think that’s part of it. But I think there is a logical reason to have concessional treatment of capital gains, particularly if –

Peter Tulip  24:33

Concessional taxation of real capital gains?

Gene Tunny  24:37

We don’t adjust them for inflation.

Peter Tulip  24:41

We do it both ways. My sense is you can argue that there is distortion, that an investor can put, I don’t know, $10,000 into a property improvement and write that off against tax with depreciation. But then that will increase the value of the property, presumably by about $10,000. And though they get the full deduction, they only have to pay tax on half the benefit. So there is an incentive towards excessive investment in housing for that reason.

Gene Tunny  25:30

Look, potentially, I think you could argue about those capital gains tax settings. Yeah, certainly, I think that was one of the things I acknowledged in the report, if I remember correctly. So yeah, I guess the overall conclusion is that I didn’t think negative gearing was the villain that it was being portrayed as, and if you did make changes to it along the lines suggested you could end up having some adverse impacts. If you look at what estimate I made of the potential impact on house prices, and you look at how much house prices have increased in recent years, you think, well, who cares?

Peter Tulip  26:15

It’s one week’s increase. I think you’re exactly right. And while I say I think there is an argument that it creates distortions, if you fix that up, you then create distortions elsewhere, as you said, between debt and equity, and there are distortions between investors and owner occupiers. And given that so many different aspects of housing are taxed differently, it’s impossible to remove all the distortions. You remove them somewhere, then create them somewhere else. And the bottom line is that this doesn’t really matter, the housing affordability. The effects on prices are small and positive. And there are offsetting effects on renters, which I think are often neglected. Negative gearing promotes investment in housing and is good for landlords. And because it’s a competitive market, the free entry, that gets passed on in lower rents.

Gene Tunny  27:21

Yeah, yeah, exactly. So I’ll put a link to that paper in the show notes. So if you’re listening in the audience, and you’d like to check that out, you can read it. Bear in mind it’s now over. It’s four years since I wrote that, and probably six years since I did that report for Walshs. I think the logic is all correct. And I think the analysis still makes sense because it was a static model in a way. Yes. It was a static model. I was just looking at how much does a change in tax policy settings affect the rate of return for an investment property? So you could argue it’s still relevant in that regard. But the whole political sort of imperative, it’s not as big, it doesn’t figure as much in the political debate now, of course, because the opposition has dropped it as a policy, because I think they’ve recognised that, look, it is unpopular, because there are a lot of people – there have been in the past – fewer people now with low interest rates, but there have been a lot of people in the past who have been negative gearing. So I think they accept that it’s probably not a policy that is popular with the public.

Peter Tulip  28:35

But also, it’s just a non-issue. It wasn’t going to deliver benefits in terms of housing affordability. So I think one of the reasons I dropped it, or at least the reason I would have told them to drop it, was it was just a red herring.

Gene Tunny  28:50

Yeah, yeah, I think that’s correct. That’s how I would how I would see it. Okay, we might go back to the Falinski report. I know it does deal with this issue in the… It is part of the conversation for sure. Where did the Falinski report come down on deciding which of these two tribes is correct? Did it make a judgement on that or did it –

Peter Tulip  29:17

It’s strongly on the side of economists, of those who argue that planning restrictions have large effects on house prices. The commission discussed it in a lot of detail. It’s all of Chapter Three, I think of the report. It’s the first substantive policy-oriented chapter of the report. It’s some of their lead recommendations. And they note that there were… I think they described it as the most controversial issue they dealt with, with very lengthy submissions on both sides.

Their assessment was that the weight of evidence is not balanced. It’s overwhelmingly on the side of those who think planning restrictions have big effects on prices. In fact, they cited our submission, which said there have been a lot of literature surveys of this research. I think we cite six of them by different authors, a lot of them very big names in the policy world. And all of those surveys conclude that planning restrictions have big effects on prices. And the commission recognise that even though it’s hard to tell in the noise on social media, if you look at the serious research, the weight of evidence very clearly goes one way.

Gene Tunny  31:01

Okay. What does that evidence consist of, Peter? You’ve done your own study. Was your study similar to what others have done around the world? And broadly, what type of empirical technique do you use?

Peter Tulip  31:17

So in fact, there have been dozens and dozens or more years of studies on this question, both in Australia and in other countries. The approach we used is… The reason we used it was we thought it was the best and most prominent approach to answer these questions. And it’s been successfully used with essentially the same results in a lot of cities in the United States, some focusing particularly on coastal cities, some on California, some on Florida. There’s a big study for the United Kingdom and a lot of European cities, another study in Zurich in Switzerland, studies in New Zealand, all using essentially our approach of comparing prices with the cost of supply. And they all come up similar results.

Other people have looked at planning restrictions more directly. So for example, we know that planning restrictions are very tight in California and very loose in a lot of Southern and Midwestern cities in the United States. And there, you get a very strong correlation with prices. California is incredibly expensive. Houston, Atlanta, places with relaxed zoning are relatively inexpensive.

Gene Tunny  32:46

So is there a regression model, where you’re relating the price of housing to cost of supply, and then you’ve got some… Do you have an indicator variable or a dummy variable in for planning restrictions? Is that what you do?

Peter Tulip  33:05

So there are lots of different ways of doing it. Yes, people have constructed indexes of the severity of planning restrictions. That’s one way of doing it. The most famous of these is what’s called a Wharton Index, put together by researchers at the University of Pennsylvania, in fact, my old alma mater. Our approach doesn’t actually – and this is a criticism that some people make of it – it doesn’t actually use direct estimates of zoning restrictions, because they’re just very difficult to measure. But when you have prices substantially exceeding costs, you need to find some barrier to entry. And just as a process of elimination, we know that zoning creates a huge barrier to supply. And it’s not clear that there are any other barriers that can account for distortions of this magnitude.

Gene Tunny  34:10

Right, okay. I better have another look at your study, Peter, because I’m just trying to figure out how did you work out what’s the cost of supply? You looked at what an area of land would cost, where it is readily available, say on the outskirts of a city, and then you looked at what it would cost to build a unit on that or a house on that site?

Peter Tulip  34:38

So where it’s simplest is for apartments, because there you don’t need to worry about land costs, and which is a big, complicated issue. But you can supply apartments just by going up. And so we have estimates of construction costs from the Bureau statistics, to which we add on a return on investment, interest charges, a few tax charges, developer charges, marketing costs. There are various estimates of those other things around, and they tend not to be that important. And the difficult thing is getting an estimate of the cost of going up, because as you increase building height, average costs increase. You need stronger foundations, better materials, extra safety requirements, like sprinklers and so on. You need more lift space. So a lot of it involves a discussion of the engineering literature in housing, where we can get estimates of things like that. And they exist both in Australia and in other countries, where the other people that did that. And that’s how we get our estimate of the supply cost.

Gene Tunny  35:59

Okay. That makes sense now.

Peter Tulip  36:03

That’s one way of doing it. There are other ways of doing it. So you can assume that’s the cost of going up. We can also do the cost of apartments by going out. And there you just make an assumption that it’s the average cost of land in that suburb or on that street or in that city, is the land cost. And then you get a cost of going out, which in some cases is a bit higher, some cases a bit lower.

Gene Tunny  36:33

Yeah, yeah. Okay. That makes sense to me. Can I ask you about the recommendations of the Falinski report? It looks like it’s come down. It supports the view that, yep, supply is a big issue. And also, there’s this issue of now we’ve got this issue of young people having this deposit gap, haven’t we, that it’s difficult to save up for a deposit? So that’s another issue. And I think it’s made recommendations that may help with that. I don’t know. But would you be able to tell us what you think the most interesting and the most important recommendations are of that inquiry, please, Peter?

Peter Tulip  37:13

So I think the most important recommendations go to the issues we were just talking about, the planning restrictions. A difficulty with that is that this was a federal government inquiry. But responsibility for planning regulations rests in state and local governments. And so there’s not a lot that the Commonwealth government can do, other than shine a very big spotlight on the issue, which I think it has done. It’s helped clarify a lot of the issues. And it’s putting more pressure on state and local governments to liberalise their restrictions. But I think the most important recommendations is it wants to couple that with financial grants, and in particular, provide grants to state and local governments in proportion to their building activity, so that neighbourhoods that are building a lot of housing get more support from the Commonwealth Government than neighbourhoods that are refusing to build anything at all.

his should help allay some of the local opposition. We get to housing developments, that a lot of neighbours and local residents understandably complain if new housing is going in, in their neighbourhood, without extra infrastructure, without transport, parks, sewerage, and so on. And what the Falinski report says is we’ll help with that, that we don’t want local neighbourhoods to bear the burden of increased population growth, it’s a national responsibility, and so the Commonwealth will help. So I think that will be the most important recommendation, that should improve incentives to local and state governments to improve housing. Want to go to some of the other recommendations that I think are interesting?

Gene Tunny  39:34

Yeah, I was just thinking about that one. They obviously haven’t put a cost estimate in the inquiry report. So they’ve just said, oh, this could be a good idea. But then we’d have to think about what this ultimately would end up costing.

Peter Tulip  39:47

So our submission put dollar figures on it, even though Jason Falinsky didn’t want to sign on to actual numbers. These conditional grants in terms of housing, good housing policies, could be in place of current Commonwealth programmes that are of less value. And one that’s just been in the news a lot the last few weeks is, I think it’s called the Urban Congestion Fund, which is essentially something like a slush fund that the government uses to channel money towards marginal seats. That’s about $5 billion the Commonwealth uses at the moment.

We could remove that invitation to corruption, and at the same time, solve some of our housing problems by instead, by making that conditional on housing approvals. And if you use that $5 billion, divide that by the, what is it, 200,000 building dwellings that get built in Australia every year, that works out at something like $25,000 per new dwelling. A grant like that will provide a lot of local infrastructure. It’ll give you a new bus route, it’ll give you a new park, it’ll give you some new shops. It’ll fix up the local traffic roundabout, and so on. You could do even more than that, if you start looking at state grants and other grants that are currently on an unconditional basis.

Gene Tunny  41:38

Right. So was the origin of this recommendation, was it from your submission, was it, Peter, the CIS submission?

Peter Tulip  41:44

In fact, a lot of people have been recommending a policy, something like this. We talked about it maybe a bit more detail. But the Property Council of Australia actually wrote a paper on this a few years ago, sorry, commissioned a paper by Deloitte, which discusses some of these issues. But in fact, it’s been proposed in a lot of other countries around the world. And so the original Build Back Better proposal from the Biden administration had substantial grants from the US government to local governments along these lines, and that’s been cut back a little bit in their negotiations. They’re still talking about substantial grants from the federal government, to local counties that are improving their housing policies.

Gene Tunny  42:43

Right. Okay. That’s fascinating. Now, I have to have a closer look at that. Yeah. On its face, it sounds yep, that could be a good idea. As the ex-Treasury man, I’d be concerned about the cost of it to the federal government, but you’re saying we’ve wasted all this money on various pork barreling projects anyway, we could redirect that to something more valuable.

Peter Tulip  43:13

And if you want to talk about really big money, you could change grant commission procedures, so that if housing were regarded as a disability, in the formula for dividing up, the GST, the fiscal equalisation payments with the states, then states that are growing quickly and providing a lot of housing should be able to claim money for the extra infrastructure charges that requires. I think that’s consistent with the logic of the Grants Commission processes. And they currently already do this, but something like this to transport. So there is a precedent, and that would substantially improve incentives for state governments to encourage extra housing.

Gene Tunny  44:08

Yeah, yeah. Okay. Just with the supplier restrictions, am I right, did they make a recommendation along the lines that local councils and state governments, they should look at existing restrictions with a view to easing those restrictions? Did they say something along those lines?

Peter Tulip  44:26

It’s not a formal recommendation, but that’s emphasised in several places in the report, and I think it might be… I can’t remember the exact wording. Recommendation one certainly discusses that issue.

Gene Tunny  44:43

Right. Okay. I should be able to pull that up pretty quickly.

Peter Tulip  44:49

It’s not something the Commonwealth can do something directing it. So the wording is a bit vague. That’s clearly the thrust of the report. Yes.

Gene Tunny  45:03

Right. Yep. So the committee recommends that state and local governments should increase urban density in appropriate locations, using an empowered community framework as currently being trialled in Europe. I’m gonna have to look at what an empowered power community framework is sometimes. I haven’t heard that before. I had Natalie Raymond on. She’s a planner here in Brisbane. And she got an organisation called YIMB, Yes In My Backyard. So I’ve chatted with her about some of these issues before, but I can’t remember hearing about this empowered community framework. Have you come across that concept at all, Peter?

Peter Tulip  45:45

It’s something that the report is very vague about.

Gene Tunny  45:50

Okay.

Peter Tulip  45:52

No, I’m not sure what that means either.

Gene Tunny  45:55

I’ll have to look it up.

Peter Tulip  45:57

Should we talk about some of the other recommendations?

Gene Tunny  45:59

Oh yes, please. Yeah, keen to chat, particularly about this idea of tapping into, well, they didn’t recommend allowing people to withdraw money for housing, for a deposit for a house. But they made some recommendation around superannuation. Would you be able to explain what that is, please, Peter?

Peter Tulip  46:19

This, I think, is one of the most interesting recommendations. And it wasn’t explicitly discussed in detail in any submissions they received. But it’s something that I and the CIS have been talking about in the past, so we were delighted to see it get up.

The argument is that people should be able to use their superannuation balances. But people outside Australia, that would be equivalent to something like a 401K or Social Security in the United States, or Social Security contributions in several European countries. People should be able to use those balances as security or collateral for the deposit for their house. And so lenders would reduce deposits, presumably by the amount of the collateral, by the amount of the superannuation balance.

The committee argued that the main obstacle towards homeownership in Australia is getting the deposit together. And this recommendation is directly aimed at making that easier, and it does it in a way that doesn’t cost the taxpayer anything. And it doesn’t jeopardise the retirement income objectives that superannuation is set up to solve.

So there have in the past been proposals that people should withdraw their money from their superannuation to pay their deposit. And the objection to that is that will just undermine retirement income objectives. And in particular, the compulsory superannuation system is set up on the assumption that people are short-sighted and will tend to fritter away their assets if they’re made too liquid. This objective, allowing withdrawals from superannuation is directly applicable to that argument.

But using superannuation as collateral doesn’t is not subject to that argument, that the superannuation balance will only be touched in the very rare and the unexpected event of foreclosure. Historically, that’s a fraction of a percent houses ever go into foreclosure. So it would be extremely unlikely to affect retirement incomes. But at the same time, people have saved this money, it’s their asset. So they should be allowed to use it in ways they want, that don’t jeopardise their retirement income. And using it as security helps in that.

Gene Tunny  49:35

Yeah. Do you have any sense of how the banks will react to this, how lenders will actually react to this? Is this something that will be attractive to them? Has anyone made any announcements along those lines?

Peter Tulip  49:51

Not that I’ve seen. You would hope and expect that if the policy is put together well, that deposits would be reduced by something like the order of the superannuation balance. And it could be a bit more or a bit less. It may be a bit less because the superannuation balances are risky. It may be a bit more because they’ll be growing over time with. We don’t know exactly how those things will factor in. You would hope and expect that deposits would be reduced by about the amount of the superannuation balance.

Gene Tunny  50:34

An interesting recommendation. I was wondering just how much of an impact it could have. But then the way you explained it, I think it makes it a bit clearer to me how this could potentially have some benefit. Yeah.

Peter Tulip  50:54

It’s not huge. The people that most want this are going to be young, first home buyers having difficulty. People having difficulty getting a deposit tend not to have huge superannuation balances. And there are a few numbers floating around. The average super balance of say, a 30-year-old tends to be, I think there was one estimate I saw, it’s about a quarter of the average deposit on a house for a first home buyer. So it doesn’t get you all the way there. It does get you a sizable bit of the way there so that instead of it taking eight years to save for a house, it’ll only take six years. And you use the super for those other two years. That doesn’t solve the problem. But I’m sure there are lots of first home buyers that will appreciate getting into their home two years earlier than would have otherwise been the case.

Maybe the other point to make in this is that I think superannuation is unpopular, particularly amongst young people, because it is an obstacle to homeownership, that people would like to be saving, but instead 10% of their income has gone off to this account that they wont see for 50 years.

Gene Tunny  52:22

Do we think they would be saving, Peter? I wonder. That was the reason we introduced the super system in the first place.

Peter Tulip  52:28

Exactly. Well, there are some people that would like to be saving for a house. Yeah, superannuation definitely makes that harder. And as a result, superannuation is unpopular. The effect of this policy is it changed it from being an obstacle to being a vehicle towards homeownership. And so I think it makes the superannuation policy more popular.

Gene Tunny  52:51

Yeah, yeah, absolutely. Okay, so I’ve got in my notes, and I must confess, I’ve forgotten what your paper… You wrote a paper with Trent Saunders in 2019. What was that about, Peter?

Peter Tulip  53:06

So that’s a big one in the housing area. We did a lot of empirical modelling of the Australian housing market, and trying to put together how the prices and interest rates affect housing construction, nd then how does housing construction feed back under prices and quantities. So there have been a lot of studies of individual relationships in the housing market. But there’s feedback between construction and other variables. So it was always difficult seeing what the full effect was, without allowing for that feedback. And the big result from that paper that got all the headlines was on the importance of interest rates. So partly interest rates are very important for construction. But even more surprisingly, they’re very important for housing prices. And in particular, the big decline in real mortgage rates that we’ve seen over the past 30 years or so, accounts for a very large part of the run-up in house prices over that period.

Gene Tunny  54:20

So with the cash rate, the RBA policy interest rate, it’s expected to go up, and then borrowing rates will go up. And there are some economists and market commentators speculating this could lead to falls in house prices, some double-digit falls, if I remember correctly, in some capital cities. So there’s that issue. I’m keen for your thoughts on that. Also immigration. If we reopen Australia as we are and we have net overseas migration running at 250 to 300,000 or whatever it was before we had COVID, what will that do for house prices?

Peter Tulip  55:09

Our paper tries to estimate. In fact, a big point of the paper is exactly to answer and quantify those questions. House prices are an interaction between supply and demand. And in the short run, the bigger effect on demand is interest rates. And that, for example, is why, we talked earlier, house prices have risen over 20% just in this past year. That was essentially a response to the record low interest rates that the RBA implemented just prior to the prices taking off. And you’re right, our model suggests that that’s going to go into reverse over the next few years as interest rates increase. Interest rates go up and down. And in the long run, you would expect them not to trend so they don’t explain trend changes in prices. The big trend increase in demand in Australia has been immigration. Our population doubles or so every generation or two. And so that creates an ever increasing demand for housing that we need to supply.

I don’t know if you’re about to ask this, but I’ll ask the question. How does this relate to our earlier stuff on zoning? Essentially, they’re asking different questions. Zoning is asking the question, how do we change process in future, how do we adjust policy? The previous paper is empirical. Policy is given, and asks, what explains changes in the past? And they’re slightly different questions. The effect of zoning is to make supply inelastic, like just a vertical supply curve. I’m sorry, I’m waving my arms around, and people listening on a podcast aren’t going to know what I’m doing. But the changes in interest rates and immigration increase the demand curve, shift the demand curve out to the right. And so it’s the interaction of supply and demand that drives house prices. So it’s a combination of rising demand and inelastic supply.

If we fixed up, if we had a better planning regime, that instead of being inelastic, the supply curve would be flatter, would be closer to horizontal. And then these big increases from immigration and low interest rates would result in extra construction instead of extra prices.

Gene Tunny  58:05

Yeah, yeah. Okay. So I’ll put a link to that paper in the show notes. I just realised Trent Saunders, he’s in Queensland now.

Peter Tulip 58:10

He’s at QTC.

Gene Tunny 58:11

Queensland Treasury Corporation, yep. He’s been doing some good stuff. So that’s terrific. Okay. Peter Tulip, chief economist at the Centre for Independent Studies. Thanks so much for the for your time today. That was great. I think we went over a lot of the economics. I’ll put plenty of links in the show notes for people because some of these studies, they’re fascinating studies and also, it’d be good to just… You may be interested in the empirical techniques and in more of the details. So Peter, again, really appreciate your time. Thanks so much.

Peter Tulip  58:56

Thanks, Gene. It was great to talk.

Gene Tunny  58:59

Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to contact@economicsexplored.com and we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.

Credits

Big thanks to EP134 guest Peter Tulip and to the show’s audio engineer Josh Crotts for his assistance in producing the episode. 

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. Economics Explored is available via Apple PodcastsGoogle Podcast, and other podcasting platforms.

Categories
Podcast episode

Investing for success w/ Paul Mladjenovic, author of Stock Investing for Dummies

Paul Mladjenovic, CFP is the author or co-author of several dummies guides on investing, including Stock Investing for Dummies and Investing in Gold and Silver for Dummies. Paul shares his views on what makes for successful investing with show host Gene Tunny in episode 133 of Economics Explored. They discuss what types of companies to look for, an often unappreciated benefit of investing in gold and silver, and what Paul thinks about real estate and crypto assets.

You can listen to the conversation using the embedded player below or via Google PodcastsApple PodcastsSpotify, and Stitcher, among other podcast apps.

This episode contains general information only and does not constitute financial or investment advice. Please consult a financial planning professional for advice specific to your circumstances.

About this episode’s guest – Paul Mladjenovic

Paul Mladjenovic, CFP, is a certified financial planner practitioner, writer, and speaker. He has helped people with their financial and business concerns since 1981. You can learn more about him at ravingcapitalist.com. He has authored or co-authored several popular Dummies guides on investing and affiliate marketing. You can learn more about Paul and his online courses at https://www.ravingcapitalist.com/

Links relevant to the conversation

Some of Paul’s books mentioned this episode:

Stock Investing For Dummies

Investing in Gold & Silver For Dummies

Transcript of EP133 – Investing for success w/ Paul Mladjenovic

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny  00:01

Coming up on Economics Explored.

Paul Mladjenovic  00:04

The bottom line is, Gene, is that healthy quality companies will keep zigzagging upward no matter what you throw at them.

Gene Tunny  00:13

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene Tunny. I’m a professional economist based in Brisbane, Australia, and I’m a former Australian Treasury official. This is Episode 133, on investing for success. My guest this episode is the author of several of those yellow dummies guide that you may have seen in bookstores, Paul Mladjenovic. He’s written Stock Investing for Dummies, High Level Investing for Dummies, and Investing in Gold and Silver for Dummies, among other books. Paul Mladjenovic, CFP is a certified financial planner, practitioner, writer and speaker. He has helped people with their financial and business concerns since 1981. You can learn more about him at ravingcapitalist.com.

The usual disclaimer applies to this episode. This is for general information only, and nothing in this episode should be interpreted as financial or investment advice. Please consult a financial planner for advice specific to your circumstances.

Please check out the show notes for links to materials mentioned in this episode and for any clarifications. Also, check out our website, economicsexplored.com. If you sign up as an email subscriber, you can download my e-book, Top 10 Insights from Economics. So please consider getting on the mailing list. If you have any thoughts on what Paul or what I have to say about investing in this episode, then please let me know. You can either record a voice message via SpeakPipe – see the link in the show notes – or you can email me via contact@economicsexplored.com. I’d love to hear from you. Righto, now for my conversation with Paul Mladjenovic on investing for success. Thanks to my audio engineer, Josh Crotts, for his assistance in producing this episode. I hope you enjoy it. Paul Mladjenovic, welcome to the programme.

Paul Mladjenovic  02:20

Thank you kindly. What a pleasure to be on.

Gene Tunny  02:22

Yes. Thanks, Paul. Yes, it’s good to be chatting with you today about investing. You’ve written several books on investing. One of your books I’ve been reading is Stock Investing for Dummies. I’ve been getting a lot out of that. I think it’s a really great book and has a lot of sensible things to say that are consistent with economics. Really, really positive about that book. I’d like to ask, just to start off with, what is your general approach to investing? Does that vary over the lifecycle? Would you be able to take us through that place?

Paul Mladjenovic  03:04

Oh, absolutely. First of all, as you know, probably one of the most important foundations of investing is good economics. You’re on the right topic in many respects. If people make good choices, and with some economic reasoning, they could prosper, among the many choices you can make out there. And it also depends on many other things, such as politics and that kind of economic environment, etc. For me, I prefer looking through things through the prism of value and fundamental analysis.

Like many folks, when the people who make sense about this, whether it’s economics from that gentleman who’s behind you there, Mr. Friedman, or in my case, somebody more in the narrow vertical of stock investing, someone like Benjamin Graham, who was like the father of value investing. And I think it’s an important concept, because many things have to make sense. In economics, once you understand the basics of your own chequebook and household budget, it’s not that far-fetched to understand choosing good companies to invest in, etc.

I’ve been teaching about investing since the 1980s. I find that if you have common sense and have some basic of economics and grasping long-term success in stock investing and other assets as well, it’s not that difficult. You are much more proficient. It’s when you understand that. Common sense and value, it goes a long way in the world of investing.

Gene Tunny  04:34

Okay, so you’re looking for companies that are reliable over the long term. Am I reading that right?

Paul Mladjenovic  04:46

Absolutely. Actually, I’ll give you a few points from my investing class that I love. You’re a very astute man, and the people in many of my classes, many of them are beginners or beginning intermediates, and the first thing I tell them is, select… I say, remember two words, when you’re choosing your investments, whether it’s directly in stocks, or indirectly through ETFs and mutual funds, two words, human need. Think about all the products and services people will keep on buying, no matter how good or bad the economy is. And I think that especially for beginners who are looking for long-term success, human need will really, I think, crystallise it very much for folks moving forward.

For example, some of the greatest companies in the last 20 years that have been chugging along, no matter what, with the crises and market crashes and booms and busts and all the rest, companies that are profitable, involved in things such as food, water, beverage, utilities, etc. This is where you start. You start with human need before you start going into other pursuits, such as growth investing, or speculating, or everything else for that matter. The first thing is get to the right category.

The second thing is, I look for companies that are profitable and have low debt. Those may sound common sense to maybe folks like you and I, but when I’ve seen the kind of selections people have made for their portfolios over the last, I don’t know, ever since I’ve started teaching, my eyes bug out. People go for the flashy stocks, big names, glamour headlines, and that kind of thing. Those stocks may go up or down in a short term. But if they don’t have star power, in terms of their fundamentals, good profitability that they’ve done year in and year out profitable… Very important.

To me, profit isn’t just a cornerstone of a good stock. I can make the argument that it’s the cornerstone of a successful economy. I was born in a communist country. They obliterated the concept of profit, which means you obliterate the incentive to produce. That’s why you invest in companies because these produce goods and services. That’s the hallmark of a successful company, so profitability.

Again, anybody in our audience, you look at your own budget, what do you look at? If your income is greater than your expenses, you’re doing fine, especially whether you’re a billion-dollar company, or you’re a household budget. That’s one aspect of it. The second one is I like companies that have good balance sheet. And again, assets exceeding liabilities, it doesn’t have to be complicated. Many people think when you’re looking at stock investing, you have to have a degree from the Wall Street school of analysis, but no. A lot of them have gone wrong, because they went beyond the scope of good economics and good common sense.

Those are the things I look for, human need, profitability, do they have good balance sheets, in other words, making sure they’re not overloaded with debt, etc. Of course, they have to be in a free market economy, because obviously, the free market is a very important and very powerful part of any successful economy out there. Beyond that, I look at other things as well, does it pay dividends and so forth.

A lot of these things, obviously, I detail that in my book, Stock Investing for Dummies. I try to also crystallise that in my courses online, etc, whenever I’m doing live programmes or recorded, because I think people, I don’t know, to me, the more they understand about good investing and their own situation, the better choices they make, not only for their portfolios, but also when they walk into the voting booth, believe it or not. I feel that’s part of it. People forget that during the Great Depression of the 1930s, people forget that many people unwittingly voted for the Great Depression, because they voted for policies,  because they didn’t understand economics, and those in turn, created just wretched conditions in many respects. But anyway, on to your other points, my friend.

Gene Tunny  09:09

I’m interested in this concept you mentioned, value investing. That’s contrasted with what’s called growth investing, if I remember correctly. This is one of the things you write about in the book. Would you be able to explain what those differences are, please, Paul?

Paul Mladjenovic  09:28

Well, value investing means that you’re not going to be putting your money into a company that’s overvalued right now. And how do we mean about valuation? You see, when people are buying a stock, they’re buying the company, and if they’re buying a stock that’s very overvalued, then you have less chance for it to grow or do well over the long term. You’ve seen that happen very frequently. I look for something like is it a fair valuation, because I can look at a company and see things like its book value, the price-to-earnings ratio. Again, I’m happy to explain all of these to folks that need it. But there are some very key ratios that tell you if you’re paying too much.

How often have people saw a company that was say losing money, but it had a very hot sexy technology, people kept on bidding up the stock, bidding up the stock, and all of a sudden, you’re paying a fortune for a company that’s not making a profit, which means that the moment the economy starts to get a little bit worrisome, unstable, recessionary, these are among the first that that see that stocks fall. If people are paying a fair amount for the company itself…

Here in 2022, it isn’t like the way it was when I first started investing. You had to go to the library and dig through 27-pound books just to find some of the right numbers. But now you’re online and on your smartphone, and you can find out the key numbers and the key metrics very quickly. And so it should be easier than ever before. But I think people get waylaid because they see all the financial commentators and everybody is… There’s that sales pitch from Wall Street, etc. But my thing is, you always go back, the way you look at the ingredients of a good recipe, you look at the ingredients of a good company, and then say to yourself… One of the things I mentioned was the price-earnings ratio. I like to find a price-earnings ratio of under 25, because that’s a fair valuation. But people buy these stocks where… Would you like me to briefly just explain the P/E ratio for the audience?

Gene Tunny  11:36

Yes, please. Yes, I think that would be great, please, Paul. And yeah, what it roughly means.

Paul Mladjenovic  11:44

The price-earnings ratio tries to make a relationship between the stock, what you’re buying, and the essence of the company. The essence of the company is its profit, of course. And what we do is take a look at the price per share and the earnings per share.

Let’s say for example, you have a company that makes a million dollars net profits, and they have a million shares outstanding. Well, that’s a $1-per-share profit. The earnings per share is $1. Okay, so we can understand it. A million shares, a million dollars. It’s $1 earnings per share. Great. But now, let’s say that company’s stock is $10. Alrighty, so basically, you’re paying $10 for the stock, and you’re paying for $1 of earnings. So that’s a 10-to-one ratio. But that’s a P/E ratio of 10. Very fair valuation. Of course, if the stock is $15 or $20, you’re still in the ballpark. I think that’s a good price that you’re paying for it. In that case, if it’s 15, you’re paying $15 per stock, and you’re getting $1 of earnings.

What happens is this. If everyone’s excited about the stock, and they bid that stock all the way up, but the earnings are still down here, then you start getting into dangerous territory where you’re over, that there is an overvaluation, the price is much higher than what the company has in basic intrinsic worth. Back when the Internet stocks crashed, many of those P/E ratios were not 15 or 20 or whatever. They were north of 100. Some of them were over 1000, which means you’re paying an awful lot of money for the company. When it’s a nosebleed territory, then it’s in greater danger of a pullback.

The reason why they bid up the stock is that they’re assuming, oh, that’s a great company, the earnings are going to come in. They’re assuming that they’re buying up the stock, that the earnings are going to eventually rise, but you don’t know that. You’re basically speculating. You’re buying stocks today, hoping that tomorrow or next year, they can have a sensational profit, but that doesn’t always materialise. So at that case, you’re speculating. You’re not investing. Investing means you look at the reality of the moment, what you’re paying for, and the actual key components that a company are in a good price range, a good valuation, and the price is closer to it. Then it’s less risky.

I prefer people starting off with value investing, because it brings out much of the risk to begin with, because if you’re paying a lot of money for a stock, then the risk is, what happens if the earnings don’t materialise? What if they start to have losses? What if the economy slows down, and 100 other variables. Then that stock gets up here. It could easily be in bubble territory, pop and come back down and you’re sitting on a loser. That’s the issue with this. You want to go for valuation early on.

It’s like if you buy a dozen eggs, if they’re on sale for $1.99 for a dozen eggs, it’s a lot cheaper than if you were going to pay 10 or 20 bucks for the same dozen eggs. The eggs don’t change, but the price in the relationship does matter. This is among the things I emphasise, hopefully, throughout the book, and to casual readers everywhere. Hopefully that are not that casual with their money.

Gene Tunny  15:03

Yes, yes. I was just checking the P/E ratio for Tesla at the moment. I’m just looking at this one site. It says it’s 193.24, March 22, 2022. That’s a P/E ratio well in excess of–

Paul Mladjenovic  15:24

Exactly. Now, I have no problem with people investing in that type of stock. But they need to tell themselves that they’re not investing. They’re speculating. Could Tesla stock keep going up? Sure. Could it crash? Yes. And if there’s a slowdown out there, and less people are buying automobiles, and that puts a drag on the entire automotive industry, that’s going to put a drag on Tesla as well. Plus, it doesn’t pay a dividend. It’s not that you’re getting paid to hold the stock. For me, that’s a speculative choice. Nothing wrong with that. There’s nothing wrong with people speculating. But they need to know that there’s a very material difference between an investment and a speculation. And they need to know that.

Gene Tunny  16:06

If my portfolio was heavy with stocks like Tesla, I would be a growth investor, rather than a value investor. Is that how I should be–

Paul Mladjenovic  16:21

If they all have that kind of valuation, you’re hoping for growth. But the thing is, in reality, you’re speculating, because you’re expecting a stock with a 200 P/E ratio, that you’re hoping that it goes to 250 or higher, translation meaning that their income is coming in and the stock price is going up. They’re bidding it up, and that way you’re holding it, and your stock went up. But you don’t know that. To me, there’s a greater risk in those kinds of stocks. But the thing is this. Fortunately, it’s not all or nothing. There’s nothing wrong with having a few aggressive speculations in your portfolio, but they better not make the majority of the foundation of your portfolio, otherwise you’ll be at risk, especially since when you juxtapose it today’s macro economic environment, it is riskier out there.

I don’t see anything here that’s going to say that a particular automotive company are going to double the number of their cars they’re going to sell next year, when there’s a lot of debt out there. Interest rates are rising. A lot of people buying automobiles. Some of them, fine, you could buy it all cash, well, good for you, I cheer you on. But the majority of the market out there would tend to be borrowing money. And if interest rates go up, then they may not choose that Tesla. They might choose a competing model for now. I think there’s a lot of fragility in today’s economy, if a lot of these things continue the way they’ve been going. I was expecting inflation and everything else over a year ago, and it’s materialising now. Gene, from what I know about you, you’re a smart guy. You were probably there even before me, and hopefully people have benefited from some of your insights months ago.

Gene Tunny  18:10

Our mutual friend Darren Brady Nelson and I were chatting about this, definitely last year, the potential inflation, just because of, as you would have seen, all of the money growth that we’ve been experiencing associated with quantitative easing, and the housing credit boom that we’ve had in here in Australia, and then in other countries. So yeah, certainly something we’ve been expecting. I’d like to ask all about the P/E ratio again. Clearly, it’s relevant to particular stocks. Are you also looking at it from the whole market point of view? There’s a measure of the P/E ratio for the whole market is in there. Is it the cyclically adjusted P/E ratio?

Paul Mladjenovic  18:58

Exactly. Whenever I see that, what is the cumulative P/E ratio for the S&P 500, for example, which is considered obviously a major yardstick and a major barometer of the general health of the stock market. I haven’t looked at it lately, but I do know that it is elevated. It is higher than it should be the last time I looked. That is also a cautionary tale.

For me, because I like to invest in human needs stocks, they tend to have a lower P/E ratio. And so that’s a measure of safety for me. Not the only one, but certainly one of the primary ones. The other side I like to look at, again, especially when I’m dealing with beginners or beginning intermediates, one of my criteria is also they should be investing in stocks that are paying dividends. We call them stock dividends, but they’re really company dividends, because a dividend that’s being paid out by a company. Obviously, if it’s a successful company, the dividend tends to rise, over an extended period of time, like years and decades. And it’s a sign of health. It’s a clear, tangible measurement of the company’s financial success. If they’re having a dividend that’s rising every year, that’s a good sign. So I like that.

And the other point of it is too is that whenever there’s a market crash or a major market event and stocks go down, you’ll find out that dividend stocks tend to be among those that tend to recover a little bit sooner. For me, if my stock goes up or down 10 or 20%, but my dividends are coming in, quarter in, quarter out, I’m not that worried about it. For many reasons, including in family accounts, we talk about having the cash flow coming in. I have clients and students that I remember from decades ago, that today, they’re getting annual dividend payouts greater than their initial stock investment from decades ago. It’s gotta make you feel good.

If a stock falls, then what happens is that… For example, again, using a simple example, if I have a $20 stock, and it’s paying a $1 dividend, that’s the equivalent yield of 5%. 5% of 20 is $1. All right. So let’s say that today, the market is crashing big time, and my $20 stock went to $10 a share. All right. Obviously, I’m not happy. But the thing is, now that $10 stock, if it’s still paying a $1 dividend – again, I’m looking at the health of the company, it’s making a profit or whatever – if it’s still paying $1 dividend and the stock is $10 now, that tells me that the dividend yield at this moment would be 10%. That is a very attractive yield. So what happens is other investors will go in and bid it back up again. And so it has an easier time recovering.

The bottom line is, Gene, is that healthy, quality companies will keep zigzagging upward, no matter what you throw at them, whereas companies that are not financially stable, don’t have all the numbers, are losing money, they’re going to be zigzagging downward. So, which zigzag you want to be part of? You look at these things, because they’re not mysteries. This is public data.

Gene Tunny  22:18

Yeah, I think it’s great advice. And it’s consistent with what David Bahnsen recently told me when I chatted with him, and he was talking about his views on dividends. He’s very pro dividends. I think it’s also consistent with Warren Buffett, isn’t it? I mean, Warren Buffett looks for those companies that deliver reliable earnings over the long term. And in his day, I’m not sure if it’s still the case now, it was Geico, the Government Employees Insurance Company, and also Coca-Cola, I think. So those are the sort of dependable companies that… Not that I’m making any particular recommendations, but it’s those sort of companies, I’m guessing.

Paul Mladjenovic  23:06

And by the way, the human needed investing, as much as I love it for beginners, etc, in the generic sense, also it tends to be a great approach and strategy during inflationary times. The last year and a half, especially with my end with the Federal Reserve, printing up trillions, look, people forget that inflation is not the price of goods and services going up, it’s the value of money going down. When you over-produce something, and you have more units of it out there, chasing the same basket of goods and services, then don’t be surprised that the prices go up.

Plus, in addition, during the pandemic, and people were worried about their economic situations, etc. , when people are worried, and there’s anxiety, and there’s a declining or low consumer confidence, then people will not invest in their wants. They won’t spend on their wants. They’ll spend on their needs. They may want fancy whatever, trips and vacations and snazzy restaurants and so much more. But if the economy is contracting, and there’s more worry on the radar screen, and people are worried about their companies, their jobs, etc, then they’re going to shrink what they’re spending on that that is want-driven. And they will keep on buying things that are need-driven, so that they’re trying to adjust accordingly to the economic environment.

So all of a sudden, you start to think that those things that we do need, all of a sudden in an inflationary environment, it’s almost like they’ve switched hats to be more growth-oriented. You have found that in the last 3, 6, 9, 12 months, the things we’ve invested in that we needed, all of a sudden, they become spectacularly solid  things to put your money in. Grains, for example. I spoke to some of my students last year. I said, “If you’re investing in money, where it’s tied to things that are rising in price such as human need, and you’re talking about energy, gasoline, you’re talking about groceries, which means food and commodities, those things have performed very well.” So, in many cases, I tell people out there and yeah, yeah, good, you can keep complaining about inflation, but part of your action plan is to be invested in those things that benefit from inflation versus being hammered by inflation.

Gene Tunny  25:34

Okay, we’ll take a short break here for a word from our sponsor.

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Gene Tunny  26:08

Now back to the show. Now with an action plan, Paul, I’d like to explore that, what that means for an individual or for a household, because we need to think about how diversified should your portfolio be, and then also how actively or passively you should manage it. Do you have views on those that you could take us through, please?

Paul Mladjenovic  26:35

Yeah. There’s the simple 80/20 rule, if you want. All things being equal, I’d love to see people put 80% of their foundational investment money into human need things, food, water, beverage, utilities. Again, it’s a very simple question. Ask yourself, what will people keep on buying, no matter how good or bad the economy is. If people are unemployed, they’re still going to eat, they’re still going to turn on their lights. And that’s where you should have your money, especially if you’re a beginner, and especially if these are worrisome times.

And I like the dividend portion, because then I know that, in many cases, especially many brokerage accounts, they give you the ability to reinvest the dividends. So even if you don’t need the money, if the stocks are down and contracting, the dividends will buy more of it. Then on the other side of it down the road, when you’re ready to have the money being sent home to you, it’d be good to know that over a period of years, and you started with 50 shares, now you have 75, 100, 150, and now their dividends are higher, plus there’s more shares, which means you’re going to have more money coming in to make yourself more financially secure in your later years.

A lot of stock investing, it doesn’t have to be mysterious or crazy. A lot of people think that to make the real big bucks got to be extra risky and extra speculative and extra growth-oriented. Well, that might be true with a portion of your money, but it shouldn’t be the bulk of your money. Absolutely. So 80% value to human need. And I’m saying this real time too, March 2022. And I think a lot of people’s experience with human need is bearing these points out. There, at least 80%. How’s that?

Gene Tunny  28:24

So yeah, 80% on investments–

Paul Mladjenovic  28:27

Of your investable money should be in human need things.It doesn’t have to be just stocks. There are ETFs. There’s actually excellent dividend ETFs, where they’re tied to human need and pay dividends. Again, I can’t get specific with this audience because I don’t know who I’m talking to. But everybody knows they can go on a search engine and find dividend ETFs. They can find ETFs.

For example, when the economy is doing very well, and everybody is flush with cash and they’re positive, then they might go for, I said wants, and that basically is a reference to consumer discretionary. When you have extra cash, what do you do? Fancier restaurants, vacation, take the missus out for the weekend somewhere, all good stuff. When you’re talking about a contracting or problematic economy and commensurate issues in the stock market, then you think consumer staples, that’s where a lot of those human needs are going to be.

There are ETFs that invest just in consumer staples or utilities. You don’t have to worry about trying to choose one winning stock. Why not a winning ETF or winning mutual funds? There’s a lot of sector mutual funds out there. There are food and beverage mutual funds. There are food and beverage ETFs. And these would make a lot of sense in today’s environment, for 2022 and probably for the remainder of this year, because I don’t see any spectacular rebound coming in the economy. And if they’re going to raise interest rates, because they’re fighting inflation, somebody’s going to win, somebody’s going to lose.

Right now, there’s people out there who have a lot of fixed bond. That bonds market is huge. You can have a spectacular problem with the bond market, because if there’s a lot of fixed debt, and interest rates are rising, what will people do? You want to get rid of your, whatever, 2.5% bond and buy a 5% bond? That’s fine, but then that means a lot of selling. And so in this environment, I tell people, if you are going to be in bonds, make sure they’re high-quality AAA, and that they’re adjustable rates. And that could be another component of your portfolio, if you want something diversified away from the stock market. Those are the kind of choices, AAA, high quality, and adjustable rates involved so that you’re not stuck. You don’t want to be stuck with a fixed interest rate, like say, 30-year bonds, and rates are going to be driven upward. That’s going to be like a hammer to the value of the bonds you’re currently holding. Okay, so adjustable rate, quality, AAA, if you can have that, that’s the kind you should have.

Gene Tunny  31:03

That’s 80%. There’s another 20%, is there?

Paul Mladjenovic  31:09

Yeah, exactly. If you’re ultra worried, and you don’t want growth, then maybe 20% should be an adjustable rate, high-quality bonds.

Gene Tunny  31:16

Oh, gotcha. Right. So that’s a really safe part of it.

Paul Mladjenovic  31:20

That’s a possibility, exactly. If you’re more growth-oriented, then put 20% into growth-oriented stocks or ETFs, again, depending on… See, the interesting thing is that investing and speculating can be something in a generic, but in many cases, it depends on the person involved. If I’m talking to somebody who’s a year or two from retirement, then you’d bet they’d have to be much more so into very secure things, human need, high-quality, adjustable rate bonds, money in the bank, low debt, and a few other features. That would be important. But if you’re talking to a 25-year-old, I’d still say, keep the bulk in your human need, but now you could put your money into growth-oriented things that are out there, some types of commodities, because inflation is pushing some of these things up. If people have seen the price of gasoline and wheat in recent months, then they get a good idea about the kind of things that grow in an inflation-driven environment, as we’re in right now.

Gene Tunny  32:18

Yeah. What are your thoughts on real estate, so both your own home and also investment properties? Do you have any thoughts on that? One of the challenges we’ve got in many advanced economies is just the very high cost of housing at the moment. And I’ve seen some commentators questioning whether buying your own home actually does make sense for a lot of young people. So yeah, I’m interested in your thoughts on that.

Paul Mladjenovic  32:48

First of all, obviously, owning your own home I think is fine. I see no problem with it. Obviously, I don’t argue with real estate folks. I know some people who will rent a cheap apartment, then they have their money and invested it and buy rental real estate. That’s fine. Some of this is a personal proclivity. Me, for example, I love real estate, but I don’t buy fixer uppers or other type of thing. My favourite type of real estate investing is true real estate investment trusts that I can buy with a few mouse clicks through my brokerage account. Those people who want to be beginners in the world of real estate, and you’re nodding your head so I think you generally agree, that I think real estate investment trusts is a great place for the beginners to be.

I like the idea that with a few mouse clicks I can get in, and a few mouse clicks, I can get out. The same rules of real estate apply when you’re talking about real estate investment trusts, REITs. You look at the type of real estate, and you look at the location, very important. For me, I like that there are a couple of hundred different REITs out there, certainly in the American market. I’m sure there’s more. I’m sure there’s some in your neck of the woods, etc. But REITs are a way that I can buy a few shares, whether it’s 5 shares, 50 shares, 100 shares, or more, I can participate in a real estate property, get my dividends, CD appreciation, but somebody else is… You have an executive team that’s managing all the properties and that’s their specialty. I prefer that.

Keep in mind, real estate investing, think about the types of real estate. Right now, in the last couple of years, I’ve told my students that I would avoid things like office building real estate investment trusts, because I think if the economy’s going to shrink, and you got pandemic residual issues, why do you want to be there?  I would be invested in REITs that are in the residential complex. For example, the last few years I’ve avoided like the plague shopping centre REITs, and instead I’ve been looking into REITs that specialise in data storage. They still pay dividends. And you see more movement there. There are REITs that are cell tower REITs. In other words, their property is cell towers. They pay good dividends. And cell towers won’t go out of style anytime soon. And if you have teenagers, you know what I mean.

Gene Tunny  35:23

That’s interesting. I’ll have to have a look at some of those. I wasn’t aware of those. That’s fascinating. Paul, can I ask you about gold and silver? You’ve written on gold and silver in the past.

Paul Mladjenovic  35:36

I’ve written two books on precious metals. And I’ve been very bullish on gold and silver and other metals over the last few years. And I feel that when everything finally shakes out, I see no reason why gold and silver couldn’t be at new market highs in the coming months. I have associates of mine who feel that these things will go to new multiples of where they’re at now. That remains to be seen. But the bottom line is, I do think that gold and silver will be appreciating for a variety of reasons. And I think they’re part of a portfolio that’s really…

Let me tell you, I can give one important reason why everybody in your audience should own at least a little bit of gold and silver. Are you ready? I’m going to give you a reason that you won’t hear very often. And by the way, if your financial advisor talks you out of them, tell them to call me. And this is what I meant. Okay, so anybody within the sound of my voice, remember the following phrase, counterparty risk. Counterparty risk. That’s the number one reason why you should have some. I’m not asking you to head for the hills and live in a cave and have a tonne of either one. No, not really. You should be diversified away from the risks of paper assets.

Me, I love gold. I love stock investing. I love the paper assets, definitely. But I favour gold and silver, the physical, because gold and silver are two assets that  are among the few assets on the landscape of choices, of investment choices that do not have a counterparty risk. You talk to your financial advisors about this, see if they know this point. It’s very important. Years ago, I remember I used to even teach financial advisors, and I think this is an important factor.

What is counterparty risk? See, here’s the thing. If you invest in any type of paper assets, you’re undergoing counterparty risk. For example, if I buy stock, the counterparty risk is the performance of the company. In other words, counterparty risk means that if you invest in an asset, the value of this asset is directly dependent upon the promise or performance of the counterparty. If I buy stock, and that company is doing great, my stock will be fine, I’m sure. At the moment that counterparty fails, falters, goes into debt, goes bankrupt, what’s going to happen to the value of my stock at that point? You follow? There is counterparty risk with stocks.

Bonds, perfect example of counterparty risk. If I invest in a bond, the first risk I think of is that, will the payer of this bond pay back the principal and the interest as stipulated in bond agreements, to me as the bond holder. There’s counterparty risk there. What if that entity defaults? Many times in history, especially during bad economic times, people have defaulted on bonds. And so you have to understand that, but also to currencies.

Right now, inflation means that that money is losing value. And that’s a counterparty risk, because a currency is only as good as the counterparty being the central bank of that country, managing, hopefully, properly, that money supply. And we’re seeing that there’s inflation everywhere, the ruble falling apart in Russia, because of the conflict, runaway inflation in Venezuela, etc. In many cases, the currency of a country is similar to the dynamic of the stock with the company. When the company is doing well, the stock does well. If the country is strong and doing very well, and they’re managing their currency, then that currency will be strong. But once you mismanage that, and the currency goes into hyperinflation…

By the way, you’re talking to a guy who has experiences personally with my family. In 1963, as a four-year-old with my family, we escaped communist Yugoslavia. And by the way, communism is a horrible thing, but that’s a different conversation. But they, in 1993, 1994, tried to help out their own economy with inflating the currency, the dinar, and you had one of history’s greatest hyperinflationary catastrophic incidents occur in Yugoslavia, and it collapsed into nothing basically. No more Yugoslavia as of 1994 . I got married in 1993. So my wife and I were thinking about going to Yugoslavia for our honeymoon, but as the civil war it was going through and collapse, these things ruin a good honeymoon. So we opted for the Caribbean instead. And in retrospect, am I glad I did.

Gene Tunny 40:18

Absolutely.

Paul Mladjenovic 40:19

Currencies have counterparty risk. Virtually every paper asset you can think of has a counterparty risk. Its value is directly tied to the promise or the performance of a counterparty. Gold and silver have their own intrinsic value. Gold and silver have never gone to zero. They had value thousands of years ago, they have value now, and likely, gold and silver will continue to have value far into the future. So precious metals, and I mean, the physical, look into bullion coins and the like. Do your shopping. As you know, I did the book Investing in Gold and Silver for Dummies. It’s a whole book on how to choose and shop for it, etc. But gold and silver, again, are a diversification away from currency mismanagement, away from the risk of paper assets, away from geopolitical and other risks. And I think that that is an important fact. And let’s face it, you hear about the rich over the aeons, the centuries, they always had gold and silver. The people are in the know. They know something, I think that’s something for you, that should be a clue to you to start figuring it out and seeing if a small portion does make sense in your overall picture. And I think given today’s economic realities, a portion of it doesn’t make sense.

Gene Tunny  41:38

What about NFTs and crypto that everyone’s talking about? Have you had any exposure to that or do you have any thoughts on that? There’s a lot of excitement about it.

Paul Mladjenovic  41:52

Let me tell you, a few years ago, I was asked about writing a book on cryptocurrency. And the point is, I think I’m good at what I know, but I know the limits of what I know. And I got them a great author on that book. So my publisher does have one called Cryptocurrency Investing for Dummies, and she does a great job with it.

Again, I feel the same way, having a small portion of it is not a bad idea. But there’s been just a lot of, I don’t know, overwrought speculation about it in recent years. And the thing is this. Part of the success of cryptocurrency, again, was the idea that it’s limited in scope. And, and so obviously, if you don’t over-produce it, and more people are buying it, then of course, you’ve seen how well it’s performed. I mean, it’s been amazingly volatile, crashing here and there. And I think investing small amounts here and there, again, as a small diversification away from everything else, is not a bad idea, but a lot of these people who are going whole hog into it, etc, we have to be careful. You have to remember that the governments of the world look at cryptocurrencies as a competitor, and nothing stops them from waking up one morning, passing a few laws and regulations, and all of a sudden, your cryptocurrency becomes problematic versus being an asset. So again, tread lightly here. Obviously, you may get a cryptocurrency expert on who will have a totally different opinion. And I’m not here to argue with those folks.

Again, I think having some cryptocurrencies is fine. And for me, some of my clients, I say to them, why not get some of the blockchain technology companies, because that way, you’re indirectly working with it. And that worked out to be a pretty good speculation. But again, same feelings as with gold and silver, have some of it, not an overwhelming amount, because you never know, because cryptocurrency… Everything we’re talking about has some kind of risk. With cryptocurrencies, what happens? I mean, it’s extremely dependent on electricity. What happens when there’s a power outage? Can you trade with it then? I doubt it.

The whole point about guys like me, in my industry… I was a certified financial planner for 36 years. I retired it a year ago, but I’m still active with education and teaching about this and I love my topic. I doubt I’ll retire anytime soon. I love what I do too much. However, the world of CFPs and financial advisors, they live and breathe the word diversification. Every asset has some type of risk attached to it, if you have money in the bank, fine, you’re away from financial risk, but now how about inflation risk, purchasing power risk, and a few other ones out there? What if the bank closes its doors because there’s a national crisis with the central bank, etc?

This is why you have a little bit across the board. That diversification just makes you stronger and not dependent on the goodness or wellness or the speculative success of an individual entity or asset class. Again, have some cryptocurrencies, fine. Have a couple of different ones, fine. But don’t have your life savings in it. Don’t put too huge of a percentage of your investable assets in it. Same thing as I would say with many other things that are out there. And of course, everything mitigates things. If you are a real estate expert, then having more of a portion of your assets in real estate is not that big of a deal, because your personal expertise is mitigating the extra exposure, but that’s fine. Knowledge is always the thing you should be accumulating the most, after accumulating your wealth, because the both of those things are tied together.

Gene Tunny  45:40

Yeah. Very good observation there, Paul. A couple more questions on how actively should a person be managing their portfolio. Typically I’ve just sort of said, maybe I made some decisions, like a couple of years ago, I’ll invest in this ETF or I’ll have these investments. And I’ll just commit to putting a certain amount in every month or whatever. And you get that, they call it that dollar cost averaging technique. You’re not worried about what the prices are at any particular time. And then over time, you do better out of that. How do you think about how actively investors should be managing their portfolios? How frequently should they be reviewing their selections? Any thoughts on that?

Paul Mladjenovic  46:36

Again, everyone’s a little bit differently, but if you’re not reviewing monthly or quarterly statements, if you’re not speaking to whoever you trust at least once a year or once every half year, then there’ll be issues, obviously. The more you’re aware about what you have, the better. I mean, I look at decisions every day, for my family. And the interesting thing is, if there’s one thing that people need to understand also, it is that to be successfully monitoring your situation, keep in mind that successful investing isn’t just what you invest in, but how do you go about doing it. If your positions are residing in a brokerage account, then nothing stops you. I highly encourage everybody within the sound of my voice to speak to your customers, to your brokerage firm’s customer service department, ask about things, about tutorials and things like stoploss orders, trailing stops. Sometimes you could do some, again, to a small extent, things such as covered call writing, which gives you income. It’s a hedge on a position as well, in some cases.

For example, trailing stops, I’m a big one on this, if, if you’re nervous about what you’re holding, alrighty, then again, it’s not just what you invest in, it’s how you go about doing it. Then you should consider trailing stops to minimise the downside. Now, what does that mean? Well, well, first of all, the generic about a stoploss order. If I bought a stock at 20, and I’m nervous about it, then I should put a stoploss order in at 18, 10% below, just as a generic point. 10% lower, you give it room to fluctuate. My stock at 20, if I bought it, obviously, there’s no upside limitation. But at 18, I now have downside limitation. In other words you’re adding discipline to your situation. You’re not just blindly watching this stuff. You could put that stoploss order in for the day or make it good until cancelled. It could sit there for three months.

If you’re worried about the coming weeks and months, go through your portfolio. If you need to go with your financial advisor, by all means, and say, I’m nervous about position x over here, what should I do? Well, they should be telling you. First of all, if it’s quality, that should remove some of the anxiety. But if you’re still worried, then either, A, sell it if you need the money, or if you don’t need the money, then put in a stoploss order in it. And then what happens? Let’s say your $20 stock zigzags up to 30. Okay, well, now what? That $18 stoploss, cancel it, like it says, good until cancelled, and replace it with one at 27, as an example. Now, what happens? The stock is at 30, you put a stoploss in at 27. Well, now what? Now if there’s a market crash, stock will go down, will trigger a sell order at 27, and you’re out. And you kept 100% of your original $20 plus a $7 per share profit. You added diligence and safety and discipline to your situation, not because you were expecting it, but because you started worrying etc. Then put those on. What’s the worst that happens? You’re selling and protect your money and keep a portion of your profits. Well then, that’s the very essence of prudent investing. You follow?

So in other words, everybody within the sound on my voice, if you have a brokerage account, go to their site. They’ve got to tutorials and other things. Call them up. Ask them, hey, what can I do if I’m worried about my stock dropping? What can I do? Have that conversation. But I find that a lot of people don’t have those conversation, and then what? Then when there is a market crash, and your positions plummet all the way down to the bottom or whatever, or lose 50%, then you do could’ve, would’ve, should’ve, you have anxiety, and so much more.

Right now, as I’m talking to you, the markets are generally in good shape today. But that could change next week. You could have a 1,000-point drop on a Monday morning, because you have trillions flowing in and out. You’ve got sanctions and unintended consequences. You don’t know when the next crisis is going to blow up, which in turn will blow up point A, point B, point C, and all of a sudden, you wake up one morning and your position or your broker has been hammered to pieces. Again, diversification. Remember that you have many tools and tactics in your pocket with these brokerage firms that you should be fully aware of. When you’re fully aware of these and you start applying some of these things in a very modest way, your confidence grow, your knowledge grows, which means more importantly, your financial security does better.

Gene Tunny  51:18

Yeah. Okay. I might ask one more question before we wrap up, Paul. There was an interesting passage in your book on Stock Investing for Dummies, where you’re asking what school of economic thought does the analyst adhere to? So this is things you should ask about analysts when you’re assessing the value of their contributions, what they’re saying, what their advice is. You make a point that if there was one that adhered to the Keynesian school of economic thought, that’s analyst A, and analyst B adhered to the Austrian School. Guess what? I’d choose analyst B, because those who embrace the Austrian School have a much better grasp of real world economics, which means better stock investment choices. Could you explain what you mean, there, please?

Paul Mladjenovic  52:05

Well, it’s funny, you brought up an interesting point. I mean, I love the Austrian School. And as you know, Darren is a devotee of that. It doesn’t necessarily mean the Austrian School… There’s a couple of other schools that are pretty good. There’s the Chicago school, Milt Friedman, I admire his work. It’s just that there are many financial advisors out there who… Obviously, Maynard Keynes, I don’t think highly of him. I mean, if I had a financial advisor who loved Karl Marx, I would be terrified, because that tells me they know nothing about economics. I’m serious about this. Yeah, I’m very serious about it.

By the way, to me, it’s not that I look for a financial advisor who’s into these particular schools. Question number 17, that helps me hone my selections. I want to make sure that they’ve been around for a few decades, they’ve seen bear markets and bull markets. That’s a much more important criteria for me that they understand these things. But if it ever comes down to the school, I’m going to make sure they understand, because remember, it was the free market schools out there were warning about the Great Depression, they were warning about stock market bubbles, and they were warning about these things. I found out that these disciplines helped me be a better tactician and strategist with the money.

I mean, I remember when I read an article about the stock market bubble in 1999, and that was from the point of view of the economics. That just cemented some of my concerns about the stock market. What did it mean? For those students and clients who were your conservative, retirement-oriented, made sure they were in safer waters. But those people out there who were speculators, like me, for example, I made sure that I was not invested in the internet stocks of 2000, because the first wave, you don’t know which ones are going to survive or not. They were all losing money. So in terms of investment, I stay away from them. However, my speculative side, I was buying long-term put options on these. So when these things collapsed, my speculative put options garnered some very nice gains. And that was my speculating.

Understanding basic economics and following some of these schools of thought would just enhance  your ability,  because obviously, understanding the macro picture makes you a better choice of which micro choices, which stocks and ETFs are going to either survive or thrive in that kind of economic environment, and it actually gives you another leg up. When you understand the big picture, it just makes it better choices in your own portfolio, so you could sleep better at night and serve the family that you love.

Gene Tunny  54:48

Okay, that’s a great point, Paul. I was just thinking about Keynes. Keynes himself was a rather good investor and made a lot of money for King’s College in Cambridge. However, I think there’s some speculation that he may have benefited to an extent from insider knowledge he gained while working for the Treasury.

Paul Mladjenovic  55:13

That’s very possible. And actually, when you think about it in the 1920s, look him up, there was an economist called Irving Fisher. When the stock market was in bubble territory, he was notorious for making the call that he feels that they’ve reached a permanent plateau. And this was whatever, like six or nine months before the crash of 1929, and he had been filing for bankruptcy. So no one should have listened to Irving Fisher, including Irving Fisher.

Gene Tunny  55:42

Exactly. Okay. Paul, any final points before we wrap up? I think this has been great. You’ve given me a lot to think about. And I mean, I think we could chat for hours on this stuff. But I think I’ll have to wrap up now. And yeah, I’d be keen to chat with you again.

Paul Mladjenovic  55:57

I really appreciate it. I mean, obviously, you mentioned Stock Investing for Dummies, I’ve done a lot of books out there. So I certainly invite people to see if those things help them with theirs. And if people want to find me, I’m at ravingcapitalist.com. But the point is this. Knowledge is really so important with all of this, and the idea that you’re a better consumer or a better investor, it also makes you a better voter, too, , and it also makes you much more aware of what policies out there will do harm and which ones will do right, and which investments will go up or down accordingly. It’s all about the knowledge. Ignorance is going to be extremely problematic in the coming months. So I invite them to get as much knowledge as possible, apply it, talk to everybody, you’ll be much better off. If they keep on listening to gentlemen such as Gene Tunny, then I think they’ll be served well, and thank you again and again. God bless your audience, and I wish them all prosperity.

Gene Tunny  56:54

Thank you. Paul, it’s been a pleasure. Really appreciate your time. And yeah, I hope to chat with you again soon. Thanks so much.

Paul Mladjenovic  57:02

Continued success to all of you. Take care, Gene.

Gene Tunny  57:04 Thank you. Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to contact@economicsexplored.com And we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.

Credits

Big thanks to EP133 guest Paul Mladjenovic and to the show’s audio engineer Josh Crotts for his assistance in producing the episode. 

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. Economics Explored is available via Apple PodcastsGoogle Podcast, and other podcasting platforms.

Categories
Podcast episode

The virtues of the free market w/ David Bahnsen – EP132

Renowned US financial advisor, author, and podcaster David Bahnsen argues the best way to defend human flourishing against dangerous economic thinking is to relearn time-tested economic truths. David talks about his new book There’s No Free Lunch: 250 Economic Truths with show host Gene Tunny. David and Gene also talk about David’s previous books on the crisis of responsibility afflicting our societies, Elizabeth Warren’s economic policies, and investing in a post-crisis world.

You can listen to the conversation using the embedded player below or via Google Podcasts, Apple Podcasts, Spotify, and Stitcher, among other podcast apps.

About this episode’s guest – David Bahnsen

David L. Bahnsen is Founder, Managing Partner, and Chief Investment Officer of the Bahnsen Group. He oversees the management of over $3.5 billion in client assets. Prior to launching The Bahnsen Group, he spent eight years as a Managing Director at Morgan Stanley and six years as a Vice President at UBS. He is consistently named as one of the top financial advisors in America by Barron’s, Forbes, and the Financial Times (2016-2021).

David’ Bahnsen’s 2021 book There’s No Free Lunch: 250 Economic Truths.

Relevant links and a transcript are below.

Links relevant to the conversation

David Bahnsen’s previous books:

Elizabeth Warren: How Her Presidency Would Destroy the Middle Class and the American Dream

The Case for Dividend Growth: Investing in a Post-Crisis World

Crisis of Responsibility: Our Cultural Addiction to Blame and How You Can Cure It

David’s podcasts:

Capital Record

The Dividend Cafe

Radio Free California

Other relevant links:

The Great Debate: Edmund Burke, Thomas Paine, and the Birth of Right and Left by Yuval Levin

Edmund Burke (1729 – 1797)

Transcript of EP132 – The virtues of the free market w/ David Bahnsen

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny  00:01

Coming up on Economics Explored.

David Bahnsen  00:04

There’s no question that whether one accepts my religious assumptions or not, that the free market properly aligns incentives better than the Marxist or central planning, collectivist vision for society that strips away incentives and does not provide the framework for best serving a customer by meeting human needs.

Gene Tunny  00:34

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene Tunny. I’m a professional economist based in Brisbane, Australia, and I’m a former Australian Treasury official. This is Episode 132, featuring a conversation with economist and investment manager, David Bahnsen. about his new book, There’s No Free Lunch: 250 Economic Truths. We also talk about his previous books on Elizabeth Warren, his approach to investing, and what he calls the crisis of responsibility.

David is the founder, managing partner, and chief investment officer of the Bahnsen Group, a US national private wealth management firm, with offices in Newport Beach, New York City, Nashville, and Minneapolis, managing over $3.5 billion in client assets. David is consistently named as one of the top financial advisors in America by Barron’s, Forbes, and the Financial Times. He is a frequent guest on Fox News, Fox Business, CNBC and Bloomberg. And he’s a regular contributor to National Review.

Please check out the show notes for links to materials mentioned in this episode, and for any clarifications. One that I know that I need to make relates to the statesman Edmund Burke, who I shifted forward in time by a century. Silly me. You can find the show notes via your podcasting app. And please check out our website, Economics Explored, where I’ll post a transcript of the conversation as soon as I can. That’s economicsexplored.com. If you sign up as an email subscriber, you can download my recent e-book, Top 10 Insights from Economics. Please consider getting on the mailing list. If you have any questions, comments or suggestions, please either record them in a message via SpeakPipe – see the link in the show notes – or email me via contact@economicsexplored.com. Righto, now for my conversation with David Bahnsen, Thanks to my audio engineer Josh Crotts for his assistance in producing this episode. I hope you enjoy it. David Bahnsen, founder, managing partner and chief investment officer of the Bahnsen Group, welcome to the programme.

David Bahnsen  02:53

Well, good to be with you. Thanks for having me.

Gene Tunny  02:56

Oh, it’s a pleasure, David. I’ve come across your work recently. A mutual acquaintance of ours, Darren Brady Nelson, mentioned you to me and I’ve been reading your great books, There’s No Free Lunch: 250 Economic Truths. You had a book on Elizabeth Warren, the Democratic presidential candidate, how her presidency would destroy the middle class and the American dream. And you’ve got a couple of others.  I’m really keen to chat with you about your views on economics. You’re someone who has had a very successful career as an investor. And you credit that partly to your understanding of economics, so yeah, really keen to understand your views on economics as someone who’s really proven the relevance and the importance of economics. First, I’d like to ask, with your book, There’s No Free Lunch: 250 Economic Truths, what was your guiding principle for selecting those economic truths? How did you go about it? And what do you think of the major truths, David?

David Bahnsen  04:01

Well, I tried to divide the book up compartmentally by categories, and I start with the belief that economics is about human beings, and not fundamentally a mathematical science or a political science. And so out of the social realities of mankind, if we’re to understand economics out of that truth, then it forces us to discover or inquire what we believe about mankind. And what we know about the human person can then inform us more about economics, if we believe in the premise that economics is the study of human action.

I believe distinctly anthropological truths about mankind, about how he was made, about the characteristics he was made with. And those beliefs serve as a kind of starting point to what I believe about what we consider economics. And so you then go on to certain a priori assumptions that there is scarcity in the world. And economics becomes the study of how humans act around the allocation of scarcity, their scarce resources. And so I’m very convinced that most people are trying to get their economic opinions out of their political beliefs, instead of getting a lot of their political beliefs out of their economic worldview, and particularly in certain policy assumptions. And so the policy beliefs and biases and so forth, I think need to be informed by a coherent economic worldview. And that’s what I’m trying to provide in the book.

And for a lot of people, I think that the book will serve as a reinforcement of things that they instinctively believe, but there may be an impulse to some of these free market assumptions, but not necessarily rooted in a deeper belief system. And that’s what I’m trying to point people back to is those foundational beliefs that can help inform a comprehensive understanding of economics.

Gene Tunny  06:32

Yeah. Look, I found that fascinating. That was something I really found valuable about your book. I mean, you reference great thinkers in economics, such as Adam Smith and Hayek, and Mises. What I really liked was your commentary as well.  You’ve got great quotes. And then you’ve also got your commentary. And one of the things you wrote, I found very profound. I want to make sure I fully understand it, because I’m not a deeply religious person.  I think I know what you’re saying here. But I want to make sure I understand it. You wrote that, “Our case is not that mankind’s fall is suspended when he transacts in the marketplace, it is that the marketplace best tames are fallen nature. The fallen nature, is this what you’re talking about with understanding where we’re coming from, people fundamentally? But is that a religious concept or is it a psychological concept? Could you explain what you’re driving at in that passage, please, David?

David Bahnsen  07:35

Yeah, it’s entirely religious. It is entirely theological. And yet, I’m perfectly content for someone to interpret it only psychologically. But the underlying teleological meaning of it, the purpose is rooted in a belief that mankind does not come in the world perfect. Mankind comes in a world where they fall in moral nature. And this is, to me, the fundamental divide between most political divisions, philosophical divisions, and I also believe economic, is if we believe that mankind is fundamentally good, and then can be corrupted by injustices amongst race or class or gender, things like that, or those who believe that mankind comes in what we in the Christian tradition refer to as the doctrine of original sin, and that we want institutions, family, communities, church, synagogue, the marketplace, to provide a sort of moral formation, and that mankind cannot become perfected. The great socialist and utopian vision is rooted in a belief that mankind can become perfectible. And this is against my own religious assumption.

But the economic relevance to it is that we are trying to solve for a system of social organisation that recognises certain assumptions. And one of my assumptions is not only the imperfectibility of mankind, but also that mankind is created in a certain way, and that that creation that I am asserting involves mankind’s rationality, their reasonability, that there is both a physical, material, and a spiritual dimension. And so those things end up having significant economic implications, because I reject the belief that our need in forming economic policy is to merely meet the material needs of mankind, to give them some sort of water and food and sustenance and call it a day. I believe that mankind has that material dimension, and that to ignore it is wrong. But I believe that they also have a dignity, that mankind is superior to the animal kingdom, intellectually, morally, their use of rational faculties, their use of self-interest, and their capacity for problem solving. But fundamentally, as moral beings, mankind is capable of doing right or wrong and is accountable for doing right or wrong. This ends up inviting non-material dimension into economic wellbeing.

And so because I believe work is the verb of economics, is a line I use at the end of the book, I reject the Marxian notion that work is dehumanising. I think work is dignifying. But why do I care if mankind is dignified or not, let alone if work as an instrument for doing such? Well, I care because I view mankind as created in the image of God. And that’s a religious belief. That’s a theological belief. And if I didn’t believe that, I would believe something different about economics. And so my rejection of a Darwinian view of economics, my embrace of a Burkean notion that there is a moral dimension to how we cooperate in society, these things are rooted in some of these worldview assumptions that I don’t know how I can escape their religious nature.

Gene Tunny  11:40

Okay. Yeah.  Burke, you mean Edmund Burke, the Anglo Irish statesman from the late 19th century?

David Bahnsen  11:50

That’s right. I guess sometimes doing American interviews I take for granted, because I consider Burke America’s foremost political philosopher, but of course globally, his name and reputation would maybe have a different context. But Burke, really known, much like Adam Smith as the Scotsman was a sort of religious or moral philosopher with great economic relevance in classical economics, and Burke was a political philosopher, but again, who brought a sort of moral dimension to his work.

Gene Tunny  12:25

Yes. I’ve been reading this great book, The Great Debate by Yuval Levine or Levin. I’m trying to remember. I might put a link in the show notes as well as links to your books, because Burke, he was involved in that great debate about what’s the goal of politic or what’s the best way to run society, and you don’t want to go and radically transform things, because there might be a reason that your institutions are the way they are in the first place. And so you have to be very careful with meddling.

I just want to chat more about this fallen nature idea. Is this related to the concept of self-interest? The great thing about the market is that it takes advantage of people’s self-interest. There’s a famous quote of Adam Smith, about how we rely on the baker for our meals and on the candlestick maker for the candles, not out of any social concern they have, but out of their concern for their self-interest. I think I’ve butchered that quite. But that’s the basic idea. Is that the idea, so it’s taking advantage of that and getting the incentives right? And if you’re in, say, what you had in the Soviet Union, then all those incentives are the wrong way. To get something for yourself, you don’t necessarily have to create value for another person. And that’s the great thing about the market. It’s that mutual exchange, that you’re creating value for the other person, for them to pay you. That’s roughly on the right track, is it?

David Bahnsen  14:12

Well, I think those things are all very consistent with the assumption, but one of the things that I’m doing from the worldview I’m speaking, which is different than the way Ayn Rand as an objectivist would approach it, and in fact, many secular economists. Secular economists would describe it descriptively, that descriptively one can do better for themselves by serving their customer better. And Adam Smith’s allusion to reference to that self-interest is what they’re referencing. And it’s almost indisputable. It’s the way the world works.

But what I’m adding is the prescriptive, not merely the descriptive, not just that you will do better by serving your neighbour better, but that you ought to serve your neighbour better, and that in so doing, we cultivate more trust in society. Commercial transactions are entirely dependent on trust. And so they’re not merely in micro transactions like the brewer or baker a candlestick maker with a customer. But on a macro level, the greater sense of moral sentiment in the society, which, of course, was Adam Smith’s other book, we couple these two coexisting realities of human nature together, which is mankind rationally working in their own self-interest, providing for their family, and at the same time, their need and requirement to have that sort of moral capacity of service. And so I think that Burke referred to this as enlightened self-interest. And I believe it is the ideal for what I’m after in a framework of economics.

There’s no question that, whether one accepts my religious assumptions or not, that the free market properly aligns incentives better than the Marxist or central planning, collectivist vision for society that strips away incentives, and does not provide the framework for best serving a customer by meeting human needs, providing goods or services that we believe people care about. But I do believe one can make an argument – and I think that this is the straw man that a lot of socialists today are arguing against – that if you don’t care about the moral wellbeing of society in your economic worldview, and that all you’re saying is that pragmatically your wellbeing will be best served the more you serve your neighbour, all we have to do is find a case where that isn’t true, and it would be okay. And most certainly, it sometimes isn’t true, because as long as you can get away with it, cooking the books can help you and hurt your neighbour. And again, you have to be able to get away with it. But a lot of people can get away with fraud, a lot of people can get away with theft.

This Darwinian view that is more driven by the best outcome for oneself, and only relies on serving others as a mere pragmatic supplemental convenience to the process, I think it falls apart in reality, because we apart from that framework that still honours service to others, then one loses the kind of holistic nature that has been the traditional case for free markets. And I would argue more or less that the outcome, that when we look at the great fruits of poverty alleviation and human flourishing that’s come out of free markets, we have never been in need of divorcing that from a moral framework. In fact, it requires a moral and a legal framework, rule of law, enforcement or private property. These are all concepts that have roots in the very 10 commandments of themselves. Coveting what someone else has is sort of the heart of Marxism. And believing in protection of private property is the heart of what we call capitalism. And yet those are moral commandments. Thou shalt not steal, Thou shalt not covet.  

I think that that synthesis between the moral nature of markets and the aspirational vision of society and the self-interest that Adam Smith talks about are entirely consistent, and in fact, not only consistent, but they’re optimised. They work best in conjunction with one another. They each work with one hand tied behind their back apart from the other.

Gene Tunny  19:22

That’s great, David. It’s given me a lot to think about, because maybe I’ve approached economics too much as a technical field, and I need to think more about the philosophy. I really value your thoughts in helping me think more philosophically about it, so that’s great. Okay, we’ll take a short break here for a word from our sponsor.

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Gene Tunny  20:24

Now back to the show. I might move on to your book about Elizabeth Warren. I guess this follows on from some of the points you’ve made. Now, you’ve written that her presidency would destroy the middle class and the American dream. She’s not president, but there’s some of those ideas, they’re out there, and they could be picked up in the future, whether by maybe AOC one day if she ends up very senior position, in a position of power.

One thing that I’m wondering is, how do you think about the balance between market and state? There needs to be some role for government. And there are countries that seem to be doing relatively well with a more interventionist state, such as the Scandinavian countries, Australia to an extent. One major difference between Australia and the United States is that we have what you would call a single-payer health care system. And that is reasonably popular. Well, I think it’s very popular. No opposition party, nowadays they would no longer campaign against it. Once upon a time they did. Political parties would campaign against it. It’s widely accepted. How do you make that balance? And what do you think is so bad about policies just to inject a little bit of what you might call socialism into the system to try and make the political system more stable? How do you think about that?

David Bahnsen  22:02

I haven’t seen an example yet of where a little bit of socialism brings more stability to the political system. I don’t recall there being anything in my Elizabeth Warren book that I would take back or rewrite or don’t still believe. But I confess, it strikes me as a little less relevant because of the implosion of her candidacy, as it pertains to her. But as you say, people like AOC, Bernie Sanders, they’re meeting hard left figures in many other countries besides my own. She just happened to be a failed political candidate that I wrote a book about that became obsolete very quickly, because her candidacy imploded. But there does still seem to be some persistence in the idea of a Green New Deal, a wealth tax, forgiveness of student debt for all. And to the extent these ideas persist in the United States, or in other countries, they remain horrifically bad ideas, even if they’re not connected to the name of Elizabeth Warren anymore.

Now, with that said, when you ask why not just a little bit of socialism to come in and kind of maybe temper things a bit, we hear that expression a lot, to sort of smooth out the rough edges of capitalism. And I love the analogy, because it always sort of implies that capitalism is like a bowl of soup, and it can get a little bit too hot, and if you just add a little cool water on top – and that cool water, in this case, is the loving, all-competent arm of the federal government – then we can cool down the soup a little bit, still get a good warm bowl, and enjoy it and have it feed our appetite, but not scalding hot, burn our mouths. And of course, frameworks of thought and of governance and political and economic philosophies don’t work like a bowl of soup.

I am a Hayekian to the core. Friedrich Hayek told us why that can’t work, that the central planner, whether they’re coming in to do a lot, or whatever it is, a little – I would, by the way, debate the idea that they are ever content to do a little. But even apart from the very reality of slippery slope, there is the knowledge problem. And there is the incentive problem.

The reason why I cannot ask Washington DC to come in and smooth out transactions between me and another economic actor that would freely transact with me in business is that the government has no chance of having the knowledge and the time and place circumstances necessary to be a party in a transaction between me and another person. And the reason why I can’t ask the government to come in and smooth out the rough edges of two free human beings voluntarily transacting with one another is because the government can’t possibly have the incentives. They don’t have skin in the game. They don’t hurt economically if it goes poorly, and they don’t benefit economically if it goes well. It’s none of their damn business.

The government’s intervention on a macro level into the affairs of society must always be limited to its role in protection of private property, settlement of civil disputes, this very rare but nevertheless important function of a civil magistrate. The Warrens and Sanderses and AOCs of the world would have the government take on a role of a central planner. And the Keynesian vision of economics is that the government can play a role on a macro basis in smoothing the difficulties of a business cycle. But of course, my belief is that such interventions not only likely don’t solve the problem they seek to solve, but they inevitably create two new problems. And so the reason for rejection of that vision of government’s role in economic affairs is that I believe that government lacks the knowledge to transact or to have planning jurisdiction over transactions in a free economy.

Gene Tunny  26:36

Fair point. And, yeah, the whole slippery slope thing, potentially there is there is some sort of slippery slope, because the government just keeps ever expanding. And one of the problems we’ve got here in Australia now is that the government’s committed to having what we call a national disability insurance scheme, which is essentially trying to provide a level of care for disabled people, but the definition of that’s expanded a lot and the costs are blowing out. It’s a big challenge. You still got a little bit more time, David, or you got to –

David Bahnsen  27:08

Yeah, I’m okay. Go ahead.

Gene Tunny  27:09

Good one. Excellent. I’d like to ask, you’re also a host of a podcast, Radio Free California, is that right?

David Bahnsen  27:19

That’s one of my podcasts, yes.

Gene Tunny  27:23

Oh, you’ve got another. Great.

David Bahnsen  27:25

Capital Record is my podcast focused on free market, economics, defence of free enterprise, defence of capital markets. And I host. It’s a National Review podcast called Capitol Record. But Radio Free California is a more political podcast that focuses on the dysfunctions in the great state of California where I was born and raised and have lived most of the last 48 years.

Gene Tunny  27:53

Yeah. Could I ask, what’s your take on, just how bad are things in California for business at the moment?  I’ve chatted about this with Dan Mitchell. And Dan pointed out just how many people and businesses are leaving. Is this something that you’ve thought about, or are you concerned about the policy settings for business in California?

David Bahnsen  28:16

Of course I’m concerned. Anybody who cares about the preservation of one of the largest economic bodies in the world, and obviously the largest economic body within the United States, should be concerned. I hear a lot from the political and economic left that they care about the middle class. Yet it sure seems that they are perfectly happy with a policy framework that hollows out the middle class. And a state like California is case in point, where very wealthy people can live in California quite comfortably, and very poor people might be fans of the welfare state or what have you, but there is a kind of middle ground by which policies, school systems, crime becomes very, very unpleasant. And California seems to me to be ground zero for this laboratory of America, what we call blue state policies. And that’s what our efforts are primarily focused on is exposing the folly of blue state policies. And then as Dan Mitchell and others have well documented, it is leading to an incredible migration of mostly middle-class people out of the state of California to go to more business-friendly environments. And I think it’s a tragedy.

Gene Tunny  29:53

One of your other books is Crisis of Responsibility: Our Cultural Addiction to Blame and How You Can Cure It. Now, what I found great about that book is you had a really interesting take on the financial crisis. I knew the basic facts, but I hadn’t thought about it in that way. But you argued that there was a failure of moral responsibility in a way, when people were simply walking away from houses where they had negative equity, which I found a really interesting take. And am I getting that right? Am I remembering that correctly?

David Bahnsen  30:39

You’re absolutely getting that right. And that, I would argue, was one of many moral failings in the financial crisis. But it was conveniently the one that was entirely ignored in the narrative. Ultimately, the desire for many of us on the right to put blame with the government, with Fannie Mae, Freddie Mac, the Federal Reserve, we were willing to look past Main Street’s faults, and the desire of those on the left to blame greed of Wall Street, of the banks, various familiar bad guys in their societal narrative, they were willing to look past the iniquities of Main Street. And I think it was entirely absurd set of stories told us about the financial crisis that chose to ignore Main Street’s culpability. And you reference those with negative equity. There’s simply no question that in the end, the pile on of foreclosures, and what really represented this purging of bad investment, that then had the domino effect into the overly levered credit and financial system. What the initial dominoes were to tipping that over-levered credit system over was the fact that people stopped making house payments when they were upside down on their houses.

And so although I would argue the very first act of moral culpability that led to the crisis was people’s Keeping Up with the Joneses mentality, and irresponsibility, and taking on a commitment they couldn’t keep, the lack of necessary protective equity in their home, dishonesty about their own income documentation. There are a whole lot of things that went into this game that was being played, that many people played well for a lot of years, until the music stopped playing. And when the music stopped playing, this house of cards fell.

And my book was attempting to say, I know what Wall Street did wrong, and I know what the government did wrong. But it is simply untrue that Main Street did nothing wrong, and in fact, that Main Street is a victim of this whole thing. That’s the way the story was being told. And I feel like five years later, my book has done a good job in telling the story that needed to be told about the financial crisis.

Gene Tunny  33:25

What do you see as the solution? Is there a solution? I think you’re right, in that there is a problem that that people are reluctant to take responsibility. I think you’ve you have diagnosed a problem. How do we solve this, David? Is there a solution to it?

David Bahnsen  33:49

Well, I think that the book goes into a whole lot of ideas. If I remember correctly, 10 of them are written to the individual person and sort of micro suggestions for a reaffirmation of personal responsibility, and 10 or macro, more of a policy level. I have a critique of the college student loan system, a critique of how we go about thinking about housing in our society.

Fundamentally, if you’ll allow me to go back to the kind of prior conversation about the religious and moral framework of a society, if people can get away with irresponsibly borrowing to buy a home and then walking away unscathed, if people get away with it without any moral compass, I don’t know why they wouldn’t keep doing it. But my belief is that fundamentally, we need a kind of restoration of basic cultural norms. This was really the whole point of the book, that people should be ashamed of what they did, but it isn’t just that they did it. It’s that they were proud of it, that other people congratulated them. Look how smart you are. You pulled one over on your bank. They could brag about it on Friday night with their friends, rather than being ashamed of the fact that they failed in their responsibility.

Paying back debts that one owes is the hallmark of a civilised person. And I think that we desperately need to restore the kind of traditional value system that would never tolerate someone being a degenerate and being so incapable of basic… I’m not referring to people in extreme hardship. We’ve always had that. We always want ways to help those who have genuinely run into very difficult times. But the notion of just simply being able to run away willy-nilly from things, heads, I win, tails, I don’t lose, this is no way to manage a society.

Gene Tunny  36:04

That’s another great example of a book where you’re thinking… Maybe economists wouldn’t normally think about these issues. I’d recommend that as well. Also, you’ve got a book on the case for dividend growth, and this relates to your investing. And I’ve just started that, but the way I’m interpreting it is you’re emphasising look for stocks with good dividends and don’t necessarily buy into all of the fantasies about you’ve got these stocks which will just grow ridiculous amounts in the future, the big tech stocks. I take it that that’s the general view in that book. Is that fair, David? Is that your philosophy in investing is looking for good earning stocks, good earning companies?

David Bahnsen  36:59

Well, dividends are simply what one is doing with good earnings. There are plenty of companies that don’t pay dividends that have wonderful earnings. But our belief is that not only do you want really good earnings, you want confirmation of the earnings, the legitimacy of them and the repeatability of them, and the growth of them, that is validated through the dividend payment to the shareholder. The dividend payment becomes a mechanical benefit. You’re monetizing your investment risk as you go. If you’re reinvesting those dividends, you’re constantly averaging and compounding your return. If you’re withdrawing the dividend for income, you’re satisfying a cash flow need, so that there are mechanical benefits to dividends. But then fundamentally, they represent proof of the profits and earnings of the company, and a vote from management in their own confidence about the sustainability of those earnings. And so dividends are just as much a benefit as they are a signal. And we want both and. That’s our view of dividend growth investing from a risk-adjusted standpoint, producing a much smoother result for investors over time.

Gene Tunny  38:22

Good stuff. Finally, David, I’d like to ask you about Alex P. Keaton, who you’ve identified as a role model. I remember watching Family Ties in the ‘80s here in Australia, and Alex was certainly someone who was very notable. What was it that you found inspirational, or I guess what did you learn from Alex? What are your thoughts on –

David Bahnsen  38:58

Just as a very young kid, I… Here there was this contrarian character on a sitcom on American television that was focused on ambition, on goals, on patriotism. He had a certain love of America, a love of self-determination. And so there was a lot of comedy associated with it and lightheartedness. And yet, at the same time, he was a character who just sort of had a personality that was similar to my own quirky personality as a young person. It’s many years ago now. It’s true, Alex P. Keaton and that character on Family Ties was a big part of my childhood.

Gene Tunny  39:53

Okay. Very good. Yeah. I think there’s a photo of you on your website as a young lad. You’re dressed as Alex P. Keaton or dressed in that –

David Bahnsen  40:04

This is true. I think I was probably nine or 10 years old. That’s correct.

Gene Tunny  40:09

Very good. Okay, excellent. David, this has been terrific. Are there any final points that you’d like to make, any thoughts on your book? Anything that you think it’d be important for us to take out of it?

David Bahnsen  40:24

I appreciate the time. I appreciate your thoughtful questions. There’s No Free Lunch: 250 Economic Truths, and it’s really intended to give people a little something to think about around the different major categories of economic thought.

Gene Tunny  40:38

Okay, thanks heaps, David, I’ll put links to your website and your books in the show notes. David Bahnsen, managing partner of the Bahnsen Group. Thanks so much for your time. Really appreciate it.

David Bahnsen  40:52

Thanks for having me, Gene. Really enjoyed it.

Gene Tunny  40:55 Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to contact@economicsexplored.com and we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.

Credits

Big thanks to EP132 guest David Bahnsen and to the show’s audio engineer Josh Crotts for his assistance in producing the episode. 

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. Economics Explored is available via Apple PodcastsGoogle Podcast, and other podcasting platforms.

Categories
Podcast episode

Concorde’s economic lessons: a closer look – EP131

The British-French supersonic airplane Concorde soared through the skies at Mach 2 in the years 1976 to 2003. Its history illuminates several important economic and business lessons. Is a supersonic airplane simply uneconomic or will commercial passengers fly supersonic again? In Economics Explored episode 131, show host Gene Tunny and his fellow economist Arturo Espinoza Bocangel discuss.

British Airways Concorde aircraft

You can listen to the conversation using the embedded player below or via Google PodcastsApple PodcastsSpotify, and Stitcher, among other podcast apps. 

A transcript and relevant links are below.

Transcript of EP131 – Concorde’s economic lesson: A closer look

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny  00:01

Coming up on Economics Explored.

Arturo Espinoza Bocangel  00:04

In probably France and Britain, they wanted to show to the war that they are able to produce this kind of supersonic airlines.

Gene Tunny  00:16

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene Tunny. I’m a professional economist based in Brisbane, Australia and I’m a former Australian Treasury official. This is Episode 131, a closer look at the Concorde. And joining me to chat about Concorde is Arturo Espinoza, research assistant at Adept Economics joining me for the first time. Arturo, great to have you on the show.

Arturo Espinoza Bocangel  00:50

How are you? I’m really glad to be here with you.

Gene Tunny  00:53

Excellent. Yes, Arturo, it’s good to have you on. Arturo, you’re an economist too. You’re helping me out with economic research on various projects. And you’ve previously worked in the trade ministry in Peru and you’ve got a master’s from University of Queensland in economics and you’ve also got a degree from the Catholic University in Lima, haven’t you?

Arturo Espinoza Bocangel  01:19

Yes, that’s right.

Gene Tunny  01:21

Excellent. Excellent. Yes, you’re well qualified to chat about economics, so pleased to have you on. Excellent. Why I’m looking at Concorde, Arturo, is because in a recent episode I did with Tim Hughes, who I occasionally chat with on the show – Tim’s not an economist, he’s providing the man on the street view of things – we talked about my top 10 insights of economics. And one of those insights was about sunk costs. One of the key lessons from economics is to ignore sunk costs. Bygones are bygones.

And in illustrating the sunk cost, what’s often called the sunk cost fallacy – the fact that people too often don’t ignore sunk costs, they throw good money after bad – an example that’s often given is Concorde, because it was colossally expensive to develop. And the British and French just kept throwing money at it, even after it looked like it wasn’t going to be a commercial proposition. Often, they talk about the Concorde fallacy.

Now, I mentioned this in the show, and Tim and I had a bit of a chat about it. And I said, look, I think Concorde was always going to be a difficult proposition. It’s probably something they shouldn’t have invested in just because of the economics of it. And then, in the conversation, it became clear that I probably needed to do a bit more research on what the underlying economics of Concorde were.

One of my listeners, so Todd, he wrote in and he sent me a passage from an article. Based on that it looks like the there are multiple issues affecting Concorde and the economics and viability of Concorde. This passage he sent me is, “Aviation regulations mandated that Concordes would have to fly more slowly overland to reduce sound disturbances over the ground. This hit French Concordes particularly hard after the post-9/11 dip in air travel. The already struggling birds were even less in demand and therefore less profitable.”

Okay, so I thought we could have a chat about Concorde and just all of the issues involved, because there are multiple issues. There’s regulations, there’s the actual operating costs, because of the cost of oil. There was the fact that there was the Air France crash in 2000 at Charles de Gaulle, where 113 people died. There are multiple issues with Concorde. Are you happy to get underway on the Concorde, Arturo?

Arturo Espinoza Bocangel  04:17

Of course, Gene. Given all those facts behind the Concorde operational activities, I think there is an important issue, which is an externality. When we talk about economics about externalities is when one activity transfer those calls to third parties. Those third parties, they are not involved in that activity. They must assume that cost. Definitely, if we talk about this case of Concorde, and the most important negative externality was related to the noisy. The takeoff of Concorde, very noisy. Also when this type of supersonic flies affected possibly private properties. For example, in USA they found that some properties were affected by Concorde flights in terms of broken windows.

Gene Tunny  05:24

Seriously?

Arturo Espinoza Bocangel  05:25

Yes, so that’s why at that moment USA government banned Concorde flights in between cities or inland. That’s why at that moment Concorde flights only focused on transatlantic flights between New York, Paris, and UK. That’s why I’ve seen behind that, it was a very important limitation for potential demand of Concorde flights or Concorde airliners. Definitely that was a huge impact on potential demand for Concorde airliners.

Gene Tunny  06:14

Yeah. There are those regulations which would prevent Concorde if it were still operating. Neither Air France nor British Airways, which were the two airlines operating Concorde, they haven’t operated Concorde since 2003. But there are regulations that would prevent inter-city flights across land. And so therefore, you are restricted. They were restricted to just those transatlantic flights, so from Heathrow or Charles de Gaulle in Paris, to JFK in New York City. That really meant that it just limited the scope of those Concorde operations. I think that’s a good point.

We might chat about what Concorde is, I just want to make sure that if you’re listening and you’re unfamiliar with Concorde… I’m guessing you probably know a little bit about it, because it’s such an iconic aircraft. It’s such a beautiful design, really sleek, and the delta wing, and that nose that… It’s like a beak, isn’t it, like the beak of a bird? I think they called it a droop nose, because it can move around. Depending on what stage of the flight you are, it will either be in the standard position or it will drop down. I think when they were coming into land, they would drop it down just to improve their visibility. It’s got an interesting nose there.

As you mentioned, it’s supersonic, so it can travel faster than the speed of sound. I think it actually travelled about two times the speed of sound, so at Mach two. It’s supersonic. When I was chatting with Tim, I said, “Oh, is it hypersonic?” No, it’s not hypersonic. Tim corrected me. It was supersonic. Supersonic is faster than the speed of sound, and hypersonic is five times the speed of sound, at least. I think there are some hypersonic missiles that have been developed that I’ve seen in the news reports.

It was a joint project. It was a joint venture in a way between the British and French governments. And the name for it came from an agreement that they reached in the early 1960s, I think. A treaty was signed on 29th of November, 1962. And so what you had was, this is something that came out of the 1950s. There were British and French companies that were investigating supersonic air travel. I think the Americans were looking at it too, but the British and French, they reached an agreement whereby there would be a joint project, because there was a British company that was looking at it, the British Aircraft Corporation, and that was being funded by the British government. They were providing funds for research and development by that British aircraft corporation. And there was also a French company, which was state-owned, Sud Aviation, which later became Aerospatiale. They were looking at it too. And so the two governments got together and decided to enter this joint venture for Concorde, whereby they would jointly develop this aircraft. They’d share the development costs. They would split the production of it across Britain and France with a view to creating jobs and all that. It was a British and French government project.

I would argue that this is a good example… There’s a few economic principles which come out of the whole Concorde experience. And we talked about the sunk cost fallacy, the fact you should ignore sunk costs. One principle, or close to a principle, I would argue, is that governments need to be very careful about going into business. Governments really shouldn’t be picking winners or picking projects. They should be doing the core business of government, national defence and the justice system, and arguably some assistance for health and education, rather than trying to develop a new supersonic aeroplane. When you’ve got governments making these decisions and funding R and D for this sort of thing,  it’s probably more likely it’s not going to be a commercial proposition, and it’s going to be a waste of money. That would be one thing, I would argue. Do you have any thoughts on that, Arturo?

Arturo Espinoza Bocangel  11:18

Of course, and that is an interesting point. In order to see what is the real scope of the government, definitely the government should focus on other issues that are more relevant for people, instead of promoting this kind of investment that, as we have seen, was a failure in terms of economic business perspective.

Gene Tunny  11:53

Who knows, maybe if things went right and the oil price didn’t increase three or four times over what it was previously after 1973, maybe the economics of the whole project would have been better and it could have been more of a mass market proposition. I think the problem that they ended up having was that it became a real niche product. It was really only wealthy people, pop stars and CEOs of Fortune 500 companies who could actually afford to fly on Concorde, as we can talk about later. I think tickets ended up being about, in today’s dollars, I think over 10,000 US dollars, really. Expensive tickets. You really have to have deep pockets. You have to be someone who really doesn’t care how much they’re spending or it’s just absolutely time critical that you need to get from New York to London or the other way or Paris to New York, you need to get there in three hours or so, because it could fly incredibly quickly.

Now, I think the figures I’ve seen is that, so this thing’s flying at basically two times the speed of sound, whereas a Boeing 747 flies at .84 times the speed of sound. It’s not supersonic. The Boeing 747 can fly about 900 kilometres an hour, whereas the Concorde could fly at 2,172 kilometres an hour. Just incredible. And at 60,000 feet too. Wouldn’t that be amazing to have been up that high?

And so it really ended up just becoming a transport option for the rich and famous in a way. One example of that, have you have you heard the story about the Live Aid concert and Phil Collins, how he used Concorde to fly from the Live Aid concert in London at Wembley Stadium? He performed at Wembley, and then he hopped on the Concorde. He got a chopper from Wembley to Heathrow Airport and hopped on the Concorde, and then got the Concorde to JFK, and then he ended up getting –

Arturo Espinoza Bocangel  14:32

Wow, that was tornadic. Wow.

Gene Tunny  14:35

It’s a huge logistical job. Where is it?

Arturo Espinoza Bocangel  14:38

Wow.

Gene Tunny 14:39

He took a British Airways Concorde flight to New York City before taking another helicopter to Philadelphia, just so he could perform at the stadium in Philadelphia, which I think might have been JFK Stadium in Philadelphia. That was in 1985, July 1985, so the big Live Aid concert for… I think it was to raise funds to help address or alleviate the suffering of people in famine in Ethiopia, if I remember correctly. That’s one of the famous examples of the use of the Concorde.

And another example of the sort of rich and famous, there’s a photo. And I’ll put a link to the article in the show notes, if you’re interested in seeing it and some other photos of the Concorde in operation. There’s a photo of Sting, the rockstar Sting, pouring a glass of champagne for Piers Morgan, so the noted media personality, editor of various newspapers that Rupert Murdoch owned. He was on Good Morning Britain. He’s doing something in Australia at the moment. I’m not entirely sure what. He’s anti-woke or he’s trying to cancel cancel culture, if I remember correctly. Big personality. He flew on a flight that they had in, I think it was late 2001. It was the first British Airways flight that they ran with Concorde after the crash at Charles de Gaulle in 2000.

There was a terrible crash when it was taking off from Paris, in the airport in Paris, and 113 people in total, so all of the passengers on the Concorde that had 100 passengers and nine crew. Then there are four people on the ground who were killed as well. Just an awful crash. There was an issue with the Concorde that meant that they had to sort of stop flying them for a while and just check that everything was okay and do some modifications to ensure that sort of thing didn’t happen again. And so what happened after that, you had that incident, and that means that fewer people want to fly on Concorde. I think that’s really what then led to both British Airways and Air France just not running Concorde again after 2003.

Concorde was launched in early 1976, in January 1976, and the final commercial flight was in October 2003. And it looks like what happened, so according to The Economist… The Economist did a good article on this in 2003, which I’ll link to in the show notes, although it may be paywalled. It looks like in 2003, they figured out that there was this cost associated with refitting the Concorde aircraft. A study commissioned by British Airways of the case for a 17 million pound refit of the supersonic aircraft showed the viability had ended with the turn-of-the-century stock market boom at the start of 2003. Airbus, the modern incarnation of the Anglo French manufacturing partnership that created Concorde, told Air France and BA, the aircraft’s only operators, it could no longer provide technical support for the aircraft at anything like a commercial price. Air France, which never made as much from Concorde as British Airways, stopped flying it in May. But BA said it would keep Concorde going into October simply to please its fans.

I think what they’re alluding to with the stock market boom is that after the share market crash in the early 2000s… In the late ‘90s you had the dot-com boom, and then there was a recession or a downturn in the early 2000s, associated with the dot-com crash in the US. And I think what they’re suggesting is that that meant that after that downturn, companies and wealthy people were less likely to splurge on a Concorde. And then there was the Air France crash, and that meant that not as many people were flying Concorde. That really just destroyed the viability of it on an ongoing basis.

Now, what I think’s interesting is that – and this is something I didn’t know until I had a closer look at Concorde for this episode – is that for a few years, Concorde was actually profitable for British Airways and Air France. It didn’t look like it was making huge amounts of money, but it was actually profitable from about the mid ‘80s and possibly up until that Air France crash. It wasn’t profitable for the governments that had invested in it originally because the cost of it just blew out massively. If we go back to the development costs of it, the cost of the British and French government’s ended up being, I think it was over one billion pounds before it even went into service. And in today’s dollars, that’s over 11 billion pounds, because it was reported as 11 billion in today’s dollars in – sorry, pounds, 11 billion pounds in today’s pounds, in 2003 by The Economist. That was 10 times what was budgeted for. The cost of it was just colossal.

It would never have been a commercial proposition if you tried to recover those R and D costs. But what happened was that the governments essentially wrote off those costs. After they’d already invested all this money, they basically let the company, so Air France and British Airways, buy the Concordes at a discounted price, so that they didn’t have to pay back or they didn’t have to pay for the cost of having the Concorde developed. The R and D costs of the Concorde weren’t actually included in the sale price of the Concordes, as far as I can tell.

What you’ve got as a situation where this huge R and D cost, it’s written off by the government. In a way, that’s the other side of the sunk cost proposition, that yes, this has already happened, this money’s already been spent. In a way, the Concorde is a gift from the governments of Britain and France to the aviation industry. It’s already developed. The technology is there. Then what matters for the aviation industry is can it make a profit with those Concorde planes as they are now? The aviation industry never had to make substantial enough profit to cover the original R and D costs, and so in that sense, Concorde was profitable for several years from the mid ‘80s.

It’s extraordinary. There was there was an AP, so an Associated Press report in 1986. Where is it? It’s basically saying that Concorde is an unexpected success, but it’s only unexpected or it’s only a success if you do ignore the fact that all of that billion pounds of research and development costs are written off, that you just accept that taxpayers aren’t going to get that money back. It ended up being an unexpected success for British Airways and Air France for a while, although not for the governments of Britain and France.

“Concorde, an unexpected success, marks 10th anniversary. London, 10 years after its detractors branded it as an enormous white elephant, the Concorde is the fastest, most luxurious, and to many the world’s most beautiful airliner. It makes money too. After years of losses and a $2.8 billion government development costs that has been almost completely written off, financial winds have turned in the plane’s favour. The Concorde brought a $17.3 million profit to British Airways last year, and a profit of 8.8 million to Air France in 1984. British Airways didn’t record profits from the Concorde until 1982, and Air France and until 1983.”

I found that quite interesting, and that was something that I wasn’t aware of. And I guess it sort of makes sense, because they wouldn’t have kept operating it for a couple of decades – because it did operate from 1976 to 2003 – they wouldn’t have done that if it wasn’t at least making a profit for those airlines. That sort of makes sense, but there’s no way in which the Concorde ever recovered the R and D costs that were paid for by the governments. Therefore, if you were back in the ‘60s looking at this project, and you’re in the British and French governments, and you had perfect foresight as to what would happen, you would have gone, “Okay, we’re going to stop spending money on this because we’re never going to recover and costs the blowing out. Let’s just cut our losses now.” Okay, we’ll take a short break here for a word from our sponsor.

Female speaker  25:18

If you need to crunch the numbers, then get in touch with Adept Economics. We offer you frank and fearless economic analysis and advice. We can help you with funding submissions, cost-benefit analysis, studies, and economic modelling of all sorts. Our head office is in Brisbane, Australia, but we work all over the world. You can get in touch via our website, http://www.adepteconomics.com.au. We’d love to hear from you.

Gene Tunny  25:47

Now back to the show. Does that all make sense, Arturo? Is there anything confusing there?

Arturo Espinoza Bocangel  25:54

It’s clear, everything about the factors behind unsuccessful operation of the Concorde. Perhaps the main objective of that project wasn’t to have the best economic successful in producing those airliners. I think probably France and Britain, they wanted to show to the world that they are able to produce this kind of supersonic airlines, that they had the best technology to share to the world. I think possibly that is another explanation and why they wanted to continue with operate.

Gene Tunny  26:48

That’s true. There’s that national prestige element involved. There was a cost-benefit analysis, a prospective cost-benefit analysis done in the early ‘70s before the Concorde was ever in operation. Do  you know that study? And I think the economist who did that, was it Woolley, he was arguing that okay, there’s actually a loss in economic terms to the governments of Britain and France from Concorde, of I think it was a negative 100-and-something million pounds, I’ll put a link in the show notes to the study so you can have a look at it if you’re interested. But he was arguing that okay, this means that the governments of Britain and France value these other elements, all these intangible elements of the Concorde project, which could include the national prestige, national pride, they value those elements as at least this much money.

And this is a point I made when I was chatting with Tim. This is a time when the great superpowers… The superpowers at the time were the US and the Soviet Union. And they were the ones who, they were in the space race. Britain and France were probably never going to get in the space race. Britain and France were once the great powers in the world, in the days of Nelson and Napoleon, the great powers in the… And I guess Spain as well. But yeah, France and in Britain were once great powers. And this could have been a way, they could have seen this as a way of getting back into that game. I think that’s a really good point.

I’m just trying to think what I should… Other things I should talk about, the operating costs of the Concorde. they did have higher operating costs per passenger than say 747. I think what I saw is that even though you’ve got 100 or so people on a Concorde versus more than 400, 400 to 500 on a Boeing 747, I think you need almost as much jet fuel. The cost per passenger per mile on a Concorde… There are some figures. There are various sources for figures. Wikipedia has got a great article on Concorde I’ll link to, and it has some figures in that. From what I can work out, Concorde had nearly twice the operating cost per passenger than a 747. It was never really going to be a mass market proposition.

I think certainly the oil shock in 1973 when the Arab nations restricted supply of oil… I think that was in response to the Yom Kippur War, where the Israelis pushed back the Arab invasion. And I think what happened was, because those higher oil prices meant that it was never going to be a mass market proposition, what you saw was that through the ‘70s, all the aircraft companies, the airliners that had previously expressed some interest in Concorde, other than Air France and British Airways, they just said, “Look, we’re no longer interested.” Partly that was because of higher oil prices. It could have been that they’re crunched the numbers and just worked out, we’re not going to make money on Concorde. The Boeing 747, it came out in I think it was 1969. And it was just such a great aeroplane. You could fit so many people on it. It’s just such a fantastic airline plane for international travel. And so I think they just worked out oh, look, Concorde’s not really going to work. Qantas here in Australia, I think it was looking at getting Concorde at one stage, but worked out it wasn’t gonna work. The only companies that ended up running it were Air France and British Airways.

Because of the higher operating costs, you needed to have a higher ticket price. And so you needed to appeal to those wealthy buyers. What I found, and this is something you notice too, Concorde, it was super quick, you’d save hours on your travel time, but it wasn’t a really luxurious experience, was it, flying Concorde, from what I could tell.

Arturo Espinoza Bocangel  31:50

Yes, that’s true. It was not comfy. I think due the design of the airliner, the people must be seated closely. It wasn’t too much comfortable to be there. I think that was one of the problems. You compare that airliners against Airbus or Boeing, those airliner offer you a better experience as a passenger?

Gene Tunny  32:26

Yes. I think I was reading that they didn’t even have enough room for on-flight movies. You’re really enclosed. You’re really close with other people. And in a way, that could be good, if you’ve got Paul McCartney or Sting or someone on the plane with you. That’s pretty special.

Arturo Espinoza Bocangel  32:48

Of course.

Gene Tunny  32:49

But otherwise, it wasn’the super comfortable. And I guess they tried to compensate for that by having the freely flowing champagne and caviar. But look, there’s only so much that only goes so far. If you’re on a business trip, you need to watch how much champagne you’re consuming. The combination of attributes that had only appealed to certain types of wealthy people. They might have wanted to impress or maybe they really did need to get – it was just absolutely time critical that they needed to get from London to New York or Paris to New York. And I think we’re talking about a really elite segment of the population. And then what happened was that after the Air France crash, a lot of those people decided well, okay, look, I’m not really sure I want to fly on the Concorde anymore.

That Economist article I mentioned before, it writes… In The Economist article it has, “In its heyday, Concorde typically flew three quarters full, earning BA about 20 million pounds in operating profits from 35,000 passengers a year. When it returned to service, paying over 8,000 pounds to fly supersonic had lost its appeal. BA could attract enough business for only one transatlantic flight a day, instead of the previous two. And even then, the aircraft was often carrying only a couple of dozen paying passengers.” You’ve got more than half your plane unfilled. Actually, three quarters of your plane if you’re only carrying –

Arturo Espinoza Bocangel  34:40

That is a loss.

Gene Tunny  34:41

“Extra seats were often filled by upgrading subsonic first-class and business-class customers. Delays and diversions due to bits falling off and engines faltering began to tarnish Concorde’s image and emphasise its age.” That’s part of the problem.

Apparently Concorde was quite fragile. And I saw one estimate that for every hour, it was every hour of flight time, it needed 18 hours of maintenance or something like that. It had this issue of needing all of this maintenance, and then they would have needed to have done a refurb of it, a refit in the early 2000s. British Airways and an Air France just looked at the numbers and thought, ah, that’s not gonna make any sense, so let’s just discontinue operations.

That’s a fascinating story. You’ve got this combination of the oil price, you’ve got a combination of it being… It wasn’t a mass market proposition. It had to become a niche, luxury proposition or for the business elite and the entertainment elite. Then that market was compromised by a downturn in the economy, people being less willing to splurge, and also the Air France crash, which hugely concerning. You really worry about Concorde.

Maybe if it was more mass market, if there was a larger number of Concordes in operation, maybe they could get more efficiencies in the operations of Concorde. They wouldn’t have the problems finding someone to service the Concordes. I just wonder if that would have meant that it would have been more viable if there were more of these planes. Certainly the British and French governments intended originally that there’d be many more Concordes in operation. I think they thought they’d be selling hundreds of these Concordes. I think I saw an estimate they were expecting by 1980, 350 or 400. I may have misremembered that, but I’ll try and put it in the show notes. And that cost-benefit analysis we saw, it had projections based on Concordes in the hundreds, whereas there are only ever 20 Concordes built, ever built. And only 14 of them were an operation. Six of them were for testing, were prototypes. It’s quite extraordinary.

Arturo Espinoza Bocangel  37:21

That’s crazy. Wow.

Gene Tunny  37:23

I think economics ultimately defeated the Concorde. Certainly the crash and the regulations contributed as well. The regulations we talked about, the fact that it couldn’t go supersonic over the land, that certainly affected viability, particularly for the French, for Air France, because I think it had to travel further overland from Paris to New York than you probably would… Maybe I’m wrong about that. Anyway, apparently it affected the French Concordes particularly hard, as that passage from Todd quoted. Then there’s the fact that you can’t do the cross-continental. You couldn’t go from New York City to Los Angeles. You couldn’t go from London to say Moscow or wherever or Beijing or something. I don’t know. There’d be a whole lot of other routes that you could travel if you didn’t have to worry about the sonic booms.

Arturo Espinoza Bocangel  38:28

The thing told you that USA government banned those kind of inland flights of the Concorde.

Gene Tunny  38:34

Right, of supersonic planes, yeah.

Arturo Espinoza Bocangel  38:38

Due to those negative impacts on private properties and people as well.

Gene Tunny  38:42

Yeah, I’ll have to look up the exact regulation. That makes sense to me. A couple of other interesting facts I thought would be worth talking about is that the Soviet Union or the Russians actually had a supersonic airliner too, the Tu-144. It had a different design from the Concorde. It looks similar, wasn’t as beautiful though, wasn’t as elegant, but it had similar features. I think it had the delta wing too, and it had the drooping nose but it just wasn’t as beautiful or as smooth as the Concorde was. And one of the problems it had, it was using an afterburner through the flight to go supersonic. And that meant that the cabin was really noisy, about 90 decibels, which I think is equivalent to a hairdryer. I think I read that.

Arturo Espinoza Bocangel  39:37

Wow.

Gene Tunny  39:40

In contrast, the Concorde turbo jets, they only needed the afterburner at takeoff, to take off. That Russian supersonic plane, it didn’t last and so they don’t run that anymore. But I thought that was fascinating that they had they had a supersonic plane themselves.

Now, is there a future of supersonic aircraft? I was surprised. This really surprised me. I read that, so the United Airlines, the US airline company, it’s announced that it will buy up to 50 of these Boom Overture Supersonic jets. And the idea is to get them operating by 2029. Now, this is a company in Denver, Colorado, that’s developing supersonic aircraft. It claims it’s going to be using sustainable aviation fuel, and so that minimises concerns you might have about impacts on the environment, climate change, because airline travel is a significant contributor to greenhouse gases.

Arturo Espinoza Bocangel  40:57

Yeah, definitely.

Gene Tunny 40:59

They’re claiming it’s sustainable. They’re also claiming that they’re looking at the aerodynamics, they’re working on the aerodynamics of the plane to reduce the sonic booms. It’ll only have a thud of 75 decibels compared with Concorde’s 105-decibel sonic boom. We’ll see how that all goes, how that works out. That’s interesting that potentially, there is a company that’s been looking at reviving supersonic flight. Now, let’s see how that all goes. I guess you want to try and look through the fact that the oil price now is spiked because of what’s happening in Ukraine. Hopefully, that’s all resolved by then. Look, I think, a supersonic aircraft, it’s still going to face that issue of the regulation. There’s always a risk that maybe it can’t fly the routes it wants to, even if it does get that sonic boom down. I don’t know. I think we’ll have to wait and see there. But I found that fascinating that that there could be supersonic flight in the next decade or so, again. Have you seen anything along those lines, Arturo?

Arturo Espinoza Bocangel  42:20

No, I haven’t checked that. But I think from my perspective, it’s going to be difficult for those ventures in order to develop these kind of supersonic aeroplanes. And of course, these aeroplanes are going to compete with these two big companies, which are Airbus and Boeing. Of course, they will face that limitation in terms of competition as well. I think that is going to be complex for them. Even if we talk about, for example, the many tries of Chinese government to develop their own airlines, or to compete with those big multinational companies, but we have seen that the results were unsuccessful.

Gene Tunny  43:15

It’ll have to have tickets priced a lot higher than standard travel. Let me have a look at this. There’s an article in the conversation in June 2021. “Supersonic flights are set to return. Here’s how they can succeed where Concorde failed.” This is by Peter Thomas, who’s an aerospace engineering lecturer at a university in the UK. I’ll put a link to that. He’s written, “Boom will be optimistic that it can overcome fuel efficiency challenges by the time its aircraft begins carrying fare-paying passengers in 2029. Those fares look set to be high, with Boom anticipating a 3,500 pound price tag per seat. In 1996, British Airways charged around 5,350 to 8,800 pounds in today’s prices for roundtrip tickets from New York to London.”

It’ll be cheaper than Concorde, but it’s still going to be much dearer than a normal fare that you’d pay, probably about, I don’t know, three times or so. I’m not sure what the exact fares from transatlantic fares are in pounds. But I’ll see if I can put something in the show notes. It’s certainly going to be more expensive than the standard fare.

“This means that like Concorde before it, the Boom Overture looks aimed at the luxury market, beyond the reach of even business class passengers.” I think that’s the problem. If you’re aiming the luxury market, then maybe it’s too narrow a segment to try and run an airline on I don’t know. That would be one of the concerns that I would have about that as a proposition, but let’s see how it develops. I’d certainly like to fly supersonic one day, I think it’d be one of those so-called bucket list things to do, if  you know what I mean.

Arturo Espinoza Bocangel  45:26

Yes, the same for me. I would like to do that.

Gene Tunny  45:30

Flying at 60,000 feet at Mach Two or whatever it is, just be spectacular. Some of the facts, or factoids you could say they are, that they have about, because who knows if they’re right or not. You just read these things on the internet. But I think one of them was saying by the time that the hostess or the stewardess pours your champagne, you’ve already travelled 26 miles or something ridiculous, in the Concorde. It’s flying that fast.

Arturo Espinoza Bocangel  46:02

Wow.

Gene Tunny 46:07

I don’t know whether that makes sense or not. You just think about how fast you’re travelling, and it’s just extraordinary. I wanted to end with my takeaways from this whole Concorde episode, or experience with the Concorde, because I think there are a lot of important economic lessons associated with Concorde. It’s more than that you should ignore sunk costs. This is the point that if the British and French governments were smart, or they were paying attention, or this thing wasn’t so caught up with their – it wasn’t such an exercise in national pride or national prestige – if they thought rationally about it, they would have cut their losses in the ‘60s sometime and just given up on it, but they didn’t do that. They ignored the key lesson, very important lesson from economics to ignore sunk costs. Bygones are bygones. Don’t throw good money after bad.

The other lesson, I think, is ultimately economics prevails. If something doesn’t stack up, it won’t survive. Even though Concorde was profitable for a while, over the long run it just wasn’t a commercial proposition. There the regulatory issues. There was the fact that it had higher operating costs than the standard aircraft because of the amount of fuel relative to passengers it needed. This meant it had to be a luxury proposition. That meant that the market was smaller, and more volatile, you could argue. I think that’s what happened. You had the Air France crash, and the downturn in travel associated with 9/11, and people being more budget conscious after the stock market fell, this perfect storm of things that happened that ultimately defeated Concorde.

Okay, my third takeaway is governments should be careful about going into business, i.e. picking winners. I think that’s something governments really need to be careful about. I used to work in the Industry Policy Division in Treasury and we would always cast a critical eye over any idea for government to get involved in business. I think you have to be really careful about that.

Number four, you need to think about those externalities. This is the point you made. There’s this externality associated with Concorde, the sonic booms. And if there is an externality, you need to think about what does that mean, what could governments do in response? And we saw that there was that regulatory response that the Concordes, they couldn’t go supersonic over land. And that really affected the economics of the operations.

Another externality, of course, is greenhouse gas emissions. And so you have to think about if you’re going to run a supersonic aircraft in the future, then what does that mean if there’s some sort of carbon tax or if there’s some crackdown on air travel because of people who are concerned about climate change? Of course, that’s why with this Boom technology company, which is looking at a new supersonic plane, that’s why it’s trying to get into sustainable aviation fuel. It’s looking at “Biofuels and synthetic kerosene that are manufactured using renewable and sustainable materials. It looks like it will mean an impressive 80%… ”  This is what the author of the article is writing. This is Peter Thomas. He writes, “An impressive 80% reduction in lifecycle CO2 emissions is often quoted.” Then he goes, “The key word here though is lifecycle. It doesn’t necessarily mean less harmful emissions from the engine.” Who knows what it’ll ultimately mean for the emissions and what potential carbon tax or carbon price they’d have to pay? Anything else we need to chat about with Concorde, Arturo?

Arturo Espinoza Bocangel  50:46

I think today, all that you have mentioned are enough to have a better idea of what happened about the case of this white elephant case.

Gene Tunny  51:04

I hope if you’re in the audience, you’ve got something out of this. I’ll put links to these articles that I’ve mentioned or have quoted from in the show notes. Check them out. There’s a lot that’s been written about Concorde, I think because people find it fascinating just because it’s such a beautiful aeroplane, and I guess the celebrities that have been on the plane and there are such interesting stories when you got Phil Collins and going to Live Aid, doing two Live Aid concerts in one day. I think even the Queen, Queen Mother, they’ve all travelled on Concorde. The Queen Mother, she’s no longer with us, but they travelled on Concorde at different times.

One other story I forgot to mention, there’s this idea that you can get a pricing lesson from the Concorde. Part of the reason that the profitability of Concorde, it became profitable in the mid ‘80s, was because British Airways figured out that they could put their prices up, because the people who were flying on Concorde, they were busy executives, or they were senior executives, and their secretaries were booking the flights. The actual people flying didn’t realise how much Concorde was costing. They thought it was actually more expensive than it was. British Airways did a survey. British Airways raised their prices and they didn’t have a fall in demand. They ended up making more money, because they increased their prices. How would economists describe that? At that point of the demand curve for those consumers, the demand is in elastic with respect to price. Is that the right way to explain it?

Arturo Espinoza Bocangel  53:00

Yes.

Gene Tunny  53:03

That’s what British Airways figured out. And so therefore, they could increase prices and therefore increase –

Arturo Espinoza Bocangel  53:12

The demand for or travelling, it wasn’t going to change.

Gene Tunny  53:20

Yeah, or very little for that group of consumers, the people who really weren’t budget conscious. I think that’s fascinating. There’s a great article, A Pricing Lesson From the Concorde from The Adaptive Marketer, Gerardo Dada, and I’ll put a link to that in the show notes.

Wow, I think we had a pretty comprehensive discussion of the Concorde, Arturo. Thanks for joining me on this conversation. I think that’s been really good.

Arturo Espinoza Bocangel  53:55

Thank you again for inviting me.

Gene Tunny  53:57

Yeah, of course. And if you’re listening in the audience, and you have any thoughts, any comments, any questions, please get in touch. You can email me, contact@economicsexplored.com. I also have a speak note service set up so you can send me a voice message. There’s a link to that in the show notes. Thanks for listening, and hope to speak with you again soon. Thank you. Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to contact@economicsexplored.com, and we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.

Links relevant to the conversation

EP129 which mentions the Concorde:

Economist article on the Concorde with good summary of what went wrong:

https://www.economist.com/business/2003/10/16/after-concorde

Conversation article on future of supersonic air travel:

https://theconversation.com/supersonic-flights-are-set-to-return-heres-how-they-can-succeed-where-concorde-failed-162268

AP article on Concorde being “unexpected success” in 1986:

https://apnews.com/article/fa1e281d544267a8afe77afceaf3f03f

Early seventies cost-benefit analysis of the Concorde mentioned in the episode:

http://www.bath.ac.uk/e-journals/jtep/pdf/Volume_V1_No_3_225-239.pdf

Other websites consulted:

https://www.businessinsider.com/concorde-supersonic-jet-history-2018-10?r=AU&IR=T

https://www.heritageconcorde.com/who-built-concorde

https://science.howstuffworks.com/transport/flight/modern/concorde2.htm

https://en.wikipedia.org/wiki/Concorde

https://ultimateclassicrock.com/phil-collins-live-aid/

https://www.cntraveler.com/story/celebrity-passengers-and-caviar-at-55000-feet-what-it-was-like-to-fly-concorde-in-the-70s

https://www.economist.com/1843/2018/09/03/when-concorde-was-the-future

Credits

Big thanks to my guest Arturo Espinoza Bocangel and to the show’s audio engineer Josh Crotts for his assistance in producing the episode. 

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. Economics Explored is available via Apple PodcastsGoogle Podcast, and other podcasting platforms.

Categories
Podcast episode

Thriving w/ Wayne Visser, Cambridge & Antwerp sustainable business expert – EP130

In Economics Explored EP130, we explore a new book Thriving: The Breakthrough Movement to Regenerate Nature, Society, and the Economy, by Professor Wayne Visser of the Cambridge Institute for Sustainability Leadership and Antwerp Management School. Wayne is reassuringly optimistic about the future of the planet due to a variety of technological and business practice changes that mean we are approaching “tipping points”, after which we will rapidly reduce the stress we are placing on the environment – all going well, of course, as nothing is guaranteed. 

In the episode, Wayne speaks about a convergence of positive developments, such as rapidly improving electric vehicles, cultured/lab-grown meat, blockchain and synthetic DNA to aid traceability of supply chains, green hydrogen, and Unilever committing to deforestation-free palm oil (by 2023, and whether it achieves that is still to be determined). You can listen to the conversation with Wayne using the embedded player below or via Google PodcastsApple Podcasts, Spotify, and Stitcher, among other podcast apps. 

Here’s a short video clip from the conversation in which Wayne introduces the concept of Thriving:

Links relevant to the conversation

DNA Spray-On Technology Could Revolutionize Food Traceability

Transcript of EP130 – Thriving w/ Wayne Visser

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny  00:01

Coming up on Economics Explored.

Wayne Visser 00:04

Being optimistic or at least having thriving as a lens is just a more effective way to be, no matter what the state of the world is.

Gene Tunny  00:13

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host Gene Tunny. I’m a professional economist based in Brisbane, Australia, and I’m a former Australian Treasury official. This is Episode 130. In this episode, we explore a new book from a world leading expert in sustainability, Dr. Wayne Visser, who joins us from the UK via Zoom.

Wayne’s new book, published by Fast Company Press is Thriving: The Breakthrough Movement to Regenerate Nature, Society, and the Economy. Wayne currently serves as head tutor, fellow and lecturer at the University of Cambridge Institute for Sustainability Leadership. He is also Professor of Integrated Value at Antwerp Management School, where he holds the world’s first Academic Chair in Sustainable Transformation, as well as being a world leading authority on sustainability. Wayne is an accomplished poet, and he shares some of his poetry with us toward the end of this episode. Wayne’s new book Thriving considers issues with huge implications for our economies, so I was very glad to chat with him about it. His book contains lots of valuable examples of how businesses and communities worldwide are attempting to make themselves more sustainable.

Please check out the show notes for links to materials mentioned in this episode, and for any clarifications. If you have any questions, comments or suggestions related to this episode or the previous ones, please get in touch by SpeakPipe. See the link in the show notes or email me via contact@economicsexplored.com. I’d love to hear from you. Righto. Now for my conversation with Dr. Wayne Visser on his new book, Thriving. Thanks to my audio engineer Josh Crotts for his assistance in producing this episode. I hope you enjoy it. Professor Wayne Visser, welcome to the programme.

Wayne Visser  02:23

Hi. Great to be joining you.

Gene Tunny  02:25

It’s fantastic to have you on, Wayne. Yes, very happy to be chatting with you about your new book, Thriving, which is on a topic that is of great interest to me, and I know to many of my listeners. It’s this issue of sustainability. Climate change is related to that, obviously a big environmental challenge. I’d like to explore what your book is about, why you wanted to write it, what those key messages are. First, I’ve just got a couple of questions about your work. You’re at the Cambridge Institute for Sustainability Leadership. Could you tell us a bit about that, please?

Wayne Visser  03:20

Yeah. Great pleasure to be talking to. The Cambridge Institute is a department of the university that was set up many decades ago actually, firstly, mainly, at the request of the Prince of Wales, Prince Charles, one day soon to be king, I guess, who’s always had a passion for sustainability. He set up a business and environment programme through the university, and it just evolved from that. And ow they it’s a very large office and runs many, many programmes, I head up their business sustainability management online programme, which is getting great traction. We have upwards of 900 students, taking that four times a year. We’re seeing the uptake. I’ve been associated there for nearly 10 years, and I really see how it’s changed. In fact, 20 years. Yeah, since 2003. Really, the interest levels are up, and the demand for solutions, especially from business, is really rising.

Gene Tunny  04:39

Right. You’re certainly right about Prince Charles. I remember visiting his country estate, just as a tourist, Highgrove in Gloucestershire, and before you go on a tour of the estate, you have to sit through a 10 or 15-minute video of Charles, of the Prince of Wales talking about the importance of sustainability. I think he’s into organic farming and that sort of thing. I’ve certainly seen his commitment to that, so very good…

Wayne Visser  05:19

He was way ahead of his time, especially on the organics side, or what they sometimes call in Europe, Europe bio. Many of the programmes have been very specific. We have very good climate legislation in the UK, for example, and also in Europe. That’s partly down to the Prince of Wales Business corporate leadership group that we set up at Cambridge on climate change, where we tried to be an intermediary between business and government, because business was saying they couldn’t be bold in their commitments, because they didn’t have clear policy guidance, and the politicians were saying they couldn’t be bold in policy, because they thought business would lobby against them. Playing that kind of role has been very, very effective in making the progress that we need to make.

Gene Tunny  06:11

I’d like to ask you later about good legislation in the UK. and EU. I’m interested in what you consider good legislation. That’s something we can chat about. Also, you’re a professor at, is it University of Antwerp, is it, in Belgium?

Wayne Visser  06:31

Yes, Antwerp Management School. It’s actually a sister organisation of the university, but it is independent. Yes, I have a chair there in sustainable transformation. It’s supported by corporate partners, BASF, Port of Antwerp and Ronstadt. I run the Sustainable Transformation Lab there, where we mainly work with corporate partners on advancing sustainability, but also on embedding it into all of the teaching for the full-time and the executive MBA students.

Gene Tunny  07:04

BASF, this is one of the biggest chemical corporations in the world, isn’t it? It’s a huge company, isn’t it?

Wayne Visser  07:14

It is, and right there, Port of Antwerp Zone, which goes for more than 30 kilometres, has one of the biggest chemical clusters in the world. And of course, it’s a great challenge, I must be honest, because the chemical industry has many, many impacts, and is one of the institutions, one of the sectors that has to transform, if you look at something like climate, and it’s not easy. There are massive technology investments that have to be made, whether that’s on using green hydrogen, to get their energy for their crackers, or even going for carbon capture and storage, investing in renewables, which they’re doing as well. But at least they’re one of the progressive ones, I would say, and they really are seeing that this is the future and they have to invest in it.

Gene Tunny  08:10

Okay, Wayne, what was that word you used? Was it crackers?

Wayne Visser  08:14

Yes, yes. Crackers are just the way that they get them, the molecules, the chemical molecules, how they break them apart. This is a very, very intensive, energy-intensive process, much like many other industries. Smelting I know is being done in Australia, for example, aluminium smelting, cement making. These are all very intensive industrial processes where there is no easy solution. For climate change, they really have to come with new technology, such as green hydrogen, where you get the renewable electricity to power the creation of hydrogen from water normally. That takes a lot of energy. But once you have that hydrogen, that can then create the heat that you need for these large industrial processes.

Gene Tunny  09:07

We might have to chat about that a bit later. I guess one of the things I’ve been fascinated by is just how a lot of these big corporations are… They’re seeing the future and they realise—well, many of them, I mean the more enlightened ones are realising, we probably have to get on top of this now, to start addressing this, or we could lose out in the future. I think that’s an example of that. Very good. One other thing I’ve saw in your bio, which I thought was really interesting, so you’re also a poet as well as a pragademic, if I’ve got that right, or pracademic. You’re a pracademic. You’re an academic and you’re also doing practical things involved in policy. You’re also a poet, and it turns out you’ve written 40 books. There are books on both environmental issues and also poetry? Is that right?

Wayne Visser  10:14

Yes, it is a mix. I must say, the majority of them are on sustainable business. And they range from the encyclopaedic, literally because I did an encyclopaedia the A to Z of corporate social responsibility, nd I’ve done a world guide on sustainable enterprise covering countries around the world, so that kind of reference work through to yes, even a fiction. Some poetry books, but also some fiction. There’s a parable on leadership, called Follow Me, I’m Lost, about a goose, a Scottish goose, who gets lost on the way to leadership school in London and ends up in Africa, travelling down and meeting strange creatures who each teach him a leadership lesson. There’s the full range.

Thriving is, I would say, in the middle. It’s really written for a broad audience. But it is about how we change society and the economy fundamentally. It includes some of the poetry actually in the book, as well as many stories, both personal stories, but also stories of the innovation that’s happening. I guess we’ll dive into that. But that’s one of the reasons I wrote the book is, there’s so much doom and gloom around now. Look at the statistics on many trends. Some of that is justified, even what’s going on in the world today with war breaking out in Europe. It’s hard not to be pessimistic, but you also have to take the bigger picture and see this global system that is in transformation and is actually speeding up. Many of the signals are all headed in the right direction. There’s so much innovation out there. This book was about capturing that innovation that’s happening.

Gene Tunny  12:09

That sounds great. That sounds great. With Thriving, so what you wanted to do, is basically you wanted to counter the doom and gloom. Is that what you’re saying? You think there’s too much doom and gloom? There’s actually a lot of innovation occurring out there, and are you trying to suggest, okay, given all of this innovation, this is what the appropriate policy settings are? Are you touching on policy settings at all, Wayne?

Wayne Visser  12:43

I touch on policy, but I would frame it like this. In fact, I start with something in the early chapter, called the Stockdale paradox. And this is named after Admiral Stockdale who survived a prisoner of war camp, I think he might have been in there for seven years, and came up with this philosophy that what you need to do to survive and thrive is to face the absolute reality, all the brutal facts, completely honestly. So don’t kid yourself about the state that you’re in. But at the same time, you can never give up faith or hope that things can change and can get better.

You’ll see in the book, it’s not a book of denial, or wishing things were better. I set out a lot of the facts on what’s going wrong, what’s really challenging, when nature, society, and the economy are breaking down. But then I look at the larger system and I look at how systems change, especially living systems, of which society is one nature is another, organisations as well. When you distil it down to the scientific principles of how those systems change and thrive, you actually see many signs that we are heading into a tipping point of change towards the better. It’s not that we don’t face these big challenges, but we’re seeing many transformational signals. And most people are not aware of that. And so yes, they get trapped in the pessimism or the doom and gloom.

It’s also that, you know, being optimistic, or at least having thriving as a lens, is just a more effective way to be, no matter what the state of the world is, because if you’re trapped in in pessimism, you’re disempowered. You sort of just give up before you’ve even made it a try to tackle the issues.

It’s a little bit philosophy, but it’s also backed up by some science of how change happens. And then lots of examples of where business especially, is really charging ahead and bringing the solutions that we need and starting to scale them, which is something that in my 30 years plus working in sustainability was always missing. We always had many of the solutions, but they weren’t scaling. Now they’re scaling. Tesla’s one of six trillion-dollar companies now, and its core mission is a sustainability mission. It’s to speed the transition to sustainable energy. That’s scaling. And it’s valued at more than all the other auto manufacturers, even though it makes less than 1% of the cars.

Gene Tunny  15:53

That’s extraordinary. That’s extraordinary. I want to go back to this point you made. You’re generally optimistic. However, you did note before that there are places where nature, society, and the economy are breaking down. Where is that, Wayne? Are you able to describe or tell us where that is most acute, because we hear all of these horror stories about bad things that could happen, tipping points, and all of that, but where are things breaking down? Could you tell us, please?

Wayne Visser  16:30

This gives a little insight into the structure of the book, really, because I structured into these six great transitions that we’re going through and that we need to go through. There are two breakdowns in nature, two in society, and two in the economy. I’ll briefly touch on each.

In nature, what we see is huge breakdown in ecosystems, so degradation of ecosystems. You’ve got the Great Barrier Reef on your shores there, and it’s literally dying, bleaching, just as one example. The loss of species is actually catastrophic right now. We are going through the sixth mass extinction. And we’ve lost 67% of wildlife populations since 1970. Something that took 3.8 billion years to build up on the earth, we’ve wiped out in one generation.

Yes, huge breakdown in ecosystems. But there is this counter movement of restoration, so protection and restoration of ecosystems. Yu start to see, there’s in fact a lot of work going on through the UN trying to create an equivalent international agreement to the Paris Agreement, which is on climate change, to have one on nature now. There is a widely promoted target for the world now to protect and restore 30% of our land and our oceans by 2030. Likewise, there’s a lot of work going on around deforestation coming out of the 26th Conference of Parties on Climate Change in Glasgow last year, where we have now more than 90% of the world’s countries committed, that have forests, committed to end deforestation and reverse it in the next few years. A lot of movement happening there, and a lot of big companies starting to actually put money into helping to protect and restore. If you look at the Bezos Earth Fund, putting more than a billion into the Congo, the rainforest in Africa, which always gets forgotten about because we know the Amazon, but the second largest tropical rainforest is the Congo. So that’s one example of a transition.

The second breakdown is depletion of resources. This is many, many nonrenewable resources, whether it’s water or timber or topsoil. All of these are being depleted at an alarming rate, nothing like what the earth can sustain. This has been going on—we call it the great acceleration—since about 1950, when we’ve had this exponential growth of economics, of economies and consumption, and of course, resources are finite.

The solution there is renewal of resources. This links to one of the market solutions I write about, which is the circular economy. How do we get it so that everything we use in our products and services either is made from nature and goes harmlessly back to nature—that’s one type of circle or loop—or is made artificially like chemicals and plastics and metals and so on, but continues to go back into manufacturing in an endless cycle. That’s the circular economy. Today, we’re around about 10% circular in the world. This is a massive transition. We have 90% of the economy that we need to change from a linear take make waste economy to a take or borrow, make and return economy. So that’s the second transition. Those are the two breakdowns and breakthroughs in nature.

In society, what we’ve got is disparity. Despite all of our economic growth over the last 50 years, inequality has gone up in almost every country. Even though we’ve had hundreds of millions of people coming out of poverty, the gap between the rich and the poor has gotten wider. And effectively, the rich are getting richer, faster than the poor are getting richer. And this has all sorts of social implications as well. If you look at a book like The Spirit Level, they do the research on this, and they find all sorts of social problems occur in the countries that have the highest inequality, including many developed countries.

The counterforce to that is responsibility. It’s actually to have what we call an access economy where we take care of diversity and inclusion. And again, there’s a big movement for that, but still a long way to go. If you just look at gender equality. If you look at the gender pay gap, according to the World Economic Forum, it will take more than 250 years to close that gap, if we continue on current trends, which is just ridiculous in the 21st century, but we still have a lot of progress to make there.

And then we have the second breakdown in nature, which is disease, which we’ve learned a lot about in the last few years with lockdown and everything else.

Gene Tunny  22:07

Sorry, Wayne, this is in society, you mean, is it? Second breakdown in society, disease.

Wayne Visser  22:13

The second breakdown in society is disease. We know all about COVID and communicable diseases, but the interesting thing is that 70% of people die from non-communicable diseases. These are things like heart attacks, strokes, diabetes, cancers. Many of these are lifestyle related. In fact, 40% are preventable because they relate to what we eat, especially how much meat we eat, in particular red meat, and also processed foods, and whether we live in toxic environments, polluted environments. Of course, there are things like stress as well that take that toll. What we want is revitalization, and so the well-being economy, which is again, a massive opportunity, lots of investment in innovation, lots of technology going in there, really exciting things happening, but plenty to do there. So those are the two breakdowns, breakthroughs in society.

Then if we look at the economy, I talk about disconnection. This is the technology piece. What’s happened is that we think we’re all connected, but we’re not. There is still roughly half of the world, maybe three or four billion who still don’t have an internet connection. Many, many billions still don’t have a mobile phone or live outside of mobile phone signal areas. The world is not all connected. And this refers to what we call the digital divide. It basically is an amplifier for inequality, because technology gives us opportunity. We have to really look at that gap and work on closing that gap. Meanwhile, of course, many are streaming ahead with the Fourth Industrial Revolution, and with 5Gg and artificial intelligence and virtual reality and all of those things, and so the gap potentially gets wider. So we have to address that.

Then there’s a second kind of disconnection, which is that the machines start to disconnect us. This is really about automation. 25% of jobs today are at high risk of automation, and another 70% at medium risk. It’s not that we want to go backwards, but we have to look at that and take care of that, start re-skilling people, upskilling people, to be ready for that hugely disruptive transition.

The solution there is all about, I call it rewiring. It’s really the digital economy, but it’s mainly about using all of those fantastic technologies, like big data, like 3Dd printing, like all of the other things, to be part of the solution rather than part of the problem. Artificial intelligence, huge potential there, but we very quickly found out that it’s racially biased. We have to take care of how technology is being used and whether it’s being used to solve the problems. I really believe that it does bring many of the solutions.

The last one is disruption. This has to do with crises and catastrophes, which we’ve also learned a lot about recently. This is where climate change comes in. If you look at the wildfires, you look at the storms and floods and the droughts, you know all about that in Australia, but also all around the world now. It’s costing the world hundreds of billions, of which roughly only a third is insured. You’ve got two thirds of the millions of people who are affected by this just left hopeless, so tackling this and other crises. By the way, COVID is another example of a massive disruption. You get industrial accidents, also disruptive. BP lost 50% of its value within 50 days after the Deepwater Horizon oil spill, just over 10 years ago, and has paid $65 billion since.

All of these have to be addressed. What do we want? We want to move to resilience. That’s the breakthrough. That means making our institutions but also our infrastructure more resilient. Some of that is physical infrastructure, like building flood walls and having buildings that can withstand earthquakes and lots of other very practical things we can do, but it’s also about how you build the economy, because what we’ve discovered is that our economy is very brittle in the crisis. Look at what’s happened with supply chains during COVID or during the Icelandic volcano a few years ago. There’s no longer any slack in the system to take the shocks. We think we’ve been very clever by making everything super efficient just in time, everything delivered, next-day delivery, everything like that. But actually, it makes us more vulnerable. This is all to do with a risk economy, everything that can reduce risk, but also help us survive and thrive through crises. Those are the six transitions.

Gene Tunny  27:28

That’s a very comprehensive overview. I’ve probably got comments on a lot of what you said, but I’ve got to ask you about that Icelandic volcano. That’s the one that no one can pronounce the name of, or certainly I can’t, if I remember correctly. Can you remind me what happened there? You mentioned that as an example of a disruption.

Wayne Visser  27:48

It was obviously just, they have a lot of volcanic activity there. But this one was so big that this cloud just spread across Europe and grounded everything, so planes couldn’t fly. As soon as you start messing with logistics, not only does it mean people literally stranded all around the world in countries, but also business grinds to a halt because of all of the trade that happens through logistics. It’s just an example of that kind of disruption. We’re starting to see more and more, the recent supply chain disruptions around COVID, but also to do with the oil price. Lots of these shocks just show us that… Even my book was delayed by over a month, because suddenly, there was no paper. They couldn’t get paper in the world. So we have to prepare for these kinds of shocks. This is the new volatile world, the VUCA world.

Gene Tunny  28:55

Yeah, well, it’s certainly taking a while for everything to get back to normal. I’m an economist, and I’ve got great faith in the ability of markets to adjust ultimately, but it takes time. We could have these sort of disruptions for another year or so. I think I saw one estimate.

Wayne Visser  29:21

And remember, the kind of COVID type disruption, earthquakes, volcanoes are a bit random, but COVID will most likely happen again. It still has a bit of course to run, but another type of infectious disease, we can expect those again. In fact, it’s linked to these risks we’ve been talking about because as we’ve wiped out nature, zoonotic diseases, which are these diseases that leap from animals to humans, also as we have this huge industrial agricultural system with livestock, the chances of, again, diseases going from animals to humans actually is going up. We can expect that kind of shock again. But all of the analysis that we’ve seen of climate change suggests that COVID is just a very mild dress rehearsal for what’s coming on climate change. The point is that we should be expecting to live in a world of disruption. We have to know how to cope with that, and how our economies can cope, how our organisations can cope, and personally, how we cope.

Gene Tunny  30:30

What will that disruption from climate change be, Wayne? What are your thoughts or what’s your expectation as to what we’ll see? You mentioned wildfires, and I guess flooding as well. We’ve just had some flooding here in Brisbane, where I am, on the east coast of Australia. Look, there’s a big debate. It seems to be it’s difficult to attribute any particular natural disaster or to say that that’s related to climate change. I’m not sure you can do that. But certainly, I understand that it could increase the risk of these things, so I accept that. What do you see as the potential future if we don’t stabilise the CO2 in the atmosphere?

Wayne Visser  31:28

You’re right, there’s weather, and there’s climate change, and weather changes. It’s hard to link individual weather events to climate change, although there is now a scientific centre that is doing exactly that through statistical analysis, showing the probability that this could have been just a normal weather event, without the climate driver. They can now very quickly, actually, on most events, give a rating as to whether this is likely to be climate related.

But essentially, what we’re going to look at is just more extremes, I think that’s one of the one of the mis-sellings of what was originally called global warming. People thought it’ll just get a little bit warmer, we’ll go to the beach a bit more. But actually, it is climate change. It’s more disruptive, because it’s hotter and it’s colder. The storms are more intense and more frequent. That’s for complicated reasons, largely that the oceans are warming up, which makes the weather more unstable. Just everything that used to be a very rare occurrence, like a massive storm or extended 10-year drought, will just become the new norm. Temperatures that we never used to see—Canada had its highest temperatures in the last 12 months—will again become the new norm.

This has impacts on all kinds of things. It has impacts on agriculture, of course, the food system, to survive those floods and droughts, but also the climate is moving. So if you’re in a particular area, and that’s no longer good for agriculture, because everything’s got warmer, then that becomes a problem. Tropical diseases will increase because we’re moving to a warmer world. So places that never had to deal with things like malaria or Dengue fever suddenly will be dealing with those. So there are health impacts. And also remember that for every degree, on average, warmer that it is, people are less productive. And there are statistics on that as well. You have economic losses as well, as the world gets warmer.

So lots of different impacts, but it’s all about the volatility and the extremes of climate and wheather our infrastructure and our organisations and even our homes are just ready for that. As I said, you know, only a third is insured of all the climate damage that we’re seeing year on year. So for two thirds of people, it’s not covered.

Gene Tunny  34:25

Okay, we’ll take a short break here for a word from our sponsor.

Female speaker  34:30

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Gene Tunny  34:59

Now back to the show. Wayne, I think what’s terrific, what you’ve done is really good with these six great transitions, I think you call them, so two in nature, two in society, and two in the economy. And if you hear that, then you’re thinking, oh, okay, there’s some big challenges that the world faces. How are these going to be addressed? It sounds like you’re relatively optimistic. To what extent will they be addressed by what’s happening with business, business transforming itself with innovation that’s occurring right now? And then how much needs to be addressed by government policy, or changes in the household that could be encouraged by government policy—changes in households and business? Could you take us through that, please, because just looking at that, those six great transitions, it looks like we need some sort of, I hate to say great reset, because that’s become such a controversial term and really triggers people, so I don’t want to say that. But could you take us through, how are we going to get through this, please?

Wayne Visser  36:19

I don’t think it’s wrong to call it a great reset. It’s become a political term. But it is of that scale. We really are looking at reinventing capitalism and going through another industrial revolution that’s very different. World Economic Forum calls it stakeholder capitalism. Now, that’s a huge shift from shareholder capitalism.

But maybe I’ll give you a little insight into another part of the book, which is to look at the underlying science, because the science tells us where the change is happening. There are six keys to thriving, which is an insight into how these complex systems change. One is complexity. This is all about how many relationships there are in any given system. And what we see is the world getting more and more complex. Of course, we’re getting more and more connected. Social media can help; sometimes it can hinder. But just in so many ways, the connections are increasing.

One of the solutions we start to see more and more, partnerships, so companies getting into partnerships with government, with NGOs, and even getting into partnership sometimes with competitors to change the landscape. When Unilever decided to go for 100% sustainable palm oil, which is a big problem in the world today, if they did it on their own it’s useless. They had to convince their competitors as well to do it. The other big ones like Nestle, for example, Procter and Gamble, and so they went through the Consumer Goods Forum, and they got everybody signed up. We’re seeing far more of those kinds of initiatives. It’s all about creating more and more connections.

Then the second one is coherence. This is about having really big goals to aim for. Now we’ve got the sustainable development goals, which are certainly helping, these 17 global goals that all the world’s countries have signed up to, that has created a common focus. But we also see coherence arising around specific issues. Like I mentioned, the 30% land and water protected by 2030, or on climate change, consensus really has emerged around a 1.5 degree warming target, not even two degrees anymore, and net zero by 2050. That’s just become the new norm that everybody is going for. We see this coherence start to emerge in different ways. Policy certainly helps here, because that’s what good policy does is it sets the destination, and then lets business innovate to get there. And we’re starting to see more and more of that good policy. If we look at the Green Deal in the European Union, it’s a great example of that.

Gene Tunny  39:18

Sorry, the Green Deal. I’ve heard of the Green New Deal in the US, but that’s not been implemented. There’s just some sort of wish list from AOC and people of that sort of persuasion, but you mentioned a Green Deal.

Wayne Visser  39:44

Yep. EU Green Deal. It’s effectively Europe’s strategy on climate change. It’s very, very comprehensive and very ambitious. And it touches everything. It’s got a Farm to Fork area which touches agriculture. It’s got a mobility area, around electrification of mobility. It’s got a circular economy element. It’s got a finance element. It’s a very, very strong policy. In some ways, America is trying to copy that with the New Green Deal. Yes, policy helps with the coherence piece.

Then you’ve got creativity, which we’ve talked about a little already. For things to change, for all living systems to change, they need innovation. And that happens through diversity. Again, there’s something we’re working very hard on, but we are living in an age of innovation, no doubt about it. In many of our most difficult problems, we are seeing some amazing solutions coming. If we just pick on one, for example, we know electric cars. I’ll leave that alone, but just remember that that is changing much faster than people think. Norway is burning fossil fuel cars by 2025. That’s just around the corner. In most other countries, UK, it’s 2030. Within 10 years, it’ll really be something to watch.

But take food, for example. There’s a whole movement of course around going more plant based. That makes sense from a health perspective, because 20% of mortality can be reduced just by going more plant based, but also from a climate perspective, and a biodiversity perspective, and of course an animal welfare perspective. But here we see innovation. You’ve seen the Beyond burger and the Impossible burger. These are really engineered to look and taste like the real thing. I know that may be a hard sell in in Australia, but on blind tests, actually, they’ve done extremely well.

Not only that, but we’ve got cultured meat coming. This is grown in labs meat, essentially grown fermented, grown in fat, like you do for insulin. And this is this is going to completely change everything, because again, you don’t have the input of land and water. You have much lower energy input, and you’re not killing anything. You’re literally just taking cells, live cells from a cow, for example, and you’re creating that. In Singapore, you can already go to a restaurant that sells cultured chicken. This is innovation happening very fast. Massive amount of investment going into this.

Gene Tunny  42:41

Sorry, by cultured chicken, do you mean lab grown, do you?

Wayne Visser  42:46

Yes, lab grown.

Gene Tunny 42:48

Wow.

Wayne Visser 42:48

That’s the popular—

Gene Tunny 42:49

In Singapore.

Wayne Visser 42:50

For everything, for steak, and you can literally grow it how you want to try, so lean or however you want it. It is real meat. It’s just that it’s grown from cells rather than the living cow that you have to slaughter or chicken you have to slaughter. And it’s very sustainable, not only in terms of those impacts, but literally, if I remember the numbers correctly, if you’ve got a factory that’s making this, every two days that meat replenishes itself. It grows back. You’ve just got this endless supply of meat that is growing much faster than a cow that you have to grow for months and months, or years. It’s just an example of innovation happening. That’s the creativity piece of the underlying science.

You’ve got a really interesting one, which is convergence. Convergence is very linked to innovation. It’s really the perfect storm. It’s when things reinforce one another. We call this in the science, positive feedback loops. And this is what creates tipping points. And here again, if you look at what’s happening, there are many of these positive reinforcing tipping points. When you were asking do we need more policy, do we need more market forces, what do we need, this is where we’re seeing the convergence because in fact, what we’ve got are the breakthrough technologies, which are starting to scale, plus the policy, which has really been a huge amount of policy reform in the last five years. We’ve just had the UN agree, for example, now to also create a plastics treaty globally, similar to the climate treaty, which countries will need to sign up to. That will happen by 2024. A lot happening on the policy front. Plus the market forces are kicking in. The likes of a Tesla or an Ørsted, which many people don’t know the name, but used to be a fossil fuel company in Denmark, completely transformed to a renewable company and now is one of the largest offshore wind companies in the world. We’re seeing this kind of transformation really happening very quickly.

And then, in addition to that, so we’ve got the policy force, we’ve got the technology force, we’ve got the market force, and then you’ve got the social movements that are kicking in. This is whether it’s the climate strike movement, or the Black Lives Matter movement, or the Me Too movement, or the extinction rebellion, these are very, very significant, with millions and millions of people, especially younger generations of people, who are just starting to say, “We want a different world. We don’t want our future sold out.” All of these are reinforcing one another.

And if I throw in one last one, finally, finances come on board, coming out of the Glasgow climate agreement. From November last year, there was something called the GFANZ. It’s now the Global Financial Alliance. This is $130 trillion of assets under management that is lined up now from the 450 largest financial institutions in the world, top 10 banks in Europe, top 10 banks in America, all committed now to fund this transition to net zero carbon. Now, practically what that means is they have to go back now to their corporate clients and say, “Show me your plan to get to net zero not only by 2050, but how you’re going to halve your emissions by 2030.” It starts to put massive pressure right through the value chain. All of these things are reinforcing one another, which is why the change is speeding up and why I think on many of these issues, we’re getting to these positive tipping points.

Gene Tunny  47:03

You’ve got a lot of great examples in your book. I would recommend, if you’re listening in the audience, and this sounds interesting, then yeah, please, you should get a copy of the of the book. There’s lots of great examples in there.

I wanted to go back. You mentioned palm oil. That’s something of great interest to me. I’ve done a little bit of work with Indonesian ministries, and palm oils are a major commodity in Indonesia. And if you go to, I think it’s in Bogor, just south of Jakarta, if I remember correctly, there’s a botanic gardens near the presidential palace, and there’s an extraordinary thing. There’s a monument or a statue or a tribute to a palm oil tree I think it is, because it’s such an important crop in Indonesia. I think it was first they imported it to Indonesia from elsewhere in the world, maybe from Africa. I can’t remember correctly. But they tested it in Indonesia, in that the gardens there. There’s a large amount of deforestation, I think in Borneo, due to it. But you mentioned Unilever is now committed to, is it renewable palm oil? Is that right? Is that having a practical impact on deforestation?

Wayne Visser  48:35

Yeah. A couple of things happening there. And you’re absolutely right, I think Indonesia maybe supplies 60 or 70% of the world’s palm oil, along with Malaysia, which provides another 20 or so. It has been absolutely devastating for forests. Indonesia has the third of the world’s largest tropical forests, and that’s really under threat. So we’re destroying these lungs of the earth for commercial interests, because the demand is there. And often the demand is from us in the West, isn’t it, the rich countries, because palm oil is in one in 10 products that we buy, everything from detergents to food. It’s very, very useful.

Yes, quite some time ago now, they set up something called the Roundtable on Sustainable Palm Oil. This has a way of growing palm that doesn’t have the impact that the old commercial approach does, and doesn’t have the deforestation but also the biodiversity impact. Companies can get certified and supply chains can be certified to that RSPO standard. All the big players are on board, whether it’s Nestle or Unilever or Procter and Gamble. They’ve all committed to go 100% to that. It takes a bit of time, but there are large parts of the sector that are still not committed to that, and so it’s a partial solution right now.

But again, here you start to see the value of policy. Part of the EU Green Deal, one of the most recent things they’ve done in the last few weeks, they have a law being drafted now that they will refuse any export or import of commodities, of which palm oil is one, that can’t prove that they haven’t caused deforestation. The onus is on the supplier. If you’re Indonesia, and you can’t prove that this is palm oil that’s deforestation-free, you’ve just lost Europe as a market. This is going to have huge impacts. It’s not just palm oil, it’s coffee, it’s tea, it’s timber, and several others. This is how change really happens.

Gene Tunny  50:58

Yeah. One of the technologies you talk about in the book is blockchain. Can blockchain help us with traceability, with understanding the origins of or the history of the products that we consume?

Wayne Visser  51:16

Yes, blockchain has massive potential, and is one of those ones, it’s an early stage technology, which still has unfortunate unintended consequences. The upside is traceability. And there are companies using that, to show the sustainability of supply chains. A company called Provenance in the UK is a good example. They track and trace a whole value chain for fish or for gold, and they can show, in a very secure way, every step of that process. Another example is a company called Circularise that does this for plastics and can track all the… They actually even use artificial DNA, which they put into the plastic so that just by scanning it, you can tell at every stage of the supply chain, exactly what is in that plastic and how it needs to be recycled. That’s the upside.

The downside is the blockchain, like cryptocurrencies, takes massive amounts of energy. Until we can solve the energy problem—it helps of course if it’s 100% renewable energy—but so long as it’s largely fossil fuel energy, it’s just adding to the problem of climate change.

Gene Tunny  52:34

I’ll have to look up artificial DNA. I wasn’t aware of that. That sounds fascinating. I’ll put a link about artificial DNA in the show notes. Okay. Before we wrap up, Wayne, I want to ask you about a passage in your book. Now, you talk about economics. This is an economic show. I need to ask about this passage, because I’m not sure I entirely agree with it, but that’s fine. Look, I’m trying to be open-minded on this show.

You write that, “Contemporary economics is degenerative. It systematically disregards ecological limits and fails to ensure that fundamental human needs are met. Economy is good at creating jobs, product services and technologies, but what is the quality of these outputs? Do they create more harm than good? The impacts of economic activity are explained away as negative externalities, as if environmental integrity and social justice exist in some realm outside of the economy, but that is not true. Everything is interconnected.”

Look, I agree everything’s interconnected. My view is you’re probably being a bit unfair on economists. I think contemporary economics is trying to embrace the environment more. There’s a discipline of environmental economics, as I’m sure you’re aware, and even ecological economics, although that’s really sort of a minor discipline. My view would be that economists are increasingly conscious of these issues. I think externalities is an incredibly powerful concept. And it can help us think about potential policy solutions. My concern is that we’re not going to be able to get to net zero globally, because to do so you really need some sort of carbon tax. You need a carbon price of some kind. But to do that properly, you need to have that agreed internationally and you have to have it applying internationally, to the same extent. I just think that we’re just not going to get that international cooperation to be able to do that by 2050. I’m a bit pessimistic on that.

I just wanted to note that, that as an economist I probably… That was the one thing in the book I really reacted to. I’m not negative about the book because of that. But I just wanted to get an understanding of where you’re coming from there. Do you really think contemporary economics is really that bad?

Wayne Visser  55:19

Let me start by saying that I’m not anti-economics, I did a major in economics in my business degree. And I studied environmental, ecological and resource economics in my master’s degree. Economics is a tool that we use to better understand the world and to help manage our economies.

What I think we have to look at is what kind of economics system we’ve had, and what kind of behaviour it’s promoted. Certainly, since the neoliberal economics really took off, since the 1970s, and alongside that, the push for deregulation, it’s been a disaster for the environment. There’s just no other way to say that. It has externalised a lot of the costs. It’s gone for production in places where the environmental standards are the worst, where the social standards of the worst, labour standards are the worst. It has resulted in modern day slavery. We have more people in slavery today than we had when it was officially abolished in the 1700s. That’s all kinds of forced labour. It really hasn’t managed to create a system that is consistently good for all people and for the planet on which we depend. That’s the issue. It’s created an economy that is linear, that take make waste economy, where many of the resources are simply not priced right, they’re just too cheap. If you look at Virgin plastic, for example, it’s just too cheap. It doesn’t take into account those social and environmental costs that we have.

I do think the concept of externalities can be effectively applied to remedy some of this. If we do have taxes on carbon, for example, or on poor social labour standards, this can certainly start to rectify that. But we just have to ask whether those are strong enough.

I actually do believe that we will get a carbon price. It may not emerge as one global price, but I think it’s emerging in different places all around the world, lots of emission trading schemes popping up, lots of companies providing their own internal carbon pricing. I think a consensus will start to emerge on what that price is, and governments will start to impose it in different ways. They have to, because they can’t get to their net zero targets without imposing that restriction on companies and on citizens. It’s definitely coming.

Of course, we don’t get to net zero only by changing production. We also need to invest in nature. That’s the way that you also can draw down some of the carbon to make up… It’s a kind of a Pareto rule, like 80% you need to reduce directly from your lifestyle or your operations or your value chain, and then the remaining 20—or some say it needs to be more like 10%—should be in actually restoring nature, which makes up the balance.

I think all of those things are happening and will happen. I do think there is a brand of economics or a new understanding of economics that can get us there. If you look at Doughnut Economics, which you’re probably familiar with, Kate Raworth and her book, I think that’s the best coherently argued alternative to what would be more conventional economic thinking. All it’s really doing is saying, how do we better build and the ecological limits, or what we sometimes call the scientific planetary boundaries beyond which the whole system is in danger of collapse, and how do we build in those social foundations, the minimum requirements that people need. Economics has been dabbling with those things, but just hasn’t been very effective if you look at some of these trends we’ve been talking about. It’s just how do we improve economics and have a new version that is more effective than we have at the moment.

Gene Tunny  1:00:09

Wayne, you’ve written a really fascinating book with lots of great examples of what business and what communities around the world are doing to try to tackle these challenges to improve sustainability. Is there anything you’d like to say to wrap up, to conclude? This has been a great conversation, and we’ve gone over a lot. I could talk to you for another few hours, but we’ll probably have to wrap up for now. Is there anything you’d like to say in conclusion?

Wayne Visser  1:00:46

Yeah, let me just mention two things, and then I’ll have a cheeky suggestion. One is that there is a chapter on the book specifically on business and how business needs to integrate thriving, the practicalities of how they do that, and there’s six steps to that. That’s based on work that I do with companies, big companies like Johnson and Johnson, where we take them through these steps of integrating. It touches on all kinds of things, on how you consult with stakeholders, how you relook at your values, how you relook at your strategic goals, how you build in new and different metrics, how you redesign your portfolio of products and services. Just be aware that there is, if you’re coming from the business world there, besides all the innovation examples, there’s also this very practical, how do I do this on Monday morning.

There’s a chapter on leadership, because that is really crucial. We are seeing a different brand or a different type of leadership emerging, that is able to tackle these big challenges and turn them into breakthroughs and into thriving. I look at the different characteristics that those leaders have, obviously, with lots of examples.

The cheeky suggestion to end with—I’ve started to do this even in keynote speeches—is to end with a poem, since as you mentioned, I’m not only a professor, but a poet. I just find that it taps into a different part of the brain. With your indulgence, I might just end with one of those.

Gene Tunny  1:02:19

Please. Thank you.

Wayne Visser 1:02:21

I’ll do the one which actually opens the book. It is a poem called Thriving. It even has a stanza that is really all about markets and economics, so you should like it. But see what you think of this. Thriving.

Our life is so much more than a duty or a chore of merely getting by without a why or what for, the law of tooth and claw, the struggle to exist, to rally and resist against life’s slow decay, the way of entropy of living just to see another day, to stay, to endure and survive. No. Life is meant to thrive. In nature, all things grow from seed to tree. We know the cycle of living through giving of reap and so, the flow. Things come and go. The cycles of grooming from sprouting to blooming of stretching for the light, the bright palette of hope, the diverse ways to cope, to cherish and flourish, bursting forth and alive, for nature means to thrive. Society lives too. A melting pot we brew from cultures and crises with spices for flavour and kindness to savour, ideas for conceiving and goals for achieving, that stretch us and bind us, that find us together in all kinds of weather, wanting what’s fair, to care, longing to love and strive for society to thrive. The markets live and breathe in complex webs we weave. The synapses of trade have made the things we need, each deed a chance to lead. While tech is getting smart, yet still it needs a heart, a compass as a guide to tide us through the storm and find a better norm. A breakthrough to renew an innovation drive. Yes, markets too can thrive. All life is meant to rise, to reach up for the skies, to move beyond the edge, to fledge with hopeful cries. Life tries until it flies. It shakes and spreads its wings and trills each note it sings. While given time and space, the race of life is run, full powered by the sun, on land, in seeds, like bees’ sweet nectar from the hive. All life is made to thrive.

Gene Tunny  1:04:57

Very good. Excellent. Professor Wayne Visser, this has been terrific. I really enjoyed our conversation and your poem at the end and fully agree. All life and society and nature and markets are meant to thrive. What a great message to the end on. I’ll put links to all your social media and your website for the book in the show notes. This has been terrific. I really, really value your time and your thoughts and all the great insights in your book. Well done and thanks so much. Hopefully I’ll look forward to your future work. I’d really look forward to chatting with you in the future. That’s been great, learned so much. Thanks again, Wayne.

Wayne Visser  1:05:54

Thanks so much for having me on. Of course, I’m always happy to find an excuse to visit you down under. I used to teach also in Melbourne, and love it down there. I look forward to those opportunities. Just also to say for people, there are different ways to access the book, so not only e-book and hardback, but also an audiobook version, so whatever takes your fancy. Delighted actually that it’s already hit Amazon bestseller status, so really looking forward—

Gene Tunny 1:06:33

Wow.

Wayne Visser 1:06:34

That’s in its first week, and number one on the new titles in various categories, including several economics categories. I’m delighted with that. Just thanks very much for having me on. I love the conversation and I hope your listeners do too.

Gene Tunny  1:06:51

Oh, very good. I’m sure they will. Thank you, Wayne. Really enjoyed it.

Wayne Visser  1:06:55

Thanks a lot. Bye now.

Gene Tunny  1:06:57 Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to contact@economicsexplored.com and we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.

Credits

Big thanks to my guest Dr Wayne Visser and to the show’s audio engineer Josh Crotts for his assistance in producing the episode. 

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. Economics Explored is available via Apple PodcastsGoogle Podcast, and other podcasting platforms.

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Top 10 Insights from Economics – EP129 show notes & transcript

In Economics Explored EP129, show host Gene Tunny reviews his top ten insights from economics with Tim Hughes. These include insights regarding specialization and trade, opportunity cost, and the price mechanism, among others. Applications to traffic congestion and climate change, among other issues, are explored.

You can listen to the episode using the podcast player below or on Apple PodcastsGoogle PodcastsSpotify, and Stitcher, among other podcasting apps. A transcript of the conversation is included below.

The e-book which is the basis of this episode is available to subscribers of the economicsexplored.com website.

Links relevant to the conversation

On comparative advantage:

https://www.economicsonline.co.uk/global_economics/comparative_advantage.html

https://www.khanacademy.org/economics-finance-domain/ap-macroeconomics/basic-economics-concepts-macro/scarcity-and-growth/v/comparative-advantage-specialization-and-gains-from-trade

On California’s emissions reduction scheme:

https://ww2.arb.ca.gov/our-work/programs/cap-and-trade-program

Transcript: Top 10 insights from economics – EP129

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny  00:01

Coming up on Economics Explored. But can you imagine what traffic would be like in central London if you didn’t have a congestion charge? I mean, it’d just be mad. Well, you wouldn’t be able to move.

Tim Hughes  00:11

It was. I remember the few times I was there, and it was like every European city. It was just chockers. But regardless, I don’t mind those kind of charges. But I do resent the fact that they’re not straightforward.

Gene Tunny  00:25

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene Tunny. I’m a professional economist based in Brisbane, Australia, and I’m a former Australian Treasury official. This is Episode 129, which is about my top 10 insights from economics. And joining me today is my occasional co-host, Tim Hughes.

Tim Hughes 00:49

Hey, Gene. How are you?

Gene Tunny 00:50

Good, mate. Very good. Thanks for joining me for this mini episode in a way. I just want to go over my top 10 insights from economics. So I’ve prepared an e-book. And if you’re listening and you’re interested in getting it, you can subscribe to the website, the economicsexplored.com website, and you’ll get a copy of that e-book. So Tim, I just wanted to go through what I think those top 10 insights from economics are. And one thing I should note is we’re recording this on the 2nd of March, 2022. Currently, there’s a huge crisis in Ukraine with the Russian invasion. We’ve got no idea how that will play out.

Tim Hughes  01:36

Hopefully swiftly and peacefully.

Gene Tunny  01:38

Yeah. But look, I mean, huge, huge risk to the world. And yeah, just feel for the people of Ukraine who are suffering from that invasion.

Tim Hughes 01:48

Absolutely.

Gene Tunny 01:48

Just terrible. Okay, so should we get into it, Tim?

Tim Hughes  01:53

Yeah, let’s do it. Can I ask if this is one to 10 in any sort of preference or order? Is it just top 10 all round?

Gene Tunny  02:00

This is one to 10 in the order that they occurred to me as I was jotting them down.

Tim Hughes 02:05

Cool.

Gene Tunny 02:06

So I think I’ve tried to order them in what I think are the most important insights. But having said that, I recognise that there’s possibly insights that other economists would put ahead of the ones I’ve chosen, or maybe they don’t agree with what I think are insights. And so if you’re listening in the audience, and you have a different view, or if you think I haven’t explained something exactly correct, then sure, please get in touch. So you can send me a message via SpeakPipe, there’s a link in the show notes, or email contact@economicsexplored.com. We’d love to hear from you, as always.

So Tim, just to begin with, I mean, this is one that I often point out when we’re just chatting is that insight about how $50 bills or $50 notes aren’t just lying on the sidewalk, waiting to get picked up. There’s a famous joke about the two economics professors walking along the street and one of them sees a $50 note and says, “Oh, there’s a $50 note there.” He’s about to bend down to pick it up, and the other one says, “Don’t be silly. If it was a real $50 note, then somebody would have already picked it up.” So it’s the idea of opportunities for profit or gains from trade are rapidly exploited in a market economy. So it’s that sort of insight, this idea of arbitrage, so the fact that you don’t have exchange rates being out of alignment. If you think about what we trade, say Australian dollars for US dollars, and then US dollars for British pounds, they all sort of make sense collectively. You’re not going to get an opportunity to, say, take your British pounds, buy Australian dollars, then sell them for American dollars, and do better than if you just sold your British pounds for American dollars. So those gains will actually be arbitraged away.

Tim Hughes  03:58

So if there is a $50 note on the footpath, it’ll get picked up so quickly that it’ll be unnoticeable on the macro.

Gene Tunny  04:04

Well, yeah, exactly. And I guess it’s a philosophy for life too. It’s something that Seth Godin, world’s number one marketing guru, will often say, that look, someone’s going to be number one, or someone’s going to win in this game. Someone’s going to be the top YouTuber. Somebody’s going to be Joe Rogan.

Tim Hughes  04:24

It’s probably not going to be you. Still hope yet, Gene, there’s still hope.

Gene Tunny  04:32

So I’ve always thought that was an important lesson from economics. That’s a key insight. It’s important in economics, because we’ve got all of these models in which there’s optimising behaviour. So we’ve got businesses trying to maximise profits and consumers trying to maximise their utility or their satisfaction. And generally if you assume competitive markets, then businesses can try to maximise profits all they like, but the force of competition means that they’re just earning a reasonable return on their capital. I mean, they’re being compensated for their investment, for their assumption of risk. But they shouldn’t generally be earning monopoly profits. Of course, then there’s that issue about, well, what about if you’re Amazon or what about if you’re Facebook, and so clearly, there are some monopoly profits or supernormal profits being earned. But the way that some economists rationalise that is that they’re being rewarded for the innovation. And you really need those supernormal profits to stimulate innovation in a way.

Tim Hughes  05:40

Yeah, it’s an interesting one, because, I mean, there are so many of those big companies. Certainly Amazon is profitable, but a lot of the big ones who aren’t profitable, just to get scale Uber, and I don’t know if Airbnb are profitable, but you know, it’s those ones that are massive to market. Spotify, for instance so they’re actually making money. But they’re getting market share. So it’s interesting to see how that’s possible without turning a profit. And it’s obviously on the future promise of reward.

Gene Tunny  06:15

It’s all based on future earnings. And so this is what’s interesting in this world of low interest rates, because interest rates are so low, and you can borrow money so cheap and invest for the long term. If you look at what these companies such as Uber could be earning in the future, and you make assumptions about, oh, well, we could all be using Uber, no one will own a car anymore, and look at what the potential revenues could be. If you’ve got very low interest rates, then if you discount those future earnings back to the present, they’re worth a lot more. And that pushes up the value of those companies, because in a way, it could make sense to borrow a lot of money now and invest in those companies, because interest rates are so low, and these companies have such huge potential earnings into the future. So that’s why you’re seeing a lot of these tech companies having such high valuations. And as soon as interest rates start increasing, that could reduce the value of these tech companies, because well, people would rather get the money in the short term, because the opportunity cost of money is higher if the interest rate is higher. Does that make sense?

Tim Hughes  07:32

It does. Yeah. Yeah. I mean, is this still along the lines of the $50 note on the on the street?

Gene Tunny  07:38

We somehow got onto that issue of … You’d talked about the tech companies.

Tim Hughes  07:42

It was my fault. I guess what it is is that they all lead from one to the other, but without getting off that first one, because it is a thing, for instance, of like, yeah, if there is innovation, and if people can copy it, then it will be copied. And generally more people will be doing it, so that general movement away, so that opportunities get taken advantage of by more than one person, obviously. If it works, then other people will copy it and follow and it becomes more dispersed. That would naturally be how it works. So I guess we’re talking about exceptions to that rule with these big, massive companies that are all on the promise of future reward, whereas most companies can’t operate that way. They have to be more instantly profitable if they’re going to survive.

Gene Tunny  08:29

Yeah, look, I may have gone on a bit of a tangent there. But that’s insight one. We might go into insight two. And that is this concept of, there ain’t no such thing as a free lunch. Now a guest I’m having on in hopefully next episode or the episode after is David Bahnsen. He’s a fund manager over in the States. And he’s written a great book, There’s No Free Lunch. And this is the idea that, look, there’s always an opportunity cost with any action. And so my insight two is it’s opportunity costs rather than cash outlays that matter in economic decision making.

Now, I think the original idea or the original, is it a proverb or a saying about there ain’t no such thing as a free lunch, came from bars in the, might have been late 19th century or early 20th century USA, where they advertised as having a free lunch to get the patrons in the door. And they’d know that they could cover the cost of the free lunch by selling them drinks, or maybe they inflated the prices of those drinks a bit while having the free lunch. So there’s that idea.

But also, if you think about it, you’ve got an opportunity cost. Someone could offer to take you to lunch, but that’s an hour of your time and that hour is worth something Time is money. I mean, that’s one of the things we often do in economics in cost-benefit studies. We value people’s time and we work out well how much benefit could erode or a new bridge provide through the time savings. There’s an Australian government estimate. I think it’s $32 an hour or something, on average, you can value people’s time at.

Tim Hughes  10:11

I think it’s a good rule of thumb. You know, there’s usually some reason for something being given freely. Sometimes if it’s charitable, then that is what it is. But in many cases, I think it’s tied in the process of reciprocation, in the form of something else, the other party reciprocating in some form or other, or an opportunity to sell a product or service at some stage. So I think everyone’s aware of … I think that’s a fair one to have in there, Gene. That’s a good home truth, I think.

Gene Tunny  10:49

Yeah. And it’s important because you’ve got to recognise the opportunity cost of your own assets. If you’ve got assets, and they’re not being used, then you’re losing the income from that. So you’ve got to recognise that. It might make sense for you to offload something that’s just sitting around, like an old car or something, that’s costing you. You’re losing money on it through depreciation every year. So yeah, why not get rid of it? So I think that’s an important concept, this idea of opportunity cost, what are you giving up through your current course of action, your current actions.

Okay, insight three, comparative advantage and gains from trade. So this is the classic principle from David Ricardo, the British stockbroker, member of Parliament I think he was, economist from the 19th century, which is essentially arguing that there’s generally going to be gains from trade. Even if a country can produce most things, or in his model, it’s even if a country can produce everything better than another country, more efficiently, it still makes sense for one country to specialise in particular goods and services, relative to another country. Then that maximises the total amount that can be produced, and then you trade amongst each other. So it’s an argument in favour of specialisation and then trading.

Often the examples are given … I think they have the example of England trading with Portugal, and they use the commodities of cloth and wine. And there’s a numerical example that shows why it makes sense for, I guess it was England specialising in cloth and then Portugal specialising in wine. What’s neat about it is it doesn’t actually matter. If one country is superior in productivity to another country, it still makes sense to have specialisation.

One of the ways it’s often explained in economics classes is if, say, you’ve got a professor, and the professor has a secretary. And the professor could be as good as the secretary in administrative tasks, or even better. They could be an even better typist, or better at the admin stuff. But they’re also a great researcher. If the professor gives up an hour to do the admin stuff, that’s going to cost them a lot in terms of the great research output they could produce, whereas the admin person, they’re not going to be able to produce in an hour. If they gave up an hour, they’re not going to be able to produce anywhere near what the professor could in terms of research output. And it makes sense collectively. If you look at it collectively, it makes sense for specialisation to occur. So I’ve got some examples in the insight in the e-book. It’s essentially the benefits of specialisation.

Tim Hughes  13:56

And then maximising the available time within that sphere of specialisation as well, I guess. So for instance, like if you’re educated to a point of being a specialist in a certain area, like in your example there, so you want to be operating in that area of specialisation for the most amount of your available time.

Gene Tunny 14:16

Exactly.

Tim Hughes  14:17

This would speak to scale though, I guess, as well, wouldn’t it? For instance, certainly around my part of the world, originally Manchester, and cotton or linen production around there was huge. And so if you do that to such a scale, then per unit cost or square metre or however you measure the product, that would be ultimately cheaper to produce than if everyone tried to do it somewhat on a smaller scale.

Gene Tunny  14:47

Yeah. I think it’s related. I mean, definitely the gains from scale, the economies of scale, that will come from specialisation. And this is I think what Adam Smith was getting at. He was talking about how just the productivity and efficiency gains from specialisation, the division of labour. Ricardo’s model, his theory of comparative advantage doesn’t depend on that though. It is related. That’s a good point. I mean, maybe I needed insight about increasing returns in economies of scale in this in this e-book. I haven’t got one at the moment. I think that is an insight. That’s an important insight.

Tim Hughes  15:33

For instance, I don’t know what Portugal’s opportunity or capability was to manufacture cotton or linen, but I know the vineyards of Manchester wouldn’t have cut it as far as supplying the local areas with wine. I don’t know if anyone’s tried, but I’m certain that we would have heard about it if it was any cop.

Gene Tunny  15:51

I’ll have to put some examples in the show notes, a link to them on comparative advantage, because there are neat little numerical examples. And, I mean, yeah, it’s just not going to work in the podcast, but I’ll link to it in the show notes if you want to check it out.

Tim Hughes  16:06

I’ve just googled Manchester vineyards and it’s just tumbleweed blowing across my screen.

Gene Tunny  16:13

What about with climate change? See what happens.

Tim Hughes  16:15

Maybe, maybe.

Gene Tunny 16:16

See what happens. I shouldn’t be joking about that sort of thing, because there was a new IPCC report that came out. Was it yesterday? Just saying, yeah, still urgent. Something has to be done. We’re not really doing anything.

Tim Hughes  16:37

As far as climate change and crops.

Gene Tunny  16:39

We’re not doing enough. I think that’s what the message is.

Tim Hughes  16:41

Yeah, absolutely. There’s a different podcast on that one. And I know we’ve talked about it. But absolutely, I think, just very quickly, urgency would be a good thing. No matter whether people believe in climate change or not, urgency in the right direction, of all the changes that would make this planet cleaner, would be a good thing. Anyway, I’ll stop it there.

Gene Tunny  17:05

We’ll have to come back to that. I mean, there is one insight where we could talk about climate change. Insight nine, we can use market mechanisms, taxes or subsidies to correct market failures. So climate change can be thought of as a market failure, because businesses aren’t … At the moment, unless they’re paying a carbon tax, or there’s an emissions trading scheme of some kind … There aren’t many of those around the world. There’s one in Europe. I think there might be one in California. I’ll have to put that in the show notes. If they don’t have that, then they’re not paying the cost of the pollution. They’re not facing that cost. So the idea of the emissions trading scheme or the carbon tax, they’re two different ways of doing the same thing. It’s a way of putting a price on the carbon dioxide that’s emitted. So forcing people to pay for it. So the polluter would essentially pay for it. They’d have to buy the emissions permits. So they would pay the tax based on their emissions. And then they’d pass it on to consumers,  to an extent. That’s one of the insights.

So now, the challenge is, of course …  That sort of makes sense.  It’s a global problem. That’s the problem. So we really need a scheme that operates globally, or there’s some sort of compatibility or trading between different countries, the schemes of different countries. Otherwise, I’ve made this point many times about Australia. It doesn’t make sense for Australia to do much to reduce emissions if the rest of the world isn’t. If China and the USA aren’t doing it, what’s the point of us imposing these costs on our economy?

Tim Hughes  18:55

It’s a fair point, because it is that thing of like, why hobble yourself if other people … Then you’re just giving an advantage elsewhere, and making it harder. But here’s one of those things, it’s like one in all in, which of course, is different around the world, like people from different circumstances or Third World countries who are going to struggle to try and meet a matching scheme. But I’m certain that whatever the future holds in the way of making things better, I think technology and breakthroughs in cleaner energy and all these different things, they’re probably the areas which will get taken up, because if you can make it cheaper for someone to have clean energy, compared to digging fossil fuels out of the ground, or having something that’s not clean energy, as soon as it becomes cheaper, then you’ll have uptake naturally. You won’t have to have schemes or anything in place. That will be widely accepted and welcomed, because you’re going to be better off doing it.

And so those kind of breakthroughs, I think, I can only hope that that would be the sort of game changers. Of course we’re talking about future technology in most cases, but given the right intent behind doing that, and the right minds, the right backing, I’ve got no doubt that that would be a reality. And so that’s where the support globally could come from, if that’s supported, to go down that road and follow that opportunity, because there are opportunities there. Then that would be the global uptake, rather than … I think it would be too hard to try and expect everyone to join a global scheme. I think that is hard. And maybe that’s just an intermediate sort of measure. Maybe that’s an intermediate measure between those who can and that still would make a difference. But anyway, again, I don’t want to get off your top 10 here, Gene.

Gene Tunny  20:47

Okay, we’ll take a short break here for a word from our sponsor.

Female speaker  20:52

If you need to crunch the numbers, then get in touch with Adept Economics. We offer you frank and fearless economic analysis and advice. We can help you with funding submissions, cost-benefit analysis  studies, and economic modelling of all sorts. Our head office is in Brisbane, Australia, but we work all over the world. You can get in touch via our website, http://www.adepteconomics.com.au. We’d love to hear from you.

Gene Tunny  21:21

Now back to the show. Okay, we better rip through these pretty quickly, because you’ve got to get going in about five to 10 minutes. So far we’ve got through … I think we’ve done four insights now. I’m up to insight four, the magic of the price mechanism, or you can ration by price or by queuing. So this is another point I often make about how a lot of the problems we’ve got is because we don’t have appropriate prices, or we’re not charging for scarce resources.

And a classic example is car parking, the high cost of free parking, as Donald Shoup I think it was, who was a professor at UCLA, that’s what he calls it. And part of the reason you can never find a park is because the councils, at different times they’ll allow people to park for very little cost or for free on the streets. And so they’re not appropriately charging for the scarcity of that resource, the fact that yeah, street park is valuable, and it’s not necessarily going to the person who would be most willing to pay for it.

Tim Hughes  22:40

So going against the supply and demand model, you’re suggesting? Is that right?

Gene Tunny  22:43

Yes.

Tim Hughes  22:44

Because normally supply and demand would go to-

Gene Tunny 22:46

Economists, we’re great believers in supply and demand.

Tim Hughes 22:48

That makes sense.

Gene Tunny 22:49

Another example is congestion. And so economists for years have argued that there’s a lot of benefit to congestion charges. There’s a congestion charge in central London, and I think in Singapore. It’s terrible, isn’t it?

Tim Hughes  23:04

I got stung. I got stung. Don’t get me started, Gene. I haven’t got time to go through.

Gene Tunny  23:11

You get confused at Marble Arch and you end up in the centre of London.

Tim Hughes  23:17

Just very briefly, we were there for two days, like five years ago. And we left central London and paid. We knew there was a fee. We weren’t sure if we were in the central area or not. We were told we were just outside it, had a higher car, etc. But you’re supposed to pay by midnight the following day. And we did it the day after that, and it was 80 quid. It stung massively. It’s like, come on. It was not straightforward or easy to make those payments. And that’s my issue with any of this stuff. Happy to pay for … It was 12 quid a day, I think whatever. That sounds about right. But to then be fined 80 pounds in such a short period of non-payment, which by anybody’s standards, by midnight the following day was like, hang on.

Gene Tunny  24:07

Can you imagine what traffic would be like in central London if you didn’t have a congestion charge? I mean, it’d just be mad. Well, you wouldn’t be able to move.

Tim Hughes  24:13

It was. I remember like the few times I was there. It was like every European city, it was just chockers, you know. But regardless, I don’t mind those kind of charges. But I do resent the fact that they’re not straightforward. When you went across the Sydney Harbour Bridge 40, 30 years ago, whatever, you threw coins into the tollbooth, and off you went. It was very clear if you paid or hadn’t, etc. There was a little bay to pull over into if you couldn’t find the loose change or whatever it may be. Whereas now those costs are far less visible, I find. You just ticker over on these costs, which come out. I think there’s an element of rot in a lot of this, which I’m not so keen on.

Gene Tunny  24:54

Tim, I agree. That’s an implementation issue there. We’re dealing with the high level ideas here.

Tim Hughes  24:58

Sorry, Gene. I got sidetracked there. It’s a personal thing, and I said I wouldn’t talk about it, but I did.

Gene Tunny  25:02

It’s fair enough. Insight number five, ignore sunk costs. Bygones are bygones. Economics is forward looking.

Tim Hughes 25:11

That’s timely.

Gene Tunny 25:13

Well, it’s true.

Tim Hughes 25:15

That’s right, just forget about it, write it off.

Gene Tunny 25:18

But we often fall into the sunk cost fallacy and we just throw good money after bad. I mean, we spend a few billion developing a Concorde jet that we figure out pretty early on is not gonna be very commercial, or it’s just a money pit. The British and the French government just keep investing in it. And it turns out it just wasn’t commercially viable. Beautiful aeroplane.

Tim Hughes 25:41

Yeah, definitely.

Gene Tunny 25:43

Amazing technological feat, but the economics just didn’t make sense. You just couldn’t pack enough people on the Concorde.

Tim Hughes  25:50

I never knew the economics behind it. It was a tragic end to the Concorde era when it caught fire, which was awful, however many years ago that was. But I wasn’t aware of the economic cost of it at all.

Gene Tunny  26:07

I think the economics of it were bad, so never going to recommission them or to build new ones because I think the problem was you need so much jet fuel to get hypersonic. I mean, it was hypersonic, wasn’t it?

Tim Hughes 26:19

Supersonic.

Gene Tunny 26:20

Supersonic, that’s it. Supersonic, that’s right. And so you need a huge amount of jet fuel to get supersonic. Beautiful design, but it was very sleek.

Tim Hughes 26:32

It was stunning.

Gene Tunny 26:33

You couldn’t pack as many people into a Concorde as you could a 747, could you?

Tim Hughes  26:39

No. I mean, I guess looking back at the time, that was very soon after the lunar landings, and around that sort of time, so it was very much a modern forethinking sort of thing to get involved in. So there’s probably a bit of ego involved in the whole thing.

Gene Tunny  27:01

Yeah. It was British and French prestige. I mean, they wanted to play with the big boys. I mean, they wanted to play with the Russians and the Americans. There was a space race, and the Brits and the French wanted to, I don’t know, I guess they wanted to show that they were technologically advanced as well.

Tim Hughes  27:24

I was just a kid at the time. But I remember there was pride in the Concorde. Pictures of it were plastered everywhere. And it did, it looked amazing. You did take some pride in that in some way. And I guess that, yeah, maybe if they felt that there was other benefits from having that kind of visibility of something that modern looking. I don’t know.

Gene Tunny  27:50

Yeah. Well, it’s a shame. But anyway, it’s the example I give about sunk cost, because they just kept throwing money at this thing, even though it was a really bad investment. So you’ve got to ignore what you’ve spent already, and just think about, is the additional money you’re spending on this endeavour, is that going to be worthwhile?

Tim Hughes 28:09

So cutting the losses?

Gene Tunny 28:10

Exactly, exactly. We better rip through the rest of them pretty quickly. Insight 10, that’s an easy one. We’ve chatted about this one before. Inflation is always and everywhere a monetary phenomenon. So that’s something from Milton Friedman. I’ve chatted about that enough on this programme. So far, we probably don’t need to elaborate.

Insight six, redistributing via the tax transfer system can be superior to redistributing via fixing prices. What I’m talking about there is, a lot of times governments try to fix prices, try to set wage rates or try to fix prices of different goods and services. Rent control is one example, generally a bad idea, because that can discourage investment in new apartments. And that can make the situation worse for people. It’s good for the people who’ve got a rent-controlled apartment, but it’s not good for the majority. So economists tend to think that rather than trying to fix prices, you’re better off letting prices adjust, because there’s the magic of the price mechanism that economists talk about. And then if people, they’re doing it tough,  because there are people who need help, then provide that through the welfare system. That’s an idea. That’s one of the insights there.

Tim Hughes  29:30

So now we’ve got something to talk about more in more depth in that area as well, coming up. It would be good to expand on that because it’s certainly an area where it’s getting very, very difficult for new homeowners to get a foot on the market ladder. And I know there are different schemes in place around the world. I know Singapore has got a scheme whereby the government buys the buildings and allows people to get homeownership through a scheme that they basically provide the building or the land.

Gene Tunny  30:08

It seems very interventionist to me. But yeah, we should chat about that in a future episode.

Tim Hughes  30:13

There were a few things. I know we never talked about having that. But it’s along the lines of this, because that still basically isn’t a fixed thing, but it’s more of an assisted service or assisted package.

Gene Tunny  30:26

Insight seven, collusion and monopoly power can be a concern and may require regulatory action. That’s probably pretty self explanatory. I mean, economists celebrate the market generally.  We think the market system’s great. But of course, there can be situations where companies become extremely dominant, they can abuse their market power, and hence, you might want to have some antitrust action against them. I mean, we’ve got an Australian Competition and Consumer Commission here in Australia to do that sort of thing. The United States has got a Federal Trade Commission, I think, or they’ve got the Department of Justice. So there’s a lot of talk now about should we break up big tech companies like Facebook, like split Facebook proper from Instagram and WhatsApp,  is there something that they should do with Google, should we break Google away from YouTube, etc. There’s  all that debate going on at the moment. I’ve covered that on the show before

Tim Hughes  31:23

 It’s a thorny issue, isn’t it?

Gene Tunny  31:28

It is. And I think what my takeaway from economics would be that, yeah, it can be a problem in some circumstances. And there’s some guidance in the literature. I’ve offered that as an insight. And I guess it’s a topic we should come back to in a future episode, because there are a lot of issues to consider pros and cons, because you don’t want to eliminate that process of creative destruction as Joseph Schumpeter, the Austrian economist, who is at Harvard, called it, because that’s important. We like that creative destruction. New companies are rising and innovating and offering services that everyone enjoys. I mean, Amazon. I’m not a great Facebook fan. Maybe Google’s a better example. I think Amazon and Google have certainly provided a lot of value to consumers and to people in the community,

Tim Hughes  32:25

it seems to come down to ethics, I think, and that’s maybe the direction to take. That would be my feeling on it, because it’s hard to put limitations on a free market. The less governance I think is always a good thing. But then there comes responsibility with these massive companies then to do the right thing and to employ people under good conditions, etc, all those kind of areas, you know. That money should be going back into society at some level. If the profits are so huge, then yeah, it would be, I think, a fair thing to tax those companies more, to give back to society.

Gene Tunny  33:07

Yeah. So there’s a big issue there on multinational tax avoidance. So that’s covered on the show with Pascalis Raimondos.

Tim Hughes 33:13

Outrageous, yeah.

Gene Tunny 33:14

Important issue. Final insight for now, inside eight, because we’ve already covered nine and 10.

Fallacy of composition and the paradox of thrift. So what’s good for the household is not necessarily good for the economy, so just the idea that in economics, you’ve got to think about how everything fits together, just how does everything connect together. And this comes from Keynes in the ‘30s. There are a lot of people who are negative about Keynes and think it’s a very … It’s the economics of depression, you could argue, but the idea is that it might make sense for a household to cut back on its spending if the breadwinner loses their job or one of the household members loses a job. But if everyone in the economy does that, it’s bad for the economy collectively. It’s less spending, less income, less production. So that’s the paradox of thrift, that what could be good for the household may not be good for the economy.

Now I’m not necessarily advocating a Keynesian viewpoint or Keynesian fiscal policies. But I think that is a key insight, that you’ve got to think about how everything collectively fits together. And if you think about governments, back in the ‘30s, when the revenues fell due to the Depression, a lot of the governments thought, we’ve got to tighten our belts, we’ve got to cut spending, to make sure we balance the budget. Sound public finance was what was going to help us in the Depression. But it turns out that wasn’t the case, because when they cut spending, that meant they weren’t spending as much on their public servants or on infrastructure projects. And that meant less activity in the economy. So it was a perverse fiscal policy.

Tim Hughes  35:13

That’s interesting, because now that’s happened more recently, when there have been cases of the government handing out money to people just to get the stimulus packages, for instance, just to keep money moving around and keeping businesses going in it. The first time it happened, it seemed like the craziest thing. I’d never seen that happen before. I’m trying to remember when it was.

Gene Tunny  35:37

2009, Kevin Rudd, the Rudd money.

Tim Hughes  35:39

That’s right. Yeah, it was the GFC, wasn’t it?

Gene Tunny  35:40

$900 checks.

Tim Hughes  35:42

Yeah. And it was just like, it seems insane. But it appeared to work, which is remarkable. But it’s exactly what you’re talking about, I guess, isn’t it?

Gene Tunny  35:51

I’d say it’s got a mixed record historically. But that’s the idea that comes from John Maynard Keynes in the 30s. That’s why Keynes is seen as revolutionising economics, because up until the ‘30s, in 1936, when he published the General Theory of Employment, Interest and Money, everyone thought that idea was crazy.

Tim Hughes  36:12

It seemed counterintuitive. We’re in tough times, and you start spending. But there was sense to it.

Gene Tunny 36:18

What’s counter?

Tim Hughes 36:19

Well, for instance, the stimulus package, like at the time, a GFC.

Gene Tunny 36:24

Oh, I see.

Tim Hughes 36:25

It would appear. And at a household level, you’d think, yeah, tighten your belts and sort of, like, hold on to everything, whereas like, it was completely the opposite. Here you go, put this into the economy, like keep everything moving. The value of that on the greater scale, on the national scale, was really effective. It was impressive to see.

Gene Tunny  36:52

Exactly. So I’m not in any way endorsing Keynesian fiscal stimulus, because there are all sorts of issues with it in terms of timing, are we gonna get the timing of it right. There’s a possibility you could actually add instability to the economy, that sort of thing. Crowding out impacts, all that sort of thing we can cover in another, or I’ve covered with Tony Makin in a previous episode. Tim, that’s been great. Thanks so much for sitting in, as I’ve sort of done this quick tour of my top 10 insights of economics. You’ve given me some things to think about. I want to add something in about economies of scale or increasing returns to a future addition to this. But at the moment, if you’re listening, you’re interested in this, please get on the website and subscribe so you can download it. Tim, thanks so much. Really enjoyed that conversation.

Tim Hughes  37:37

Thank you, Gene. That was great. It was really interesting.

Gene Tunny  37:39 Thank you. Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to contact@economicsexplored.com, and we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.

Credits

Big thanks to my guest Tim Hughes and to the show’s audio engineer Josh Crotts for his assistance in producing the episode. 

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. Economics Explored is available via Apple Podcasts, Google Podcast, and other podcasting platforms.

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Podcast episode

Risk, CBA, & the Enlightenment w/ Prof. Deb Brown – EP128

In Episode 128 of Economics Explored, Philosophy Professor Deb Brown helps us explore some big questions around risk, cost-benefit analysis (CBA), and public policy, particularly relating to the pandemic. Deb also explains what was so important about the Enlightenment. 

You can listen to the episode using the podcast player below or on Apple Podcasts, Google Podcasts, Spotify, and Stitcher, among other podcasting apps. A transcript of the conversation is included below.

About this episode’s guest – Prof. Deb Brown

Deborah Brown is Professor, School of Historical and Philosophical Inquiry at the University of Queensland, Australia. During her time in the Faculty of Humanities and Social Sciences, Deb has coordinated a wide range of projects focusing on critical thinking. She has been instrumental in establishing connections and partnerships within the school sector, including with the Queensland Department of Education, as well as building partnerships across UQ and with international education providers. 

As part of her role, Deb works to link the UQ Critical Thinking Project into relevant projects within the university to provide educators with an understanding of how to embed critical thinking in classroom practice and assessment and to maximise outcomes for students, particularly those from disadvantaged backgrounds. Deb has established a professional development program for educators, booster courses for school and university students and research collaborations with a diverse range of researchers from the broader UQ community. 

Deb has a Bachelor of Arts from the University of Queensland and a Master of Arts and PHD from the University of Toronto.

Truth (or the lack of it) in politics and how to think critically with help from Descartes – EP123

Abbreviations

QALY Quality-Adjusted Life Year

Transcript of EP128 – Risk, Cost-benefit analysis, and the Enlightenment w/ Prof. Deb Brown

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny 00:01

Coming up on Economics Explored.

Deb Brown 00:04

What is the Enlightenment is that the movement is about promoting intellectual autonomy, not just relying on what others or testimony or what authority tells you.

Gene Tunny 00:17

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene Tunny. I’m a professional economist based in Brisbane, Australia and I’m a former Australian Treasury official. This is Episode 128, on philosophy, risk, cost-benefit analysis and the Enlightenment. This is part two of a conversation that my occasional cohost Tim Hughes and I had in January 2022, with University of Queensland philosophy professor Deb Brown. Part one of their conversation was broadcast in Episode 123, in which we chatted with Deb about truth and critical thinking. In part two, which is in this episode, we consider some big questions around risk and public policy, particularly relating to the pandemic.

Assessing government policy measures during the pandemic has been very challenging. In my view, there aren’t easy answers. Basic Facts are disputed and people are making different subjective assessments of what restrictions on our liberty are justifiable, for public health reasons. I found this conversation with Deb really helpful in clarifying some of the important issues for me. And I’ll aim to come back to the pandemic in a future episode soon with some further thoughts.

Deb also helped me understand just what is meant by that critically important period in our history known as the Enlightenment. Part of the way forward out of the mess that we’re in globally at the moment, in my view, surely has to be a greater appreciation and a recommitment to the values of the Enlightenment. Okay, please check out the show notes for links to materials mentioned in this episode, and for any clarifications and abbreviations, such as QALY, Q-A-L-Y, which stands for quality adjusted life year, that’s one of the abbreviations that Deb uses in our conversation. You can find the show notes via your podcasting app, or at our website, economicsexplored.com. If you sign up as an email subscriber, you can download my new e-book, Top 10 Insights From Economics. So please consider getting on the mailing list. If you have any questions, comments, or suggestions, then please either record them in a message via SpeakPipe, see the link in the show notes, or email me via contact@economicsexplored.com.

Righto, now for our conversation with Professor Dave Brown on philosophy, risk, cost-benefit analysis and the Enlightenment. Thanks to my audio engineer, Josh Crotts, for his assistance in producing the episode, I hope you enjoy it.

One thing that I’m always conscious of is that as economists, we do cost-benefit analysis studies. And we try to put everything in dollar terms. And we do this over the lifecycle of a project or over X number of years, 30 years. And we come to conclusions such as, well, the present value of benefits exceed the present value of costs, and therefore this is a good thing to do. But we’ve always got to bear in mind that there are some big philosophical assumptions we’re making when we’re doing a cost-benefit analysis. And in some cases, those assumptions are fine. Or if we’re doing a cost-benefit analysis of a bridge or a new raw railway tunnel or a road, okay, well, then, maybe that’s okay to put everything in dollar terms. But it’s difficult in the context of the pandemic, because we’re dealing with people’s lives and you’ve got –  there are all the issues of like, can you quantify that in dollar terms? And then even if you did a cost-benefit analysis, there’s a utilitarian assumption underlying cost-benefit analysis in economics is Benthamism, this Benthamied approach. And I think if you understand that, as an economist, that helps you in understanding how much you should take out of any particular bit of analysis you do. You need to be honest about what it is and you need to have an understanding of this – I think it’s  David Hume, his problem.

I find I’ve been thinking a lot about that during the pandemic and I’ve been tried to be less dogmatic or less – maybe it’s making me less confident in saying that if you’ve got a particular cost-benefit analysis result and that’s the right thing. That’s a bit of a ramble. Sorry, Deb, but do you have any thoughts on that or in response?

Deb Brown 05:01

Yeah. First of all  cost-benefit analyses have their place. Sometimes I wish there were more of them driving decision making because sometimes I look at decisions and think that that isn’t even valid from a cost-benefit analysis. The fact the matter is, is that there are other considerations as well. There are considerations of ethics and equity and morality and so on. And I actually sort of do hold the view that morality has its  advantages, and that we only get those advantages if we aim at morality, not if we aim at something else. And I think the problem with utilitarianism is that because it focuses on the consequences and maximising what’s perceived as utility, that other factors can be obscured in the process. So the pandemic is a good example.

I was part of a webinar series with the Chinese University of Hong Kong, which included virologists from UQ, and people in the medical faculty, and as well as people who worked in biomedical ethics, which is not a specialisation of mine, so bit out of my league there. But, I was looking at these quality based arguments against lockdowns and, I actually think that… There, the argument was that you should only lock down if the quality0adjusted life years of doing so from a cost-benefit perspective outweigh not locking down. This was back in 2020, and at the time, it was relatively older people who were dying. So the quality0adjusted life years saved by locking down compared to the $11 billion a week it was costing during lockdown looked like it wasn’t justifying locking down in terms of pure monetary value. But the problem with this is that quality0based analyses and decision making, they make sense in certain contexts. So, here’s where I think that cost-benefit analyses do have a point.

So if you’re a hospital, and you’re trying to decide whether to invest in in one medical technology over another, and you’ve got information about how much QALYs each one will save, then you should go for the one that has the highest return on investment, in terms of QALYs. But the thing is, there’s an implied ceteris paribus clause there. All else being equal, if you’re choosing between A and B, and A gives you the biggest return on investment, in terms of QALY, then B should go for A.

But what was happening in the pandemic is that it wasn’t the case that all things were equal. So there were certain communities who were more durable than others. So not just the elderly, but also migrant communities in the United States. It was African American communities and indigenous communities who are being adversely affected by COVID. Often, because they’re frontline workers they’re often living in more crowded housing, and all of these different reasons contributing to them being a more vulnerable group, than say whites, or in the US, Asians. Here in Australia we were seeing that we’re certainly affecting low SES communities more, and in the UK, same deal. And also in the UK we’ve seen recently that disabled people are more adversely affected by COVID than other communities as well. And so things are not equal. So in those kinds of circumstances, you can’t just rely on the cost-benefit analysis, you have to take into account these fundamental issues of equity.

Gene Tunny 09:31

Yeah, there are all sorts of issues to take into account. Equity is important. So I’m trying to think how Gigi Foster, who is someone who came out and she was against the lockdowns because of she thought it wasn’t justified. You couldn’t justify it with a cost-benefit analysis for the reasons you were just describing before. And I think that Gigi is associated with that view. She would probably counter that, well, we could take that into account in our cost-benefit analysis with weights. We could, we could weight the loss of life for particular groups, we would provide more of a weight to that or that there’d be some way you could adjust it, I’m sure she’d say.

The problem is, what I think is incredibly difficult in analysing policy during the pandemic is we just don’t know. Early on, we just didn’t know how bad this would be. And now, the pandemic keeps surprising us with Omicron. And it’s just incredibly difficult to know what the right policy is. And we’re going to have to assess this in future decades. Well, what made sense, what didn’t?

I think we also need to take into account issues of civil liberties. And I think one of the problems with lockdown as a policy, even if you did think that in a cost-benefit sense it maybe it did make sense, o if you took into account the effects on different groups in the community, maybe you could argue it made sense. But even if it did, there are people who value those individual rights, the civil liberties, and you could argue that well, this was a breach of that this is something that really – I don’t think anyone contemplated government would do what they did during the pandemic. I think it’s quite extraordinary measures. I never thought governments would impose those lockdowns and stay at home orders that they did implement. And they saw what happened in China. That’s one view, argument, that we imported this policy of lockdown from China, which is an authoritarian regime. So depending on what your values are, you could argue against lockdown, because you think this is such a breach of our individual liberty. Am I on the right track there, Deb? Is that an important value to consider too?

Deb Brown 11:52

Well, certainly liberty is an important value, but the concept of liberty and the , associated concept of a right is not unqualified or unconditional. So from the earliest discussions of rights, take for example, John Stuart Mill back in the 19th century, so, you only have a right, if the exercise of that right does not interfere with the liberty or rights of others. Okay, so this is often referred to as Mill’s harm principle. So I don’t have a right, I don’t have a right to drive on whatever side of the road I like, because that will deprive you of your freedom of movement and your right to life. So that’s always been a constraint on the notion of freedom and the notion of freedoms and rights is that you just do not have a right to something, if that right is going to deprive somebody else of their rights and their liberties.

The interesting thing to me about this whole discussion around lockdowns is that we accept all sorts of curtailments of our freedom big so as to avoid harming others, right. I don’t remember this kind of stink about not allowing people to smoke in public places. Right? So we ban smoking in bars and clubs and public places and buildings and so on. And we’ve all just sat that out, because, and the argument was, is that people are exercising their right to smoke whenever they like actually causes harm through secondhand smoking to others. And so it can interfere with the exercise of their rights, their right to health and life and so on. And the kind of mask mandates lockdowns whatever might be our infringement on what you might think of as our freedoms, but we don’t have the liberty to harm others. And that’s the justification for those kind of mandates.

Now, it doesn’t mean when you when you curtail somebody’s freedom or their rights, it doesn’t mean that you are you are not respecting the concept of a right or a freedom. Right. But as I say, right, it has to be measured against what are the foreseeable harms here. I think that’s very different from embracing authoritarianism and I think we need to keep a distinction there. Not every curtailment of our freedom means that we’re subject to authoritarian control, right.

But it was interesting. I don’t know whether either of you saw this this wonderful publication pre 2020 by the Rockefeller Institute. They do this scenario kind of planning. And, and one of the scenarios that that they discussed is called Lockstep and they anticipate a global pandemic, and, and what sort of behaviours it will drive. And one of the things that that they envisage there is that in some countries, it will drive authority an acceptance of authoritarian control, and it predicts that those countries will do better in terms of managing the managing the pandemic, but at considerable costs to the liberty of citizens or subjects in those countries. Right. And that that may have long term consequences that are not justified by the authoritarian control. It also predicted that there would be anti-authoritarian movements. So, you can read this document and think, oh, my gosh, they were reading the tea leaves on the pandemic, because all of those sort of anti-authoritarian anti Vax movements are also predicted as well where people , do feel that they are suddenly being thrust under authoritarian control. And that’s why it’s very important to distinguish between authoritarianism to not sort of operate with extremes, to not just think because we have to wear masks in public spaces we’re heading in the direction of an authoritarian regime. No, it’s more subtle and complicated than that.

Gene Tunny 16:38

Okay, we’ll take a short break here for a word from our sponsor.

Female speaker 16:44

If you need to crunch the numbers, then get in touch with Adept Economics. We offer you frank and fearless economic analysis and advice. We can help you with funding submissions, cost-benefit analysis studies, and economic modelling of all sorts. Our head office is in Brisbane, Australia, but we work all over the world. You can get in touch via our website, http://www.adepteconomics.com.au. We’d love to hear from you.

Gene Tunny 17:13

Now back to the show. Did you have any thoughts, Tim?

Tim Hughes 17:18

Actually there’s so much involved in this whole in this whole talk. Could go on for hours. I’m cool with that. For instance, with the authoritarian lockdowns, etc. it is a very effective way of treating with contagious diseases and everything. So it’s been around for centuries that that whole thing. It’s an authoritarian measure, but it’s still very effective in locking down or containing contagious diseases.

Gene Tunny 17:52

I think quarantine or cordoning off particular areas.

Tim Hughes 17:56

Yeah, isolation.

Gene Tunny 17:57

Where there is infection. Yeah.

Tim Hughes 17:58

As far as measures go, it was a predictable measure that was going to come in. But I understand and agree. There’s this lively debate around how long and if it was the right thing to do, etc. I just hope that we get good modelling from this for whatever comes next, because who knows what may come in the future, but hopefully, we’ll be better prepared for it for what we’ve gone through with this.

Gene Tunny 18:26

Oh, absolutely. Let’s hope. We certainly will be. We’ll be talking about this and analysing this for decades. Deb, I was just thinking, this point about how we, you’re right, we don’t have a right to harm others, that’s right. The issue is what level of harm or risk or probability of harm, what’s the threshold, because every time we go out into the community, there’s a risk that we could be involved in a traffic accident, say, and we could harm someone else so there’s a level of risk that’s assumed, but this may be too big a question to deal with. This is where I think this whole issue of the lockdowns, that’s what annoys people. Some libertarians are thinking well, okay, well, what’s really the risk? I guess that the argument is that each person, anyone breaking the rules could actually start off a cluster and then that could grow in numbers. This is not relevant now in Australia, because it’s gotten out of control and it’s out there so that we’re not going to have any more lockdowns so there’s probably no point. But in the early days, the argument was that anyone doing the wrong thing could actually start off a cluster and so therefore, yeah, that could affect everyone else. Maybe I can see the logic there but that’s what I’ve been struggling with, what’s that level of risk to others in the community that would justify a restriction on liberties. And I don’t think we’ve got an answer to that. Has anyone been doing any thinking on that?

Deb Brown 20:07

I don’t know, although I think you’re exactly right, that we really need to, we really need to think about risks here, because you’re right, that there’s all sorts of things that we do. We assume normal risks, because the benefits of taking those risks warrant the risk. As you say, every time we get in the car there’s a risk that we could lose our lives, or suffer serious bodily harm. But overall, people agree to those risks, because driving has benefits, let’s say. Maybe less so as climate as climate change takes off. But for a long time, that’s what really justified people in assuming a level in that level of risks. And so then the question there’s been a lot of discussion.

I think, actually, Robert Nozick had something to say about this, and there were economists that he was drawing on as well, about the difference between a normal risk and an abnormal risk. Right. So we allow certain levels of normal risk in a society but we don’t allow, for example, people to play Russian roulette, right not for any amount of money, not for any benefit, right. And we regard that as, as an abnormal risk, it’s not justified and so on. And so the question is, like, where at various stages of the panic of the pandemic,  … Panic pandemic, that’s interesting. Where at various stages of the pandemic, what kinds of risks are we actually facing here? And I think I think that underlying a lot of the policy changes that we’re seeing recently is just the assumption that we are moving more into that normal risk space. And because I’ve sort of gotten tired of hearing about sheer numbers of people with COVID. The relevant data is numbers of hospitalizations, numbers of deaths. Deaths and hospitalizations, per capita, those are the relevant figures. If it’s true, I think it’s probably too early to say, but if, if we are moving more with the kind of vaccination regime into to having fewer hospitalizations, per capita from the pandemic, then that will sort of shift the balance. And lockdowns won’t be as justified as they were when the risks were much higher, when it was a bit like playing Russian roulette in terms of number of people dying from the from the pandemic. So I’m not myself a risk analyst. And you in your field you’re kind of masters of risk analysis. So I would have to learn from you here. But conceptually, it seems to me that’s the sort of space we need to be in.

Gene Tunny 23:10

Absolutely. I haven’t seen an authoritative analysis along those lines yet, for the pandemic. Hopefully. I’m sure economists will be turning their minds to that. There have been some. Judy Foster’s done a cost-benefit analysis of a sort for Victoria. She presented that to the Victorian Parliamentary inquiry. Gigi and some of her colleagues have written a book on the great panic. You could consider it polemical, in a way, but we do need to have some sort of authoritative analysis along those lines, because these are big questions about just how do we manage these things and what regulations are acceptable, what level of risk are we willing to bear. I’m going to have to look up that, that work by Nozick. It seems to ring a bell, but I’ll look it up, the normal risk versus abnormal risk. That looks like it could be highly relevant.

Deb Brown 24:14

Yeah. It’s a chapter in Anarchy, State and Utopia. as I as I recall, though it’s been a while since I looked at it.

Gene Tunny 24:24

Okay, I’ll I’ll look that up.

Deb Brown 24:28

I’m trying to remember the name of the economist, whether it was French or something beginning with F. I’m not sure. Yeah, there was an economist on whom he was, I think drawing in terms of that risk. He was sort of particularly interested in compensation, so when is compensation warranted for risky behaviour? And of course, being very interested in… He’s a libertarian right. So he’s sort of interested in in when is it ever justified to restrict people’s freedom to take certain kinds of risks, and when is compensation warranted and so on. That’s what I recall from that.

Gene Tunny 25:07

Okay. Oh, yeah, I’ll look it up. But that may be of interest. I may try and cover that on the podcast in the future. We’ll probably have to wrap up soon, given how much of your time we’ve taken, Deb. Sorry.

Deb Brown 25:18

No, I’m having a ball.

Gene Tunny 25:19

Oh, very good. Okay. Oh, well,

Deb Brown 25:21

I was just going to talk about the media literacy issue because I think in terms of the critical thinking project, that’s, that’s a massive area. And I’ve been shocked learning from colleagues at Queensland University of Technology, and University of Western Sydney, and particularly Tanya Notley there is a specialist on youth media literacy. I’m kind of shocked at the data coming out about not just the general public, but also sort of academics capabilities, in terms of fact checking and checking the sources of media articles and being able to do lateral searches, and so on to see what different sites say about the same the same article. Then I’m also shocked that the youth, right, get most of their news entirely from social media, there’s very little engagement with mainstream media, very little engagement with credible news and media. So I think this this is another kind of – the lack of media literacy is another kind of pandemic, and it really does contribute substantially to that culture of, of confusion and mistrust.

Tim Hughes 26:45

I love you’ve said that because that was what I was going to come back to because way back and, we’ve touched on it with intention and trust. And I think it’s such a big area, and you’ve gone straight to it, which is great. And how do we trust the new sources? And this isn’t a present day problem. This has always been a thing for everyone throughout the ages. How do you how do you trust your source of any kind of news, whether it be from a person or from an agency, or whatever it may be. And so with that also comes a limited amount of time that we may have as individuals to make our minds up on these different things that come up to us where we form an opinion, and any opinion is only as good as the information it’s based on. So if we’ve got good information, we’re going to have a reasonably good opinion, the more varied information, again, better opinion. So all of these things, and like you’re touching on, for instance, people getting their information, information from just one source is going to be biased, or maybe not a full picture. There are all these different ethical sort of problems with … We form our opinions. And we find our trusted news sources. And of course, there are more and more coming out all the time. Where does this sit in with critical thinking and to try and do this in a in a reasonably quick period of time, knowing that most people only have  a certain amount of time in their day to give towards forming an opinion on something in the new cycle? How can we do this better?

Deb Brown 28:31

I mentioned earlier we have this collaboration with the Impact Centre, which works with office forces and critical thinking to school students. And last year, one of my colleagues, who was the UNESCO Professor of Journalism at the University of Queensland, Peter, Greste – do you know Peter Greste, the foreign correspondent with that awful experience in in Egypt? So he approached me and he said, “I really want to work with schools to try and get a kind of journalism media literacy course going with schools. And I know you have all these collaborations with the Department of Education.” And, and he and I together, and other colleagues as well, and colleagues and the collaborators in the Impact Centre, put together this course on media literacy in journalism, and it’s offered to senior secondary students. And effectively what they’re doing is they’re learning about media literacy, but they’re also learning it in conjunction with critical thinking.

So often, when you look at the media literacy courses, they often concern tips and tricks for checking sources, right, finding out who the sponsor is of a page, doing lateral searches, but adding a layer of critical thinking over that. What you get is you get students thinking about how their thinking is framed, within, within an article. So what gets to be in the headline? The headline shapes how you’ll think about the rest of the article. How’s the information presented? What’s up front? Right? Is there an argument developed? Is there an analysis? Right? What justification is there for the things that are said in the article, so getting students to interrogate an argument, look within those practices of justification.

Then in conjunction with that media literacy course – and then there are teachers at the Impact Centre, particularly Dr. Luke Zaphir and, and Dave Thornton, who put together a fantastic course for school students, developing all those critical thinking and media literacy skills. It’s just amazing. In conjunction with that, the students also develop their own article. Sorry, they work with journalists from In Queensland, which is an independent news service in Queensland, and has a commitment to public service journalism. Journalists from In Queensland work with students in the, in the Media Academy to basically construct articles for publication in In Queensland. So if you look at the In Queensland website, they’ve got a Media Academy tab, and those are all the articles that were written by students in school. Fantastic opportunity for students to learn how journalism works, how it’s actually produced, and to think critically about the way in which information is presented in an article.

And I think , another big problem within media is that if you haven’t got a kind of blatantly biased media outlet, right, on the right, or on the left, whatever it might be, you’ve got this kind of bizarre assumption that all you need to do is to provide a balance of opinions. Right, and you’ve done your duty in critical analysis. First of all, there’s very little analysis. Often it’s just kind of putting together these polarised opinions and this assumption that as a journalist, you have to stay neutral. Neutrality will come through, if you actually do a critical analysis, right. I think that sort of presenting balanced opinions just contributes to the confusion out there, right. People think well, there’s this opinion and that opinion, and everybody has got a different opinion. So I can believe whatever I like. No.

Tim Hughes 32:52

Actually, one of the things with this, because we seem to, which isn’t a bad thing, but we look for certainty where we can. We’re always looking for definitives and absolutes. We like to know this is this is correct, and that’s wrong, etc, whereas, of course, the reality is, there’s a spectrum of likelihood or possibilities with so many things that we look at. And I love that in the article, the ABC article, you mentioned that one of the keys was being comfortable with doubt and uncertainty, and feeling free to change position if evidence or new information required it, which we touched on earlier. But it’s just such a great statement, I think, in allowing people to be okay being not so sure, this is the best yet, at the moment, this is the best information that’s out there is going to change and being open to that change and to changing opinions when things evolve now, so I think that’s a really … When we talk about polarisation, quite often, that’s because people have found a certainty maybe too soon or without researching it very much, whatever the issue may be, and, and then being sort of loyal to that certainty, regardless of what other information comes through, which of course, is a problem.

Deb Brown 34:17

I think being able to divest one’s ego from the argument of work is very, very important, but it’s very difficult for people to do because their identity is so much bound up with what they think and what they believe.

Tim Hughes 34:30

That’s right. And so to change their mind would be affecting… It’s a decision then to change their identity, or tribe, even. It can be part of the group that you’re in or the environment that you’re in, which you identify with. And so the incentive to change opinion or to change mind or to hear different views, of course, is not a welcome one.

Deb Brown 34:53

Yeah. It’s interesting that in collaborative reasoning environments, if they’re run effectively, you do see that behaviour shift, because the focus of the group is on the on the pointed issue, on the topic. And if you sort of don’t allow people to just make assertions, but to actually back that up with reasons very soon you start to see them giving and taking reasons where – not just giving out reasons, but taking them standing corrected. In children, you see that behaviour shift remarkably quickly. And then something happens to us, and we end up terrified to change our minds. Where did it all go wrong?

Tim Hughes 35:39

With this, with the critical thinking project, teachers and students, is it also open to anybody who might want to get in touch and learn from this? You might have mentioned this before, so apologies if you’ve mentioned it. But this is open to everybody? Is there something there for everyone? Because everyone I think could benefit from it.

Deb Brown 35:58

Oh do I get to do some product placement here?

Tim Hughes 36:02

 You do. Well, you are God after all today.

Deb Brown 36:05

[unclear 36:05]. Of course, working with the Department of Education, that’s restricted to government schools. But we also, we also have contracts with other schools. Peter and I have both done corporate training, for example, in critical thinking. I had a wonderful time in India with fin tech capital of the Tata Group, Tata’s biggest company in India. Had a wonderful session doing critical thinking with them. It was it was really fun. Like I said, we’ve got contracts and done work with Singapore, and UCLA, University of California, Los Angeles. They actually included the media literacy and journalism course in their critical thinking summer programme last year. And it was a huge hit. And I think so I think that that course could easily be made available to anyone. And I think it should. This is not just for kids. We all need this.

Tim Hughes 36:18

Yeah, for sure.

Deb Brown 36:19

The other issue that the other issue that’s driving along misinformation is just the unavailability of peer-reviewed publication sites. So the more open source publishing, open access publishing we can do – I would love it if university libraries we’re open to the public again, not just coming onto campus, but actually the online edition, but there’s all sorts of issues there around publishing as an industry as well, right? So that’s what sort of impedes that. But the more information we can make accessible, and quality information, we can make this accessible, the better off we’d all be.

Gene Tunny 38:03

Yeah, you’ve got those big journal companies, such as Elsevier and – is it Springer, I’m trying to remember – but they make millions or hundreds of millions or whatever out of university libraries paying for subscriptions to journals. It’s, it’s a bit of a racket, arguably.

Deb Brown 38:25

It’s very strange. We do all the work, the writing, reviewing. We do all the hard yards, and then [unclear 38:33] business model that one.

Gene Tunny 38:35

Yeah, that’s true. Okay, I think we’re gonna have to wrap up at a minute. This has been great. I did have one question. We’re hearing a lot about the need for these Enlightenment values. More people are talking about the Enlightenment and the Age of Reason, because there’s this recognition that we’ve, maybe we’ve lost touch with that. And then I know you’re an expert on Descartes. And he’s associated with rationalism. Is rationalism, like, how does that fit in with the Enlightenment and the Age of Reasons. Is the Age of Reason the same as the Enlightenment? Is rationalism – is that a very specific part of the Age of Reason? Is that just a hyper or a total reliance on reason, or is the Enlightenment something broader? Is there a way for us to understand this, Deborah, or is it just such a big question that it’s not really answerable in this context in this podcast?

Deb Brown 39:29

No, it’s a great question. And I’m all for a renaissance in the Age of Reason. So I think those terms are often used interchangeably, Age of Reason and Enlightenment. And a lot of people trace the Enlightenment as beginning really with Descartes, the publication in 1637 of his Discourse on Method, which really was sort of that introduction to the new method of relying on reason and needing yourself to be intellectually autonomous, as opposed to intellectually heteronomous, where you’re relying on authority.

The Enlightenment was connected up with this metaphor of light that permeates discussions in the, the 17th and 18th century. So Descartes appeals to the natural light, and distinguishes that from the teachings of nature, right? Nature might teach you that things are hot and cold. But if you examine them from a scientific point of view, it’s more likely that that heat is certain motion of molecules, and cold is nothing at all.

So the light of reason will revise what nature teaches you, if you like, and one should be guided by the light of reason, not by what seems to want to be true on the basis of sensory apprehension. The light metaphor was common. So you get lumiere in French, and you get aufklaren, which means sort of clarity or light in German, as being in opposition to Aristotelian scholastic philosophy, which dominated philosophy, particularly in the schools and universities, up to the end of the 16th century. And it was perceived as being doctrinaire and authoritarian so, even though a lot of original work went on in the Middle Ages, there was always this deference to authorities as Aristotle said, as Augustine said, and so on. And with the advent of the scientific revolution, that begins in the late 16th century, with people like Copernicus, and Kepler, and Galileo sort of developing a heliocentric view of the universe and really starting to develop this new mechanical, scientific theory and doing a lot more sort of experimental work and observational work using telescopes and so on. That all sort of doctrinaire, the categories of Aristotelian scholastic philosophy were thought to be mysterious, occult and didn’t fit with the new science.

Also coming into the 17th century, you’ve got] the European humanist tradition, right, this reclamation of ancient texts, particularly the Stoics, but also the sceptics as well. And both Latin and Greek texts, and that revival of kind of classical as opposed to Scholastic philosophy. All that sort of feeds into the 17th century.

And then you get Descartes who thinks that we can’t just keep going with philosophy has to kind of catch up with these revolutions in science and also in engineering as well. And it needs a nice new face, and it needs a new message, right? And it needs to be grounded in reason, because only that will sort of, in a way fit the kind of mechanical mathematical science that that is really taking over the whole scientific space. And Descartes, of course, is also motivated to ground that new science in a system of philosophy that’s not antithetical to religion, but is really basing his connection to religion on reason, right? And I think when people talk about the Age of Reason, this is what they mean is they mean a sort of rational foundation for religion as opposed to faith, right.

And that goes all the way through to Thomas Paine’s book, The Age of Reason, which is really like a rationalist kind of attempt to sort of ground religion on reason, as well. But yeah, so the Enlightenment is sort of set in opposition to the so-called Dark Ages, which is a term that seems to be coined by Petrarch, who’s one of these European humanists in the 14th century, even though he’s embedded in that mediaeval context, but he’s sort of arguing against this kind of authoritarian aspect of philosophy in that period.

And so when you get to the 17th and 18th century, you’ve got a new method, you’ve got this method of doubt, you’ve got scepticism being taken seriously again, and that scepticism becomes part of the message. Again, that’s just subjecting what you believe to doubt and upholding the highest standards of reasoning and evidence. It wasn’t as if it was all rationalist. I don’t actually like the division between rationalism and empiricism myself because the so-called rationalists like Descartes and Spinoza and the Leibniz, Newton, these are often [unclear 45:06] people are doing experimental philosophy, and often the empiricists so the people like Barclay and Locke and Hume and so on, are often relying on philosophical reasoning as well, not just sort of observation and induction. And, of course, Hume famously problematizes the very inductive method of science anyway, so those kind of binary categories are not really helpful.

But I think in a way, Kant kind of encapsulates in his essay what is the Enlightenment, is that the movement is about promoting intellectual autonomy, right? Not just relying on what others or testimony or what authority tells you, but applying the the methods of reasoning and analysis, so that your own beliefs on the securest foundation they can possibly be.

Gene Tunny 45:57

Yeah, yeah, that’s, that’s a great explanation of that, Deb, I was just thinking, not trusting, don’t necessarily trust authority. And this is where we’re getting into problems nowadays, because we’ve got people who are thinking, oh, well, I’m doing my own research. Fauci says this, but I’m doing my own research, but often it’s on the internet. It’s on the net, and the source might not be that accurate. And you could argue that maybe they haven’t thought enough about the reliability of what they’re looking at, to justify their dismissal of what the certain authorities such as the CDC, or in our country, what different state chief health officers are saying.

I guess this is where it’s challenging, because there is value in being sceptical. And this is an important part of, of scientific method is being sceptical. Then the challenge is, sometimes there is something valid being said by some of these authorities, and you can take that scepticism too far. Particularly if you’re not relying on , good information, if you’re not, if you’re not fully embracing that critical thinking and you’re thinking critically about the information you’re getting and the points of view you’re putting across. So that that just occurred to me, then when you talked about the importance of being sceptical and not necessarily deferring to authority.  I thought that was a really good point.

Deb Brown 47:36

Yes, it’s interesting. My husband and I spend each morning looking at World Metre. That’s what passes for fun nowadays. Let’s have a cup of tea and see how the virus is doing, darling. In general, I’m a little frustrated, just that you often can’t get the data. I think there’s an issue that maybe a lot of people are not going to be able to even interpret the data. And that’s certainly a problem. And that’s why everybody needs some training and statistics and critical thinking. But there’s a lot of data that you just can’t get like this data, I want to know, hospitalizations, I want to know deaths. Then there’s also this issue about how much of this is being reported. Make more data, make more information available. That’s sort of one thing.

And then there is also this question of trust. So who can you trust in this in this context? And one of the I guess the most important questions to ask is who has a vested interest in a certain kind of outcome being reported? I’m happy to trust Fauci because I don’t think that he has any vested interest in this. I’m less inclined to trust somebody who I think is spinning a yarn, because they’re only interested in being reelected or making their political party look good. Right. That’s an important question to always ask about any source. Then you do have to do those lateral searches, right, how is this being reported by these different organisations, what are their interests, who’s sponsoring this page and so on. You’re right, it’s a minefield, and the more information that there is out there that is just sort of polarised and politicised and all that, it just noise that interferes with being able to give an accurate assessment of the situation.

Gene Tunny 49:52

Absolutely. Okay. Deb, that’s been great. I think we’ve got to wrap up there. We’ve taken so much of your time. I’ve got so much tape here. I’ll have to think about whether release it as a whole episode or Imight have to split it up in two.

Tim Hughes 50:08

Six parts. Six-part series.

Deb Brown 50:12

I’m sorry.

Gene Tunny 50:14

Not at all.

Deb Brown 50:15

I’m just not getting out enough. This constitutes as getting out. I’m just so excited, I got a bit carried away.

Tim Hughes 50:21

Not at all.

Gene Tunny 50:22

That’s great.

Tim Hughes 50:23

We could completely carry on because it is fascinating. And they are very big topics. So really appreciate the care you’ve put into the responses there, Deb.

Gene Tunny 50:34

Yeah, thanks so much. Deb, really enjoyed chatting with you. And I’ll put links to as much of the material that you mentioned in the show notes so people can find that. Really valued your perspectives and your great knowledge of philosophy, which it’s given us a lot, given me a lot to think about, and a lot for Tim and me. I’m sure we’ll be chatting about this a lot in the future, these issues that came up today.

Tim Hughes 51:06

That’s the thing. They’re big issues that remain big no matter where you are in history, and important questions.

Deb Brown 51:18

Thank you. I really enjoyed your questions, and it was such a great conversation. Thanks for having me.

Gene Tunny 51:24

It’s a pleasure. Professor Deb Brown from University of Queensland. Thanks so much.

Tim Hughes 51:29

Thanks, Deb.

Deb Brown 51:28

Thank you. Bye-bye.

Tim Hughes 51:29

Bye-bye.

Gene Tunny 51:31

Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to contact@economicsexplored.com and we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.

Credits

Thanks to Deb Brown and Tim Hughes for their great conversation and insights, and to the show’s audio engineer Josh Crotts for his assistance in producing the episode. 

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. Economics Explored is available via Apple Podcasts, Google Podcast, and other podcasting platforms.

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Transcript of EP127 on US inflation, Woke Capitalism + weird Aussie tax rules

In Economics Explored Episode 127, Darren Brady Nelson of LibertyWorks spoke with show host Gene Tunny about the 40-year high US inflation rate, so-called Woke Capitalism, and China. In the second part of the episode, Brendan Coates, Economics Program Director of the Grattan Institute, explained the implications of the peculiar Australian tax rules relating to superannuation and company dividends. You can listen to the episode via Apple PodcastsGoogle PodcastsSpotify, and Stitcher, among other podcasting apps. A transcript of the episode is presented below.

Here’s a recent clip of video from the episode:

Transcript of EP127 on US inflation, Woke Capitalism, and China + weird Aussie tax rules

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny 00:01

Coming up on Economics Explored.

Darren Brady Nelson 00:04

For the viewers who saw me take a sip of coffee from my favourite local café, the past year, it was about $3.50, maybe $3.75 for a coffee and now it’s 75 cents to a dollar more.

Gene Tunny 00:22

Welcome to the Economics Explored Podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene Tunny. I’m a professional economist based in Brisbane, Australia, and I’m a former Australian Treasury official. This is Episode 127, which started out as an update on inflation, covering the four-decade high US inflation rate, but it ended up being a wide-ranging discussion, not only about inflation, but about so-called Woke Capitalism, and China as well. This is a longer episode than usual, because following the first part of the episode, we have a segment responding to a listener’s question prompted by Episode 112, on taxing the rich.

Our first guest this episode, returning for his ninth appearance on the show, is Darren Brady Nelson. Darren is chief economist of the Australian libertarian think tank LibertyWorks. He’s also a policy advisor to the Heartland Institute in the US. Darren has previously worked for an Australian senator, the New South Wales Treasury, and the Queensland Competition Authority. Right now, in February 2022, Darren is based in Milwaukee, Wisconsin, so he has firsthand experience with US inflation, as we discuss in this episode.

I’ll probably come back to the topic of inflation in a future episode soon, as I want to have a closer look at this question of whether the market power of big corporations is allowing them to jack up prices more than would be justified by cost increases. Darren and I start a conversation on this issue in this episode, but I want to return to it and have a closer look at the data and how economic theory may help us answer the question. I think this is a very important question to answer.

Okay, my second guest this episode is Grattan Institute Economic Policy Program Director Brendan Coates, who answers a question from regular listener James about a peculiar feature of Australia’s tax system. Please check out the show notes for links to materials mentioned in this episode, and for any abbreviations used and clarifications I need to make. I’ll include links to all the articles and charts that Darren and I discuss, and materials that I discuss with Brendan too.

Regarding clarifications, I need to clarify something I say about Amazon. I say it pays minimum wage, whereas I should have said that it pays low wages. It appears Amazon does at least pay above the US federal minimum wage, so sorry about that.

You find the show notes via your podcasting app, or at our website, economicsexplored.com. If you sign up as an email subscriber, you can download my new e-book, Top 10 Insights From Economics. please consider getting on the mailing list. If you have any questions, comments, or suggestions relating to this episode or the previous ones, please either record them in a message via SpeakPipe, see the link in the show notes, or email them to me via contact@economicsexplored.com. I’d love to hear from you.

Righto. Now for my conversation with Darren Brady Nelson, on inflation, Woke Capitalism and China, among other things. Thanks to my audio engineer, Josh Krotz for his assistance in producing this episode. I hope you enjoy it. Darren Brady Nelson, Chief Economist at LibertyWorks. Welcome back to the programme.

Darren Brady Nelson 03:51

Thank you. Thank you for having me.

Gene Tunny 03:53

Oh, it’s great to be chatting again, Darren, about an issue that we’ve spoken about quite a lot. We had a previous podcast episode on inflation. Inflation continues to accelerate around the world. We had a reading for the US the other day for January, if I remember correctly, and it’s a 40-year high. US inflation hit a 40-year high in January after food, electricity, and shelter drove a bigger than expected rise in the consumer price index and pushed financial markets to price in a higher chance the Federal Reserve will hike rates by 0.5 percentage points in just over a fortnight. that’s from Matthew Cranston, US Correspondent for The Australian Financial Review. Now, Darren, this is something you’ve… You’ve been expecting this, haven’t you? You’ve been expecting inflation to continue to accelerate, even though some people have thought it may only be transitory. Is that right?

Darren Brady Nelson 04:55

Yeah. It’s certainly in one of the episodes that we spoke. We used a kind of a jumping off point was an article that I wrote for Town Hall essentially saying that. Often in the mainstream media there’s, you know… From my perspective, they don’t quite get inflation for the most part. There are exceptions definitely. You mentioned Matthew Cranston from the Australian Financial Review, which I quite like his work. But I think even better, in terms of economics, would be Adam Creighton. I think you might also agree. He’s certainly someone in Australia, he’s part of the mainstream media, and he’s always been very good at tying it back to the most important factor, which is inflation of the money supply. There’s a lot of factors that obviously can exasperate that, and in a market sense, obviously, prices are ultimately responding to demand and supply situation. But people like Adam Creighton and myself and some others, we go a little bit deeper. Okay, right, demand, what’s driving a lot of what’s going on in demand, that’s where the money supply really comes in, because that’s where the money balances are coming into people’s possession through various means. That’s where you start getting the really, if you like, the demand pull side of inflation, more so than a supply push.

Gene Tunny 06:26

Yeah. This is because what we have is, what’s the old saying about too much money chasing too few goods?

Darren Brady Nelson 06:37

Yeah, that saying, that’s a good quote.

Gene Tunny 06:40

I think that might be from Milton Friedman. We get so many great quotes about inflation and money.

Darren Brady Nelson 06:47

For the viewers, he’s to the left on the top stream there.

Gene Tunny 06:54

Yes.

Darren Brady Nelson 06:57

It warms my heart.

Gene Tunny 06:58

I’m not necessarily making an ideological statement, but I am making a statement about… Friedman, to me, is the ultimate economist of the 20th century. He’s the economist who I think best combined theoretical rigour, a grasp of the empirical data. He wasn’t a great econometrician or mathematician, I don’t think. I don’t think he’s in that sort of league. But he is the person who best combined the theory with the evidence with the communication ability. He was just a master at that. Even though there’s a lot of debate about just how right he was about the monetarism and that policy recommendation with the constant money supply growth rule, there’s a lot of debate about that, but to me, Friedman is the… If I could be any one economist from history, this is gonna sound odd, but it’s probably a tie between Friedman and Keynes. I think they’re both great in their own way. Keynes, he was so influential in the policy circles in Britain. I think that was quite impressive. Yes. Then obviously he transformed economic theory. There’s a big debate about the Keynesian legacy. But he had a huge impact, too. Yeah.

Darren Brady Nelson 08:25

But look, yeah, I certainly can’t deny, in terms of the 20th century, I guess those two would be the most influential economists of the 20th century. Obviously we’re gonna talk about inflation. But I think in my article, I don’t actually have it close to hand, but I do quote both those people that you mentioned. Friedman and Keynes, they’re on the same page, at least to some extent, on inflation and it not being a good thing, and something that’s actually a policy outcome, basically. Whether you think it’s intentional or unintentional, that’s a separate issue. But it is something that’s under the control of the policy levers. They both agreed on that.

I think the third person I quoted, who is my favourite economist of the 20th century, is Ludwig von Mises. As you mentioned, Keynes was certainly very original. I personally think he’s wrong, for the most part, but he was certainly very original. That’s probably where Friedman isn’t. Friedman’s not on that scale of originality, whereas Mises and Keynes are actually, for me, the two most original economists of the 20th century.

But I would certainly agree that even though Friedman and Mises were certainly very close in the way they viewed economics, not completely, but the way they viewed economics and obviously what their policy prescriptions were were certainly not light years away. I’d certainly agree that Friedman certainly was a more powerful communicator to a broader audience or to the policymakers. I agree with you, with the caveat of Mises and Keynes as the two most original economists of the 20th century. All three of them obviously talk about inflation. That was an important topic.

Gene Tunny 10:10

Yeah, we’ll have to come back to Mises in a future episode. I’d really be interested in exploring his ideas. You mentioned Keynes, you quoted Keynes in that article. Were you quoting Keynes quoting Vladimir Lenin, was it? Is it Lenin?

Darren Brady Nelson 10:28

No. Not that. No. It’s just basic pointing out that inflation… One of the important things he pointed out, yeah, this is a bad thing, it’s something that’s under controlled policy, but the greatest thing that he pointed out there is, there’s winners and losers, important part is there’s winners. People sometimes, and even I in the past even just jumped to like, ultimately, we’re all losers from inflation. That’s not true. That’s not true. Ultimately, so far in the central bank era, what’s called in the US from 1913 onwards, it’s obviously a different date in Australia, that there’s winners. With any policy, even though you look at it overall, you go like, “Wow, this is really bad,” but there will be winners.

Then throw in, I guess, a different school of thought, the public choice school, which I’m also a big fan of. That’s where they come into play, to really highlight the fact that in the political marketplace, which inflation is also influenced by the political marketplace, there’s winners and losers. The winners are quite a small group of people compared to the losers, but they win big, relatively, compared to the losers, which is why the losers aren’t always fighting back very hard, because they can’t combine, they’re not as animated to combine, and it’s much harder for them to combine, compared to the small group of winners. That’s public choice economics 101, basically.

Gene Tunny 12:03

Let’s go over that. I think this is interesting. Let’s look at the losers first, because it’s more obvious who the losers are. That’s going to be people going to the supermarket. You’ll notice your prices are rising. If your wages haven’t been increasing, if they haven’t been increasing at the same rate as prices, and we know that in the States that is certainly the case. I think we were looking at some data the other day, where at the time inflation was up 7% through the year. Now it’s 7.5% through the year. The figure I found for average hourly wages growth was about 5.3%. There’s that real loss in having a real pay cut of 1 or 1.5% or something or whatever it was. Maybe it was 5.7% wages growth. I’ll put the exact figures in the show notes. But yeah, that’s costing households. There was some estimate from, was it the America First Policy Institute? You sent me some article they had. They were calling that an inflation tax. What I think they were talking about was the loss of real purchasing power for households. They estimated it was about $850 per annum. You’d have to compensate households by that much to make up for the fact that their prices have increased more than wages. I guess the first sort of group that’s affected is consumers. Is this is something you’re noticing on the ground there, Darren? You’re in Milwaukee, in Midwestern USA. Are you noticing those price rises yourself?

Darren Brady Nelson 13:40

Oh, very much so. For the viewers who saw me take a sip of coffee from my favourite local café-

Gene Tunny 13:48

Fairground Coffee and Tea.

Darren Brady Nelson 13:49

In the past year, it was about $3.50, maybe $3.75 for a coffee, and now it’s 75 cents to a dollar more, in a year. It’s in a year.I think there used to be, once upon a time, the Coca Cola. Wasn’t there a price index that you know was used to relate to just the average sort of person who’s not an economist. I still like Coke to some extent, but coffee’s kind of the thing I notice the most. I believe you’re also kind of a… You’re a coffee and cafe aficionado like I am.

Gene Tunny 14:24

Less so during the pandemic, but yes. Yeah, generally I am.

Darren Brady Nelson 14:30

Yeah, that’s another story obviously, another episode.

Gene Tunny 14:34

The cafe across the street from me, that we’ve had coffee at from time to time when you’re in Australia here, that shut down, because the hotels on the street where I live, they were so dependent upon interstate and international visitors. That all went away for a lot of the pandemic, and so that cafe couldn’t survive anymore, unfortunately. But I expect I’ll be back out and about again soon. We’ve just had the Omicron wave here, but that looks like it’s dying down, which is good.

Okay, so you’re noticing the price rises. I just thought I’d ask that because it does seem to be something that’s being noticed by a lot of people. I know there was one of the audio or the podcast… There’s a lad, Bandrew Scott, who has a channel on YouTube, Podcastage, and he does reviews of microphones and things like that. He was talking about inflation the other day, and I thought, “Oh, that’s interesting. It’s not the usual thing you’d talk about.” But he mentioned it. You hear it in the commentary of people, when they’re talking about just the general state of things. It seems like it is starting to impact people over there.

Darren Brady Nelson 16:00

The CPI figure, the way the CPI is calculated in the US is different from in Australia. It’s basically got less stuff in it, less important things than the Australian version does. The Australian version is pretty good, actually. You could say, yeah, there should be some more stuff in there, whatever, but it’s a lot better than the US version.

There’s this organisation called ShadowStats. They do really good work, but there’s a lot of paywall stuff. But the person who runs that recently said, basically, he did the CPI calculation, not in some really weird and wonderful way, he just did it the way they used to do it originally in the US for quite a long time. He said, using the way they did it then, we’re talking 15%. 15, so double what the current US CPI is saying. Even if you go debate, like, “Okay, that’s too high, blah, blah,” the point is it’s probably worse than 7%. That’s what you see just talking about my coffee, obviously. I go grocery shopping, obviously, like everybody does. I don’t do a whole lot of restaurants, but certainly groceries and going to cafe and and having my coffees. It is certainly even worse than the 7%.

I’ve seen different estimates of CPI. It clearly doesn’t represent all the economy. I’ve seen figures like it’s only 40%, and whatever, but obviously there’s the asset prices, which is hard. There’s no really good statistic that does an asset price. There’s also the Producer Price Index. Obviously the US and Australia has that. You got to look at that too, because that’s getting some other prices. You start to get the full picture of what’s going on, how prices are inflating all over the place. We obviously don’t do it uniformly. Then Australia and the US, you can dip down into things like, you mentioned energy, you can look at housing separately. That’s not to say that it’s a cause and effect relationship necessarily, because really, at the end of the day, the cause is the money supply. That’s the main thing.

But it can be exasperated by things, various things, including I think a topic you may want to discuss, I think, in regards to John Quiggin’s latest article, is to what extent does the degree of competition in the economy, whether you’re talking about competitive markets or monopolies or cartels, what role does that play? Does it make it worse, or is it more just moving the deck chairs around? That’s an interesting question.

Gene Tunny 18:44

We might come back to that. There are a few things I want to come back to, but I better go back to the winners and losers from inflation. We talked about losers. Now, who’s winning? It’s people who have borrowed money to invest in other assets. Is that right? The inflation is eroding… Go ahead.

Darren Brady Nelson 19:07

I’ll give you the quick logic sort of thing. It’s definitely from the Austrian School, Mises, Rothbard, Hayek, and all sorts of people, who talk about basically the people who get the money first. They get this inflated money first. Essentially, it’s a game of keep your income/revenues ahead of your costs/expenditures. That’s business and individuals. It’s the same logic, right? The people who get that, and really in the system, there’s kind of certain people who always get it first, obviously government itself, the treasuries, but then there’s Wall Street types and various other words, those sort of people, but then also you’re getting into the people who are attracting funds more easily in larger quantities anyways, like Big Tech, Big Pharma. That’s putting aside whether the monopolies or cartels are competitive. At any point in time, it’s not a universal thing that Big Pharma or Big Tech always get it first.

But in the recent economy, particularly in the COVID times and whatnot, Amazon, obviously, who was already doing extremely well in the world of what’s called retail, if you like, and then they killed it during COVID, whenever most everybody else was not killing it. Those are sort of people who can get the money first and stay well ahead of the bad aspects of inflation. Oh, and then throw in it may be some sort of… There was also a recent article about Woke Capitalism. That starts to cut into that. It cuts into the sort of people who could often get this money first, who often have monopoly power. That’s also an interesting aspect, for them to have the cultural, the censorship, and all these other interesting things that come into play as well. I raised a lot of different things.

Gene Tunny 21:14

Yeah, I’ll just go back over that. You get the money first. That’s an interesting way of looking at it. I borrow the money, and I buy an office building, or I buy some shares, and so they’re going to appreciate in value. The bank, which lent me the money, it’s lent me a million dollars or something, or whatever it is, or a couple of million to buy, actually I probably need more than that if I’m going to buy an office block nowadays, but however much they’ve lent me, they’re going to lose out with inflation, because I’m going to be paying them back, I’m going to pay back that $2 million with dollars in the future that are, in real terms, worth less than they were, than I borrowed them. If the bank hasn’t charged me a higher interest rate, in expectation of that higher inflation, then they’re going to lose out. It’s people who borrow money, who they can actually benefit from inflation, if they’ve used that to go and purchase assets that are going to appreciate in value. The people who lose out, consumers and anyone who’s just holding on to money, if you’ve just got money sitting in a bank account, or if you’re a retiree.

Darren Brady Nelson 22:40

The pensioners, all that, fixed income. But even taking what you were getting at, but there’s gonna be … Even that lending market, the Amazons, they’re gonna have lower interest rates than what we’re gonna be getting, and a whole lot of other businesses, not just individuals. They’re gonna be able to get a hold of the money quicker, in bigger quantities, and put it to use better to stay ahead of their cost curve, if you like, that ultimately everybody’s going to get impacted to some extent by the inflationary cost curve, but they can stay ahead of it, and then bigger, more quickly, and to a larger extent. Things like, as I said, the degree of monopoly power will factor into that, putting aside how you figure that out empirically. That’s a separate question. But yeah, that’s the basic logic, and I can’t remember who basically had that kind of terminology. It might have been Rothbard, actually. I would have to go back to find that out. But obviously, Rothbard learned from Mises and Hayek. They would have all agreed with that.

Gene Tunny 23:47

Right. We’ll go on to the causes of what’s underlying inflation. I think that’d be good to chat about it in a moment, but first, what do you mean by Woke Capitalism, Darren? Could you tell us what you mean by that, or what do they mean by that term?

Darren Brady Nelson 24:05

Yeah, look, I’m not sure exactly what the definition is. You can, like always, usually, I believe you share different articles, links. There’s a link that goes through the history of it and who originated that term. But essentially, yeah, look, it’s the Big Tech people who seem to care more about … Like Amazon. Look at Amazon. They have such big, if you like, monopoly type profits, that you can afford to do all this virtue signalling, you can throw money at campaigns, political campaigns, for one, but you can also throw all these virtue signalling campaigns. In the US, we’re getting them all the time, about how diverse they are and how they care about gender. They can afford to get involved in the culture wars, either directly through, they go like, “Oh, this is what we’re doing inside our company, and our hiring policies are this,” basically signalling that they’re not hiring on merit, essentially, they’re just hiring based on the colour of your skin, your gender is, or what you identify as, all that sort of culture war related stuff, that the corporates have really come out big in favour, the past two years in particular, but it’s been coming for some time.

I think in that particular article, and I would agree, that that’s a rich person’s game, basically. You have to have a lot of supernormal type profits to afford that. If you’re in a company and in a particular market where your profits aren’t supernormal at all, that’s pretty hard to sit there and really play that game, except look, you could probably afford a small marketing budget to say you’re doing that, but you’re not really doing it, whereas I believe Amazon actually is doing it, because our mutual friend, Tim Wonhof worked for Amazon, and he can confirm with the hiring practices and people who get promoted in there is not so much based on merit at the moment, or there’s a big degree of not based on merit. That’s part of Woke Capitalism, virtue signalling, and just like a competitive market place would suggest you would be doing.

Gene Tunny 26:18

Yeah, I’ve heard this term increasingly. We’ll get on to, a moment, what it means for or what monopoly power means for inflation. We’ll get on to that. I just want to spend a bit of time on this, because it’s interesting, because I’m hearing this term more and more. There’s that book Woke Inc, I think it was, and this idea of Woke Capitalism. Now, they’re woke in some ways, but not in others. Amazon’s renowned for how poorly it treats its workers in fulfilment centres, isn’t it? They don’t get toilet breaks. They’re having to pee in bottles. Tt least that’s what the stories are. They’re paying minimum wage. they might have these great diversity policies on the one hand, but on the other hand, working conditions at Amazon are pretty dreadful.

Darren Brady Nelson 27:06

Look, they’re probably not dreadful as such in the US, but they’ve got in the headlines in the US about just they’re fighting all these unions around the country to make sure that the wages don’t go up, for  the people who are on the minimum wage. Obviously, that doesn’t impact people above minimum wage, which there’s plenty of people at Amazon like that. I’d highlight more of the fact that they source most of their stuff from China now. China is, rightfully so, infamous for its use of actual slave labour, not the pejorative, like, “Oh, I think you’re paying someone too low.” They’re the actual slave labour where they don’t actually get paid. They’re forced to do the job. I think that’s actually even more hypocritical than them fighting in the US against unions about whether the minimum wage should be $15 or $17, right?

Gene Tunny 28:01

Yeah. What are we talking about there, Darren? Are we talking about people in China who have been imprisoned for various different reasons? Look, they’re going to have a variety of political prisoners over there, for sure. There’s the oppression of the Uyghur people. Is this what you’re talking about?

Darren Brady Nelson 28:17

Yeah, that’s it. These people are often the sort of people who are making the things that then Amazon not only sell, but they actually promoted. This is what’s changed with Amazon. I’ve been a customer of Amazon since they’ve been around, basically. I think that’s something along the mid to late 90s. I’ve just totally noticed a very huge change. Even when you actually go to type in well-known brand that you want, yeah, you’ll get it, but it’ll be down the list. They’ll have all these Chinese knockoffs of various sorts. We don’t know, empirically know, who is who in terms of using slave labour in China. But it’s a common practice, and it’s certainly there. There’s a pretty good chance that you’re buying products that have been made with slave labour. That to me is far more, if you like, hypocritical or immoral than the questionable conditions in a US warehouse. That’s on quite a different scale. If you’re making the broader point that they’re hypocrites, yeah.

Gene Tunny 29:29

Yeah, I think that’s a point that, that I hear on some channels. I think it’s a point that people like Krystal Ball and Saagar Enjeti on their show, on Breaking Points have made. I think it’s a good point. We’ll have to come back to that topic of China in a future episode, because it’s fascinating. I’d like to know what the actual evidence is. Then there’s a question about what do we do with it. What are our obligations as consumers? What should the powerful countries in the world? What should the United States? What should Britain, to a lesser extent Australia? We think we punch above our weight, but who knows? What should we be doing?

Darren Brady Nelson 30:10

Australia does. Australia does, definitely. We won’t go into this, but even on the inflation thing. Maybe it’s a topic for another time, why the US gets away with a bit more, because it’s the reserve currency for the world, right? You have a lot of dollars just in other countries. Some of the inflation is being spread throughout the world from them, from their US dollar inflation, and surely it’s a top five trading currency, so they can punch above their weight. The reserve bank can get away with a little bit more than New Zealand can, for instance, even in a relative sense.

One thing to sow the seeds for a China discussion in the future, whether it’s with me or someone else, is it’s just completely illogical that somehow China, in such a short period of time, went from essentially a Soviet Union economy, where really, the people aren’t productive, they’re not very good at anything, even manual labour they’re not very good at, and they just attracted 80% of the world’s manufacturing. Really? There are those poor countries that in a free market… This is what I’m getting at is China’s rise is not quite as free market as it’s been portrayed over the years, but a lot of dirty deals done, basically, US, Europe, Australia, etc, to artificially throw trade their way, that they wouldn’t have actually won in a competitive marketplace in the world.

Gene Tunny 31:44

Okay, we’re gonna have to come back to that. There’s so many issues there that I’d want to explore. Let’s come back to that, in a future chat. We’ll go back to this question of monopoly, why we brought that up. You sent me an article earlier today, I think it was Woke Capitalism Is A Monopoly Game or something like that. That was, I’ll put a link to it in the show notes, from the Mises Institute, by Michael Rectenwald I think.

Darren Brady Nelson 32:19

He’s legit.

Gene Tunny 32:20

Yeah. I guess this Woke Capitalism, that’s a reflection of the fact that there are all of these monopoly profits out there. There’s arguably been an increase in concentration in monopolisation in the US economy and in other advanced economies, and this has been behind a lot of the calls for antitrust action. There’s been a renewed interest in antitrust. I chatted with Danielle Wood from Grattan Institute here in Australia about antitrust last year, I think it was. Why is this relevant to inflation?

One of the assertions that’s being made is that this inflation is partly being driven by greedy corporates taking advantage of this, all of this discussion about inflation, this inflation narrative, and using it to jack up their prices, and they’re taking advantage of their monopoly power.

I sent you an article by John Quiggin. I’ll put a link in the show notes to that. John did a blog post on this where he was criticising Larry Summers. Larry Summers was dismissing that he says, “Oh, there’s no sort of reason to think that just because we’ve got this monopoly power out there or this market power in some parts of the economy, that that would exacerbate inflation. John Quiggin goes, “No, that’s not quite the case. I’ve written this paper with Flavio Menezes that demonstrates in our model that this can actually be the case. Do you have any thoughts on that, Darren? What extent could this be due to monopoly power, due to market power, that companies taking advantage of this inflation narrative to jack up their prices, to the detriment of consumers?

Darren Brady Nelson 34:02

Look, that was actually a very interesting… It’s a very short article. For people who want to read it, it’s very short. Strangely enough, I’m something in between, I think, between what Summers and Quiggin are saying. I don’t usually have a lot of alignment with John Quiggin on economics or policy or much of anything else.

Gene Tunny 34:29

Just for clarity, John’s a self-described Socialist or Democratic Socialist, so yep, yeah, that’s what you mean there. I think John’s a very good economist. A lot of things I agree with him on, but there are things I strongly disagree with him on. I just thought I’d clarify that for people who are listening.

Darren Brady Nelson 34:48

Look, he’s Australia’s Paul Krugman in many ways. Look, on this point. I would think that ultimately, I think it’s going to be an empirical question. That’s not going to be an easy thing to figure it out, to be honest, because it’s basically going… We talked about who’s getting the money first or the order of how that’s coming in.

I would think, logically speaking, and we’ll even come back to the Woke Capitalism as well, but yeah, look, I would’ve thought that those companies with the monopoly power, particularly in these growing industries… It’s one thing if you’re a monopoly power in a utility industry, okay. They’re not the most dynamic, go-getter type industries. They got monopoly power. Then they’re also usually facing some regulators who are going to try to eat away at that and all that. We’re talking the Amazons of this world. I’m not saying they’re a monopoly as such. Under textbook definitions of monopoly power, they seem to have a fair bit of it. Those sorts of companies, yeah, why wouldn’t that money be attracted more to companies like Amazon, than to a utility, a non-dynamic utility with a regulator on top of them all the time, because the antitrust authorities, they’re kind of hit and miss. Actually, sadly, in Australia, too.

It’s very politically driven. It depends on who’s in power. Once upon a time in Australia, that wasn’t the case, in the good old days of Allan Fels, for instance. But the ACCC’s gotten a little bit more political over time, to be like the US’s Department of Justice, who are extremely political, for the most part, and they actually have been with antitrust for not just… It’s not under the Biden administration. They’ve been political for decades. I would expect places where the supernormal profits are there and they’re expected to continue or increase or at least not decrease too much. Yeah, why wouldn’t that money be attracted more to that? I guess, does that sound like I’m actually more in Quiggin’s camp, I guess, than Summers’s?

Gene Tunny 36:56

I’m not quite sure what you’re driving at there. The money is more attracted to that sector.

Darren Brady Nelson 37:02

Chasing returns, so obviously, monopolies are gonna have bigger returns, right? That’s investment 101.

Gene Tunny 37:09

Yeah. That’s right. the money’s going there. But we’re talking about the-

Darren Brady Nelson 37:17

Oh, they’re greedy.

Gene Tunny 37:18

The prices, yeah. Why does that monopoly-

Darren Brady Nelson 37:21

That argument has been made by the Biden administration. Did Quiggin actually make that argument in this paper?

Gene Tunny 37:27

No, no, he’s assessing that argument. That argument’s been made by the Biden administration, among others.

Darren Brady Nelson 37:34

Yeah, but Biden’s administration was doing two things at once, like talking out of the mouth one way and then the other way, like antitrust, which this what we’re talking about, the degree of competition in markets, and does that exasperate it. Again, it’s probably, I think, an empirical question. Does it exasperate it overall in the entire economy? I’m not sure. That’s certainly an interesting thing. That’s certainly an area worth exploring, because  two things. Is it being attracted to monopolies and cartels more than it is to competitive markets? Then what does that look like overall in the economy? I think that would depend also on to what extent is your economy… How many cartels and monopolies are there in your economy versus competitive stuff. You’re touching on a lot of things. Greedy’s a separate issue. That’s making a almost nonsensical moral assessment. I think greed existseverywhere. Are there more greedy people in monopolies? Maybe. I don’t know. I don’t even know how you would go about assessing that. As economists we’re less concerned about what people’s intentions are, because greedy’s going… That’s your intention.

Gene Tunny 38:50

Oh, yeah. I haven’t characterised what they’re saying correctly and I was just using greedy to illustrate, to make it more interesting.

Darren Brady Nelson 39:00

No, you’re right, though. People are saying that right. The Biden administration is saying that. It doesn’t look like Quiggin is actually saying that, but he may agree. I’m not sure. But you said he’s a Democratic Socialist, so he might gravitate towards the idea that just capitalism in general is more greedy, even if it’s competitive. I’m not sure, but that’s a totally different question. Good luck trying to figure that out. Greed exists in governments. You’re telling me that bureaucrats on high salaries, with no threat of losing their job, that there isn’t greed amongst those sort of people? Politicians, I think most people could see how politicians might be a bit greedy, with their ridiculously large pensions and all that sort of stuff. I know Aussies certainly view it that way, even across parties. In the US is a bit more polarised. Democrats think their politicians are like saints for some reason, whereas Republicans seem capable of criticising other Republicans. But that’s a separate issue, of course. Quiggin and Summers, that’s a very interesting point. Yeah. I think it’s a legitimate area to be explored. I think the logic is, yeah, I’d expect more money to be attracted to monopolies and cartels. That would exasperate, certainly, in certain industries and for certain consumers. Does it exasperate over the entire economy? I’m not sure. I’m not sure. What do you think?

Gene Tunny 40:27

I think, potentially, it is the case that these… Look, to some extent, I think these companies could be getting ahead of what they see as the inflation that’s to come. It’s possible that yes, they could rise their prices more than maybe justified by the increase in their costs. If you’ve got monopoly power, that’s certainly possible. I think there could be something to it.

I think trying to characterise the inflation as just a result of profit-maximising monopoly companies or companies operating in perfect competition, I think that’s going too far, because underlying all of this, as we’ve been talking about for quite a while now, is that big monetary expansion that we’ve seen in the US and other economies, so there is a reason to be expecting the inflation that we’re seeing. It’s not just because of greedy corporations. But look, it could be part of it, as could the supply chain disruptions.

What’s challenging I think, here, Darren is that there are so many different things going on. We’ve had the disruption due to the pandemic. We’ve had the supply chain disruption. We’ve had a drought, which is affecting meat prices. Meat prices, that’s an important part of the CPI. That’s one contribution. Fuel prices have been increasing. Used cars, new cars. There are factors affecting these specific markets which are driving up prices. That’s led some people to think maybe it’s just this supply chain disruption due to COVID, it’s going to be transitory. Look, I really don’t know. It’s hard to say. But we know as economists that it’s that monetary expansion, inflation is always and everywhere a monetary phenomenon. That would lead us to think that this inflation is something that could be locked in for quite a long time, unless the Fed takes quite aggressive action. I just don’t know whether they’re going to do that or not. Probably we’ll start to see the federal funds rate increase this year. There’s going to be, what is it, the tapering they’re talking about with the balance sheet? I really don’t know. It’s just so hard to determine what the relative contributions of all these different factors are. Do you have any thoughts on that?

Darren Brady Nelson 42:58

I think you’re right. I would just add in that, again, coming back to, just as per my article and our previous discussions, CPI is not a measure of inflation as such, because inflation is the money supply. That’s a measure of the effect on obviously quite a few prices in the economy, but not all the prices in the economy. What’s been different is the inflation previously has been showing up in PPI. It’s actually been mainly showing in asset prices, the usual stuff, stock markets and property.  Those are the classic places where the easy money shows up first. Pretty much every money inflation boom, if you like, that’s where it always goes. Then sometimes it goes to some other places too, new and wonderful places. It depends on where the economy is at. Obviously Big Tech’s a thing nowadays in social media. You have to keep on looking at…

It’s interesting how it’s really showing up in CPI. That gets the public’s attention. Obviously, as you said, even more so is literally the coffees and other things that people are buying. They’ll hear the CPI figure, but if they’re actually seeing it in the stuff they’re buying, that’s… That’s where it gets, if you like, definitely, the pressure will come on to the politicians who would otherwise like to keep on inflating. Then the Federal Reserve and the Reserve Bank and all the different central banks will also start feeling that pressure, because at the end of the day, they’re not independent of government. They’re quasi-independent of government. For instance, the Federal Reserve, obviously the head is chosen by the President. That clearly shows you that’s not a completely…

The Federal Reserve has a funny ownership arrangement where it looks like it’s private, but  it in practice, it operates like a government agency. In Australia, it’s more clear cut. The Reserve Bank is a government agency, etc, etc, and we know it is. But that doesn’t really change the characteristic of how a central bank operates.  I’ve never seen any difference. The Federal Reserve can operate differently from the Reserve Bank, not because of its ownership, but because obviously, it’s the world’s reserve currency.  It’s got some different things at play that, if you like, it can hide that US dollar inflation, spread it throughout the world, and have it not hit quite as hard inside the US as it might if it was a different, like was New Zealand or something. New Zealand can’t get away with inflating their money supply like the US can. Even Australia can get away with it more than New Zealand can, because it’s one of the five top traded currencies in the world. Australian dollar’s not just sitting in Australia, it’s out there as well.

Gene Tunny 45:54

I think there’s a lot of speculation on the value of the Australian dollar.

Darren Brady Nelson 45:58

Yeah, it’s more a speculative thing, but there’s a lot of Aussie dollars that just aren’t in Australia, if you like, or it’s out there being used for other purposes and speculation and whatnot. Obviously, Australia is a big player in certain areas, like mining and agriculture and stuff, which also tends to have a very international flavour to it.

Gene Tunny 46:18

Yeah. Just finally, I thought we should touch on the government as a potential beneficiary of inflation. I think you were sort of suggesting that before. I guess there are a few different things to chat about there. Governments can have a… They would prefer the inflation, or they could prefer policies that are inflationary, particularly in the lead up to the election, because that can help people get jobs. Then the inflation could come later, and they can worry about that later on, or another government could worry about that. That’s one issue.

Then there’s also the fact that governments benefit from inflation, because of what I’ve always thought of as the inflation tax. People use that term in different ways. But one way that has been used is to talk about what’s the erosion of the federal debt, so the money that the government owes, and that’s denominated in dollars. The real value of that decreases with inflation, so the government’s getting a benefit in that way. It’s borrowed all this money in the past, and then it pays it back with money that’s worth less because of inflation. The economy is bigger in nominal terms, its tax take is bigger in nominal terms, so it gets a benefit from inflation.

Darren Brady Nelson 47:46

The bracket creep…

Gene Tunny 47:48

Yeah, that’s right. That’s another part of it. Yeah, governments can actually benefit from inflation, although if it gets too high… It looks like this is what’s happening in the States now. You see all the commentary. Even Biden, I think, at a press conference the other day, didn’t he make a comment about, just a sarcastic comment about, “Yeah, inflation, great,” or, “That’s great, isn’t it?” because someone asked him about, “Do you think this is a great… Do you think this is going to help you in the midterms, or what’s it gonna mean for the midterms?” Do you remember that comment? Was it Steve Doocy?

Darren Brady Nelson 48:24

Are you talking about where he did the thing under his breath and got caught?

Gene Tunny 48:27

Yeah.

Darren Brady Nelson 48:28

It was quite rude. Yes. There was a Fox News reporter.

Gene Tunny 48:35

Doocy. Was it Peter Doocy? Steve Doocy’s son? I’ll put a link in the show notes for people.

Darren Brady Nelson 48:41

Which one’s the son and which one is the father? I can’t remember their names.

Gene Tunny 48:44

I think Steve Doocy is the one on Fox and Friends, and Peter Doocy’s the one in the White House press pool.

Darren Brady Nelson 48:52

Peter Doocy’s good. He’s very good at… He asked a lot of uncomfortable questions, but in a very professional way.  Biden’s response to him wasn’t particularly professional enough.

Gene Tunny 49:03

It was funny.

Darren Brady Nelson 49:05

It was funny. It was funny.

Gene Tunny 49:07

He said, “Yeah, yeah, inflation, high inflation, yeah, that’s a real asset for us going into midterms, you stupid SOB.”

Darren Brady Nelson 49:17

Look, I’m a little bit disappointed in Joe that he wasn’t as creative as that. What was that comment he had in the election to one of the people in the audience  at one of his town halls? He called her, I think it was, a… It was something, it had pony and dog in the … Something-

Gene Tunny 49:37

You’re a lying dog-faced pony soldier or something. Was that it?

Darren Brady Nelson 49:42

That’s the one.

Gene Tunny 49:44

Whatever that means.

Darren Brady Nelson 49:46

I’ve never heard that term before. I’m disappointed he hasn’t used it more often since. He should have used that with Peter Doocy perhaps, rather than just going so lowbrow with what he said.

Gene Tunny 50:01

Yeah. I don’t know, it showed that he’s a real person. I thought that was quite authentic, that moment. Anyway. Inflation, right. We didn’t even get on to those charts, Darren. You had prepared some charts.

Darren Brady Nelson 50:20

Oh, exciting stuff.  I hope this works for people at home.

Gene Tunny 50:25

I thought one of the charts you showed was really… They’re all interesting. There was one that showed that inflationary expectations are increasing, too. People in the markets are expecting, or people in the community are expecting this inflation, this high rate of inflation continue into the future.

Darren Brady Nelson 50:43

I think we’ve been…Apple’s telling me or Zoom’s telling me that I have to somehow go into some system and do security and privacy or something.

Gene Tunny 50:53

All right. I can put them in the show notes. I’ll just put the charts in the show notes. But I thought one of them was quite… It demonstrated that those inflationary expectations have increased. I’ll put that in the show notes for people.

Darren Brady Nelson 51:09

Oh, and so people aren’t confused, it has the word Michigan in it, and it’s not the inflationary expectations of the state of Michigan. The survey is done by an institution that’s in Michigan, basically. I think the one I had had the one-year-out expectations, but plus alongside a five-year expectation sort of thing. Are they only expecting it in the short term to be problem versus in a longer term sort of thing, and both weren’t looking good, basically.

Gene Tunny 51:44

Yeah, I’ll put that there. I thought that was a good chart for context, because as I said, there’s this debate about whether it’s transitory or is it just due to used cars and new cars and meat prices and petrol, all that, or is it something longer term. It’s looking like it’s-

Darren Brady Nelson 52:01

Then there’s also a chart in there with wages, too. That’s an important one to do, to what extent is wages versus inflation, if you like, people’s costs versus their income. Obviously if your expenditures are going to be higher than your income, in real sense, then obviously, that’s a problem.

Gene Tunny 52:22

Okay, Darren, this has been great. There’s so many issues we’re going to come back to. I’ve got to come back to you or to, say, John Humphries might be a good person chat with about this, but I want to chat more about China. Lots of important issues there. Also, we could do a deeper dive on Woke Capitalism. I might do some reading up on that, to what extent is this a real thing or is it just the cover for some unsavoury practices. I wouldn’t believe Amazon’s really a woke corporation, given some of their labour practices, what I’ve been seeing. But yes, I think we can come back to that. Any final thought? Go ahead.

Darren Brady Nelson 53:01

Another one, because I want to write a paper at some stage, or at least an article to start out with, is revisiting trade. I find most free market economists are garbage on understanding free trade. What I mean by that is they jump from the theory of free trade good to then look at China, everybody go, “That’s an outcome of free trade.“ They kind of miss the linking the two together.

Also, I’d go even a step further, that they rely too much on… A lot of these people who even specialise in international trade seem to be that their education in trade was nothing more than what they learned at their first year at university. They go like, “Oh, here’s the theory from Ricardo on comparative advantage,” okay, fine, without actually doing a deeper dive into it and go like, “All right, how valid is that?” Yes, comparative advantage of trade between businesses and human beings, yep, gotcha. How can you then jump to a political nation state and say that it’s exactly the equivalent, beyond a teaching tool? I’m fine with it as a teaching tool. But I think it’s completely overstated, because you’re dealing… A nation state is a completely different beast, and all the little things inside that nation state, particularly when you’re talking about China, because you’re never dealing with a private free market corporation in China, for the most part. You’re always dealing with government inside China. You’re talking a very different beast.

Then I’ll throw in the fact that they didn’t win all this business because they were actually better or in reality were offering cheaper products. They weren’t even offering cheaper products in a market sense, because not just the slave labour, but just all the government fiddling inside the country that goes on. Anyway, I’m just sowing the seeds for-

Gene Tunny 55:03

Yeah. I think we’ll probably have an extensive debate in that one, Darren, because I may be one of those free market economists that you’re talking about, or very pro free trade. Maybe not a debate, but I’ll want to explore what your contentions are a bit more.

Darren Brady Nelson 55:23

Oh, and by the way, I’m debating me from not that long ago as well. Again, just to be clear, I am totally for free trade.

Gene Tunny 55:34

Good.

Darren Brady Nelson 55:34

I’m not trying to argue that free trade is bad. I’d be happy to revisit the Trump tariffs and all that and the logic behind them, and bring in concepts we both obviously love, like cost benefit analysis.

Gene Tunny 55:47

Excellent. Any final thoughts on inflation, Darren, before we wrap up?

Darren Brady Nelson 55:51

Inflation bad? It’s gonna get worse, at least for a while. But it’s really a political thing at the end of the day, so it’s going to be heavily influenced by the midterms, in the US, just to look at a US picture, because there is a distinction between the Republican and Democrat Party on what they think about inflation, whereas in Australia, sadly, both parties are just kind of cool with it for the most part.

Gene Tunny 56:20

Okay, now, the Democrats are gonna get absolutely wiped out in the midterms.

Darren Brady Nelson 56:26

They should.

Gene Tunny 56:26

I’m not making a comment on whether they should or whether they shouldn’t.

Darren Brady Nelson 56:31

No, sorry, I’m saying like projections, that looks like… That’s what I’m talking about.

Gene Tunny 56:36

The GOP is going to be in power. What do you expect? The Federal Reserve’s ultimately the important institution, isn’t it, in controlling inflation in the States?

Darren Brady Nelson 56:48

Yeah.

Gene Tunny 56:49

How’s the midterms gonna matter? How are they going to matter, in terms of-

Darren Brady Nelson 56:54

They’ll be under pressure because they know… Look, internally, these are people who… There’s some of these people actually like things like MMT, or who would be happy to keep inflating, but not everybody in the Feds views it that way. Fortunately, the Feds actually kind of decentralised. It has a head. But  there’s actually different Federal Reserves, and they have often very different philosophies on inflation and its importance and what you should do about it.  That’ll be interesting.

They’re gonna feel the pressure, not directly, because they don’t really report to Congress as such. They’re supposed to be independent, but the head gets appointed by the President. I think they’re going to be feeling the economic and the political pressure, if it is a… The Biden administration’s gonna be able to do nothing, basically, once the Republicans… We might actually see, whether you agree with it or not, we’ll probably see a lot of, I’m expecting possibly impeachment proceedings. That’s probably what I’m going to be seeing. I think we’re going to see that. Then we’re going to see a Republican president, whoever that is, in 2024.

Gene Tunny 58:08

It’s quite possible, yeah, that with impeachment. This is an economic show, not a political show, but just from my observation of what’s going on in the States, certainly that could be possible if you get more of the Marjorie Taylor Greene, Lauren Boebert types into the Congress, then yeah, that’s certainly possible. Just on the House and others in the Senate or the Congress, what does that mean for inflation? The only way I could see that as having any impact is if there was the opposite of what’s going to happen, is if there’s a blue wave, and you have more AOC types coming in, and then you have a massively inflationary Green New Deal or something like that, but the prospect of that happening is absolutely… It’s almost zero.

Darren Brady Nelson 59:01

Look, no, it actually isn’t even that. If they just held on by one seat, the AOCs, etc, hold far more sway than you would think. Not only within Congress, but then in the White House as well. They just have to hold on by one. That’s all they have to do. They just have to, because they’re desperate.  There’s a lot of things that they shouldn’t be doing, because they’re probably going to lose. But I think the psychology is like, “Hey, we’re probably going to lose, or at best, we might just hold on, so let’s get this stuff done now that we’ve always wanted to do,” for not just years, but sometimes even decades. The sort of things that  the AOCs, etc, of this world want done. Look, there’s a small chance that, okay, let’s say the Republicans do, sorry, that’s not a small chance, that Republicans win and perhaps win big, but there might be even a chance that the old Joe Biden who used to actually do deals with the opposite side may reappear somehow, because we haven’t seen that guy so far. He did exist once upon a time, pretty much throughout his career actually, to be honest. This Joe Biden is actually quite different than we’ve seen over the decades.

Gene Tunny 1:00:14

Looking at what’s happened, Darren, you haven’t seen any radical policies being implemented by the Biden administration, have you, in terms of economics? But this infrastructure bill that was ultimately bipartisan, the larger Build Back Better Bill, was not bad.

Darren Brady Nelson 1:00:31

That infrastructure bill had no infrastructure in it virtually. It was all about the woke agenda on education and  race policy and all that sort of stuff. Now, that’s extremely radical. Just because you got a couple Republicans who went along with it doesn’t mean it wasn’t a radical bill. It’s a very radical bill.

Gene Tunny 1:00:50

It was a lot smaller than what they wanted to implement, so the full Build Back Better, which some people on the other side we’re labelling Build Back Broke.

Darren Brady Nelson 1:00:59

Yeah, but the percentages of stuff that actually went to infrastructure stayed the same. It was a very small minority of actual physical infrastructure as we know it. They defined infrastructure to be something completely different, that bill.

Gene Tunny 1:01:13

I have seen that. I think that’s right, to an extent, yep. I’m gonna have to come back. Either you or another guest I’ll have to invite them on and unpack that. I’m interested in that. It’s probably too much to go over there. Darren, every time we chat, I just think about all of these other things we need to explore. But I think we better wrap out now because we’ve been chatting for quite a while. But yeah, I really want to thank you. Unless there’s anything else you want to say, to end with, we can call it a-

Darren Brady Nelson 1:01:45

Quick one. Because we’re both renaissance men, we don’t want to be pigeonholed into one little thing.  We’d like to go off and explore different things.

Gene Tunny 1:01:54

Exactly right, Darren. Darren Brady Nelson, Chief Economist at LibertyWorks. As always, I’ve really enjoyed it. Thanks so much for your time.

Darren Brady Nelson 01:02:03

Cheerio. Thank you.

Gene Tunny 01:02:06

Okay, we’ll take a short break here for a word from our sponsor.

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Gene Tunny 1:02:40

Now back to the show. Brendan Coates, Economic Policy Programme Director at Grattan Institute, good to have you on the programme.

Brendan Coates 1:02:50

Thanks for having me on, Gene.

Gene Tunny 1:02:52

It’s a pleasure, Brendan. You’re gonna help me respond to this question from a listener, a really curly one. Now, in response to an episode I did with Miranda Stewart, we chatted about wealth inequality and taxing the wealthy. There’s a big conversation going on about that at the moment. James, one of my listeners, wrote in and said, “I’d be interested in hearing more on how low-income/labour tax rates and tax credits work together, to oblige the government to pay wealthy individuals. I instinctively start from a position that the least anyone can pay in taxes $0. I was frustrated by the conversation in 2019, around imputation credit refunds, that people could actually have a negative tax rate that creates a liability for government to pay. However, I also realised that the conversation is bound up in concerns around double taxation, and would be interested in hearing from someone unravel those threads in an upcoming podcast. “

You’re probably one of the best people in Australia to talk about this incredibly complex issue that ended up becoming… It was one of the contentious elements of the Opposition Labor Party’s policies at the 2019 federal election and possibly cost them some seats. Just to begin with, Brendan, would you be able to explain what’s actually going on here? I think James is on the right track. He’s talking about this interaction of the low-income labour tax rates and the tax credits. Could you sort of explain what’s going on, please?

Brendan Coates 1:04:42

Thanks, Gene. First of all, thanks to your listener, because you’re bringing back bad memories, nightmares even, of the 2019 election and trying to simply explain how franking credits work. In its heart, franking credits are… We have an imputation system in Australia for dividends for corporate profits. When you’re paid a dividend by a company, it has a franking credit attached, which represents the tax that’s already being paid on those profits by the company. They can be used to offset any personal income tax the shareholder owes to the Tax Office. So in a sense, franking credits represent the tax that’s already been paid.

Now, when the system was set up, back pre-Howard, basically you could only use those franking credits to offset your personal tax income, if you had a tax liability. If you had no taxable income, therefore, no tax liability, then you couldn’t use those credits. Now, what happened after Howard in 2001 was we essentially, and Castello, is they allowed people to claim those franking credits, the tax already paid, to reduce the tax, their taxable liability that they had to pay as a person. The whole point is to sort of look at an individual and the company tax systems collectively and say, how much does someone owe? What you should be paying is essentially a marginal tax rate on both your income from all your other sources, and the tax that you’re paying on any dividends you receive for owning shares in Australian companies.

Gene Tunny 1:06:15

Okay, so this comes from the fact that we’ve got this peculiar way of taxing companies in Australia, this dividend imputation system that we share… Do we share it only with New Zealand? I’m trying to remember if that’s right. It’s really a different system from the typical classical company tax system, whereby the company would pay tax, so it might be, say, 20% tax on corporate profits, and then you would get paid a dividend, and then you would pay income tax on that dividend. But that’s not what happens in Australia, is it? Although, actually, the company’s paying tax at a 30% tax rate on its profits. If you get paid a dividend, the tax office takes into account the fact that the company’s already paid, say, well, the 30%. If your marginal tax rate is higher than 30%, so if you’re one of the top, if you’re on the top marginal tax rate, and…

Brendan Coates 01:07:33

Then you’re paying 47 cents on the dollar so 17% [more].

Gene Tunny 01:07:37

Yeah, so you got to make that up. But on the other hand, if you’ve got, effectively a zero marginal tax rate, because you’ve got all of these tax-exempt earnings, so we’ve got a tax-free threshold of 18,000 or something, then the company’s paid all of this tax on behalf. Theoretically, well, there’s been too much taxation paid, because the company is, it’s really an aggregation of individuals. The idea is that the company is just the sum of the individuals. What’s relevant is all of the marginal tax rates, and so there’s been too much pay. That seems to be the logic. Am I on the right track there, Brendan?

Brendan Coates 1:08:25

Yeah, that’s right, Gene. But the basic idea is that every shareholder in Australia pays tax at their marginal tax rate on those dividends, like they do everything else. Now, the problem here, so Labor’s policy was to remove refundability, to reverse the change made by Costello and Howard in 2001, and to mean that if you had a marginal tax rate of… If you had no taxable income left, then there was no tax, there was no ability to deduct those franking credits, the tax that’s already been paid.

Now, the original sin per se is not actually refundability. Refundability is actually a relatively normal part of a tax system. The issue is that there are a lot of Australians, particularly a lot of wealthy Australians, that don’t pay any income tax, which is why when Labour announced the policy to reverse the changes they were gonna collect a lot of money. I think the revenue figures are sort of in the ranges of five, six billion dollars a year. It’s because superannuation earnings. You put your money in super. You contribute through your working life, you hit retirement, and during your working life, any earnings, any dividends super fund earns on your on your behalf, are taxed at 15%. But when you hit retirement, they’re tax free. You have hundreds of thousands of retirees, often quite wealthy, self-funded retirees, paying no tax at all, and then claiming these franking credits back as well.

Labour’s approach was, okay, instead of going after what is the key source of the problem, which is the tax-free status of superannuation earnings in retirement, the fact that it’s 0% tax rate, they instead went after the franking credits themselves, because it was largely only hitting largely the top 10, 20% of the earnings distribution of retirees. It wasn’t hitting their base. It was hitting wealthy people, who frankly probably should be paying more into the tax base than they are. But it was certainly a second best solution to a third best problem.

Gene Tunny 1:10:24

Okay, okay. Right, there are a couple of things I might pick up on there. Okay, with the taxation of super, so it’s taxed in the earnings phase, or when it’s in your super fund, so there, it’s taxed, but it’s at a concessional rate. Then when you withdraw it, when you get that sort of pension in retirement, then it’s not taxed. There’s an argument that your super is taxed highly concessionally in Australia and it’s a growing cost to the budget if you look at the tax concessions as a cost.

You mentioned this concept of refundability. That’s whereby if you get a tax credit you can have a negative liability with the Tax Office, and therefore they would pay you the money. Instead of you paying money to the Tax Office, they pay you. That was something that was brought in in 2000 or 2001 by the Howard government. This is where the issues come from. I think the opposition, they were pointing to the fact that this is a growing cost to the budget, is that right, the money paid out for these franking credits?

Brendan Coates 1:11:58

That’s right. You can think of the money…as a refund, as a refund of the tax already paid, right? It’s refund the tax that has already been paid on your behalf by the company, which took the tax out of the money it was going to give you and gave you a smaller dividend, because it paid the other 30 cents the dollar at the Tax Office.

Now, the issue here is that we have an aging population, which generates challenges in its own right, because health spending in particular rises with age.  There are some long-term intergenerational challenges in terms of Australian federal government budgets in particular. The issue here, though, is that we also at the same time have retirees or older Australians who, because of the tax-free status of super, essentially opting out of the personal income tax system. The share of  over-65s that pay any income tax at all has gone from just under 30% 25 years ago, to more like 15% today, even though they’re receiving larger benefits from the State because they’re receiving more in healthcare and the rest of it. You’ve kind of got a generation that’s paying a lot less tax than it used to, than the generation before paid at the same point in time. It’s also drawing more in services.

I think the ALP would argue that the franking credits proposal was a way of trying to right that wrong, because it’s particularly wealthier super annuitants with very large balances that were paying the most, that were getting the largest tax concessions from the superannuation system, because they’re not paying any tax at all on their earnings or on their withdrawals from superannuation.

Gene Tunny 1:13:38

Yeah, and so this is a function of clever financial planners basically getting people before retirement to just put all your money and assets into super because it’s going to be taxed concessionally in retirement, so that must be what it is. Whenever you create a rule, you’ve got all of these clever, I guess financial advisors and accountants and lawyers trying to figure out how to get the best for their clients out of it. It’s a function of that. Okay.

Now, I think we’ve covered this point of double taxation that James had. That’s the idea that, well, you could look at it as double taxation if you got rid of franking refundability or franking credits, because the company has already paid that tax on your behalf and you shouldn’t have paid any tax, given the rules and the system, the tax rules what your marginal tax rate is. I think that explains that point there. I think that’s a good observation you made. Rather than the opposition tackling the concessionality of superannuation, super earnings, they decided to address this refundability of franking credits issue. I guess a couple of things there. One, I guess tackling the super concessions, that would be politically courageous, very difficult. There must be a case, is there a case for some concessionality on earnings from superannuation, Brendan?

Brendan Coates 1:15:17

Like anything that involves the taxation of savings, there’s often a lot more complicated or there’s more to the story. It’s not necessarily complex, but there’s often a little bit of nuance to the story. It is certainly true that we should be trying to tax superannuation earnings in retirement more than they are. The 0% tax bracket we currently have on earnings is unsustainable in the long run, particularly as more money in the super system enters the retirement phase, because that concession takes off from the age of 60.  People have got a lot of time left in their lives from the age of 60 onwards, where they’re basically opting out of the tax system entirely. But it’s fair to say as well that the tax rate on savings, on superannuation and the like, probably should be the marginal rate. It shouldn’t be 47 cents on the dollar for the top income earner, 32 cents on the dollar for the median. That’s because when you tax the return of savings, those tax rates compound over time. Basically, you get compounding at higher effective marginal tax rates if you tax the return to savings.

Now there are some that say, this is the UK, there was a public review for the Mirrlees Review that said the optimal arrangement is to have a 0% tax rate on the state, so you’re not distorting the choice between should you consume money today or consume money in the future.

I tend to fall on the… I think some of the other literature is pointing to the fact that the rates should be concessional relative to the marginal rate. It’s okay to tax return to savings a bit, partly because returns to the savings rates themselves don’t seem to be particularly responsive to the tax settings.  People don’t tend to change their behaviour very much. If you tax the return to savings, they might. They’re not that responsive. If you’re going to tax that margin less, then to raise the same revenue, you’ve got to tax other margins like labour income more.

On balance, we think that the appropriate tax rate on savings, it might be 15, 20 cents on the dollar, rather than say 47 for the top marginal rate. Now, if you’re thinking of something like superannuation, look, you are still taxing that savings, because you’re taxing a bit on the way and the income that you’re earning is being taxed, so 15 cents on the dollar when you put those contributions in. It’s just that a 0% tax rate in retirement, it is too much. It is too high. if we’re thinking about shifting the balance of tax in Australia in a way that’s going to improve economic efficiency, the taxes on super savings probably should be a little bit higher, and maybe the taxes on other forms of savings like term deposits, which are taxed at full marginal rates, probably should be a bit lower.

Gene Tunny 1:17:59

Okay, just for clarity, Brendan, I better make sure I’m getting this right. We’re talking about this is the money you take out being tax-free, out of your super. What about the money or the funds that still remain in your super fund once you’re retired?

Brendan Coates 1:18:16

Let’s back up a little bit, Gene. There are three stages. There’s the money you put into super contributions. There’s the earnings on the dividends. Then there’s the fact that you can withdraw the funds. Australia under Howard and Costello in 2006 removed all taxation on those withdrawals. Taking money out of your super is tax-free.

The issue is that at the point when they took the money out, they removed that tax on withdrawals, which was a very complex tax. It was called the reasonable benefit limits. Anyone who’s  an accountant or financial planner that listens to your show will agree that it was a complete pain in the ass. The issue, though, is that the taxation on those earnings is also tax-free from the age of 60. You’re paying no tax on the earnings as accounts, and then no tax on withdrawals.

Now, I should say that since some of the changes that the Turnbull government put through in 2017, look, if you’ve got more than $1.7 million in super, it’s only the stuff less than 1.7 million that’s tax-free. Anything above that is taxed at 15%. But most of the money is those people with less than 1.7.

Gene Tunny 1:19:26

Okay, it’s so complicated, isn’t it?

Brendan Coates 1:19:29

It’s just like pulling an onion apart. There’s layer after layer after layer.

Gene Tunny 1:19:33

If you’re listening, whichever country you’re in, regarding taxation, retirement income matters, please speak with a financial advisor, because they’re going to be the best people to help you. It’s just so complex. You and I both worked at the Treasury. You remember all of the hundreds of people in the revenue group dealing with these tax policy issues. It’s so incredibly complicated. Okay, Brendan, it’s been good. Anything else? Have we missed anything? Is there anything else we need to chat about? Oh, yes. I like the way you characterise this. You’re talking about abolishing franking credits. Did you say it’s a second best solution in a third best world or something like that?

Brendan Coates 1:20:22

That’s right. It takes us in the right direction. It’s not the reform I would have done. I would have introduced some sort of taxation on super earnings in the retirement phase, so that the dividends people are receiving from companies in which they own, that they pay some tax on those earnings, as they do before they retire. That would be the cleaner, neater solution to the problem, because you’re hitting all taxpayers, you’re not just hitting the ones that don’t have any income against which to offset their franking credits. That would be more efficient from a tax perspective, from say a tax economics perspective. But it’s just not the path that the governments or oppositions have gone down. We’re working on it. That’s obviously an area of grants research and advocacy. We think that is something that needs to change. But  it’ll be a bold government that does go and take that step.

Gene Tunny 1:21:20

I think what’s interesting, Brendan, you made this point that the cost of these concessions, this concessional taxation and superannuation, that is increasing over time, and it’s increasing at a faster rate than government revenue, isn’t it? Is that right?

Brendan Coates 1:21:38

That is right, because you’ve finally got these compounding amounts of money. The super system has $3.2 trillion in it. I think the amount of money… That’s rising really quickly. In 2014, it was $1.4 trillion. then at the same time it’s more than doubled in that short period of eight years. At the same time, you’ve got, as population ages, you’ve got a growing share of superannuation assets hitting that age 60, were super earnings becomes tax-free. The size of those concessions is growing really quickly. I think the retirement income review that was done by the Treasury estimate that I think by about late 2050s, actually might even before that, it might be a bit earlier, the cost of the tax concessions themselves will cost more than the age pension.

Gene Tunny 1:22:27

Right. Okay, I’ll have to have a closer look at that. It just seems to me that with these concessions, and also the NDIS, there’s some cost issues to do with the National Disability Insurance scheme. Eventually, yep, there will have to be some hard decisions made somewhere in the Commonwealth Government regarding Commonwealth programmes and tax policies. Unclear exactly what those will be.

I think Grattan’s doing a good job at highlighting what all of the issues are and just crunching the numbers. I’d just like to say to you and your colleagues, keep up the good work. I’ve been lucky enough to chat with quite a few Grattan people on the podcast and always, always find it a really great discussion, and I learn a lot, as I have done today, Brendan. If there’s anything else, yeah, happy to hear it. Otherwise, I think that’s been great. I’ve certainly learned a lot. Thanks so much for your time.

Brendan Coates 1:23:34

Thanks very much, Gene. If I can leave you with one final thought, which is something I think you should think about for a future podcast, is with an ageing population, you tend to find that the services that people rely on are often provided by government, like health care. It does raise the question that if you want to provide these services with an ageing population, the size of the state probably ends up being a bit bigger than what it has historically, which means you need the tax revenue to fund it. Now, there’s always spending you can try to cut, but all else equal, it strikes me that that’s the direction you end up heading in, just as a matter of just the dynamics of ageing Australia. I think that’s something we’re just yet to grapple with in Australia, that it probably does mean tax to GDP, it probably increases from where we are today.

Gene Tunny 1:24:26

Yeah, yeah. If there is that political desire to have those higher expenditures, then naturally, you would need to have that higher rate of tax to pay for it. Personally, I may not support that. But look, I accept that that is the case, that if there is the desire from the public, if that’s how people vote, and they support that, then exactly, those expenditures have to be funded. Very good point. I think I will try and cover that in a future podcast episode, because Richard Dennis I’ve seen has written a book, Bigger, or Big, maybe it’s Big, from the Australia Institute. I don’t know if you’ve seen that. I think Richard’s making a similar point to what you’ve made. I’ve been meaning to get a copy of that and delve into it and see if I could get a podcast episode out of that. Great suggestion, Brendan. Great.

Brendan Coates 1:25:24

Thanks very much, Gene.

Gene Tunny 1:25:26

Cheers, Brendan. Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to contact@economicsexplored.com and we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.

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