I had a great conversation with regular Economics Explored guest Darren Brady Nelson on the Go Woke, Go Broke hypothesis in episode 139 of the podcast. I’ve cut a couple of clips (see below) from the video of our Zoom conversation so you can quickly see some of the highlights.
You can listen to the conversation using the embedded player below or via Google Podcasts, Apple Podcasts, Spotify, and Stitcher, among other podcast apps. A transcript and relevant links are also available below.
What does the economic policy platform of a Pirate Party look like? What does it say about intellectual property protection (i.e. copyright and patents), the Right to Repair, UBI, taxation, and business support? And what type of pirates are Pirate Parties inspired by exactly: Captain Jack Sparrow or Kim Dotcom? Pirate Party Australia Treasurer John August answers these questions in a conversation with Economics Explored host Gene Tunny in Episode 138 of the show.
You can listen to the conversation using the embedded player below or via Google Podcasts, Apple Podcasts, Spotify, and Stitcher, among other podcast apps. A transcript and relevant links are also available below.
Here’s a clip from the video recording of the conversation in which John talks about the Pirate Party’s views on intellectual property.
About this episode’s guest – John August
John August is the Treasurer of the Pirate Party Australia and a Fusion Party candidate for the electorate of Bennelong in the 2022 Australia federal election. John does computer support work in retail and shareholder communication. He is passionate about justice and ethics in our world, particularly as it plays out in law generally and intellectual property in particular. He has stood on behalf of the Pirate Party in the Federal seat of Bennelong and also as a Councillor for Ryde City Council.
Along with technology and law John is also interested in spoken word and poetry. He broadcasts on community radio and hosts the program “Roving Spotlight” on Tuesdays from noon-2pm on Radio Skid Row Marrickville Sydney, and writes about his ideas on the website www.johnaugust.com.au. You can keep up to date with what John is up to via his Facebook page.
Transcript of EP138: The Pirate Party’s economic policy platform w/ John August
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.
John August 00:04
And there is the whole thing of, you know, patent trolls who have a bunch of patents sitting on the shelf, and all they do is run around with a mallet and whack people on the head who try to make that. And to my way of thinking that’s a complete abuse of what a patent should be.
Gene Tunny 00:18
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 138, on the economic policy platform of the Pirate Party, Australia, one of several Pirate Parties around the world. I’m joined this episode by John August, treasurer of the Pirate Party Australia, which is part of the Fusion Party Coalition. The Fusion Party brings together the Pirate, Secular, Science, and Climate Emergency parties. This episode was recorded in late April 2022 in the lead up to the 2022 Australian federal election. John is running as a Fusion Party candidate for the Sydney-based electorate of Bennelong. Please check out the show notes for relevant links, any clarifications 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 John August on the economic and policy platform of the Pirate Party. Thanks to my audio engineer, Josh Crotts, for his assistance in producing this episode. I hope you enjoy it. John August from the Pirate Party of Australia, welcome to the programme.
John August 01:35
Well, thank you, Gene. Great to be here.
Gene Tunny 01:38
Yes. Good to have you on the show. I’m keen to learn about the economic policy platform of the Pirate Party. So I’ve recently had some discussions with some members of the Pirate Party regarding UBI. I had one member reach out to me after they listened to my episode with Ben Phillips. And so I’ve been speaking with him about that. And I’d just like to make sure I understand this where the Pirate Party is coming from because you hear pirate party and instantly you think of Long John Silver, but I mean, that’s not quite the case is it? So I’d like to understand then where’s the Pirate Party coming from? So if you could take us through that, please, that’d be great.
John August 02:24
Okay, well, I guess you’ve got the right thing that if you actually look at our policies, you’ll find that we’re very much into individual freedom, at the same time as we’re also into social concern. And one of the things, I think this will come out in this discussion, is that every party claims to get that balance or claims to sort of put some effort into it. But you know, obviously, I’m not just saying this. Hopefully, it’ll come out in the discussion. But I think the Pirate Party does a better job of realising that duality than I think any other political party.
And you know, one of the things, yes, there’s this stuff about pirates, they have to understand that way back when, I guess computer games were in fact copying software and other things. And the industry was calling them pirates. And so they thought, well, hang on, if you’re going to call us pirates, we should embrace that and run with it. And along the way, I guess the pirate movement, you might say, they started to appreciate how business was actually flexing its muscles and abusing its position. And then you also had a certain concern about government. So the Pirate Party is, I guess, both concerned about corporate overreach, and also government overreach and government censorship. And we also believe in individual freedom.
But the thing is, along the way, you’re starting to think, look, we believe in individual freedom, we believe in personal initiative, and drive and enterprise and so on. But what does the good drive, the good initiative really look like? And I guess we saw in business, a lot of businesses abusing the situation, you know, rent seeking, abusing intellectual property, and similar. And I guess there’s also, you know, land ownership, you know, the Georges do actually talk about the land ownership monopoly. And we’re certainly informed by those sentiments. So we came from a point of view of saying, we want to celebrate real economic initiative, at the same time as we want to be compassionate and care for people and enable them. And again, no political party runs into government claiming they’re not going to do that and that the devil is in the details.
But like when it comes to social welfare, we do actually believe in the pirate universal basic income, which you might say, I guess it’s more a guaranteed minimum income because not everybody gets it. The idea being that if you make the nominal amount you neither pay tax, nor do you get a top up, but if you make less than that, you get A bit of a top up until finally at zero, you get a certain amount of money regardless. And that means that you provide people with the incentive to apply themselves, you save on bureaucracy, and obviously at the top end, I have to be careful, they’ll call it an incremental rate of taxation. Because obviously, in one sense, it’s a flat rate, but it’s not a flat rate, because it doesn’t, you know, intersect the origin. But certainly, if you are, I guess reasonably well off, you make a bit of money, and you will get a relatively fixed portion of that. Obviously, it’s mathematical, it’s, you know, the offset plus the gradient and this sort of thing.
So I suppose I guess you’re sort of more concerned about economic policy, but we certainly cherish individual freedom, freedom of speech, freedom from government intervention. And look, it’s not economic, but we’re certainly concerned about Witness K and Bernard Collaery and Julian Assange, and I guess the government surveillance laws to sort of eavesdrop on our mobile phones and make fiddles and change, it’s with them. And I guess you also have, you know, the corporations who are basically pulling large amounts of data and taking advantage of it.
So we basically are concerned about government and corporations in equal measure. But we do believe in freedom of speech, and we do believe in individual initiative. And as I say, No, I don’t think any political party claims to not believe in enterprise, or these various things. But I think our particular combination, is a result of this being targeted by both government and corporations. And that’s where we’ve ended up. And I think, as a result of the journey we’ve taken to get here, we actually have a, as I say, a much better point of like mixing the celebration of individuality and also looking after people as well.
Gene Tunny 06:58
Yeah. Okay. So is the Pirate Party explicitly Georgist? You mentioned Georgism, or the philosophy of the American economist Henry George from the 19th century. And I mean, you’re probably better placed to explain what his philosophy was. But I guess he was in favour of taxing land, wasn’t he? He talked a lot about the unearned rent from land, is that right?
John August 07:28
That is correct. Now, of our policy platform, if you look at it, we do say, look, land value taxation is a good thing, it would be good to sort of re-emphasise our tax system to do that. And like when you have the universal basic income, I guess there’s lots of people will chuck moral rocks at it, but one of the things we do try to do is say, look, how do we actually cost this in such a way we don’t need print money to actually give people this basic income. And okay, I’m going off on a bit of a tangent. But you know, one of the principles is, once you give people that basic income, without constraints, we reasonably expect, a lot of people will just work a few hours a week, because they don’t fall off a cliff and lose all their benefits. So you will immediately sort of enable that initiative.
But getting back to Henry George, yes, let’s just say I suppose one way of capturing this duality is that if you have a property, and the government does something that lowers the value of your land, you wouldn’t believe you know, the hew and cry, the number of letters to the editor, you know…to the local member. But let’s assume the government sets up a rail station, not so close that it’s polluting noise and making life inconvenient, but actually makes life very convenient for you. And the value of your land just shoots upwards. And I have yet to see a queue of guilt-ridden people at the tax office saying, wow, you’ve increased the property of my land enormously. I’ve got to give you some of that money back. So that’s sort of capturing what Georgism is about.
Now, the speculators will say, oh, by buying and selling land, we sort of contribute to the proper operation of the economy and society and so on. And okay, that’s its own rabbit hole. And I, broadly speaking, say that, to the extent that’s true, people are getting overly remunerated for that. But yeah, the thing is land is in scarce supply. And, you know, if you actually tax land, it’s a much better way of doing things, let’s say, going off on a bit of a tangent, but I think whether you want to have a right wing or left wing inclination, you know, everyone says you should get rid of payroll tax, and yet there was this idea we deal with GST, where supposedly the tax states were going to get rid of payroll tax and it didn’t happen. But the point is, if you actually tax on land, on the one hand, it’s fairer, and another hand it’s actually progressive in its way because if you’re wealthy, you’re more likely to own land. But the other thing is as society changes, and business can be conducted here or overseas, and people can telecommute, and so on, taxing labour when labour is so mobile, you know, I think it makes more sense to say, here’s a business, a business is set up in this location, and we tax it based on the operation there.
But yeah, the idea of the unearned increment, I mean, that is one of the things. With a lot of economic perspectives, I guess we all draw the difference between genuine work that yields an income and basically just sitting back and raking it in. And that’s, I guess, a moral distinction. And I think most, where there might be a hybrid of economic and other perspectives, they demarcate the good economic effort from the dodgy economic effort. And we do actually celebrate innovation, not Silicon Valley style innovation. But like, you sort of say, hey, you know, there could be a green grocer here, maybe I should set up a green grocer. That’s being creative. And that’s what we consider to be the real, worthwhile creativity of economics. But sitting back and speculating, we don’t see that as being so useful. And we think there’s an over-return for it.
So bringing it back to Georgism, taxing land makes a lot of sense. And, of course, the word tax has, you know, all these negative connotations. Some people get neurotic about tax. You could say, the charge on land is paying for the privilege that you have that monopoly. And I guess I’m going off on… You’re prompting me with other tangents. But if you’re aware, there’s some Georgists in Melbourne that actually did some analysis of apartment blocks, based on the water usage. And they figured out that a lot of these apartment blocks were actually owned, but vacant and unused. And I know, I’ve actually heard some commentators on your programme talking about supply and demand of housing. And believe it or not, in a limited sort of way, I do actually endorse the idea of supply being a factor, but what we identify is that people are doing land banking, rather than actually either living at their property themselves, or renting it or otherwise putting it into the market. And the incentives we have is such that it makes sense to just sit on property. But widening it out, we sort of say, if the economy was more based on actual innovation, and real economic activity, then people would have… Shall we say, the non-speculative part of the economy would be stronger, land would be easier to afford, and it’s a win-win situation. You know, basically, accommodation is cheaper, but the non-land non-speculative part of the economy is also more dynamic and stronger.
So but I think that story of the railway station setting up next your place, and the value shoots through the roof, and you know, just everyone just swallows up that and just sort of, oh, this is lovely, I think that captures a lot of what Georgism is about, the idea that maybe there’s some speculation, maybe there’s some useful speculation that lubricates the economy. But really, a lot of it is people, I guess, having unearned income. And that’s ethically problematic. But yet the Georgist perspective does actually fix that. Now, I emphasise, the Pirate Party is informed by Georgism, we emphasise land value taxation. But if you look at our policies, our economic policies, everything, it is a part of what we’re about.
Gene Tunny 13:43
Yeah. Did he advocate for a single tax on land? Was that correct?
John August 13:49
That is correct. I don’t think we would go so far as to say a single tax on land. You know, we are believing in this negative income tax. And we also believe in fiddling around with the other parts of the tax system in order that that guaranteed minimum income and negative tax of that package can be sustainable. And you can basically give people who earn no income a moderate amount of money, without breaking the bank, so to speak, and part of the picture to sort of beef up our tax intake would be landowner taxation. But equally as I say, as our economy changes as a global economy changes, I think it will actually make less sense to emphasise income as a source of taxation.
Gene Tunny 14:36
You mentioned the rail line and boosting property values. You may have seen it already but there was a good study that was done by a fellow Queenslander who’s attached to University of Sydney, Cameron Murray. I don’t know if you saw Cameron’s study of the Gold Coast Light Rail, and he estimated some percentage value uplift for land within, you know, several hundred metres of the Gold Coast Light Rail. So I’ll put a link to that in the show notes. I don’t know if you’ve seen that. But you may be interested in that study.
John August 15:08
I haven’t seen that. But I will sort of stick my oar in and say, we have actually had Cameron Murray in on a more general discussion of housing, within the auspices of the Pirate Party. And Cameron Murray has also written that book Game of Mates, which I’ve had a read of. And that Game of Mates book, I think that one of the origins of that was actually a paper, where he was talking about how there are all these increases in land value. And surprise, surprise, it seemed like the recipients of those improvements were often relatives or in some way related to people at Council. And that, you know, I guess, let’s say we don’t want to point fingers at anyone in particular, or name anyone, but call that grey corruption, and his sort of thing that he was talking about, was a taxation of the uplift. So if you have a zone change, and that increases the value of your property, then that improvement is taxed. I think it’s called a betterment tax was what it was called originally. And that’s one of the things that Cameron Murray is talking about. Now, obviously, a zoning change is obviously a windfall in its own way.
I guess, my story I started with was the railway station within moderate proximity to you. And that’s not really a zoning change, apart from I guess the fact that maybe they had to change the zoning in order to have a rail line there and a station there or whatever. But yeah, there’s different ways of increasing your property value. And one of them is, you know, the railway station. Another one is actually the shopping centre nearby, you know, or the swimming pool or whatever. And, you know, one argument is that if you’re just living there, and the world just changed around you, and it was your choice to live there, and that’s a bonus, well, fair enough. But if you’re essentially buying and selling and you’re actively in the market, and someone else does something, and you get the financial benefit from that, you can wonder how fair that is. But, you know, one of the things about economics, there’s all this hand wringing about what’s fair and unfair, and I recognise that’s part of the picture.
Gene Tunny 17:17
Yes, yes. Okay. Okay, we’ll take a short break here for a word from our sponsor.
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Gene Tunny 17:55
Now back to the show. You mentioned this negative income tax, so then a guaranteed minimum income, so you’re not necessarily going for a UBI. Is that right? You’ve got something –
John August 18:08
That’s right. Okay, yeah, I guess there’s a terminological issue here. I call it a pirate UBI. Technically, it’s a guaranteed minimum income. Now, your universal basic income is a wad of cash that you get regardless. I think in Alaska, they have this thing where they’ve re-allocated the money from them, their oil or their mineral reserves there. And everyone just gets a plunk of money every year, but in a sense, that is sharing the real wealth that’s created. So that’s fair enough, I guess. But yeah, your pirate UBI, or the guaranteed minimum income we are talking about, if you make the neutral amount of money, you pay no tax, nor do you get a top up. If you make less than that, you get a bit of a top up, so the government gives you a bit of money. And finally, if you’re making no money, then you get a wad of cash, which is our guaranteed minimum income. And notice, in a sense, it’s means tested. We’re not just giving people lots of money regardless, so we are trying to avoid the inflationary risk. And in fact, really do our best to make sure that the budget actually balances and we’re not actually printing money to pull this thing off.
If you there is a criticism of some forms of universal basic income, we’d say. If you just give everybody you know a wad of cash each year, regardless, that’s going to be inflationary risk. And we agree that our guaranteed minimum income is targeted. If you’re not making income by other means, you get this wad of cash. And if you’re making a little bit of money, you get a top up. And the thing about that whole slow incline is that you don’t have a poverty trap. You rarely will have a disincentive to sort of work or just work a little bit extra. Who knows there might be some benefits, some concessions or so on that you might lose. And that’s going to be a little bit of a disincentive, but not falling off the cliff like you do at the moment.
Gene Tunny 20:09
Right. And so it’s a negative income tax because below a certain amount of income, the tax office is actually giving you money. When you get up to that level of income, you start paying positive income tax. Okay.
John August 20:25
That’s correct. Yes. Yes, that’s right.
Gene Tunny 20:27
Good one. Okay. I think I chatted about that with Ben Phillips. I think he mentioned that was one of the models, because, you know, UBI, in practice, you know, that’s one of the ways you could do it. And, you know, there are all these sort of terminological issues about what’s UBI.
John August 20:45
I suppose with terminology, you have this broad thing called UBI, which is like the general, you know, we’re giving people some money. But UBI is universal basic income, is we give everybody a certain wad of cash, regardless. The guaranteed minimum income is that it’s to some degree means tested, we give people money, if they need it is a bit of a leg up.
Gene Tunny 21:08
Yeah. Okay. So what I found interesting, so far, and I didn’t realise was that influence from Henry George, I mean, he’s a major figure in economics. At different times he’s been very influential. I mean, there are a lot of, you know, still followers of Henry George. And, you know, he always gets written up in the histories of economic thought. And there’s also the thinking or the philosophy of the people in IT, in the tech sector. And it’s an interesting blend of that. I know that labels can be… They may not be suitable. But is it possible to describe the Pirate Party as a left Libertarian Party? Or am I on the wrong track there?
John August 21:57
I think left libertarian would be a good way of describing it. And we have had some limited overlap with I guess you’re right libertarian parties. I think one was the Liberty and Democracy Party. Some time ago, this is quite separate to economic policy. But they articulated a position about the civil marriage versus religious marriage. And what he had to say, yeah, you guys are on the mark there, you actually expressed it better than we could, though, certainly those right libertarian parties, they don’t believe in Medicare, public health. We actually believe in expanding public health to include dental care, and expanded support for mental health, you know, supporting the NDIS. But all the time, we want to be, I guess, financially responsible about doing that.
I mean, so much of social welfare, I think… Look, there are financial constraints, but the way it rolls out, it really does feel very penny pinching to the recipients. And I know some people who, yes, they got their NDIS, but the amount of reports and you know, turning up to doctors and, and getting XYZ certified, you know, you listen to their stories and go, well, alright, maybe one doctor to say, tick the box and say you really do have that condition, but there seems to be this overload of bureaucracy there. And like with the universal basic income, I mean, obviously, yes, we want to, we want the books to balance, but you do have a saving in bureaucracy, because at the moment, whole government departments have to figure out whether you really are unemployed, whether you have been trying to look for work, all these sorts of things, and you would get rid of those sorts of overheads in administering the system.
Gene Tunny 23:45
Yeah. Can I just ask about NDIS? So National Disability Insurance Scheme, if you’re listening internationally, this is a scheme we have in Australia to assist people and their families or their carers if they have a disability. And yeah, I mean, John, you rightly mentioned that for recipients, they see that it can be bureaucratic, and it can be hard to get the support that they need. At the same time, there is an incredible amount of money being spent on it. I mean, what is it? Is it going up to 30 to 40 billion or something, or there are projections of that? And it’s going to overtake Medicare. So our single payer health care system here in Australia, we’re going to be spending more on NDIS than that. And yeah, I mean, so what are your thoughts on that? I mean, how do we control that cost? Or how do we pay for that?
John August 24:44
Well, there are the various broad changes. We’ve been talking to the tax system, you know. I did mention you know, land value taxation. Another one is to properly tax religion. Now I’m going off on a bit of a tangent here, but I know they were some people who analysed the value, I think it was Catholic church property in Victoria, and said it was comparable to the Westfield property holdings. And then there was a council in Bondi. This goes back to the 1980s. But they said that they had to double their rates to cover the cost of garbage collection, because they couldn’t charge the churches for garbage collection. So again, that’s the thing where sometimes the tax is a tax in the more pejorative sense. And sometimes it’s more a payment for services. And you know, those church properties get away without that.
But let’s see, then another one we’re talking about doing is doing capital gains tax if you use an asset to secure a loan. So there’s a whole gamut of tax changes we can make. And look, I acknowledge the thing about NDIS is you want to properly support things, but at the same time, you want to control the cost, and you want to have it that at least it doesn’t feel markedly bureaucratic to those participating in it. And let me just acknowledge that that is still a work in progress.
I’ll be a little bit political here and say, if you look at the current government, you know, lifters and leaners, the age and entitlement is over, all this sort of rhetoric, and, you know, sort of suddenly saying that, you know, the unemployed aren’t working hard. And, you know, if you look at, say, the Illawarra, that’s a region to the south of Sydney, that over five or 10 years, their rate of unemployment suddenly shot up. And it doesn’t make any sense to say that suddenly, over five or 10 years, all these people suddenly became lazy and couldn’t be bothered working. And yet, that’s sort of the rhetoric of the government going around. So I would say, look, who knows, maybe occasionally, the government does actually have some good ideas that are, shall we say, morally neutral or morally good. But it’s in the context of then having form in terms of saying all these narky petty things, and implementing all these narky petty things, like say, there’s Robodebt. I guess I’m being a bit political there. But what I’m saying is, look, you can have good ideas for economic reform. But if the rest of your story is dodgy, no one will believe you. Now somehow, John Howard managed to implement GST and get away with it, which was a bold thing in its way, but for a government to credibly make grand changes, and do it credibly, and be believable, you know, I think that’s hard.
But anyway, getting back, I’ve gone off on a bit of a sidetrack, but let’s just say, Yes, coping with NDIS and not having the cost blowout, while trying to sustain it, and not have it heavily bureaucratic in the rollout, that is one thing there. But the other thing I would try to… I mean, I haven’t looked into in detail, but I would like to think that if you can run NDIS properly, support people properly, you will then give them the opportunity to participate in the economy. And as it were, bring some of that investment back. And, you know, people, I guess maybe that’s happening already, and we haven’t really identified that benefit. Or maybe we need to target our schemes better. You know, there may be ways of trying to reduce, shall we say the overall financial impact of NDIS while still will be money coming out of the government at some level. So anyway, I’m not sure I’ve answered your question properly. But let’s just say yes, it is a challenge…
Gene Tunny 28:32
Yeah. Yeah. Just occurred to me when you mentioned NDIS, so that I/d bring that up, on the taxation of religion, it’d be good to see some of religious organisations, which are largely, I think that they’re exempt from tax, aren’t they? It’d be good to see some estimates of that, what that could bring in. I haven’t seen them. But yeah, it could be it could be substantial.
One thing I was surprised by, and you probably know this already, but I went to a friend’s birthday party, they held it at the Presbyterian Church, their head office here in Brisbane city, on Ann Street. And I never realised but back in the 19th century, the state governments of the day granted land to the various churches. There was some authority under a New South Wales Act of Parliament, to provide grants of land to churches, and so Catholic Church and the Anglican Church and Presbyterian Church and various others. And so in part, that’s why they have these inner city properties. So that’s why they’ve held on to them, I guess, and they had some extra land that was surplus to requirements and they’ve redeveloped that land. So, you know, that’s helped them out immensely. It’s related to an initial grant of land they had from state governments back in the day, which I found quite interesting. I don’t know if you’re aware of that at all, John.
John August 29:59
In Sydney there’s a suburb called Glebe. And it’s called Glebe because it was originally attached to a church. And I think over time, you know, the church only had its only tiny little part of Glebe. But Glebe is called Glebe because it was originally a church allotment. So I’m sort of aware of that.
But yeah, it is the broader issue that churches have a lot of privilege. And they excuse it, because of the good things they do. But at the same time, it’s not very transparent, and you just have to take their word for it. And I think also, our government in the past has like, basically thrown a lot of money at churches for services that I don’t think were efficiently thought through or efficiently allocated. So I guess it is pointing a finger at the church and saying that they are the equivalent of a feather bedded monopoly, I suppose, you know, would be one way of looking at it.
Now, sure, the churches do have some community stuff to do. But you know, that community stuff should be supported by the people in it. I mean, you could say, look, there’s only a certain number of people who are Catholics, but taxpayers at large pay for that privilege. You know, so there’s some things that are really out of whack there. But I know, there’s the book The Purple Economy, was written quite some time ago.
And, look, it’s great that you’re asking these questions. The sad thing is, I was a bit more up on these things 10 or 15 years ago, and it has been a topic of debate on the fringes, but it’s never really hit the mainstream. And, you know, look, if the government is struggling to pay for, you know, XYZ, you know, they play silly buggers, they screw over us with taxation, councils are obliged to jack up their parking fines rather than charge the council’s rates. But, you know, the government never thinks laterally and says, Well, hang on, let’s take a good look at this religious privilege, and maybe we can reform things and basically get a bit of extra money to spend on these things we want to do. But like, I just see just how creative government is at sort of shaking trees and finding money in high logs, but they never look in that direction though.
Gene Tunny 32:12
Just with the taxation of religion, you mentioned, it was something you were more up on 10 or 15 years ago. And you’re right, it hasn’t really been a prominent issue. The only time I remember it becoming an issue in say the last 10 years was when Jim Sorley, the former Lord Mayor of Brisbane, who was a preacher at one stage in his life, he brought it up and suggested that given that, you know, many religious organisations are doing very well, they probably should, or they’ve got substantial assets. I don’t know how well they’re doing day to day. Then, you know, they could actually pay some or make a greater contribution, or they could make a taxation contribution. So I thought that was interesting.
John August 32:55
Makes a lot of sense, because occasionally, you do get your secular religious types. And, you know, obviously New South Wales, and one of the contrasts I make is that Gillard was an atheist, but she had to be dragged kicking and screaming to do, you know, inquiry into churches and child abuse. Kristina Keneally was an Australian Catholic, and in New South Wales, she was the premier that oversaw the introduction of ethics education in schools, of non-religious education in schools. But yeah, at times, you get religious people who really are quite considerate. And if you look at a lot of elements of the Uniting Church are actually quite secular in the way that they relate to things. Obviously, yes, they get a bit of religious privilege, but it’s not something they covet, if you know what I mean. And at times, they will even push back against it. So you know, it does vary. And obviously there was this particular person you’re saying that was was sort of saying, hang on, maybe the churches should pay tax.
Now, if you go back far enough way, way back in the depths of time, before there were the Greens, before there was the Democrats, there was actually a political movement called defence of government schools. And they were very concerned about the way the government was feeding so much money into religious schools and was trying to say that it was against the Constitution. Now, I’m no constitutional lawyer. But I’ve read the commentaries, when people were writing the constitution of Australia. And I think based on what they were saying about the Constitution at the time, we never really should have given all this money to religious schools. Obviously, yes, I’m not a lawyer, and it was the High Court judges who get to make these calls. But yeah, if you go back decades, there was the defence of government schools movement. It was such a strident political force before the Greens or the Democrats. And it really had a lot of energy to it before my time, and I read about and think, wow, this is amazing. And the sad thing is, that was decided in the High Court when it was in Melbourne. So then the High Court moved to Canberra and it basically fell off the radar of the High Court because the High Court loves to sort of parade all the controversial decisions that were made within its halls, even if the public didn’t like them, or the controversial or whatever. They couldn’t get [inaudible] decisions made in Melbourne before they moved to Canberra. There you go.
Gene Tunny 35:20
Right. Okay, I’ll have to look into that. I mean, it’s a big issue, the division between church and state and therefore, what governments can do to assist religious organisations or schools. I mean, I guess the issue in Australia was that, at the time, didn’t we have some Catholic schools that were struggling financially because they charged relatively low fees, and they couldn’t afford to install the science blocks. This was during the Cold War, and there was a push to educate people in maths and science. And so therefore, you could argue there was some public policy rationale for it.
John August 35:57
There was a bunch of schools in Canberra, Catholic schools that went on strike because they weren’t getting the money together for that. And details of that story are not sort of close to hand. But I do know, during the Cold War, even though the US was very religious, and you even had some fist-waving creationists, when the Russians put Sputnik into orbit, they all thought, oh, shit, we better roll out the science education in our schools. And, you know, that’s my understanding, that that was why creationism took a backseat until the Cold War sort of thawed out, and there was no longer that pressure. So I do believe that’s not got a lot to do with economics, of course, but I do believe that’s some of the history there.
And look, it’s not at my fingertips, but there has been this whole thing of charities and the definition of charities. And I certainly would say that churches have a lot of privilege when it comes to charities, but my narky observation about the government is they really want to reduce the charitable status of any group that might criticise government. And, you know, of course, you know, there’s the whole freedom of speech thing, yada yada yada, but yeah. Let’s say yes, historically, this whole thing of what is a charity, we should have a charities commission and so on, that was bubbling away at the side. And again, I was more familiar with this 10 or 15 years ago, and then I got serenaded by intellectual property and the Pirate Party, I suppose.
Gene Tunny 37:25
Okay, well, yeah, we want to get on to IP, because that’s fascinating too. Just with religion for listeners internationally, I should know that when I mentioned Jim Sorley, he was a former Lord Mayor of Brisbane here, so well-known figure in one of the political parties, in the Labour Party. And yes, he was also at one time a Catholic priest. So that’s why it made news when he came out and said that the churches should pay tax.
John August 37:52
Yes, well, it is one of the things that a secular Australia I should say, that the minority seat of secular Australia do actually say that Gough Whitlam made a deal with the Catholics to get into power. So that’s the one narky thing that secularists will actually say increased criticism of Gough Whitlam. I don’t want to get embroiled in the whole bog mire of Gough Whitlam. That’s one observation I’d make.
Gene Tunny 38:17
Okay. Okay. Well, we might move on to IP and then we’ll finish off with a discussion of business support or crony capitalism, or however you want to describe it. The Game of Mates, you might like to describe it. You mentioned Cameron and Paul Frijters’s book before. What’s your position on IP? I mean, is it complete no protection of IP, something extreme like that? Or is there some protection to encourage innovation?
John August 38:46
We do believe in some protection for IP. But there’s a whole heap of reforms and changes. Like, as far as copyright’s concerned, we’d have a whole heap of like, what is it, fair use exemptions. Now, one of the things we get into is like, the right to repair, say. It is actually bubbling. And I think it’s sort of starting to get to the mainstream. But you know, the cliche is, you’ve got this farmer in Western Australia. They’re so damn far from civilization. They’ve got this farming equipment. Their harvest season runs a few weeks, and if one of their bits of equipment is out of action, and they’ve got to wait a few weeks for some guy from Perth to travel all the bloody way. Oh, okay, we need this spare part ordered. That will be a week away. That sort of makes no sense. And, you know, there is the idea of the right to repair.
And this is another thing about individual freedom. There’s some people who run repair cafes, they talk about the dignity of risk, okay, and you know, it is one of those things that I guess a slightly libertarian sense is, you know, cotton wool drawers and that sort of thing. And, you know, my own personal view is look, companies have a legitimate concern that, you know, you don’t mess with their thing, injure yourself and get sued. Okay? We do think there needs to be some sort of way of saying, look, I’m going to mess with this. I’m taking the responsibility onto myself. If I injure myself, it’s my own problem. But I do think a lot of firms run around saying, oh, we can’t let the consumers do blah, blah, blah, because they might hurt themselves. And that’s actually an excuse for them to flex their muscles in terms of intellectual property.
Gene Tunny 40:39
Yeah. So John, just for clarity, what do they do that prevents you from repairing it? They void the warranty? They say the warranty is voided if you do any work on it, if you actually open it up?
John August 40:49
There’s a few things. One is the warranty is voided. The other one is software that basically logs the fact that you’ve opened the case or tried to tamper with it. And worst case, you have software that basically self destructs if you meddle with something. That’s getting even more serious. I mean, there was a story of I think, Sony put a dodgy thing on CDs, that actually put a programme in your laptop that stops you from doing further copying of CDs. That caused quite a kerfuffle in the IT world. Whether it got to the outside world, I don’t know. But there’s some dodgy stuff that goes on there.
But anyway, so fair use exemptions for copyright. Okay. And obviously, that sort of spilled into the copyright of bits and pieces and of right to repair rather. And certainly, I think the Australian Government does have something that if you sold a car and you stopped selling it, you gotta keep selling the fit spares five or 10 years. Well, we also think that once a car is no longer really properly supported, it should be a free for all for people to make knockoffs and you know, run their 3D printers, bananas, whatever. So I think they should be thresholds where, okay, until this point, people could can claim a bit of copyright and this sort of thing. But beyond this point, come on, let people rip in.
But as far as patents go, for sure, our view is a few things. One is that that basically patents should only be used to protect stuff that’s actually being bought and sold in the market. And if you go back far enough, in our patent legislation, but there was a previous thing saying that if you have a patent, you have to serve the market. There was actually an obligation in legislation. In other words, it was saying, if you’ve got a patent, you should be making stuff and flogging it. Our position is that if you have a patent, then you should be making it. You shouldn’t be using that patent defensively and stopping others from doing it. And there is the whole thing of you know, patent trolls who have a bunch of patents sitting on the shelf, and all they do is run around with a mallet and whack people on the head to try to make that. To my way of thinking, that’s a complete abuse of what a patent should be. And we also have actual schemes where you actually declare the value of your patent. And if you’re not declaring it properly, someone can just put up their hand and buy the patent off you. So you have to value it publicly in a way that that sort of is sustainable.
And I suppose there is a whole thing of copyright that it shouldn’t be, you know, death of the author plus 50 years or 70 years, which is ridiculous. Now, the US kept trying to extend the copyright of Mickey Mouse to keep them. And so that was to my way of thinking, clear abuse of the patent process. So you’ve got patent trolls. You’ve got so-called evergreening of patents where a medicine is used for one use, and then they figure out an alternate use and get an extended patent on it. But it still gets a bit grey as to whether you could use it for the use to sort of run out a patent.
And I suppose a broader thing would be, it would be lovely, my vision is that, you know, an arm of the UN farms out grants the universities for basic research. And if some particular university then comes up with a idea, then the free market can get that idea for a nominal licence fee, and then rip in and sell it. And that’s re-pivoting the whole way corporations relate to medical patents. So notice we’re not totally against patents for medicine, but you know, these medical firms, I think there’s something like, oh, look, they spend a bucketload on R&D, and they spend even more on marketing. I think that’s telling us look, there’s something wrong with this picture.
And there was a story goes back… Unfortunately, I’m not up on these things recently. But going back about 10 or 20 years ago, there was a bunch of researchers in the UK that made this variant on interferon and that actually evaded the then existing patents and then they hired some Indian chemical firms to crank this stuff out. And it was what you might call an open-source pharmaceutical metaphorically. Those sorts of models I think are much better. But then there’s the fact that in the US, like me clicking on a button, software patents, to my way of thinking…
Look, this is going into the technical details of patent law. But I know a lot of commentators who said that like, way back when 100 years ago, in the UK, a patent was something that you basically bribe someone to do good things in the community, for the general good of society. In other words, yes, you were making a profit. But it should be articulated that not only were you making a profit, but society as a whole was benefiting. And that was the way the Brits articulated patent law 100-odd years ago. And it’s my view that that got morphed into the US, and the US much more was worried about coveting assets, you know, people own this, and we’ve got to protect the people who own it. And then the lawyers got in and defined all these things around it. So the emphasis changed. And along the way, the idea of the inventive step got watered down. And it used to be that was a very strong thing. This had to be really creative, you’ve done something big here. And then that’s been diluted in US patent law to think, oh, you’ve run this algorithm that anyone could have dreamed up, you clicked over here, oh yeah, we’ll give you a patent for that.
And, again, going back in patent law, there was, I think, a manufacturer of, goodness me ,of airline engines, of engines for aircraft, and they actually came up with this way, you can operate this engine in a certain way and reduce noise, and they wanted to get a patent on it. And the judge at the time said, look, these people piloting these planes responsible for hundreds of lives. And you want to add to their cognitive load that they can have to actually figure out whether they’re licenced to operate this bit of equipment in this way, or not, based on how they’re licenced. And that particular judge said, go away, that’s nonsense. And then, you know, there’s obviously the more recent excesses like the EpiPen. Someone was sort of making a gadget to check for COVID. And someone else wanted to do a patent injunction against them. I mean, even if they have a bit of a case, the best that the legal system should do is say, this is something of merit for society. Let’s let these people make the COVID equipment. And you can do a court case and extract profits from them after the event if it really is relevant. But so there’s a whole lot of messiness to do with intellectual property.
And what’s a few other things I can point out? That like, with Hollywood, I don’t know if you’ve heard the term Hollywood accounting, there was a guy who wrote the novel… Goodness me, what was it called? Forrest Gump, I think it was. And the first movie didn’t make a profit and they wanted to make a sequel. And he’s saying, Why the hell do you want to make a sequel if the first movie didn’t make any money? And so I think there’s this moral duplicity, where Hollywood gets very resentful about people copying their movies, but has no problem with dibbling their creative partner partners on their end of the fence. So there’s some dodgy stuff going on in the copyright industry there.
And there’s various cases of, you know, bands in Australia getting done by overseas copyright claims on music in their tracks and, you know, I think the band Men at Work was dragged through the courts. So there’s a whole lot of dodgy shit going on with intellectual property. What’s another story? I think Mattel had the Barbie doll and they had a copyright on the Barbie doll. And someone wanted to do a book on anorexia that had Barbie in the title. They said, no, you can’t do that. So again, copyright, trademarks, defamation, you had all these things into mix. Sure, you shouldn’t be able to sell a knockoff doll and call it Barbie and make money out of it. Okay, maybe. But, you know, protecting your trademark and stopping people from doing derivative creative works. I mean, come on.
Oh, yes. Okay. There’s one more thing I will say, which is, I think, a bit of a sideline to do with Trump. Now, you might remember, Trump was pushing back against the Trans-Pacific Partnership, and he obviously managed to win an election. And it’s my suspicion that a lot of people in the Rust Belt saw all of these trade treaties, and what those trade treaties meant was that, you know, overseas countries would sell stuff in the US, in exchange for them recognising US intellectual property laws.
And look, let’s just say, look, you’re the economist, and I’m sure we will agree that on paper, you have international trade and parties benefit, and the net wealth is increased. But under the hood, what happened in the US was there was a net transfer of wealth from people who made stuff with their hands to people who owned ideas. And it’s my suspicion that that might have been one of the factors in the Rust Belt of people going, hang on, there’s all these lovely trade treaties, which are supposed to be so beneficial, and we see ourselves losing our jobs. So that’s sort of, I guess, less to do with intellectual property directly. But I think it’s one of the things going on in in global trade and global politics. Look, I can I can say more about intellectual property. You got me started, but maybe I’ll leave it at that for the moment.
Gene Tunny 50:54
I’ll make a few comments on that. John, very good points. With the Rust Belt, look, yep, absolutely. And economists have studied that. And they have concluded that there certainly has been an impact on some of those regions. Some regions have been disadvantaged, jobs have been lost, and they haven’t come back. Metropolitan areas have prospered. They’ve done well. Their consumers are getting cheaper products. But then there are some Americans in some states, in rural areas or in the Rust Belt, as you call it, that have been disadvantaged. I’m trying to remember the study. It might have been by David Autor. I can put a link in the show notes. He looked at I think he called it the China shock.
That point about trade agreements, there is actually a debate in economics about these preferential trade agreements, free trade agreements. They’re not necessarily welfare enhancing for countries. I mean, the best thing you can do is actually to lower tariffs for all countries selling to you. So there are issues with these preferential trade agreements. In particular, if we sign up to some of these IP provisions that mean that we have to pay the American producers more, as you mentioned.
What’s the other point? Oh, I think you’re on strong ground on the IP stuff, because, yeah, economists generally think that… At least my impression is that economists are very much against just this, you know, these excessive IP, these copyright terms. So you know, what is it, 70 years you mentioned. And I remember when I was in Treasury, in Canberra, we had a visit once from David Levine, I think it’s Levine, from Berkeley. He’s a professor of economics at University of California, Berkeley. And he was arguing that, look, I mean, that as an economist, what you want is you want people to be incentivized to innovate, and to create new works. But you actually don’t need a lot of copyright protection to do that, right? I mean, you might need 5, 10, 20 years at the most. Beyond that, that would discount any sort of benefits beyond that practically to zero. And I mean, they’re not really going to care what their heirs… I mean, maybe some of them do, but they’re not really going to care about what their grandchildren are going to be earning from their creative works. That is not what is motivating them to be innovative. And I thought that was a good argument. So I don’t know if you’re aware of his work.
John August 53:29
Certainly, I mean, the echo there is, a long time ago, Walt Disney came up with the Mickey Mouse character. Did he think, wow, this is lovely, 70 years after my death, my estate will still be making money from this. So this is a bloody good move on my part to come up with this lovely looking mouse. And that’s sort of echoing your sentiment. And I suppose further to the point that we’re making before is that I think particularly in the US, they are artificially by legal means extending the life of assets to benefit the person who owns that asset, but not in any meaningful way contributing to the economy at large. And, as I say, my feeling is that in the US, they really got behind, oh, you own that thing, oh, we need to protect you. And that sort of just went a bit crazy in the US as compared to the origins of intellectual property in the UK, which were a bit more restrained and sensible.
Gene Tunny 54:26
So on the trade agreements, I might put a link in the show notes, there’s a book that I’ve read recently that I can highly recommend, Termites in the Trading System, by Jagdish Bhagwati, one of the great Indian American economists. He’s based at Columbia. He’s a professor there. So very good book and he’s been very critical of all of these trade agreements, for reasons including what we’ve talked about there, that they’re not necessarily welfare enhancing, just the way that they’re rolled out. Okay. Finally, John, it’d be good to chat about business support. Do you have a blanket ban? Or are you against business support? So all of the subsidies, the what you might call crony capitalism, what’s your position on that?
John August 55:21
Well, in broad terms, yes, I’m very much against crony capitalism, against support for business. Now, look, there are some exceptions for very well-defined social outcomes. Now, this is going off on quite a tangent, but you know, the whole thing of like, childcare, and like, you know, subsidies to consumers of childcare. And, you know, I guess it’s more a personal position that’s informed by other, not that I’m an economist, but other economists in the Pirate Party. And we talk about subsidising supply. So it may make sense to have grants to businesses to either establish childcare facilities, expand childcare facilities, and maybe have a hex discount for people who are trying to qualify themselves to work in childcare. And notice, that would be a corporate subsidy for a very well-defined social need that needs to be properly articulated and costed, and yada yada yada yada.
But in broad terms, I think a lot of the subsidies we get, like, I guess the whole cliche is, you know, the government expands this port, spends bucketloads of money on it, then these firms sort of ship the gas off overseas, and we end up paying more for the gas as a result of the cabinet investing in the port works, you know what I mean. There’s a lot of dodgy stuff like that, that you can point to. So certainly against that. And I suppose we have a broader position against bureaucracy and rent seeking broadly defined. So that’s certainly the case. But to get into the nuts and bolts of that, I have to admit, I’m going to struggle to get into…
Gene Tunny 57:00
That’s okay. Well, I mean, it’s probably a good time to wrap up. I’ve had you for nearly an hour, and we’ve had a really good discussion of IP and before that on Georgism. I thought that was really interesting. Also the negative income and the taxation of churches. So something that I’ve been interested in in the past, particularly when –
John August 57:21
I can but say, yes, go back 10 or 15 years ago. And look, there are a moderate number of like, shall we say, economically qualified people on the secular side of the fence, who are all going, look, look, look, and no one’s paying attention. So in a sense, it’s lovely that your programme, which you might say, as it’s starting to approach the mainstream is actually putting a bit of light on this sort of issue. And that is actually quite wonderful, I have to say.
Gene Tunny 57:45
Yeah, well, I’m trying to be frank and fearless. And as someone who was in, I worked in the treasury, and I’ve worked in around policy, I think we really should approach these issues rationally, and not have these… I guess a lot of people probably think, oh, we can’t do that, or we’ll upset these people. And if you look at these things rationally, that a lot more policies become, or changes become, you know, something that should be discussed and debated. So that’s what I’m trying to do with this show.
John August 58:16
Well, I will put in a bit of a plug for the Pirate Party. Look, I’m not saying we’re not were the only innovative party out there. But as a small party, we can actually talk some very creative and innovative things. And as I say, look, who knows, maybe the Liberal Party will have the odd good idea. But for them to do it, and have people believe that they’re honest and honestly inclined, you know, they have such a track record, where a party who can say, look, there’s some economic realities we should consider here and let’s think about XYZ. And if the Liberal Party did something like that, people would just shake their heads and go, Yeah, another one, you know. So there are some opportunities that small parties have to put innovative ideas out there.
And yeah, as I say, I won’t claim that pirate party is the… I should say Fusion. Oops, I think we’re finally got to this point, I should emphasise the Pirate Party is a part of the Fusion amalgam. And so that does actually include the Science Party, the Secular Party, the Pirate Party, and Climate Emergency. So they are the different branches of Fusion. And while what you were saying, certainly, there are degrees of development of policy within the Pirate Party, and like we have our basic original form of the Pirate UBI that you can look at, and that’s all very good, and we’re continuing to develop our ideas, and obviously, that’s within the Pirate realm or the Pirate branch of Fusion. And obviously, the Fusion has sort of more universal policies that everybody adopts. But you know that that’s a limited subset of what we’ve been talking about.
Gene Tunny 59:59
Yeah. Okay. John, this has been great. I’ll put links to your social media channels. And you’ve got your own radio show. Is that right?
John August 1:00:11
Yes, I have a radio show broadcasting out of Marrickville in Sydney on Radio Skid Row. So there’s some links to that. You can check out some old episodes. There’s also my own website, johnaugust.com.au. But, you know, hopefully, you’ll put that amongst the links there. And I will also mention, there’s a gentleman, Quinton Fernandez, Professor Quinton Fernandez of University of New South Wales. And he’s actually been saying that, like, the UK was abusing the free trade situation when they were the top dogs. And he’s also got his own views on intellectual property, like value global value chains, and just how much intellectual property is a part of the fact that like, things are a token amount coming out of Taiwan. And then the price goes up by 10 times because of, you know, intellectual property and branding. And it’s quite staggering when you listen to the picture that he paints.
Gene Tunny 1:01:11
Okay, I’ll, I’ll have a look at his work and might see if I can get him on the show sometime in the future. Okay, John August, thanks so much for your time. I really appreciated learning about the Pirate Party platform, and just the discussion of the economic issues because you raised some very good ones there. And it was great to be reminded of the work of Henry George, because it’s one of those fascinating ideas that economics has come up with over the centuries. I remember what I learned about him in the history of economic thought, I thought, that’s a fascinating perspective. Yeah. So very good. So, again, thanks so much for your time.
John August 1:01:58
Well, there is a lot of merit in what Henry George says, but I don’t believe in the single tax. And I do think that his philosophy was 90% correct. There will be some little sort of rejoinders I’ll make to what you said, but you know, it’s certainly 90% got the full picture.
Gene Tunny 1:02:15
Yeah, that’s an important thing to note. I might try and find a guest to cover Henry George in a future episode, just to go through some of the intricacies of it. Righto. Okay. John, thanks so much for your time, and all the best. And, yeah, hopefully I’ll chat with you again soon. Thank you.
John August 1:02:39
Oh, well, I do look forward to that. Thank you very much for the opportunity. I think the Pirate Party has been saying some interesting stuff. It would be lovely for that to be more broadly recognised, and it’s lovely that you’ve obviously taken the interest in interviewing me, so very much appreciate that.
Gene Tunny 1:02:54
Okay. Very good. Thanks, John.
John August 1:02:56
Okay, thanks, Gene. Bye.
Gene Tunny 1:02:59 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 EP138 guest John August and to the show’s audio engineer Josh Crotts for his assistance in producing the episode.
In episode 137 of Economics Explored, Australian Universal Basic Income (UBI) advocate Michael Haines chats with show host Gene Tunny about the benefits and costs of a UBI, with an extensive discussion of how it’s paid for in Michael’s proposal. The conversation considers money creation and so-called Modern Monetary Theory (MMT).
You can listen to the conversation using the embedded player below or via Google Podcasts, Apple Podcasts, Spotify, and Stitcher, among other podcast apps. A transcript and relevant links are also available below.
About this episode’s guest – Michael Haines
Michael Haines is the CEO of VANZI, the Virtual Australia and New Zealand Initiative. Michael has 40+ years of experience in a wide variety of senior management and consulting roles across a range of industries: government, telecommunications, brewing, construction, consumer goods, car manufacturing and transport and logistics covering a wide range of disciplines. While he has previously sat on the Board of the Australian Logistics Council and remains a member of Austroads Intelligent Transport Industry Reference Group, he was instrumental in establishing VANZI and his entire time is now devoted to the VANZ project.
Transcript of EP137: UBI advocate Michael Haines on its benefits and costs
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.
Michael Haines 00:04
Whether it’s through accident, the health, being sacked, being divorced and losing the income of your partner. All sorts of reasons why suddenly you lose that income. Well, if you’ve got a UBI coming in, at least you’ve got enough to live on.
Gene Tunny 00:24
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 137, on benefits and costs of a UBI, or universal basic income.
I’m joined this episode by a retired Australian CEO in the manufacturing and logistics sectors, Michael Haines, who has been doing a lot of thinking about the benefits of a UBI and how to cover its costs. This conversation will give you a good idea of what advocates of a UBI see as its major benefits. You’ll also hear a discussion about the relevance of so-called modern monetary theory, MMT to the UBI debate. If you’re a regular listener, you’ll know that I’m highly sceptical about both UBI and MMT. But I did my best to remain openminded in my conversation with Michael.
Please check out the show notes for relevant links, any clarifications and for details of how you can get in touch with any comments or suggestions. I’d love to hear from you. As Michael indicates in the discussion, he’d welcome your thoughts on his ideas and his proposal. So please send them my way. And I’ll pass them on to Michael. Righto. Now for my conversation with Michael Haines on the benefits and costs of a UBI. Thanks to my audio engineer Josh Crotts with his assistance in producing this episode. I hope you’ll enjoy it. Michael Haines, welcome to the programme.
Michael Haines 02:01
Well, thank you, Gene, very much for having me here. I’m really excited to have the opportunity to speak to your audience who is probably more educated in these topics than the people I normally speak with. So I’ll be looking forward to any feedback you receive.
Gene Tunny 02:17
Okay, yeah. So keen to chat with you about universal basic income. I’m interested first in your journey to becoming an advocate for a UBI. Could you take us through that, please, what got you interested in this as an idea, and then we can go into what you see as the merits of it.
Michael Haines 02:39
Have you got time for a life journey, Gene?
Gene Tunny 02:41
Oh, please.
Michael Haines 02:42
Back in the 1980s, I was group general manager of one of the top 200 public companies, and first to actually, as far as I know, get involved in the use of trusts to minimise tax in a public company. And in the course of that, I guess I began to query myself as to the whole issue of why we pay tax and the complexities of our tax system and money system. And so through that, I just took a journey myself to explore tax law and integration with the money system, banking system, and so on, and develop thoughts then around how we might integrate a flat tax system on spending with a flat payment, which is effectively a UBI, which would turn the tax on spending effectively into a progressive tax on income if it was structured correctly. So I have worked my way through that for quite a few years and talked to a few people about it. But it really never gained any traction. I didn’t have the academic background, because I was involved in business, to really progress it, and drifted over the years.
And then I guess more recently, it’s become apparent that across the world, there’s a lot more interest in a UBI. And that spurred me to… I’m now 73. So I’m effectively retired. It spurred me to do something about it. So, a bit over a year ago, I got involved with a group called Basic Income Australia. And through them, I undertook the task to write a policy document, which is about 111 pages long, and I don’t expect anybody to read it. It was really aimed at capturing our understanding of all of the ins and outs of a UBI across the world, pilots that have been undertaken, what they tell us, what the academic community feels about it, pros and cons, and then to, I guess, evolve the ideas that I hope to talk to you today about, which we believe provides a bit of a different wrinkle to how UBI is seen and how it can be implemented with relatively low risk. So that’s my journey.
Gene Tunny 05:17
Right. And can you tell us a bit about Basic Income Australia, please, who’s involved in it?
Michael Haines 05:23
It’s just a small group that was started by a guy called Josh McGee a few years ago. He’s a highly talented mechatronics engineer, and he’s just qualified. And he took an interest in the UBI quite a few years ago, and gathered together a group of miscellaneous miscreants who had a similar interest. And so it’s not a professional group. It really is a cross-section of people who are interested in seeing the basic income become a reality in Australia. So I guess I’ve endeavoured to bring some sort of more rigour into the specifications of what a UBI might entail. And that was through the process of writing that policy document. So I’d very interested in, as I’ve been speaking to you earlier, to get the feedback from your audience, as to what they think about the proposal.
Gene Tunny 06:27
Absolutely, and I’ll put a link to that policy document and some other articles that you’ve prepared, or that you were telling me about, some Medium articles, is that right?
Michael Haines 06:37
I’ve just completed a series, or completed a series of about seven articles that look at the rationale for UBI compared with welfare and the job guarantee, look at how we can implement it without increasing taxes or debt or taking money from other programmes or incurring excessive inflation. So that sounds like magic. But we believe that there is a way to do it. Another article then considers in more detail, how to implement it with low risk. And then three papers looking at the benefits. About 24, we’ve identified for the individuals, about 19 or so I think, or 17 for business and the economy and maybe 19 for government and individuals. So that series, we hope, they’re only about a five-minute read each, should give people a good understanding of what we’re about.
Gene Tunny 07:39
So it’s interesting, you were thinking about this in the 80s. And that it’s recently that you’ve come across this UBI idea, that this is something that is, this idea is taking off worldwide. And I’m trying to remember when I first heard about it. It probably would be in the last maybe 5 to 10 years, it’s associated with the sort of Silicon Valley crowd, isn’t it?
Michael Haines 08:05
[Unclear 00:08:05] and BIEN as well, Basic Income Earth Network, which Guy Standing and others have been involved in. I think the history of it goes back to Thomas Moore, and others. So we’re talking about people throwing these ideas around for a long time. But one of the biggest concerns people seem to have, and rightly so, is the cost because most people say that’s a wonderful idea. And, you know, if I was to say, well, we’re gonna give everybody a super yacht, similarly, that’s a great idea. Yeah, I’m all for getting my own super yacht. But, you know, quite realistically, we can’t pay for it. So that’s one of the major focus points that we’ve looked at, you know, how do we afford it.
Gene Tunny 09:03
Yeah, yeah, we’ll definitely come to that. I just want to start off with… Before we get to that, I’d like to ask you, what do you see as the merits of a universal basic income? And I know that you’ve referred back to, well, prehistory in a way, haven’t you, in thinking about that? So could you take us through what you see as the merits of it, please?
Michael Haines 09:28
If we go back to prehistory, every human born had a basic birthright, which was to live off the land. And the richness of the land would determine basically how well you lived, but that birthright was there regardless. With the advent of property rights and money and a system of paid work, that is no longer available for most people to live off the land. It’s meant that the human species now, at least in the developed world, is absolutely reliant on money. You have to have money if you want to buy a sandwich down the street, a bottle of water. It doesn’t matter what, money is the source, or the access point for the resources that you need to survive.
And so given that, we then have to look at well, while this whole new system has been really advantageous for the great bulk of people, lifting living standards, health and so on, for a section of the population, it has really left them out. About 12 to 14% of the population, in most of the developed world, live in poverty. They’re mostly single women with kids, aged, disabled, they’re unpaid carers, mostly family, and also people who are between jobs, all of whom lack savings and family support. So in Australia, that’s about 3.2 million people and 17% of all children.
So it’s an indictment not of those individuals, but of the system, that they are living in poverty in what is essentially a very wealthy country. So there is no doubt that we have the resources to ensure everybody has enough to survive, food, clothing, housing, and so on. So what is lacking is neither the resources nor the money. We create the money. So what the problem is, is getting the money into the hands of people who need it, and the way that we’ve traditionally done that is through welfare.
But welfare comes with a poverty trap. And that is, it is perfectly rational for a person to look at a benefit and say, I’m gonna take the benefit instead of this shitty low paid job. So it’s nothing to do with moral failings. It’s, you know, you and I, given the choice between the two, we’re gonna say, well I’m gonna take the low pay benefits. So it is then perfectly rational for government to say, well, hang on, we’ve got work out there that needs to be done. We got people who are capable of doing it. So we must keep the benefits really low in order to encourage those people to take the work that’s available. And that works in the main, right? People, if they can get off the welfare benefit and into work, and they can do it, they will.
But there is a whole section of the population who cannot do paid work, which as I said, is the single women who are caring for kids and they’re carers for the aged and so on, so that it’s creating a poverty trap, which we could solve with more welfare, or higher benefits, if we absolutely could guarantee the ability to identify those people who genuinely can’t work at any time, and have a real time system that as soon as people fell into poverty or came out of it, we could always capture them immediately. And some countries do that better than others, but nobody has really solved it, because as we said, across the world right now, we are faced with 10, 11, 12, 14% of the population who are in poverty.
So what we’ve looked at is said, well, a universal basic income in which everybody has, as of right, a payment to ensure they can meet their needs, well then they’ve got that money, there’s no need to apply. There’s no need to justify. And if you suddenly find yourself without an income, so most people are at risk of losing that income overnight, whether it’s through accident, their health, being sacked, being divorced and losing the income of your partner. All sorts of reasons why suddenly you lose that income. Well, if you’ve got a UBI coming in, at least you’ve got enough to live on.
And so yeah, that’s where, I guess what we saw as the rationale for a UBI. But we’ve also identified over 50-odd benefits that once you do have it in place will flow from it. So I don’t know where you’d like to go from here. I can talk through how we might fund it, how we can introduce it, we believe, with low risk, and what some of the benefits are.
Gene Tunny 14:51
I’m keen to stay on the benefits for a while. What do you see as those as those benefits? I mean, you talked about the fact that it is an income redistribution tool.
Michael Haines 15:04
Can I stop you there, Gene? I don’t see it as an income redistribution tool. And this is why it’s necessary to explain how we see funding it. Because we don’t believe it is necessary to take anything away from anybody in order to ensure that everybody has the basics, simply because we do have the resources in Australia, to feed people, to clothe them, and ultimately to house them. What we don’t have is a mechanism to get the money into people’s hands. And so we believe we can do it without redistribution, which is what I’d like to explain.
But if we put that aside for the moment, and again, just look at the benefits, for a very simple one, it would reduce for an individual reliance on debt. So no more payday loans and the stresses that that brings. It provides us with sort of indicated income and basic income insurance, because if you lose your job, at least you’ve got that money coming in to live on. It eliminates, as we said, the welfare poverty trap. It eliminates bureaucracy for people. You no longer have to be worried about, you know, these mutual obligations and ticking boxes and just going through the hoops, for the sake of quotes, proving your entitlement. It eliminates social stigma and intrusion into your life, because you’re just getting it as of right like everybody else is. It underpins lifelong learning. It means that people who might want to take some time off to do a short course will cut back their hours. So I can’t do that. I’m struggling to meet my daily needs. With the UBI coming in, it will assist them in that.
It empowers people also to do the right thing. So we know that people through the threat of poverty are forced to do unsafe, illegal and unethical work. And when now as a society getting to the stage where we’re recognising the need for consent in the bedroom, a UBI empowers people to have that same consent in the workplace to be able to say, no, this is unsafe, this is illegal, this is unethical.
It provides some flexibility too for where you might work and the type of work you do, because it gives you some income to actually move to where the work is. If you are destitute, it’s all very well to say, hey, there’s new work in New South Wales. But how do I get there, and my few goods from where I am to where the work is? But with the money coming in, it provides increases in employment opportunities, because what it means is that as the money gets spent into the economy, it is going to generate more demand, which will generate more need for more labour.
It provides some recognition for in-home care and home maintenance and looking after families and creating the social bonds that people do who are not in quotes paid work. But maintaining those social bonds in the home are critical to a well-functioning society. At the moment, we don’t place any monetary value on that, and a UBI would, by paying a person to do that work. In effect, it provides respite for home carers. So people who are struggling to look after aged and disabled now will have a bit more money coming in to maybe put the person that they’re looking after into care or taking some time themselves. It actually adds to the income also of the aged and disabled.
We see it working such that the UBI would be treated as income under our existing welfare systems. So as the UBI increased, it would naturally reduce benefits, but the benefits would remain intact. And so depending on the level of the UBI, it would supplement the benefits that are netted from the existing system so nobody can be worse off. But most people in that circumstance should be better off.
Another big factor is it ought to reduce the incidence of family violence and also facilitate escape, because a lot of family violence is created from the financial stress that occurs when people are living on the edge. And so by leaving that financial stress, it should reduce the incidence of violence, but for women, and it’s mostly women who are caught in that sort of relationship, they now find that they can’t escape, because where are they going to live? How are they going to survive? They’ve got no income, they’ve got no job, whereas with a UBI, they’ve got that money coming in and can move anonymously and set up a new life. So it helps them. As we said, it is enables escape from poverty. That’s probably number one.
From around the world, we’ve seen studies where ensuring people have enough to live on, it improves their cognitive function and improves behavioural disorders, prevents suicide that is driven by financial stress, helps kids focus on schoolwork and higher education, for the same reasons it improves cognitive function. And evidence from the pilot says that it also improves nutrition, and in fact, reduced alcohol and tobacco use.
Gene Tunny 21:18
Right. Do you know which pilot that was?
Michael Haines 21:20
Yeah, I can give you that detail. I haven’t got it off here. But I can certainly give you that. And it would enhance self-determination, which is especially important for our First Nations people who have for a couple of centuries now been treated as a society of dependent individuals who have to be looked after, and so on. Whereas, if we pay UBI, unconditionally to everybody, well, that includes those of our First Nations people who can then make their own decisions that they are able to thrive instead of just simply survive, especially by pooling their resources, and so on.
So, I mean, these aren’t silver bullets that are going to solve all the problems, but they are additive and cumulative in the way that they can help us address some of these issues. So that’s just the 23-odd benefits for the individuals. There’s a whole lot for, as I said, business and the economy, for government and for the people in general. I don’t know whether you want me to go through all of those how much time we’ve got.
Gene Tunny 22:38
I can put a link in the show notes to that list. I want to ask you about this concept of technological unemployment. Is that one of the motivating factors behind UBI? Have you thought about that? Is that one of the reasons you’d advocate for it?
Michael Haines 22:57
Yes, absolutely. And so one of the things that we’ve looked at is that once we get the UBI to the poverty line, and there’s a whole process to get there, then what we’re suggesting is, in fact, the UBI be set up and managed by a new authority under its own charter, independent of normal government. Funding would not go to the government deficit, because the money would not be going to the government, it’s actually going directly to the people. And so that authority would manage the money. Now I’ve lost track of what the question was you asked me.
Gene Tunny 23:37
I was asking about technological unemployment.
Michael Haines 23:41
So that authority then would have the capacity to say, well, we’ve now got the UBI to the poverty line. If as a result of automation and virtualization, we start to see a drop-off in employment, we can then increase the UBI and allow the market to rebalance dynamically, back to full employment, because everybody has a different propensity to take on paid work, depending on their age, the commitments or the money they might have coming in.
And so as the UBI is raised, there will be people will say, hmm, I will now live on this money with whatever else I might have. I’m no longer going to worry about looking for work. And so we can tell, as people drop out of the workforce, we will begin to see a lengthening of standard recruitment times. The labour market will be seen to be tightening and the authority says oops, well, we don’t need to go up any higher. We’ve gone as far as we need to go. The market is back at…
So it gives the government through the authority a much more targeted or more precise tool to help manage and balance the labour market than simply the cash rate through the Reserve Bank or fiscal spending, which is a very indirect means for managing it. But because the UBI is income for people, then as their incomes change, they will make real time decisions about whether or not to move in or out of the labour market. So we see it as a very valuable new tool for the government to manage this disruption. Personally, I don’t see there’s any end to work. It’s going to be a never ending requirement for people to be doing different things. But there will certainly be disruption as traditional work is overtaken through automation and virtualization.
Gene Tunny 25:53
Okay, just thought I’d ask you that. Because my impression was that one of the reasons that a lot of the Silicon Valley people have been advocating for a UBI is that they see this new world in which there’s all this automation and AI, and you’ll have lots of people without work. And I mean, I know with automation of the vehicle fleet in the United States, for example, that they’re talking about the next 10 or 20 years, you could have 3 million people driving trucks who are no longer needed.
Michael Haines 26:32
It’s going to come quicker than that, through what I’ve just recently seen, that there’s a new robotics company, which is taking a very different approach to robotics in the workplace. Whereas there’s two types of robots, or three types, there’s the traditional type, which is very structured and has to go through these very specific steps. There’s a new type that has got some spatial awareness and some ability to act autonomously. But nowhere near the general intelligence required to do sophisticated manual handling work and so on and making decisions on the fly. Well, what this company is doing is saying with high-speed internet, now, we can actually globalise the workforce, while the worker is the robot in the local economy, controlled remotely by somebody anywhere else in the world. And that, in my mind is a major shift in how our labour markets… So now again, I’ve lost my train of thought.
Gene Tunny 27:45
We were talking about robots and being controlled by people remotely.
Michael Haines 27:51
It’s just that new way should see the continued globalisation of the workforce, despite the re-localization of the production capacity. So we’re seeing more and more production capacity relocalized. A lot of it is automated, but still a lot would remain with a need to have local people doing many of the jobs. But if a robot can be controlled remotely, then that’s a whole different ballgame again, so yeah.
I think the essence where I differ with maybe the Silicon Valley tech view, which has been promoting quotes a basic income as truly basic, and that what you end up with is, you know, millions and millions of people just eking out a living and a terrible society, structured with a few earning huge money and the rest eking it out. If we take the view that the UBI should be set to balance the labour market, then individuals are making their own choice about whether I go off and do other things, creative things or become more engaged in the community and sport. I mean, there are hundreds of thousands of things that human beings can do other than work once they actually have the freedom of mind to do that. You know, there is the whole issue around work providing meaning, and it does but there are lots of things that people find meaningful which don’t necessarily involve paid work, and a lot of paid work is hardly meaningful. It can be bloody soul-destroying. What it does, it allows each person to make their own choice in a market where the UBI is set to achieve balance.
Gene Tunny 30:05
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Gene Tunny 30:40
Now back to the show. So we might go into the particular plan that you have, Michael. I’m keen to sort of explore that. Because as you know, I mean economists are going to be… Well, I think economists are very concerned about the cost of a UBI. They would say that you need to pay for it somehow. There’s no free lunch. So that’s a maximum of economics, there’s no such thing as a free lunch. So would you be able to take us through your concept, please, and explain just how it works? Because I know I’ve got some questions about it. But I want to make sure I understand the logic first, please.
Michael Haines 31:27
Well, you’re absolutely right about no free lunch. I guess the lunch part of it is to do with our actual resources, right, the sandwiches we eat, the houses we make, the engineers we have, and the chefs available to do the work. So that is the constraint. And one of the things that we’ve looked at is to the whole modern monetary theory, and which doesn’t have a good name broadly through the economics profession, and I think, to some extent, rightly so, because unfortunately, the way in which it has been pitched is as effectively an unlimited flow to government to then make decisions about how the money gets spent into the economy. You then have politicians and bureaucrats, you know, with their hands on this, quotes, unlimited spigot of money, and expecting that they are going to make good decisions that support the wellbeing of the whole economy. So we’ve looked at it different.
And so let’s go back to first of all understand how money gets into the economy. And apart from quantitative easing, which in fact, most of the money went into the financial economy, the real economy, but most of the money, as I’m sure your audience knows, gets into the real economy through bank lending. And so as a borrower goes to a bank, the bank creates the money, the borrower says, thanks very much and spends it in the economy, creating new activity that would not have occurred had that borrowing not take place, because the money is effectively new purchasing power, and it redirects our resources. It’s the source of growth in the economy, as businesses borrow and others borrow to spend into the economy.
So if we are creating money for that purpose, then the opportunity is to do the same thing, create money out of thin air, but instead of giving it to borrowers who are obliged to repay it, and so they should, because they’re getting an advantage purchasing power that they haven’t created or added to themselves. So they should work, add value out of that value, earn the money to repay the loan. So that works fine.
But if we’re now going to pay, create money and pay it to every single person to meet their basic needs, then we’re able to look at this and say, well, if there’s an example where suggesting that the amount of money should be $500 per week per person. Now, that comes out, for 20 million adults, about 520 billion bucks a year. Absolutely can’t be sustained.
But if you offset it against the welfare benefit, if you recover a substantial proportion through earned income and allow for the fact that some of the money is going to be recovered again via taxes, as the economy grows through the spending, some is going to go offshore, some into the financial economy. We think there’s about $100 billion net that would get injected into the economy of new money every year.
Now, some of that can be offset simply by reducing bank lending, because bank lending is putting new money into the economy every year. So instead of the new money all going in via bank lending, some of it now would come in through the UBI. And we can manage that as we do now, by managing interest rates. So as interest rates go up, there’ll be less bank lending, but there’ll be more UBI coming in, which should continue to ensure the economy maintains full capacity. But more of the capacity will be going to meet basic needs and less on other spending.
Business will have to adapt to that new pattern of demand. And we are suggesting a way to implement that with low risk by starting small, so just 10 bucks a week to start with, paying everybody, ramping up over five years. So what that does is allows the supply chain time to adapt to the new pattern of demand without causing shortages that drive inflation. And then you’ve got, at the end of the day, more money going in via UBI, and less via bank loans.
If there’s a net addition, we’re still looking to grow the economy 3or 4%, we’re looking for 2 to 3% inflation, and $100 billion in a 2 trillion economy is about 5%. So we see that it ought to be feasible to get to that 500 bucks a week level with the offsets that we’ve designed in. But we don’t know, and nobody knows, and nobody can really model it. But we don’t have to model it or guess, because if we start small and increase slowly, we can actually see what happens. We can see what’s happening in the economy. And if it looks like the negatives are starting to outweigh the positives, then we hold it and address the negatives.
My feeling is that, as we talked about the benefits to the individuals and the many other benefits, we will see a wealth of positives. And that’ll encourage us to actually speed up the rollout rather than cut it back. We don’t have to guess because we can actually see what happens. So that’s how we’re looking to implement it. And I haven’t spoken in detail about the offset and the recovery. But I’ll leave you to ask the questions now.
Gene Tunny 37:53
Yeah. So that recovery, I think one of the things you were talking about is what Ben Phillips was talking about when I spoke with Ben about the claw-back. I mean, what is that recovery as you as you earn money from work? And you know, what happens to the UBI payment? I mean, is there any claw-back of that? Is that what you’re talking about?
Michael Haines 38:17
Yeah. So what we see us that we don’t want to touch welfare as it is, but we treat it as income for welfare. So all of the rules and entitlements and everything stay the same. And the same with our tax system. We don’t want to touch the tax system, because that gets into all sorts of arguments. What we want to do is, under the separate authority, every week, they will be paying out the 500 bucks a week to every person, but they will appoint the tax department as their agent to recover the UBI from people via group tax, the GST system or the annual returns based on a very simple formula, that you will have to pay back 32.26% of your gross income through the tax system, in addition to whatever tax you’re paying, because the tax you’re paying relates to your income. The recovery relates to your UBI. So we’re going to give you the UBI. But the more you earn, the more you will have to pay back, so that by the time you get to $80,600, everybody earning that and more, they’ll be getting their 500 bucks a week in, and every week or so over the paying the 500 bucks back to the authority. That money gets put back in and recirculated in the next cycle.
And you say well, hang on, why pay people 500 bucks just to take it back off them? And the answer is because circumstances change overnight. And by paying people the money, it becomes like basic income insurance. It ensures that if I suddenly lose my job, I get sick, I have to care for a family member, for whatever reason, my income is suddenly lost, a pandemic comes along, there’s floods, fires, storms, whatever throws people into… They get divorced. That money is there coming in.
And now when I’ve lost my income, there’s no more recovery. So I’m getting the full amount, there’s no delay, there’s no need to apply. And then when I find I’m in a position to look again for work, I can do it without having to go and tell anybody. I don’t have to tell anybody what I’m doing to get it or whether I’m retraining myself. I don’t have to tell anybody how much I’m earning or any details at all, other than, of course, the tax department, which I normally have to do. And through that tax department, once I start earning again, the recovery would start to take place. But again, I’m better off because whatever I’m earning, at less the tax, is on top of the net that I get out of the UBI.
So up until $80,600, I am going to be better off by having the UBI. And we think that covers probably 75% of the population, and the other 25% are no worse off, which is why I said earlier, we don’t see this as a redistribution. What we see it is as a way of providing people with the means to express their needs in the market, and for the market to respond to meeting those needs. without taking anything off anybody else. You could say that if interest rates are going up, then people are unable to borrow as much as they might have. But on the other side, the money that’s going into the economy is going in debt-free. And that money will therefore, as it flows through the economy, to profits and investment, it’ll help the economy to grow and stabilise without the need for such high levels of increasing debt. So we see that’s also an advantage for the economy.
Gene Tunny 42:29
Yeah. Okay. So I think that argument would be more persuasive if we did have this high level of technological unemployment, if we had a large amount of unemployed resources. And that argument is going to be more persuasive. I guess the concern that economists would have is that, well, if you’ve got an economy that’s operating near full employment, as you could argue the Australian economy is now, then we don’t really necessarily want to be adding that additional demand to it because it could be inflationary. So concerns about inflation will be one of the major concerns about this proposal.
Michael Haines 43:12
So you’re right. And that’s why we are proposing to start small, because at 10 bucks a week, that is really a big deal for somebody living in poverty. That’s food for a day. So it might not seem much to you, or to most people, but at 10 bucks a week, it’s a start, but it’s not going to destroy the economy. It’s not going to, you know, cause havoc. But in a quarter’s time, we would see that being increased by $25 a week. So people are now getting 35 bucks a week. So it’s a bit more, and we can see what is happening.
Our expectation is that while there are inflationary pressures, they are in specific parts of the economy. And for things like food and clothing, and some of the basics, the opportunity is there for businesses to redirect resources. At the moment, you’ve got cafes and people like that crying out for labour and so on. But if the resources are directed towards meeting more basic needs, because people now have the money to express those needs, we would simply see over time, a shift in the way the economy is structured, which is why we are wanting to do it slowly, so over five years. Otherwise, you put 500 bucks a week into the economy, even with the claw-backs, it would create havoc, as we have seen with the disruptions due to the pandemic and now the war, where you alter the supply chain overnight, literally. It creates bottlenecks that are really hard to manage.
I was once manufacturing manager for Toyota, and also on the board of the Australian Logistics Council and ran a major logistics company in my day. So I really understand how the supply chain works. And you can’t just turn a tap on and say, okay, now people start spending this money, and expect it to just flip overnight, but you can expect it to change over a period of five years. And in that time, we are going to see more and more automation. And the UBI, in fact, could assist in helping firms to automate, because there’ll be a number of factors in play.
You will have people who are getting the UBI, who now say, well, I’m not going to work, I’m happy to live on the UBI. So the labour market might tighten. But you also might have people who are you saying, well, I’ve now got the UBI as a base, I’ll actually take on this extra work, which wasn’t previously worth my while because of the benefits I lost. But now I’ll take it on. And the new automation pressures might come in that interplay. We don’t know whether there’s going to be more people wanting that extra work or less.
But over time, regardless of what people are doing in terms of offering themselves to the labour market, it’s clear that there is going to be more and more automation, and virtualization. So virtualization is a hidden factor in that you don’t realise what you don’t have. And if you look at all of the devices that the smartphone replaced, there’s a huge amount of what used to be physical work and effort in producing all the goods that’s now all done by software on a little phone. And that’s just going to continue now. And so we are going to see this automation play out more and more.
Gene Tunny 47:24
Remember when there used to be Kodak processing centres all over the country, all over the world, and don’t have those anymore. Right. Okay. Now, one of the other things I want to ask you about, Michael, is this… You do recognise rightly that your proposal is leading to an expansion of the money supply. And look, you’re right about bank lending and what it means for the money supply. That’s correct. There’s a Bank of England article about that. And I’ll link to that on money creation.
Michael Haines 48:01
That is the best article. When I said I was back in the 1980s, one of the things that I – realisation I came to was actually how money was created. And talking to economists back in those days, it was absolutely shot, because until that Bank of England paper came out, there was often not the recognition of just how money was created. And so, yes, I really appreciate you making that link. Because it is such a good, clear, concise paper.
Gene Tunny 48:40
Yeah, money creation in the modern economy. I think I mangled it before. I mispronounced it. Yeah, well, I think, yeah, there was this debate in the ‘60s and ‘70s, about monetarism. And there were economists at the time who were pointing out that money was actually endogenous to the economy and that it was associated with the actions of banks and people borrowing money from banks. Who was it? Was it Nicholas Kaldor, who was one of the famous Cambridge economists? He was a student of John Maynard Keynes, whereas I think Friedman made a lot of great contributions, but he was probably off track a bit where he was assuming almost that the money supply was this exogenous variable that could be controlled easily by the central bank. Now central banks, obviously, they can influence it, but it’s not necessarily…
Michael Haines 49:46
It’s not easy to control. And so, one of the things that we would see is that the new authority with the central bank, as the UBI was raised, it’s very important that because that UBI is now signalling new demand, that firms and individuals be able to borrow, to increase capacity to meet that demand. And we don’t want the cost of that borrowing to go up. And so what we would want is for individual banks on a case by case basis, under guidelines, making decisions to say, well, you’re asking for this loan to help increase our capacity to meet the basic needs of our citizens. So you’re going to get this at no extra cost. But if you’re borrowing for other, say, nonessential purposes, then we want that borrowing to be reduced to free up resources to shift across to meeting more basic needs. And so the cost for you to borrow is going to go up. Now, this is a whole different way of thinking about it. It’s applying a premium on top of a set of loans rather than increasing the base, which is what we do with the cash room.
And so let’s take an example of how that could work, say in housing. At the moment, housing prices go up and the bank starts to worry, we’re into an inflationary period, we’ve got to crunch it and increase interest rates. That increases interest rates for everybody, including the poor little guy who’s got his highly productive business, but now it’s pushing him on the margin, when really all we want to do is we want to increase the supply of houses and reduce the price pressures in the housing market. And the way to do that is very simple, to say, well, if you’re going to borrow for an existing home, you’re going to have to pay an extra margin, and that margin won’t go to the bank. It will go to the central bank. It’s there purely to dissuade you from borrowing for an existing home. We’re not going to charge anything extra on the cost to create a new home because that’s what we want. We want new homes built. And so what it does is it depresses the price of existing homes, in favour of new builds.
And so again, this is I guess, outside the whole UBI debate. But again, we would see that treating the money as an essential part of the driver of economic activity, and making specific decisions about what it is that we as a society want. We want, for example, basic needs met. And we want houses built to meet accommodation needs. And so we ought to be able to make those high-level targets and aims, but leave then market to sort out where it’s done and how it’s done and what’s provided based purely on the availability of funds made at specific interest rates under those guidelines.
What I’m talking about here I don’t think is entirely necessary for the UBI to be put in place as a starting small and growing it, because we can do that, whatever happens in the broader economy, because at any point, we can stop increasing. So we might, under normal circumstances, not get to the poverty line, but we’ll get somewhere. If we then begin to think about how else we can manage this broader economy to rebalance the inflow from borrowing and the UBI, then I think we can get to that poverty level with maintaining full employment, maintaining full economic activity without high inflation.
And we’ve got plenty of time to sort of sort through. We are aiming for, we would like to see a government, not in this Parliament, but three or four years’ time at the beginning of the next Parliament, agree to implement it. And that might be 2025. And it wouldn’t be fully implemented until 2030. So in that intervening period to then discuss these other mechanisms to refine them and test them and talk them through. So we don’t want to hold up the UBI until we’ve sorted out all these other problems, because we think that the low-risk way of implementing it should address concerns regardless of what the final decisions are.
Gene Tunny 55:21
Right. Okay. Look, that’s given me a lot to think about, Michael. Yeah. Now did this issue, did this idea of yours of, well, you have to intervene in bank lending, so you’re trying to control the growth of the money supply by… You need to increase the cost of borrowing for… You’re saying that you’ll just have that limited to borrowing for existing property. Now, that’s a lot of the borrowing that does occur. Right. But then you’d say that you would have it that they wouldn’t be able to… I’m just trying to think about how this would work in practice. I mean, are you saying that there’s a particular interest rate you have to lend to people who want to build a new house or buy a new house?
Michael Haines 56:14
So the market, whatever the cash rate is at the moment, there is a market rate for lending. And so the idea is that you don’t interfere with that, that what you do then is simply say, well, we want to discourage certain types of lending and borrowing, because it’s not achieving our overall economic objective. Our overall economic objective is, A, to meet our basic needs. And we want business focused on doing that. So it’s not a socialist method of providing the goods and services. It’s simply targeting the money to drive the market.
And so we’re saying that, yeah, we would need to have banks be given some guidelines. And they only need to be broad guidelines about the types of lending we want to promote and the types of lending we want to discourage. And then seeing what happens in the market, that if interest rates increased by an extra margin, that then goes to the Reserve Bank. If those interest rates start to really negatively impact the economy, just like increasing interest rates do anyway, at some point, you will then say, okay, well, that’s enough, we’re not going to do any more, we’ve achieved as much as we can do, because to go any further now might end up pushing us into recession. And in fact, our feeling is that the Reserve Bank is never going to get it right, we are going to go through these cycles that we already have. They’ll push it too far. It’ll start to go into recession.
But with the UBI, we can make that a very shallow recession, just like we did with JobKeeper. we put the money into the people. It keeps them going and keeps the economy going. So we will still have swings and roundabouts. But they should be less severe than we’ve seen in the past using the UBI as a floor.
Gene Tunny 58:33
Hmm, that’s an interesting concept. I’d like to just look at it a bit more closely and think about how’d it all work. I mean, I think you’ve got the right idea. It started off low, and you’d experiment with it, just to see how it actually works in in practice. I mean, my natural inclination is, against intervening in the banks in that way to say, well, we think you should be doing that lending rather than this other lending, because who’s the… The bank should be making that decision based on what it thinks is sensible? It should be looking at, well, can the person actually afford this loan? Are we going to get our money back? And they should be charging for that based on the cost of their funds, right?
Michael Haines 59:38
So what you say is true, Gene, all of that process should still happen. The difference is that instead of the cost of funds being pushed up from the bottom, across all lending, it would be added to on the top, so the banks will still be making the same margin that they would have, because instead of having to pay a higher cost of funds, their cost of funds won’t have changed, they will be making the same decision to lend to the same people. But the person who is borrowing will now have to factor in that in addition to paying the bank’s interest, I’ve now got to pay this extra margin. And that will dissuade some people from borrowing. If it dissuades some people from borrowing, that means that there is less money that is being created through the banking system going into the economy. Now, that is what we want, because we are at the same time putting money into the economy through the UBI. And there should simply be over time, a shift in productive capacity from spending more on basics and less on whatever else would have been done.
So it is a policy decision of society to say, yes, we want everybody in our society to have their basic needs met, as a priority for any other things that money might be spent on. And the reason is, because we have now created this wonderful system of property rights money and paid work, which is delivering huge value for us. But in its design, at the moment, it is forcing millions of people into poverty. And we don’t want that. So it is a policy decision. Right. And once we make that decision, I believe the economy will chug on even better than it has, because you’ve now got a demand being expressed that was previously latent. And that’s bad for the people who miss out on the goods and services. It’s bad for the businesses who could meet that demand. And ultimately, it’s bad for society.
So yeah, look, we recognise that this is not going to be a simple discussion, but hoping over the next three years to get one of the major parties at least, if not both, to begin to seriously examine it with a view to, as we said, implementing it, not in the upcoming parliament, but the one after, and that taking this slow approach should make people feel comfortable that it is a pretty low-risk strategy for what potentially could be massive, massive benefits.
Gene Tunny 1:02:45
Right. Okay. So I’ve got two more questions, and then we might wrap up, just on the cost of it. And you talk about this authority. And I think you’re suggesting that this could be off budget. Now, have you had any advice on this, or have you talked to any statisticians about this issue? Because it just seems to me that this is effectively government spending, this is a transfer payment, and therefore, under the guidelines from the IMF, on government finance statistics, it should strictly be counted as government spending. So have you thought about that? Do you have any advice on that?
Michael Haines 1:03:35
You’re right, this hasn’t been an issue, up until now. And so there isn’t a neat place to put it. But the way I try to characterise it was to say, look, new money is created under the banking system, under the auspices of the Reserve Bank, and the other banking authorities. And so it’s government regulated, but the money when it’s created, goes to individuals who spend it. And that money, even though it’s created under the auspices of the government, is not treated as government spending, because it isn’t government spending, it’s spending by individuals. And the same thing here that what we’re doing is that we’re reducing the amount of money that is spent by individuals through bank borrowings and increasing the money spent by individuals through direct payments to them of new money. So it’s not transferred, it’s not come out of tax. It’s not come out of anybody. It is just like the bank lending new money, but it’s now going to everybody to meet their basic needs.
And so this does require a different categorization, a different way of thinking. And you’re right, probably as things stand, people will struggle, Gene, with coming to grips with that. But yeah, if we don’t regard bank lending as government spending, why should we regard spending by individuals who are not being directed by the government, it’s not supplying government goods and services, it’s not coming out of the hands of taxpayers, it is new money created by the Reserve Bank, just like it’s new money created by the banks for the borrowers.
Gene Tunny 1:05:26
Okay, I can tell you what the economists will argue. And I mean, I don’t necessarily want to be negative about this, because I’m trying to be open minded. But what they will argue is that how you’re paying for this in part is through an inflation tax. So that’s one way that you would be paying for that, because there’s this, you know, there’s the money creation, and in the long term that will be inflationary. And so there’s a transfer of resources from between households, because with the inflation, that’s going to be reducing the value of money holdings of other households in the economy. That’s why economists I think would argue that there is a redistribution and it’s being paid for by an inflation tax. So I think that’s what they would come back with. They would just argue it is effectively… It’s similar to government, a government transfer payment.
Michael Haines 1:06:39
And you’re right, to the extent that it is inflationary. But as you would know, we’re looking for some amount of inflation, maybe 2 to 3%, in order to maintain a sort of a forward-looking economy. And we’re also looking for, 2 to 3 to 4% growth. And that amount of money has to be to support that inflation target and that growth. New money has to get into the economy. And so at the moment, it’s coming in virtually all through bank lending, through newly created money, driving additional activity. And so what we’re saying is that, yes, there would be a redistribution then, not out of the past earnings or the past wealth. So we’re not taking it away from your earning capacity, or out of the wealth that you have. What we would be doing is shifting the ability of some people to borrow and get new money versus the payment directly to people without borrowing. And so that certainly will result in a shift in economic activity. But it’s a prospective shift. It’s not a past shift or a current shift, because you’re restricting people’s ability to borrow for the future.
And so it is a slightly different view. But even if that view isn’t accepted, then we would be arguing that the amount of inflation is not excessive, if given our $100 billion a year net payment, is the total amount being put into the economy every year, which is about 5% of our GDP. But beyond all of that, we are suggesting that by starting small, we don’t have to theorise, we don’t have to guess, we can actually see what happens. And if through automation and through other adaptive means the supply chain shifts to provide extra basics, we might find that that extra capacity is generated over five years without changing anything, that the economy will continue to grow with people borrowing for new housing and everything happening, and people won’t even notice the shift because the economy is continuing to operate at full capacity.
Gene Tunny 1:09:44
Right. Okay. Well, I think, yeah, it would be an experiment. I mean, I’m not entirely sure what would happen. I mean, I’ve got my suspicions of how it would play out, but I think it’s something that you would want… To get the best evidence, you really need to implement it, right? This is something that would be very difficult to model. And so, yeah, so I think that’s good you want to start out small just on the bank lending. The other point I’d make is that the bank lending, as you know, that it is accompanied by a requirement that it’s paid back by the household. The money supply expands with the bank lending, and then as households pay it back, then that’s pulling it back in.
Michael Haines 1:10:42
It’s the net of advances versus repayments that actually drives the growth. So over time, if you’ve got more new lending than you have repayments, you’ve got a net extra going in. And so we would see that people are still going to borrow for homes. They’re going to borrow for all sorts of reasons, as they do now. And we don’t want to stop anything any more than the banks, the central bank now looks at housing prices and other prices and says, look, things are heating up too much, we’ve got to quiet it down. So the same approach would exist except hopefully a bit more targeted, and with an additional tool, which is the UBI to keep lifting the floor up, so that we don’t send the economy into the dire depths that sometimes occurs when the central banks get it wrong, and they go too far. So we’re not changing that approach. We’re changing the way in which the tweaks are done, to some extent.
Gene Tunny 1:11:53
Okay. Now, finally, yeah, there are actually two things I wanted to sort of ask. One was about poverty. And you were mentioning, several million in poverty. I’m interested in where you get that that impression from. I mean, I know that there are certainly households that are doing it tough. Yeah, I just want to, because I know a lot of people will go, oh, hang on, there are a lot of… The problem with our poverty definition is that is relative and, and we’re often over-counting the number of people who are in poverty. So I’m just interested in that. And second, did you think about whether this sort of thing could be funded with a wealth tax or inheritance tax, or are you just against that sort of thing?
Michael Haines 1:12:37
Well, I’ll answer the last one, at least. Look, if somebody can get it up with a carbon tax, a wealth tax, income tax, GST, that’s great. Our concern is that if we go that route, you are setting up oppositions and arguments and having a fight that really is unnecessary, because if we do it, as we’re suggesting, and starting small, we don’t have to say to anybody, other than possibly some borrowers, that it’s going to impact you negatively at all. There’s going to be a lot of people who it’s going to impact positively. But we’re not going to have any negative impact. So we’re removing that fight. But yeah, I’d be happy if anybody can get up a tax to partly fund it, then that means that there is a less pressure on managing the money supply through bank lending. So yeah, it’s not out of the question, but it’s not vital.
As for the poverty stats, I’ll send you the link. I haven’t got it on the top of my head, but it’s come through I think, might have been Anglicare or Uniting or somewhere who are looking at the stats based on their data, for people who are looking for charity and support. As I’ve said, it’s mostly single women with kids, aged, disabled, they have family who are caring for them without any pay, and people who are literally between jobs, while they have no work, they’ve got no savings, and they’ve got no family support. And when you add up all those people at any…
This is why it’s a system problem and not a moral failing because the people in that group constantly change. The kids grow up. The disabled age. The aged die. The unpaid carers and the jobless find work, but they’re replaced by a new cohort continually. So despite 30 years of continuous growth up until the pandemic, that percentage of population has hardly budged. So all those factors show that it is a system problem. And the UBI tackles that problem at root, by providing the money to allow people to express their needs in the market. So it’s not a socialist ideology driving it. It’s a market ideology, because in order for people to participate in the market, they need money.
Gene Tunny 1:15:36
Yeah. Now, you know, there are certainly people who are falling through the cracks of our existing welfare system. I mean, just look at the growing number of homeless people in Australia. So yeah, certainly people who are–
Michael Haines 1:15:52
I mean, who could live on, what is it, 43 bucks a day?
Gene Tunny 1:15:55
So we’re talking about the JobSeeker payment, are we?
Michael Haines 1:15:58
Yeah. I mean, who can live on that? I mean, it’s just nonsense. But as we said, there is a rationale for it. It’s not because people in government are cruel by nature. It’s evidenced when the JobSeeker supplement was being paid, the employers are saying, hang on, I’ve got young kids and others here, they’re not prepared to work, because they’re getting all this money. And so you drop the money, and now they suddenly are looking for a job. And that’s all rational behaviour. It’s rational behaviour by the people who want to stay on the benefits rather than work. And it’s rational behaviour by the government to say, well, we’ve got to create these at poverty level. But what it does indirectly is push all of these people who can’t do paid work into poverty. And that is an indictment on our current system.
And we can solve it, we’ve got the resources, we’ve got the means of creating the money, we’ve got a means to manage the way in which the money goes into the economy without creating excessive inflation. And we can keep the economy at full capacity, which is in the interest of business, by allowing over time a shift in the pattern of production to meet the new needs that are evidenced by the UBI.
Gene Tunny 1:17:26
Okay, I mean, what I would say in response to that, Michael, is that that is your hope for the policy. I mean, as you’ve mentioned, you’d roll this out, you’d start off small, and then we’d test whether that would be the case or not, because I mean, economists, as I’ve mentioned, they’re going to be concerned that, well, this is inflationary, this is modern monetary theory.
Michael Haines 1:17:53
Not all of it I agree 100% with, Gene. If we can do it slowly, then there should be no reason why. In effect, what we’ve had is lots of pilots around the world where it’s been focused on a particular group of people or a particular region. And it’s been set at a level which from day one, is regarded as adequate for whatever the purposes of the policy are. But people look at it and said, well you put that across the whole of the country and who knows what’s happening.
So by starting small, we are effectively doing a proper pilot at a national level, to see what are the impacts. And at a very low level, there are probably zero negative and plenty of good impacts. And as we increase, we can determine, are the negatives becoming unsustainable here? And if they are, then we better halt it, keep the UBI at the level, whatever we’ve reached, and look at well, can we measure these problems and go forward, or is that it, we’ve gone as high as we can go? So we’re not taking away any welfare. So whatever level we get to is better than it was. We’ve not increased anybody taxes. So again, there’s been no negative as a result of that step. And up until that stage two, we’re not even saying to the banks to change their lending practices. We’re not changing any of the interest rate margins, or adding any extra margin on top, so we’re just paying the benefit and seeing what happens.
Gene Tunny 1:19:41
Michael, any final words before we conclude?
Michael Haines 1:19:45
I think you’ve exhausted me. I’ve been able to give you something of an insight. But there are a series of I think about seven articles that I’ve now written on Medium, and I’ll send you a link to the first article, and each article then links to the next, which hopefully is a bit more coherent than I’ve managed in our discussion, having lost my train of thought a few times, but yeah, the articles ought to spell out what I’ve been trying to explain here. And yes, I really look forward to hearing from your audience, their feedback, and, you know, whatever concerns that they might have. I will certainly be looking to take them on board and see how we might address them. And maybe another day, Gene, in the future we look at those, and come back and have a talk about it.
Gene Tunny 1:20:50
Yeah, absolutely. I mean, I know there’s a lot of interest among listeners in this topic. And it was suggested by one of my listeners, and then I had been on and then I’ve had other people get in touch. And I know that there certainly is a lot of interest. So yes, sorry if I’ve exhausted you, but I wanted to chat about it, because it’s an interesting proposal, and it’s innovative. And you have thought about the implications of it. So now, while I might disagree on whether, you know, this would be a good thing to do or not, I understand that you actually have thought about it, and in your judgement, this is the right way to do it. Now, I think that’s good you’ve thought through the implications of it and what you’d have to do to manage it. And that was the discussion we had about bank lending. So look, it’s given me a lot to think about. And if you’re listening in the audience, and you’ve got thoughts on the proposal, then please get in touch and I’ll pass them on to Michael. And Michael, as you suggested we could possibly talk again?
Michael Haines 1:21:57
That would be really appreciated, Gene, after we get the feedback from your listeners, because that will be valuable for me as well, because as I said, I’m now beginning to talk to people in the political parties, and whatever views your listeners express, I’ve gotten to encounter in those broader discussions. As they say, forewarned is forearmed. So I really, really appreciate the opportunity to chat with you, Gene. And thank you.
Gene Tunny 1:22:33
Oh, pleasure. Okay. Michael Haines, thanks so much for your time. Really appreciate it.
Michael Haines 1:22:38
Thank you, Gene. All the best. Bye.
Gene Tunny 1:22:42
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 EP137 guest Michael Haines and to the show’s audio engineer Josh Crotts for his assistance in producing the episode.
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 Podcasts, Apple Podcasts, Spotify, 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.
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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.
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 Podcasts, Apple Podcasts, Spotify, 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.
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.
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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.
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.
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.
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.
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.
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/.
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
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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.
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.
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.
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.
Female speaker 19:55
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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.
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.
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.
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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.
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 Podcasts, Apple 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:
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
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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.
