Category: Podcast episode

Why we’re in the Decisive Decade with China & what the West should do w/ Dr Jonathan D. T. Ward – EP182

Post author By Alec Krishna
Post date April 9, 2023
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Dr Jonathan D. T. Ward discusses his new book “The Decisive Decade: American Grand Strategy for Triumph Over China” with show host Gene Tunny. Dr Ward argues the US should adopt “a two-pronged strategy of economic containment toward China alongside the revitalization and evolution of American industrial and technological power.” Dr. Ward is an internationally recognized expert on Chinese global strategy and U.S.-China competition. He earned his PhD in China-India relations at Oxford and his undergraduate degree at Columbia, where he studied the Russian and Chinese languages. Dr Ward is the founder of the Washington DC-based Atlas Organization, which provides strategic advice on US-China competition to businesses and government agencies.

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What’s covered in EP182

How Dr Ward’s new book The Decisive Decade picks up where his previous book China’s Vision of Victory left off [2:02]
What’s the actual concern with China at the moment? [5:20]
What does economic containment mean? [9:40]
Dr Ward proposes to restructure the world economy in favour of the democracies and against China [14:18]
Is China such a threat that we should sacrifice our economic gains from trading with China? [19:25]
China’s economic development has allowed it invest large amounts in its military [23:18]
Western companies and forced labour supply chains in China [26:51]
Dr. Ward’s final observations on China [33:24]

Links relevant to the conversation

Dr Jonathan D T Ward’s bio is available from the Atlas Organization’s website:

https://atlasor ganization.com/

Jonathan’s book The Decisive Decade: America’s Grand Strategy for Triumph Over China:

https://amzn.to/3TQyGoi

This may be the Ben Franklin quote Dr Ward had in mind: “Those who would give up essential liberty to purchase a little temporary safety deserve neither liberty nor safety”:

https://www.npr.org/2015/03/02/390245038/ben-franklins-famous-liberty-safety-quote-lost-its-context-in-21st-century

Related previous podcast episodes:

China, Taiwan & the Indo-Pacific w/ Dr Greta Nabbs-Keller – EP146 – Economics Explored

How to Defeat the Dictators w/ Charles Dunst, Asia Group – EP180 – Economics Explored

Transcript:
Why we’re in the Decisive Decade with China & what the West should do w/ Dr Jonathan D T Ward – EP182

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 00:06

Jonathan Ward 02:02

Sure. So first of all, Jean, this book picks up where my first book, China’s vision of victory left off. And the first one explained the global grand strategy of the Chinese Communist Party, you know, the military ambitions, the sort of economic ambitions, the history of the party’s view of the world its view of itself as ascending and completing what they call the Great rejuvenation of China of the Chinese nation, which seeks to return them to a place of preeminence in the world, and basically, their vision of the world order and where it’s going. And so the decisive decade picks up, where that left off, which is to explain that, you know, if we wish to stop that vision of victory, if we wish to prevent it, to maintain the rules based order to sort of ensure that the security of the free world coheres. And that the world isn’t simply, the rules aren’t rewritten by the People’s Republic of China, we’re going to have to take actions of our own, and then we have to engage in Grand strategies of our own. And this is written primarily as an American grand strategy, but also one that is very focused on the alliance system, the free world, the democratic world, the democracies, you know, all of that. So how to create a counterpoint a real, whole spectrum counterpoint to Chinese global grand strategy. So the decisive decade is, you know, the title refers to what I talked about in China’s vision of victory, which is essentially this isn’t a contest for the very long term. 2049 is what the communist party thinks of as the symbolic date, but 100 years after the founding of the People’s Republic of China, they will have completed the great rejuvenation of the Chinese nation, they will have completed military modernization the Belton Road, made in China 2025, all of these things track that long term, somewhat symbolic timeframe. But to me, for our side of this game, what matters is the contest for 2030, the fact that this game, I think, will largely be won or lost in the 2020s. And I even saw in a recent article in ABC, Australia, somebody’s talking about, you know, if there were to have to be a military conflict between China and the United States or the Allied Pacific powers that comes in the 2030s, it would be likely that we would lose whereas now, you know, there would be a stalemate? No, this is a peacetime strategy that I’ve written, I should make that clear. It’s a strategy for how to win the long contest without a conflict, how to win it chiefly, through rebuilding our economic advantages, and our military power and returning to peace through strength through deterrence, which we can already see that that entire construct is breaking down in Europe. And the question that’s on the minds of every, you know, major capital in the Allied world is will that also break down in the Pacific? Are we going to see China act in the Pacific alongside its partners, and Moscow in a kind of replay of the early Cold War relationship where they, you know, frankly, expressed to each other that they would divide up, divide and conquer Stalin told now he would focus on Europe and China should focus on Asia and the next thing we got is the Korean War. So we’re in times that requires serious responses ice still believe we can do this through economic power and integrated deterrence. And that’s what my strategy proposes.

Gene Tunny 05:07

Right? Yeah. So you talk about a two prong strategy of economic containment toward China alongside the revitalization? Sorry, the revitalization and evolution of American industrial power. Yep. So you’re keen to ask you about those in a moment. I just want to stick with this issue of what’s the what is the actual concern at the moment, we’ve just had, like all the level of concern, our former prime minister, Paul Keating, here in Australia, the other day made some rather extraordinary statements at the National Press Club and critical of the current government, which is on his side, and also the government while he was in that political party and the government before him, the current government. And I mean, he, he asked, why would China want to threaten Australia? What would be the point they get the iron ore, the coal, the weak? What would be the point of China wanting to occupy Sydney and Melbourne? militarily? What is the real threat? I mean, China wants Taiwan, they’ve they’ve been explicit about that. Do you think they have imperial ambitions? Beyond that? What explicitly are they after? Sure. So

Jonathan Ward 06:18

let’s think about that. I mean, for him to say that this results in the occupation of Sydney or Melbourne, I think, is taking it to a strongman extreme. I think the point here is Australia already has seen what coercion looks like, from the People’s Republic of China. And you saw that very early on, when they you know, shut off trade to Australia, because they were concerned about comments about the COVID origins. And, you know, Australia’s I think ability to act as an independent actor. And this is the subject of, I think, a very robust discussion. And, you know, frankly, a lot of the great research on this comes out of Australia. So, Australia, in many ways, this led aspects of the charge here in terms of calling the the threat of the Communist Party for what it is, but you think about banning Huawei, and the 14 points declaration that the Communist Party of China issued to Australia basically establishes the terms of what it would look like to have a healthy and productively relationship. And I think that was met with revulsion across Australia, the idea that they could be, you know, sort of dictated to by the Communist Party of China. In the meantime, China’s going through with HR McMaster, the former US national security adviser called the largest peacetime buildup, the largest military buildup in modern history. So the naval buildup they’ve undertaken the missile buildup, you know, the Air Force, sort of activity, I mean, they now have the largest and peer forces in the Indo Pacific, the largest Navy in the world, largest ground forces in Asia and Xi Jinping on a very regular basis way before but for, you know, I don’t know, Paul Keating myself, but certainly before his comments, I mean, Xi Jinping himself is speaking on almost a quarterly basis about preparing to fight and win wars now against whom, you know, Air Force manuals from the Chinese military talk about the ability to after seizing Taiwan, the ability to produce famine in Japan, you know, these ambitions, they have, I think, are part of, you know, a concept of dominating Asia. And that does include Australia, and I think for the United States and Australia, when our relationship, economic, military and values based goes back so far, and it’s so deep, when you think about something like the Second World War, where one of the most important pieces of our joint military strategy was to keep America in the Pacific through the California to Australia, you know, oceanic highway and the Japanese were trying to cut that off through the Pacific Islands. So, you know, the military geography of the Pacific is something we’re all familiar with. It’s something that China has studied in depth. I mean, their ambitions towards the island chains, I think are very well understood. And this is why, you know, according my understanding Australian Defence is very, very focused on the challenge from China. And in the meantime, I even, you know, without anticipating being on your podcast, and thank you for welcoming me, one of the first pages of my book includes just as a matter, of course, you know, threats that China has made to different allies, and that includes the threats that they made of quotes, possible nuclear attacks in the future on Australia. I mean, you know, they’ve threatened us with that, too. So it’s, it’s par for the course. But still, I think, I think they’ve made very clear how they feel about their position in the world. And it’s one of my friends in Australian Defence once said to me, when I asked What does China really want from Australia, and she said, it wants to be it wants Australia to be a neutral farm in mind. So if I don’t think that’s the future that that we’re all looking for, is to be sort of fun, you know, dependencies in a economic empire headed by the Chinese Communist Party. On the other hand, that’s certainly what they would like.

Gene Tunny 09:42

Yeah, I’ll have to look up that quote. That’s a that’s an interesting one, a neutral farm and mine. Okay.

Jonathan Ward 09:48

That one’s in China’s vision of victory.

Gene Tunny 09:50

Gotcha. I’ll have a look. That’s your previous book, isn’t it? That’s excellent. Okay. Can I ask? What do you mean by economic containment? And what does that look like?

Jonathan Ward 10:01

Sure. So the way that I see this, I mean the way to win this contest and to to avoid the hot war and to not have it just keep on culminating in a rising China that’s continuing in the military buildup and has its various territorial ambitions. And that’s all just a matter of fact, I mean, their claims against all of their neighbours, the wars, they fought in the 20th century against many of their neighbours, not least of which was the Korean War, which involve both the United States and Australia, in which they saw as central to the what they called the new China, just the rise of China back then, you know, we’re seeing, I think, a replay of some of those ambitions as they threaten papers today. But the bottom line, I think that this is largely, you know, it really comes down to the gap that we once had, as the free world between ourselves and the major dictatorships, and not least of which was the People’s Republic of China, and through economic engagement, and the strategy that we sought to do was to bring them into the world to trade with them to invest in them to establish business ties People to People ties. And that wasn’t the end of it, we did not necessarily expect that that would empower the Chinese Communist Party, we thought that it would lead to liberalisation in a political softening of the of the CCP, perhaps a reduced role and its influence. And really the opposite happened. I mean, China transformed from a largely agrarian society in the 1980s, to an industrial technological superpower, which now has totally changed the military balance in Asia, has created world leading companies has dominated strategic industries like money, intellectual property theft concerns are the subject of an enormous amount of study at this point. And that all culminates for them in economic ambitions of becoming really the centre of the world economy. And, and in doing that, they seek to then bring in a military strategy where they defend their, what they call the ceaseless expansion of their Overseas Interests. So in a way, it’s an old school sort of Imperial strategy, we recognise it very clearly as such, if this were the 19th century, but it’s kind of lost in the language of development and trade in the 21st century. So, you know, bottom line, I mean, they they see themselves as rising to a preeminent position. And then the world economy is doing that through mastery of certain strategic industries. And frankly, they can only get there if we help them. So a lot of the point here is economic containment really is about ceasing to empower to enable and to enrich the Chinese Communist Party in the People’s Republic of China for as long as it has these tendencies and ambitions and, you know, sort of dangers. And I think it’s a very simple thing where, you know, economic containment, as I’ve described it in three parts, it has to do with market access, it has to do with technology transfer, it has to do with access to capital. And as long as we’re providing access to capital access to technology, and then access to our markets, we’re enabling their growth, whereas you start to produce that. And the ascendancy slows down a great deal. And either way, we should remember that decoupling, which is a popular word is a two way street. I mean, Xi Jinping has made very clear through programmes like made in China 2025, that they seek to establish indigenisation of key strategic industries. So it’s not that our companies are over there in order to capture unlimited market share, and they’re essentially over there to transfer technology. That’s been the deal that Western businesses run with the People’s Republic of China for 30 years now. But it’s culminated and Chinese dominance of certain industries and then on the other hand, you know, they really do need access to global capital markets. And that’s where we have a far greater advantage, and they need to be able to sell to the OECD markets. And if you look at their trade composition, I mean, a great deal of it is, you know, let’s say a lot of value added since microelectronics, for example. So some of the industries that we already know, we have to secure I mean, I do not think it creates leverage over an adversary state that is, you know, creating a force structure that’s designed for combat with with us, you know, with America with Australia with Japan, that our supply chains are there, I mean, that doesn’t create leverage over them that creates leverage over us so so we know that we have to pull back certain strategic industries into the meantime, Xi Jinping, dual circulation strategy, means that he would like, in this is how the party is orienting. He would like the world’s supply chains to become more dependent on China at the same time for China to become less dependent on, you know, external supply chains. So so, you know, they’re looking to do this one way. And, and, you know, decoupling is something they’ve initiated in many industries. And then, you know, we’re gonna have to do that too, in certain ways. So so there is a natural restructuring. And the question, in certain ways is who, you know, what is going to be the outcome, ultimately, of that restructuring? And we have to do it in such a way where I think we’re working together, and we’re going to restructure the world economy in the favour of the democracies and not in favour of the People’s Republic of China.

Gene Tunny 14:44

Okay, and how do you propose doing that? What policy measures do you have in mind you have in mind tariffs, do you are you talking about banning certain types of investment into China certain types of trade? What exactly are you proposing?

Jonathan Ward 15:00

Sure, so I think you know, you need to go industry by industry and sector, you know, sort of company by company and look at all the key inputs that really matter. And I think that’s where this goes into a level of detail that will have to be, it’ll be the subject of policymaking in the decade ahead. I mean, what precisely do we want to allow? And what do we not want to allow? I mean, you can imagine, for example, it’s not necessarily strategic for, for McDonald’s to be operational in the People’s Republic of China. I mean, they’re taking their own risks by being there. And let’s not forget, every single company just learned a very big lesson in Russia. I mean, the amount of the corporate Exodus after Russia invaded Ukraine should be the real lesson for companies that are investing in China and building trading relationships, what actually happens, if they do decide to use force, that’s a separate problem. So the business sector, I think, has this issue on their own plates in a different way. But then for the policy world, you know, we’ve already seen much greater action in terms of export controls, you know, the foreign direct product rule is very important to limiting the transfer of technology that could be applied much more widely. Outbound Cepheus, a committee on foreign investment in the US provides a template for looking at strategic industries. And the concern has largely been over inbound investment from China into industries that we consider important, but also outbound because any multinational is going to have to ultimately, you know, allocate capital in order to remain competitive in a China market where their intellectual property has probably already been stolen. And perhaps commercialised. So, you know, the capital, you know, allocations continuing look at something like Tesla, for example, their giga factory in Shanghai is not owned, it is rented on a 50 year basis with a CapEx minimum and a revenue minimum every year. That’s the kind of deal that’s going on in order to syphon capital from multinationals alongside technology transfer today. So, you know, that kind of capital allocation, I think, is bad. I mean, we’re still mainlining hundreds of billions of dollars of capital, just as the United States. The other thing is, you look at large pools of capital, such as pension funds, you know, large index creators and allocators such as BlackRock and State Street have, you know, MSCI China index season, and there are companies in the US that are tied to civil military fusion, to the human rights abuses, and certainly to the Chinese Communist Party, because at this point, the party is basically reversing course, on Deng Xiaoping’s original opening up the private sector, and they’re putting party members on boards and controlling these companies. And all of these companies operate in the interest of their larger strategic programmes. So when we allocate capital, we are helping to finance military modernization, the Belt and Road and a surveillance state that I think is the subject of an enormous amount of documentation. And, frankly, you know, concern if not, we’re across the free world. So I think you start to do that. I mean, you start to cut back from, you know, and civil military fusion, perhaps I should explain, I mean, it’s the party’s initiative to transfer innovation happening in civilian industrial sectors into the military to make sure that the military can, in their words, close the gap with the United States and other Western militaries. So they are taking the economy that we helped them build, and converting it into maximum military power to be directed against us. That’s the thing that you want to break down. So why should we invest in that? Why should we transfer technology to that, and on the subject of exports, I mean, I think it’s really about export diversification. For example, Australia’s trade relationship is largely about selling coal and iron ore and, you know, commodities to China. And then I think Australia is one of the very few countries in the OECD that runs a surplus with China. But what’s important is pretty much true across the OECD, it’s a lot of micro electronics, and, you know, those sorts of sorts of value added goods. So, you know, looking for new supply chains, so that we do not have to, you know, have our exports come in from China. And that’s something we work that out, and we start to cut down their export, you know, based and that changes the structure of their economy. And it takes a lot of the growth out of the equation. And in the meantime, you know, it’s possible to reinvest in our own societies and our own industrial bases. I mean, we can do manufacturing, too, we just haven’t, because of the exigencies of, you know, basically, competitive advantage and competitive advantage, I think, is a fine concept. You know, theoretically but in a political economy, where you’re dealing with an adversary state that, in its own words, is preparing to fight and win wars, including with you and your allies. Perhaps it’s, it makes sense to see what else you can do.

Gene Tunny 19:25

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Gene Tunny 20:00

Now back to the show. Yeah, it sounds like you do need a lot of policy intervention to bring this about. And you’re talking about power of measures industrial policy to promote this reshoring or whatever you want to call it. Yeah, I mean, as an economist it, it looks like you’re talking about losing a lot of the potential gains from trade. And I mean, my I’m not sure yet. I mean, I’ll have to read your first book. I do know China is a is a threat. And there is a lot of espionage going on. At the same time, I recognise that a lot of countries engage in espionage. Is China such a threat that we should sacrifice those economic gains? I mean, you’ve made a judgement that they are such a threat that we can forego some of those economic gains? I mean, how do you think about this in in terms of, do you think about it in terms of a cost benefit analysis? Or are the national security concerns primary for you? How do you think about this? How do you weigh everything up?

Jonathan Ward 21:08

Well, I think it’s a little bit of all of that. I mean, on one hand, it’s not my judgement alone, I think this has become pretty commonplace across most allied capitals, the idea that the trading relationship with China or economic engagement is certainly not produce the political outcomes that people saw. And let’s not forget, that was one of the primary reasons for doing it, you can see that for Batum, across the entire discussion in the 90s, ahead of the WTO session, this was not just let’s trade with a dangerous state and hope for the best let’s trade with this state that is an authoritarian state, because we believe it will produce liberalisation, that did not change. So then you have to ask yourself, what are the consequences of that? I mean, the consequences of that is like, sure, I mean, people are making money in Australia, they’re making money in the United States. And it’s why people keep doing it. On the other hand, we’re also on a constant basis, enriching and improving an adversary state that’s declared its intention. So I think, you know, having a full appreciation for what that looks like, through their own eyes, I mean, how the Communist Party of China seeks to, you know, take this well beyond espionage. And that espionage is for a purpose. At the end of the day, they’re reconstructing industries that contribute to national power, and they’re building a military that’s designed for war with the Asia Pacific. So So you know, I think that’s very clearly understood in most capitals at this point. And it’s, it’s, you know, not really a matter of debate, in that sense as to the intentions. It’s just a matter of, you know, they’ve, they’ve told us that we can watch it all happen in front of us. On the other hand, I mean, sure, if you’re, if you’re in the business community, or the trade community, I mean, just looking at, you know, Australian Department of Foreign Affairs and Trade. I mean, one of the first lines on doing business with China, is trade and investment with China is central to Australia’s first to Australia’s future prosperity. So I think this is the contradiction that just lies at the heart of the entire Western world approach to China for the past 40 years was that they used to call it engage, but hedge and the idea was that we would engage economically, but we would hedge militarily, we would build defences against this. And the problem with that is the more you engage economically, the less possible it is to hedge because they’re, they’re reinvesting it into defence. I mean, that’s what they’ve done. They felt, you know, the largest military in the, in the Pacific. And, you know, if they were totally friendly about it, maybe we’d be talking differently, but by the way, they’re not they’ve issued pretty graphic threats to all of our countries at this point. So, you know, so So I think the question is really do the economic gains, you know, in fact, bring security or prosperity. And, to paraphrase Ben Franklin, I mean, those who would trade security for prosperity will probably have neither, in the end. So you know, that’s where I’d be concerned. And I think the real economic activities here, and keep in mind this, it’s going to be industry by industry, at the end of the day, selling raw commodities into China’s industrial base is one form of business, but selling, you know, let’s say equipment that helps them undertake a military buildup or build the surveillance state or any of that, you know, this stuff can be, you know, looked at from the point of view of China’s companies. I mean, you know, the 97 SASAC corporations that make up the bulk of the state owned enterprises, certainly the big ones to the largest ones on the Fortune Global 500. I mean, those are deeply aligned with the state. I mean, they’re owned by the state, and they’re used for strategic programmes. I mean, you take for instance, the islands in the South China Sea, you know, we can debate whether or not that’s a threat, but you know, frankly, I think it’s, it’s generally seen to be one and that was built by China communications construction Corporation. For example, I remember I was at Oxford Business School alongside my PhD and, you know, with with the MBA students, we were doing a leveraged buyout model of an aerospace composite parts company from from from Austria, and it turned out that it was owned by a VIC which is China’s military, aerospace, corporate. Should everyone’s looking at the financials. And I was the only one that said, hey, look, these guys just landed, you know, you know, military aircraft on the islands in the South China Sea this month. Does anyone care about that? That’s the problem with separating pure economics from from political economy or from history is, and as a historian where you have to look at all of this, I think we also have to look at the consequences of blind economic engagement. And that’s the debate we’re all going to be having. I mean, in fairness to Australia, I think your economic rules with relationship with China is relatively clear cut. Whereas, you know, I mean, for us, I mean, our biggest issue is our fortune 1000 is still very deep in the China market, but they’re taking on risks. And I think that’s actually a separate problem, the risks that businesses are taking, and this is something I’ve advised businesses in the US for the past five and a half years on this stuff to help them appreciate the level of risk they’re actually taking on. Because, you know, if you look at the, let’s say, the case studies from what happened after Russia invaded Ukraine, I mean, you know, where does this really go for you, if you’re not de risking, you’re trying to stretch if you’re becoming too dependent? If there’s actually, you know, any kind of conflict, all of that will be lost, as it was in prior periods. We’ve been through this before in history. We’re just going through it again, as they’re blind.

Gene Tunny 26:17

Yeah. I love that. Benjamin Franklin, quote, I think I’ve heard it before, I’m going to have to revisit it and put it in the show notes. I thought that was that was really good. And yeah, highly relevant to the conversation. Just finally, Jonathan, I know, you will have to wrap up soon. You talk about corporates, you write in your book, that American corporate exposure and involvement in China is creating risks and perils to the United States and to global stability. Can you give some specific examples, please? So we know what you’re, you’re driving out there, please?

Jonathan Ward 26:51

Sure. So, you know, one example comes from the Australian strategic policy institute, which I think was one of the first global think tanks to to break ground on the role of Western corporates in, you know, in the forced labour supply chains. And keep in mind this this, you know, the shinjang genocide is something that I believe all of our governments, you know, agree is a genocide. So, so our companies are there, I mean, whether it’s Volkswagen from, from, from Germany, or, you know, Nike in the United States, or Ralph Lauren, or polo, I mean, there’s a pretty big list from SP, and that’s important. So, you know, the participation of our own companies and human rights abuses is something that’s increasingly well documented. But then one of the aspects of this that I highlight that I think is less well appreciated is the role of our companies in civil military fusion, and also in strategic programmes such as the Belt and Road. I mean, I use the example of Caterpillar, which was brought before Congress in the United States at least once because they were marketing themselves as helping China build the Belt and Road and we all kind of understand at this point, the strategic nature of the Belton road and what it seeks to do for, you know, China’s sort of economic hegemony in the region. And to have our multinationals or OEMs, out there building something like that, or to have, for instance, Google, doing artificial intelligence partnerships at Ching Hua University. And then the dean of Ching Hua goes and issues a statement, which talks about how Ching Hua will be a centre for artificial intelligence, human machine combat cooperation for the Central Military Commission of the People’s Republic of China, I mean, again, we are participating in a nation state that is organising itself for, for more in for, you know, human rights atrocities. And all of that is, I think, clearly understood. And, you know, the best example, really, historically was in the 1930s. Many American companies certainly were entangled in the reconstruction of Germany, and you know, with places like Ford and Standard Oil, and IBM most notoriously was, ultimately became, you know, its machines for use in the Holocaust. And Thomas Watson went to Berlin, and I believe 1937, and to speak at the International Chamber of Commerce. And he was given a medal by Adolf Hitler, and the title of his speech was peace through trade. So, you know, we’ve been down this road business. And again, to me, business is not the bad guy here. If business changes course, I mean, arguably, we won the second world war, because all of those great companies ultimately came to the right side of history. And we’re going to need to do that, again. What we didn’t get into today is how the global economic contest is one. This is not simply about containment of China. This is also about hitting the accelerator when we’re about to go through an event in economic history called the Fourth Industrial Revolution. And if the free world can hit that, and accelerate, we’re going to create a gap between ourselves in the authoritarian states, the likes of which we haven’t seen in many years now. And certainly, we gave that gap away. In the post cold war, but if we’re able to do that, if we’re able to accelerate Well, at the same time, ensuring that they do not get onto that track, through engagement with us, we’re going to create, I think, a new economic divergence that will lead to much greater outcomes and resolve some of the geopolitical, you know, dangers on the road ahead. And our companies are gonna have to go out and win a battle for global markets that they barely understand yet, they’re going to be competing against the Chinese state, with enormous quantities of capital in with stolen intellectual property. So you know, that that’s something that, you know, ties right into the strategic competition, I mean, the role of our companies is going to be central to winning or to lose, and if they don’t change course, and in the meantime, they’re taking on risks that I think are increasingly clear, as, for instance, the global focus on Taiwan comes into sharper relief.

Gene Tunny 30:53

Right? Yeah, sorry, I didn’t get around the fourth industrial revolution. But would you have a second just to go? Or just a few minutes to go over what you think those are? The main ways to create that gap? Ah, I mean, he was talking about, essentially, you know, cutting China off from that knowledge from that innovation?

Jonathan Ward 31:12

Well, look, I think if we start to, you know, to restrict engagement along the lines of market access technology and capital, then you’re going to start to see the difference between the democratic systems and, you know, China’s authoritarian, you know, totalitarian system. So we, I think we want to be in a systems competition with them, we don’t want to be in a competition where we’re the r&d base that they produce at scale. I mean, that’s one where we lose on a long enough timeframe. But the the industries themselves have been pretty clearly identified. And I’ll just give you an example. Because I think something that’s worth noting is that, you know, made in China 2025, identified some important industries, and then the chips and science sector in the United States identified another set of industries, that’s almost the same. So you can see that some of the critical industries have already been identified, but from the chips and science Act, to artificial intelligence, machine learning and autonomy, semiconductors, and advanced computer hardware and software, Quantum Information Science and Technology, robotics, automation, advanced manufacturing, advanced communications, technology, and immersive technology, biotechnology, genomic synthetic biology, data storage, advanced energy, advanced materials that go on, but bottom line, it’s going to be these industries of the 2020s and 2030s. It’s also going to be this sort of, you know, Internet of Things and digitization of physical infrastructure. So for instance, I remember being in China, you know, before the pandemic, and, you know, looking at an r&d lab somewhere and you know, Alibaba, smart homes and Huawei smart homes, we’re not going to be using that you’re not going to use them in Australia, and we’re not going to use them in the US. So there’s going to be a natural bifurcation that happens. But then the question is, how do we turn that into productivity and power that has a lot to do with markets, because at the end of the day, the US in a free world and you know, Australia, and everybody we’re, you know, 50 to 60% of global GDP when you add up the free democracies, and we’re 75% of global wealth, which may be even more important. So we have these tremendous advantages. And we’re going to have to restructure the world economy so that it isn’t simply the Communist Party of China does not achieve its vision of victory. And we can do that. There will be costs, but there will also be opportunities, particularly in reintegrating amongst one another.

Gene Tunny 33:24

Okay. Dr. Jonathan Ward, any final observations before we wrap up?

Jonathan Ward 33:29

I think we should leave it there. But thank you for having me. And, you know, great to be with an Australian audience and a huge fan of the country and have many friends.

Gene Tunny 33:38

Excellent. Dr. Johnson would. It’s been great, thank you. Okay, I hope you found that informative and enjoyable. I found it valuable chatting with Jonathan given he has a very different perspective from me on China. While I think we need to proceed cautiously and restrict any technology transfer that could threaten national security, for sure. I’m unsure economic containment is the best approach to China at this stage. As an economist, I have a strong bias towards free trade. That said, I know that China needs to be watched closely. And you may recall, I previously talked with experts about the prospects of an invasion of Taiwan and about the enterprise China model. And I’ll put links to those episodes in the show notes. I acknowledge it’s possible there is a significant threat from China. And I’m very grateful to Jonathan for appearing on the show to talk about his new book. Please consider purchasing a copy of his book find the link in the show notes. Jonathan’s book has received some impressive testimonials, including from former US national security adviser, retired Lieutenant General HR McMaster. Incidentally, McMaster also gave a testimonial for Charles Dunst book, defeating the dictators and you may recall I chatted with Charles about his book in Episode 180. So please check out that episode if you haven’t done so yet. As I’ve noted previously, I think it’s important to cover geopolitics on this show because geopolitical developments can end up having huge economic impacts. As I’m sure you will appreciate, given the impacts that the war in Ukraine has had on fuel prices, among other things. Please let me know what you think about my conversation with Dr. Ward. Do you agree with him that we should adopt an economic containment strategy against China? As always, feel free to email me at contact@economicsexplored.com Thanks for listening. Righto, thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

36:26

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Credits

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Podcast episode

Using Coase’s 1937 theory to explain Hutchies doing its own concrete formwork – EP181

Post author By Alec Krishna
Post date March 31, 2023
No Comments on Using Coase’s 1937 theory to explain Hutchies doing its own concrete formwork – EP181

Why do firms do some activities “in house” and contract out others? British-American economist Ronald Coase gave a cogent explanation in a classic 1937 paper on the nature of the firm. Show host Gene Tunny explains to his colleague Tim Hughes how Coase’s insights (e.g. the concept of transaction costs) can be applied to understand the actions of an Australian construction firm Hutchinson’s deciding to employ people to do concrete formwork rather than relying on subcontractors.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

What’s covered in EP181

Episode topic: What determines what activities a business does in house? [0:06]
What is formwork and why does it matter? [3:29]
Hutchinson’s moves to bring formwork in house [8:54]
When is it important to have an in-house workforce in your firm [14:42]
Why you don’t always contract out [20:00]
What’s done in house and what’s outsourced? [25:03]
Gig economy platforms (e.g. UpWork) [33:02]
A closer look at The nature of the firm by Ronald Coase [40:56]

Links relevant to the conversation

Courier-Mail article on Hutchinson’s decision to do its own formwork:

https://www.couriermail.com.au/business/citybeat/hard-labour-hutchies-plan-to-survive-building-crisis/news-story/e3b8acc34728e49cc04d0c4b88bafc8d

Ronald Coase’s classic article on the nature of the firm:

https://onlinelibrary.wiley.com/doi/full/10.1111/j.1468-0335.1937.tb00002.x

American Express article on pros and cons of hiring versus outsourcing:

https://www.americanexpress.com/en-us/business/trends-and-insights/articles/pros-cons-hiring-house-vs-outsourcing/

Transcript:
Using Coase’s 1937 theory to explain Hutchies doing its own concrete formwork – EP181

Gene Tunny 00:06

Tim Hughes 03:29

Tim, you’ve worked in construction and you have at different times. Yeah, yeah. Are you able to explain what formwork is? Yeah, formwork is basically putting up wooden surrounds, I guess, to then be the boundary for a concrete pour. If you’re doing if, say, for instance, a floor is gonna have formwork around for the edges of where the concrete is. And then you’d have reinforcing etc, throughout. But yeah, basically, it’s, it’s whatever is there to contain the concrete. So that once it’s set, the formwork gets taken away, and you’re left with the structure.

Gene Tunny 04:04

Okay, and so you need this in place. Do you before you pour the concrete? Yeah. Yeah. So this is, so what’s going on here, it appears is that Hutchinson’s is bringing that in house. So rather than sub contracting that out there, making sure they’ve got the people on hand, that they’re employing them permanently, as you know, in their workforce to make sure that they’ve got the skilled labour that they need, when they need it. So that I guess, so they don’t delay a job. So because that’s on the critical path of the job, isn’t it getting there? Getting the formwork done, so then you can get the concrete poured?

Tim Hughes 04:42

Yeah. And one of the typical issues with any building project is that, you know, all the subbies have their different schedules that they’re trying to keep in they always have more than one job. And so, it becomes this issue of, then servicing different jobs at the same time, in general. And so it becomes this catalogue of finger pointing quite often, where somebody doesn’t do something because somebody else hasn’t done something. And so there’s a chain of events or a sequence of events, you know, for instance, you can’t pull the concrete, for example, unless the form where it’s been done, you know, yeah, if you know that has to follow, everything’s sequential, or largely sequential. Certainly, once you’ve got the roof on and everything like that, then there are different things that can happen at the same time. And you might end up with an electrician, Spark is chippies, carpenters, etc, they can work in the at the same time because the roofs on the site is watertight or secure. But there’s always that sequence of events. And it’s a strong like, it’s a confident move. And a smart move from Hutchinson’s from what I can see because they’re secure in the workforce. Because one of the problems at the moment is now trying to make sure that you can line somebody up and be certain that they’re going to be there when you need them. So it’s a confident move, but obviously, with having permanent workforce, then you’re taking that point that you can keep them working, you know, obviously, nobody wants to have somebody on the books and not enough work coming in.

Gene Tunny 06:15

I guess if you’re a big company like that, yeah, then well, I mean, they’re expecting they’re gonna have plenty of work for him and for them, and if they don’t, then they’re willing to bear the cost of that under utilisation, to an extent because there’s such a benefit from having them on hand, because the cost of the alternative is just so high for them, not having the people they’re not having the formwork done, and then the delays to the project, the costs associated with that, and not being able to get the work done and then be able to invoice for it.

Tim Hughes 06:49

Yeah. And it’s obviously been a well thought out move. But it’s good to see I mean, because there are, you know, they’ve done a lot of great work around Brisbane, for instance, certainly in the entertainment industry. And now Scott Hutchinson has been played a big part in keeping, for instance, the Tivoli, which was a den danger of being lost to development knocked down. And the same with the princess Theatre in Berlin, GABA, you know, to beautiful music venues, which historically, there have been some great venues lost in Brisbane, you know, in the 80s. Just being knocked down in the middle of the night, like Cloud lands, for instance. Yeah. You know, so it’s great to see a building company, Scott Hutchinson, I know, he’s led a lot of that with the music venues, it’s great to see them having this confidence. So yeah, yeah. Because well for them.

Gene Tunny 07:37

Yeah. I mean, they’re having to do it because of the conditions in the industry. And I think, I mean, they probably would rather not have to do it, then historically, they haven’t. So we might just go over their justifications for other reasons. And then I want to go on to the micro economics of it. So how would economists think about it? Yeah, sure. Because when I read that article, it made me think of a famous theory put forward by a British American economist, Ronald Coase, who was a Nobel Laureate. So Coase was at University of Chicago, toward the end of his career. 1910 to 2013. He had an incredible life. Yeah, that’s a good clip. 103 year. I think he got 202 102. Yeah, pretty good. Yeah. Yeah. Pretty impressive. He obviously managed stress well, and lived well or lived moderately. Differently, give into temptation.

Tim Hughes 08:39

I know, there’s another story that for sure, it’d be interesting to know. The secrets were

Gene Tunny 08:44

Yeah, I may learn that today. When I was preparing for the podcast. He lives so long. I’ll have to try and find out what it is. There’s got to be a story there. Yeah, absolutely. Okay. So we’ll get on to his theory in a moment. The moves so they’re talking about the Hutchinson’s moves to bring this formwork in house. Yeah. So rather than subcontracting, bring it into the business bringing it into the firm. And the article continues. The moves come as major national building company PBS building group collapsed, leaving at projects unfinished and owing $25 million. Due to the instability of the market, through insolvencies, we have had to sell sorry, we have had to self perform a number of the tradies we would otherwise subcontract out like formwork ceilings and partitions Mr. Hutchinson revealed in the company’s in house newsletter, hutches truth. We have to get subscribed to that, Tim Yeah, for sure. A looming threat to our business was a shortage of formwork contractors to build slabs and columns, which are vital to keep high rise projects on schedule. Okay, so that’s pretty much what we were talking about before.

Tim Hughes 09:57

Yeah, some that’s a good sign, you know? Like, because the last few years have been so interrupted with the whole pandemic and the supply chain being disrupted. The knock on effect is still going on and will do for some time. Now, there’s been a lot of a lot of companies and subbies subcontractors who have gone under, it’s been very, very challenging times.

Gene Tunny 10:21

Yeah, yeah. Now, as I mentioned, this story made me think about this important theory in economics, this very important paper from the 1930s, the nature of the firm in 1937 paper published in economics, which is one of the well, it was a major economic journal, I think, I think it comes out of LSE. I’ll have to check though. So this article, the nature of the firm, and what Coase was trying to do there was to think about, well, how do you define the firm the business? What are the boundaries of the business, because economics tells us that the market is efficient, the market competition brings benefits, there can be benefits from participating in the market and taking advantage of the competition amongst potential suppliers. But we know that their businesses exist. And in businesses, there’ll be some control there’ll be Well, I mean, they’re almost like a command economy inside a business. They’re not run. It’s not as if they’re bidding. In my business, I don’t have to bid all the time for the people working for me to do a particular job. I don’t have to put out a request for for quiet and get them to the bid for the work. Or I’m not having them compete against each other I’ll I will be determining who does what jobs. So there’s a there’s a socialist or a command element within a firm itself rather than a competitive market element. Right. And so the question is, how do you determine the boundaries of a firm? Why do firms exist? What determines what size they are? So? So for example, for a consultancy business? I mean, we talked about hutches before and we talked about the formwork and what they brought in, but they were bringing that in house well, for a consultancy business. consultancy businesses will typically they’ll have employees who do the jobs. But one option is just a subcontract every time so you could just hang out a shingle and you may not even need a physical office and there are some consultancy businesses that will do this. And they will subcontract, you know, a particular expert to help them out on a job as it comes in.

Tim Hughes 12:48

hang out a shingle.

Gene Tunny 12:50

Isn’t that what you say? Don’t know. Actually, if you don’t have an office, you probably don’t hang out a shingle?

Tim Hughes 12:55

I haven’t heard that term before. Okay. I’m not sure if it’s legal. But um, yeah, I get the gist of it. Yeah.

Gene Tunny 13:08

I think you do put out a hang out a shingle. I think that’s what the term is. Do I get the gist of it, though? Yeah. Okay. Very good. It was not the right term. I’ll cut this out. So there’s this issue about what determines the size of the firm, what activities should be done in house where there’s not a reliance on the market mechanism within the within the business, there’s somebody directing things, what should be done in house in a particular business versus what should be done through the market? So it could just be I mean, there could just be one entrepreneur, and then for every job that their business needs to do they just contract out every time they just get someone to supply the services. And then there are things that I’m contracting out in my business. I mean, I’m contracting out the website, design, the website management, or the podcasts. Yeah, the editing. Yeah, podcast editing. Because, I mean, that takes time. And I can’t do it as quickly as someone else. And not as skillfully. So that’s something that I’m happy to contract out. And now because of things like Upwork, and free, what’s the other one? Fiverr it’s so much easier to find people to do stuff to contract out. So the lower cost of contracting now that’s going to mean there should be more of it. So it should mean that yeah, there’s maybe you do have fewer people in your business than otherwise, because you can contract out so much.

Tim Hughes 14:42

Yeah. And I guess because that I mean, it’s part of the gig economy, like Yeah, and it makes a lot of sense. So that’s something we’ve talked about before is, you know, being agile being able to scale up or down quickly, which is something for instance, like there’s a an office at WhatsApp ended just moved to a larger office. So it’s like a, like we share, or we work rather, it’s a workspace. And so it allows you to be agile and sort of move around and go up and down and expand and contract. And I guess that’s we’re not contracting, but not contracting, there’s no going back. But is that thing of like? Obviously, it’s like paying casual rates, etc. So you pay a little bit more when you when you saw something, you know, occasionally, etc. Whereas, like, using hutches, for instance, as an example, that will be paying the guys doing the formwork, a little bit less than they would do for subcontractors, because they’re on the books, you know, and they would have then holidays and all that kind of stuff. I would imagine. I mean, I could be wrong there. But it was suggested in a normal traditional situation, that’s what would be happening.

Gene Tunny 15:50

Yeah. And I think that’s because when you’ve got people on in your firm, to some degree, they will be. I’m just trying to think through this. If they’re a subcontractor, yep, they’ve got all of their overhead costs as well. Yeah, if they’re in your firm, you’re paying the overhead costs yourself. But when you subcontract out, you have to pay for the overhead costs of the subcontractors. And as well as their you know, what they need to do the job. And then there’s also the fact that they’re possibly more specialised, and they’re going to get the job done. Now, they’re really motivated to get the job done if they’re a subcontractor.

Tim Hughes 16:36

Yeah, I mean, I guess that would be a question for Hutchinson’s really like it would be, it’d be great one day too. If I, Scott, I shouldn’t listen to the podcast, and pick his brains. Because, yeah, I wouldn’t know about that. But you can imagine that that would be the case, for sure.

Gene Tunny 16:52

Well, I think that might be one of the motivations for contracting things out. Because you can specify the job, you can have the the scope of work, and you can say, I need this by this demand, and you’re paying more, and there’s an expectation it gets done by that day. And

Tim Hughes 17:11

the responsibility lies with the subcontractor to say that on one of the things, though, as well to consider is having your in house workforce, if you like, would give a lot of confidence, I would imagine to people who are giving up projects, you know, if you’ve if you’ve got a project someone is bidding for, and they’ve got a large in house workforce, that gives a lot of confidence that, you know, that aren’t maybe the issues that may be around with other developers and builders that have to rely on the subcontractors to be available for when they need them. So there’s a level of confidence so that that would, you know, maybe attract or give them a better chance of winning different, different contracts?

Gene Tunny 17:50

Yeah, so certainly in the current market environment where it’s been hard to get those skills, because there’s been a lot of work on and there’s a lot of competition for skilled labour. Yeah, that could make sense. Yeah. Okay, so I should get back to COEs did my explanation of the problem the intellectual issue, the what Coase was trying to address the the question he was trying to answer. Did that make sense about the nature of the firm? Why should you have a business at all? Why should you have a business that employs people rather than just say, a single entrepreneur? No, it didn’t make sense.

Tim Hughes 18:30

Not to me, but I mean, it’s funny, because I did quickly read it beforehand. And for that, for me, it didn’t jump out at me as being one of the things that, for instance, myself, can take on straightaway, I think I’d have to absorb that over a period of time and really take a bit more time. Because I understand the premise of a business, but I don’t fully understand what the nature of the firm is addressing or talking to. But that might have just been me. And my,

Gene Tunny 19:01

I guess it’s a it’s a rather subtle thing, isn’t it? So he’s asking the question, Why did firms exist at all? Okay, let me see if I can find,

Tim Hughes 19:15

I mean, by firms, it’s business, yeah, business, any business or company. And I guess they exist to make money. I mean, that they’re set out to be profitable, and to serve a purpose and solve problems, you know, builders, build places, you know, everybody has a job to do kind of thing. And if you’re going to build a business, the idea would be to be a profitable one, I would imagine.

Gene Tunny 19:39

Yeah, I mean, this is an article that has been very influential, and it was identified as having solved that problem of how do we justify the existence of a business that employs people and has this long term relationship with employees rather than just sub contracting? All the time to get the services that it needs. So to me it, it’s an important article because it it highlights the relevant considerations and it’s all about minimising the transaction costs. So the reason why you don’t just always contract out so why Hutchinson’s for example, why did it actually employ some people? And it’s not just contracting now for everything so Hutchinson’s would have its own project managers, I suppose, or, you know, people in the head office. And so it’s not going to contract out every time to get someone to come in to, I’ll have to be careful here, because I can’t say I’m totally familiar with their business. But say their accounting, I mean, they, they will have a dedicated, Chief Financial Officer. Yep. I’m pretty sure that have that. So each time they they need some financial analysis, or they need the someone to sign off on their books, they won’t just they won’t contract out that every time they won’t go to the market to try and get that done, they’ll probably have someone who does that, that they’ve employed. And they’ve worked out that that’s the least cost way of getting that thing done. Over the longer term, is if they contracted it out, then they’d have to pay a bit more, presumably. And there’s always a cost in trying to engage with the market. So trying to find out who the people are, who could supply the services, what the cost of the services are selecting the best person?

Tim Hughes 21:38

I mean, I guess like for me, I don’t truly understand the question behind it, because I just thought it would be clear that a business grows or bills, deer to be profitable. And so the decisions that you make along that way would be, well, if it’s more profitable to have in house people for this department, it was something rather than something that out, then that would be an economic or financial decision to be more efficient and save money. And so it’s all about, you know, making money at the end of the day. And then obviously, there are there are quantum leaps taken at different times, which might be a bit of a pun, and they either work or they don’t, but they’re the best guess at the time. But it’s all about growing safely to increase profits. I mean, that isn’t at the foundation of any any business in terms of supply and demand. And, you know, the market in that regard. Yeah, exactly. Competition, etc.

Gene Tunny 22:33

Yeah. So I guess what Carlos was trying to do was to provide a solid intellectual foundation for what you were saying there, which is rough, you know, roughly what he’s driving at. It’s about finding the way for the business to be profitable to be most profitable as as it grows. And so yeah, I think, yeah, maybe it’s a case of over analysis. But it has been an important paper in economics. And I mean, yeah, I guess I might have explained it very well. Why it’s an important paper.

Tim Hughes 23:07

That’s the thing. I’m sure there’s more to it, but like, it seems like a clear question, as to I mean, there’s there’s obviously more.

Gene Tunny 23:14

Yeah. So we’re, I guess where it comes from, is that economists talk a lot about supply and demand and the market and the virtues of the, what they call the price mechanism, which is the fact that, well, we don’t need someone who’s responsible for the control of the supply of bread to the City of London, for example, because the market sort of set out, okay, don’t need someone to allocate that. You’ve got people wanting to supply businesses wanting to supply because there’s, there’s a demand there. And so I might read from coasters papers, because I think this, hopefully, this is illuminating, and it resolves this, an economist thinks that the economic system has been coordinated by the price mechanism and society becomes not an organisation, but an organism, the economic system works itself. This does not mean that there is not planning by individuals. These exercise, foresight and choice between alternatives. This is necessarily stuff there has to be order in the system. But this theory assumes that the direction of resources is dependent directly on the price mechanism. Indeed, it is often considered to be an objection to economic planning that it merely tries to do what has already been done by the price mechanism. Yeah, so what the issue is, is, what’s the limit to a firm? I mean, I clearly there’s reason for many firms to have more than just the the entrepreneur or the the owner manager, they will hire people in rather than just contract out each time to get the services that they need. Where’s the limit to that? I mean, why don’t we just have one big Corporation. Yeah, that does everything or one. So I guess that’s what?

Tim Hughes 25:05

So is it like, for instance, whatever widgets you might be selling, at some point, you have your own delivery drivers or Exactly, yeah, you outsource it to the the post service, etc. So at some point there’s a parameter to what’s in house and what’s outsourced or

Gene Tunny 25:23

exactly. That’s what is driving it. Right. Okay. Yeah,

Tim Hughes 25:26

I get that. Because yeah, there’s so there’s a, there’s a limit, or there’s a wall, if you like to, you know, what you do in house? Exactly. Yeah. And that would be, then back to those things we talked about, like, you know, well, is it efficient? Is it profitable, you know, what risk is involved, etc. And I guess that’s when those decisions, come to the fore and drive where that wall is?

Gene Tunny 25:48

Exactly, yeah,

Tim Hughes 25:49

I get it. Yeah.

Gene Tunny 25:52

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

Female speaker 25:58

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Gene Tunny 26:27

Now back to the show. The fundamental concept that Coast introduced, which is then had been widely applied in economics is this idea of transaction cost of the fact that there’s a cost of transacting in the market, right? There’s a cost of trying to find, you know, issuing a request for quiet and you know, sorting through those and and then contracting them in particularly like if you need a lawyer to, to write a contract for you. I mean, that’s an additional cost.

Tim Hughes 26:59

Well, that’s a good point, actually. Because I guess you get to a critical point or a critical mass where you have your own in house legal department. So I guess there are certain sizes of you know, the need for those different services, professional services, whereby at some point, you then have your own department in the company. You know, that your own legal department, for instance? Yeah. Marketing, yeah, marketing department, etc.

Gene Tunny 27:23

Exactly. If you’ve got enough work for them. Yeah.

Tim Hughes 27:27

So I mean, so going back to Hutchinson, for instance. So that’s, and you would have to say, in every instance, it’s a sign of confidence, of expansion or of growth, to have that in house, because that’s obviously a commitment and a cost. That wouldn’t be easily withdrawn, because it’s expensive to, to let people go, you know, there’s a cost with everything. I guess

Gene Tunny 27:50

there’s positive in in that sense that they expect that we’ll be able to keep these people employed doing formwork? Yeah, they’ve got to, they’re confident they’ve got enough work to do that. But I mean, it looks like it’s a defensive measure to me, they wouldn’t be doing this if it weren’t for the the challenging conditions in the industry, the difficulties of finding people the the challenges of, you know, what you don’t know whether the subcontractor, you engage with whether they’ll survive, and no, because they could let you down mid job?

Tim Hughes 28:23

Yeah. So I see what you mean. And I think you’re absolutely right. Like, it wouldn’t necessarily have been done if the certain situations weren’t around, and maybe other people will follow suit.

Gene Tunny 28:34

I mean, how cheese can do it? Because it’s a reasonably big company. So it’s got the, the real, I mean, you need some, some cash on hand to be able to finance this. Yep. And they’re able to do it. Yeah, some other businesses may not be able to, but it could give them a as I think you were suggesting this before it could give them a competitive advantage in the market, because the purchases are the people wanting the work done. They’ll see how Jesus got this capability. And that reduces the risk.

Tim Hughes 29:08

Yeah, I can only imagine via that it gives them an advantage. Going for contract. Yeah. You know, and also, depending on Well, if they’re taking skilled workers from the labour force, and who are fewer to go around for the other potential competitors.

Gene Tunny 29:26

Yes. Mm hmm. Yeah, it could be a cunning plan or something suggesting to

Tim Hughes 29:32

plan would be proud, very good.

Gene Tunny 29:35

Guy. So might, I might read Ronald Coase as explanation. I’ll put a link in the show notes to the nature of the firm, which I think is one of those. Just one of those outstanding

Tim Hughes 29:46

sisters 1937 Yeah, so he was 27 years old. Yeah.

Gene Tunny 29:51

Pretty impressive. Yeah. Yeah. Yeah. And it well, and then he followed it up with another famous paper and economics. So he won the Nobel Got a prize in 1991? For the essentially for this paper and another paper in the early 60s called the Theory of social cost. Both of them were hugely influential. Yeah.

Tim Hughes 30:12

That’d be interesting to do another episode on that paper.

Gene Tunny 30:17

Yeah, we could. Yeah. It’s, it’s about how you manage pollution and things like that. And yeah, so maybe we could talk about that.

Tim Hughes 30:27

Well, that’s topical all the time, but never more so than right now.

Gene Tunny 30:32

It’s a controversial paper, because some critics of it argue that what Carlos was talking about was a very special case. And it’s been interpreted as saying, Well, you don’t have to worry about pollution, because people affected by it will. They’ll do some deal with the people doing the pollution, and it’ll be resolved somehow. So that’s a simplistic way of describing it. But it’s a controversial paper, there’s Coase was, it looks like he was talking about a special case. And it can be interpreted as saying, well, we could just leave things to the market, we don’t necessarily have to have regulation, which wasn’t really what he was saying. So it’s controversial. I think we’ll have to cover that in another episode be interesting to have a look at that. Yeah, it’s another famous paper. Yeah, so 1937 27 years of age. I mean, he might even been 26, when he wrote it. So he did well, he writes, the main reason why it is profitable to establish a firm would seem to be that there is a cost of using the price mechanism. The most obvious cost of organising production through the price mechanism is that of discovering what the relevant prices are, these costs may be reduced, but it will not be eliminated by the emergence of specialists who will sell this information, the cost of negotiating and concluding a separate contract for each exchange transaction, which takes place on a market must also be taken into account. And I think that’s, that’s going to be one of the major ones, isn’t it? And, and also the delays in finding people. So I think about why I would want to have a, well, if you think about the choice between, say, a permanent person, a full time person and a casual person, for example, then it’s good to have a permanent person, because they’re on hand, they can deal with a variety of different issues, which, whereas with the casual person, you’re not always sure if they’re available. And if you want to contract out, if you want to get on up work, then the people that you might have used previously might be busy doing something else. And you don’t always know what the other person on the other end is what they’re telling you is that right? I guess without work, there’s an advantage in that platforms like that as a rating, and there’ll be some feedback. But still, if you haven’t worked with them before, it’s hard to know how they’ll, they’ll go.

Tim Hughes 33:02

I mean, the costs of doing business on those sort of platforms is has gone up from what it started out as, but it’s still relatively inexpensive compared to outsourcing locally, certainly, I mean, because one of the benefits of this is you can get work done from anywhere in the world. And that’s one of the technological advances that we have at our disposal for sure. It’s cheaper than it used to be 1520 years ago.

Gene Tunny 33:28

It is. So there’s that arbitrage, again, that geographical arbitrage you can take advantage of you could employ someone to, to do a job that you’d have to pay more for here in Australia in the US, and you might be able to find someone who can who’s really good who can do it. And they might be living in India, or Pakistan or somewhere like that. But generally, I think what you find is that the more skilled, well, the higher the rate they charge, generally, the more productive they are, and you get what you pay for, ultimately, so that geographical arbitrage isn’t as or that opportunity to get lower cost. Labour in other countries is not as great, I don’t think it’s as great an opportunity is, as some might think, oh, at least that’s my that’s my experience,

Tim Hughes 34:20

I guess, with increasing any workforce within the company. The nightmare for any employer is to have people twiddling their thumbs and not earning money for the company. So you have to keep that source of work coming in, you have to and also to make sure that people are working efficiently, you know, because the bigger everywhere becomes then I mean, you know, I haven’t had huge experience in this, but I’ve worked with so many people at different levels of management and you know, it’s clearly not straightforward in the bigger companies as to how the hierarchy works. And there’s always people unhappy with how things are the in those really big companies, but yeah, It seems to be there. They take on a life of their own these big companies with all the departments and the hierarchy. And it’s an interesting human experiment. I think, having these insights into these big companies that, obviously, some do really well, some do do not so well, but they become their own living, breathing thing that is clearly difficult to manage, you know, but at every level, the bigger it gets, it comes with a whole different problems for Yeah, just managing the sheer size of something.

Gene Tunny 35:32

And that’s why they’re often Outsourcing Things or something, sometimes they asked us and they bring back in because they had sorted didn’t work out too well. But in terms of outsourcing, look, cuantas. And, and that’s, that’s possibly a good example of the one of the trade offs there. So quite as, as you remember, when they outsource their baggage handling. And they did that to save money. And I mean, they just had a record profit didn’t know. So obviously,

Tim Hughes 35:59

it was very controversial. And I do have a friend who has a lot to say about this particular thing, because he used to work at quantas. And, and so he has insights that far, closer than anything I know. Yeah. But it did appear certainly, from what I understand that like, that didn’t seem to be a great thing. And I’m just going from what I’ve read in the news with this. And, you know, clearly it’s a skilled job, you know, that could that kind of thing where there’ll be problems all the time with baggage handling, as an example that always be these issues with that will come up and experience in any job. And using that as an example, experience wasn’t there with a new workforce, to be able to sort out the issues as they came up. And you can imagine that with pretty much anything, you know, if you change the workforce, and you don’t have that experience of what can go wrong, and what you do to fix it, there’s going to be issues, and that clearly seems to be the case with the baggage handlers. And as to how fair it was or unfair. You know, there’s plenty of commentary on that. But just losing that experience base yourself was, you know, that’s, that’s a difficult thing to replace, it takes time to build. And it’s, it’s clearly clearly was an issue anyway, at the time.

Gene Tunny 37:13

And I think the people who worked for cuantas, as baggage handlers were better motivated, they had better morale, they cared about the image of cuantas. And so they weren’t just throwing pegs around. Well, we’re human

Tim Hughes 37:24

at the end of the day, yeah, there’s that thing of like, whatever job you have, if, if there’s pride in it, and if, you know, I think when people talk about culture in a in a company, you know, this is, this is the reality of it, you know, you can’t just do broad sweeps here and there, and expect everything to maintain some level of pride in the work, for instance, you know, and all of you know, there are very human things that we all sort of respond to, and taking pride in your work, for instance, will be one of them, no matter what your job is, you know, and so I think, yeah, I guess I don’t know enough about that particular thing. But I know, there’s a lot of commentary that has gone on, and it didn’t appear to be a very popular outcome.

Gene Tunny 38:04

No, no, exactly. And I think that’s why, you know, occasionally I have to try and find an example of a company which is outsourced and then brought something back into the company is don’t know any off the top of my head, but I’m sure it’s occurred, brought something back into the company. Well, because there’s what I’m driving at is that, I mean, you’re talking about companies and they can serve, you know, they can grow and you know, you can end up with all of these different departments. But then when they get into financial trouble, that they might realise, oh, we have to rationalise or we have to do things better, and they’ll outsource various different parts of their business. Yeah. And, you know, the baggage handling was one example. I’m thinking, where’s an example where there’s something that’s been previously in house has been outsourced, and then it’s been brought back in house? If you’re in the audience, and you if you know, of an example, please let us know. I’ll try and dig one up and put it in the show notes. But you know what I’m driving it.

Tim Hughes 39:05

I think every scenario that you can imagine must happen, some of has happened. But yeah, for sure, that would have happened.

Gene Tunny 39:12

Yeah, yeah, definitely. Okay, so we might get toward the end of coasters, or his summary of his argument. And then I’ll just go over a couple other things. Chris writes, we may sum up this section of the argument by saying that the operation of a market costs something and by forming an organisation and allowing some authority and entrepreneur to direct the resources, certain marketing costs are saved. The entrepreneur has to carry out the function at less cost taking into account the fact that he may get factors of production at a lower price than the market transactions which he supersedes because it is always possible to revert to the open market if he fails to do this. That’s just saying that yeah, I mean, you’re only going to hire someone if it ends up being cheaper than going out to the market each time. Yeah, to subcontracted out the question of uncertainty as one, which is often considered to be very relevant to the study of the equilibrium of the firm, it seems improbable that a firm would emerge without the existence of uncertainty. And I think that’s an important point, what is driving out there is uncertainty is one of the major reasons why you have a business, you know, that the Will you hope that people are going to turn up to work. And you know, they’re going to turn up, it provides some certainty, whereas in this is the situation Hatch’s was facing, or has been facing, it’s concerned about the uncertainty of whether it will get the formwork the people with the form working skills to make sure the form work gets done the so that the concrete can get poured, and the building projects can go ahead on shedule.

Tim Hughes 40:56

It’s interesting, actually, because some it’s just formwork is that they’ve taken on just thinking about it a little bit more. And it’s the big guts of the building, you know, concrete pour. From that point, everything else can sort of happen. I mean, there are still things that happened before a concrete pour. But it’s, you know, it allows everything else to sort of go. So it’s one of the first you know, it’s an ongoing thing, depending on the structure of the place, there’s going to be more than one pour. But yeah, it means all those other things can then happen, you know, so for instance, yeah, it’s different than having a whole team of electricians or a whole team of carpenters, chippies, whatever it may be, and I’m sure they’re building companies that do maybe hajis to have some of those guys on board too. But because it’s the formwork, it’s like, yeah, they need that at that very, you know, the putting the skeleton, the bones of the place together so that all the the rest of it can happen. I think

Gene Tunny 41:53

in project management, you would say it’s on the critical path. Yeah, yeah. Yeah, exactly. Okay. So many questions or any thoughts on on that the theory of the firm the the nature of the firm by Ronald Coase,

Tim Hughes 42:08

it’s interesting, I can’t say I fully get it. But that’s what I enjoy about these conversations. I come in as a layman and get exposed to these different things. And it’s always interesting. And I have to add, there was another venue, of course, the first value musical that The Hutchins centre Scott Hutchinson was involved

Gene Tunny 42:27

in service when I saw the Johnny Cash tribute concert. Yeah, it was that textbook and no, that was another one though. It was someone else. It wasn’t textbook, it’s unfortunate textbook.

Tim Hughes 42:37

And yeah, if you get a chance, hello.

Gene Tunny 42:41

Okay, so in the shownotes, so as well as linking to that story about Hutchinson’s and the the nature of the firm by Ronald Coase. I’ll link to a really good article on the American Express website, the pros and cons of hiring in house versus outsourcing. And yeah, I thought it went over a lot of the relevant considerations. Things like one of the best things about having people in house is you get the face to face conversations, you build the relationship, you learn how to work together. So there’s benefits from that. Possibly, you can get a sense of whether people are ethical and honest. I mean, I guess one of the challenges and one of the problems with issues with contracting out is that sometimes you could get ripped off, right? It’s

Tim Hughes 43:29

definitely I mean, it’s an interesting point, like, certainly, I’ve heard from friends in the creative industries like architecture, where a lot of the benefits were lost during the lockdowns and working from home was in the collaboration of different ideas. And that yeah, that sort of thing, where you just sort of organically go and check in with someone and someone else might. I mean, of course, there’s, you know, people can waste time, but with creative industries or creative work, that collaboration is really important to be able to share ideas organically as they come up, and it is different face to face as it would be on the screen, you know, like so. It was it was good seeing the respect and the sort of benefit for those kinds of face to face interactions, you know, which I think people have valued since the pandemic and it’s like yeah, that’s something worth holding on to.

Gene Tunny 44:26

Yeah, for sure. The other pros have in house are in that they talk about intellectual property may be more likely to remain confidential. You don’t have to worry about some supplier coming in and learning about your business and ripping off some of your IP so perhaps that’s an issue. However, there are cons of in house hiring could be well it can be difficult finding the right people. There, there might be others. is no benefits you have to pay them. So medical and dental benefits. So that’s more of an issue in the states where the employers have to cover that. And finding, interviewing and negotiating can take time. And then if someone leaves, you have to find them again. So there can be there’s a cost of onboarding people. Yeah. There’s a cost associated with trying to get people to get suppliers in through the market. There’s also and there’s also a cost of trying to get people to work for you.

Tim Hughes 45:28

I guess it’s building trust as well. I mean, what yeah, of course, isn’t exclusive to it working out if it’s in house, you know, look in the house or outsource to the seller level of trust, that takes time to build up which has value.

Gene Tunny 45:45

Yeah. Pros of outsourcing. Most freelancers are pros at a very targeted discipline. So you can get really good people. Outsourcing can be ideal for short term projects in which talent is only needed for the completion of a one off project. Yeah, so the so I’m going to outsource the design of my website every few years or so there’s no point me having a dedicated web designer. Yeah. In the firm, obviously, not yet. Not yet. Yeah, so cons of outsourcing. Near the IP issue. Fake freelance profiles can exaggerate talent. Yeah, there could be different different styles, you may not be used to how the Freelancer works, or the can the person you outsource to, there may be some cultural differences. For example, there can be communication gaps. And yeah, freelancers can get quite expensive. Yeah. So I think that’s quite a good list of pros and cons of in house hiring and pros and cons of outsourcing. So I’ll put a link in the show notes. Okay, I’ll have to have a another read of the nature of the firm when I get a chance, and maybe I’ll have to come back to it and and try and illuminate it a lot better than that. But I was hoping that, at some, at least some of the core principles are clearer.

Tim Hughes 47:17

Yeah, I certainly have a better understanding of it from my first overview of that, again, but it’s, you know, it’s that thing of like, it’s interesting seeing it put down in a single paper, you know, like, I guess, in many ways, I’ve got to the point where I’ve taken it for granted, that kind of outlining, and, and formed my own opinions as to why it has happened. And so it seems like, you know, I’m sure there’s more to it than what I originally saw, you know, which we wish we got to in the in the conversation, but I’d be very interested in having a chat about the other paper whose it was the theory of social cost. Yeah. And with the pollution and everything, that would be good. Yeah. And also to find out what his health regime is, I mean, he got 102 That’s probably fine. It was a chain smoker and drank lots of whiskey, you know, but if it works, it works.

Gene Tunny 48:10

That’s right. I mean, that’s that’s funny, isn’t it? When they asked the 109 year old woman, what was that? What was the secret fear of longevity? I had a brand new every day.

Tim Hughes 48:20

There’s always some French farmer who lives 114 And he’s a chain smoker with colour wise and he drinks red wine for breakfast. These are outliers in the genetic field. So yeah, all power to them.

Gene Tunny 48:34

Good. Save any any other thoughts or any anything else that’s on your mind?

Tim Hughes 48:38

That probably is gene but I think we should probably leave it at that and I look forward to the next one. Okay, thanks to Jeremy.

Gene Tunny 48:50

Okay, have you found that informative and enjoyable? Ronald Coase, his article on the nature of the firm is one of my favourites in the economics literature. It’s highly readable and incredibly insightful. The paper was probably so good because it was based on extensive fieldwork by coasts is a great 9097 reason interview with coasts in which the story is told about how he wandered around the US Heartland in the 30s talking to business owners about how they organise their firms. Based on that field workers concluded that business people were well aware of the relevant trade offs, trade offs that Tim and I talked about in our conversation. Unfortunately, I’ve been unable to get any insights into how COAs lives so long 102 is an impressive run. If you know anything about rollercoasters health regime, then yes, get in touch and let me know and they’ll share it with other listeners. Also, let me know what you thought about my conversation with Tim. As always, feel free to email me at contact at economics explore.com Thanks for listening. rato thanks for listening to this episode of economics explored you Have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economics explore.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

50:42

Thank you for listening. We hope you enjoyed the episode. For more content like this where to begin your own podcasting journey head on over to obsidian-productions.com

Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au.

Tags building, business, company, contract, contracting, cost, cuantas, economics, firm, guess, house, hutchinson, instance, job, market, outsource, outsourcing, paper, people, projects

Podcast episode

Odd way to fix housing crisis proposed by Aus. Gov’t: invest in stocks first w/ Dr Cameron Murray, Sydney Uni.

Post author By Alec Krishna
Post date March 31, 2023
No Comments on Odd way to fix housing crisis proposed by Aus. Gov’t: invest in stocks first w/ Dr Cameron Murray, Sydney Uni.

The Australian Government has been having trouble getting its proposed Housing Australia Future Fund (HAFF) passed by the Senate. The policy looks odd. With some justification, the Australian Greens have commented: “In its current form the Housing Australia Future Fund (HAFF) legislation will see the housing crisis get worse. We can’t fix the housing crisis by gambling money on the stock market and not guaranteeing a single cent will be spent on housing.” In their dissenting report on the bill, the Greens’ cited the views of this episode’s guest, Dr Cameron Murray. Cameron is a Post-Doctoral Researcher at the Henry Halloran Trust at the University of Sydney.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

About Dr Cameron Murray

Dr Cameron Murray is Post-Doctoral Researcher at Henry Halloran Trust, The University of Sydney. He is an economist specialising in property and urban development, environmental economics, rent-seeking and corruption.

Book: Rigged: How networks of powerful mates rip off everyday Australians

Website: https://fresheconomicthinking.substack.com/

Twitter: @drcameronmurray

What’s covered in this bonus episode

Cameron’s submission to the Senate Inquiry into the Housing Australia Future Fund Bill [2:39]
What’s going on with the Housing Australia Future Fund [5:02]
The only reason you can make a premium is if you take risk [8:57]
Why you need to separate the funding and the spending [10:36]
Why doesn’t the Future Fund just directly invest in new houses? [14:21]
How governments are increasingly doing financially tricky things that don’t make sense [19:23]
Cameron’s thoughts on the impact of the bill on the level of investment in housing [23:14]
What’s going on behind the scenes at Parliament House [26:18]

Links relevant to the conversation

Cameron’s submission to the inquiry into the Housing Australia Future Fund:

https://fresheconomicthinking.substack.com/p/australias-housing-future-fund-my

Direct link to Senate Committee inquiry report:

https://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/HousingPackageofBills/Report

HAFF inquiry home page:

https://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/HousingPackageofBills

Transcript: Odd way to fix housing crisis proposed by Aus. Gov’t: invest in stocks first w/ Dr Cameron Murray, Sydney Uni.

Gene Tunny 00:06

Cameron Murray 02:39

Thanks for having me again, Gene.

Gene Tunny 02:40

Oh, it’s a pleasure, Cameron, I read with much interest your latest post on fresh economic thinking. And it’s about your submission to the Senate inquiry into the housing Australia Future Fund Bill 2023 and other bills. Could you tell us a bit about what that involves? So you’ve written a submission to this inquiry? And you’ve also presented to the inquiry you gave testimony? Did you?

Cameron Murray 03:07

Yeah, that’s right. So this bill was passed their house, the lower house, and now the Senate is reviewing it. And what they’ve done is held this inquiry asked for public submissions, and had people who made submissions come in for a day of expert testimony so that their senators can ask specific people, you know, technical questions, what do you think about this? What about this design element? And so I was part of that on on Wednesday, this week. And yeah, so the bill itself is called the housing Australia future funding bill. And the basic idea is the government has decided to address Australia’s current housing problems. We’ve seen rents rise, we’ve seen rising homelessness, we’ve seen longer queues in public housing waiting lists, they’ve decided the best thing for them to do is take $10 billion from the Treasury and give it to the Future Fund, which is a sort of publicly managed investment fund, and cross their fingers and hope that that fund makes a return that’s higher than their opportunity cost, you know, the cost of the government’s dead and use that margin on the risk to fund something in the future, some unspecified, granting in relation to what in the text of the bill is called supporting housing need. So that’s what it was all about. And, and yeah, I gave some testimony on Wednesday.

Gene Tunny 04:35

So the federal government’s claiming that this is going to help them build I think 30,000 social housing dwellings over the next five years or so. So that’s their that’s the plan. But I think what I like about your submission is it essentially talks about how this is a rather roundabout way of going about it, which doesn’t actually guarantee you’re going to deliver it to you As in,

Cameron Murray 05:00

this is the mad thing. And this is. So let me start by saying, to be clear what they’re doing to build houses is taking $10 billion and buying all sorts of assets in the future funds that are not houses. Right? So that’s what they’re trying to do. And it’s really funny because there’s an actually an episode of Utopia, you know, the comedy show about the bureaucracy in Australia, where Rob switches character, who’s the sane one, amongst the insanity is explaining to a political staffer who says to him, What about an infrastructure? Future Fund? Yeah, don’t you get it, it’s about the future, he says. But spending the money on infrastructure today solves the future, we don’t need a fund. We don’t need a new office, we don’t need these fund managers. And you know, when we watch utopia, we all laugh and think we’re the same guy in the room. But what happened at the Senate inquiry is that I was the only guy and everybody else who laughed at Utopia when they watched it was the crazy guy who thinks that spending money on not houses is the best way to spend money on houses. And so there was this really perverse political slogan that kept creeping in, which was, this is going to secure funding for the future and insulated from future political decisions. And I just sat there going, I don’t, I’ve read this bill, because this funding is riskier, because you’re investing in a risky asset and the current Future Fund loss $2.4 billion last year, and spent half a billion dollars on fund managers to achieve that outcome. So we almost lost $3 billion last year. So it’s possible that we put 10 billion in this fund and have 9 billion next year. And then that’s the way we’re securing the future funding. The legislation is also written such that the future Minister has the discretion of how much from the fund to spend, and on what projects. And it also introduces a cap of 500 million per year that a future minister can withdraw from the fund. So what you’re actually doing is providing a great excuse for a future minister to spend less than 500 million. And in fact, zero if the fund is losing money. So there’s this weird disconnect between the political slogan of securing long term funding insulating it from politics and the reality, which is adding risk to a fund compared to just having 10 billion in the bank or at the Treasury where it is, and not insulating at all, and just still relying on future ministers discretion with no commitments. So that 30,000 dwellings you said, is not enough. There’s no, it’s not written in their rules. It’s written in the guideline as a hypothetical of how much, you know, if all went according to plan, and we would expect this, and I’m like, but there’s like, like many housing strategies and plans that the federal government and state governments have had in the past, there is nothing holding them to account on those promises. So yeah, it’s, it’s a really, really strange one. And I felt like there are about 20 or 30 witnesses or experts at the hearing. Now, only two or three of us actually calling this out the majority of the industry. And the researchers had really, I don’t know, bought the line that this is something that it’s not.

Gene Tunny 08:16

Yeah. So what’s going on, it appears to me is they’re essentially that borrowing, they’re going to be borrowing this money, or it’s going to increase the borrowing requirement by $10 billion, because we’re currently we have been running budget deficits. So it’s going to increase that, that borrowing requirement, we’re going to put that into this the future funds, so we’re essentially borrowing money to then invest in the share market or Enron’s Yeah, well,

Cameron Murray 08:45

if we’ve invested in bonds, we’re borrowing money to buy the bond back off ourselves. If this fund, if this fund is like eight or seven or 8%, government, Australian government treasury, that’s just pure accounting. Yeah, you know, trickery, you know, and that shows it but the whole thing is accounting trickery, right? Because, you know, you’re just recycling the money via the current shareholders of BHP into Telstra and Commonwealth Bank, right, by buying the shares off them and then later selling it back to them. And the only reason you can make a premium with this fund over the over not borrowing it, right, because you still gotta pay interest on the Treasury borrowing. The only reason you can make a premium is if you take risk. Yeah, if you’re taking risk, then it’s not a secure, long term funding thing. You’re just adding risk unnecessarily, and delaying spending money on building houses. And, you know, it took a little bit of explaining to get that through at the hearing. But ultimately, I had, for example, John Corrigan, you know, back me up on that argument, and I think Brendan Coates from the Grattan Institute who is a big supporter, the policy sort of had to concede that Yeah, at the end of the day, you’re adding risk in the hope of increasing the funding. But risk is real, right? We just can’t count on winning In the next few years,

Gene Tunny 10:02

right, so Brennan was buying the government’s line that this is about getting a secure funding source. He, I mean, I know you can’t speak for Brendan, I’m just wondering where he was coming from?

Cameron Murray 10:13

Well, actually, the idea is actually from one of our Grattan Institute report, and they proposed a $20 billion social housing fund. And, and, and, you know, I’m not averse to the government sort of diversifying the capital side, right on its balance sheet. Yeah. And and owning some high risk assets? I don’t, I’m not averse to that, in principle, right. But you’ve got to separate the funding and the spending idea. So the way I try to tell people, if the government’s saying we don’t have the money for it, it means we don’t want to do it. Because look at the submarines look at every other big look at the Olympics, right, no one’s has gotten the Olympic Future Fund, no one’s got a submarine future fun. We spend on what we want. And if someone’s saying where’s the budget, or where’s the funding, you sort of missing the idea, but but even more fundamentally, you know, if you go and raise money in the share market, from new investors for your business, each investor doesn’t say, I’ll give you this money, but you can only spend this money on, you know, cleaning your office and and the other shareholder says, no, no, but I only want you to earmark my money for doing this, right. What we do is we pool that money together and spend it the best way we can on the operations we need to do and it’s the same for the government, you need to separate Well, we’re gonna raise money, the best way we know how, whether that’s different types of taxes or borrowing, and we’re going to spend money the best way we know how and tying two things together is bad. Operationally, it’s just like, it’s bad for my business to promise one shareholder that their money goes to one type of spending, and another shareholder that I’ll only spend yours on new trucks. You know, it doesn’t really make sense it and it’s very hard to break through this kind of weird, I don’t know, budget illusion that we’ve all got that, you know, we must do this. For this, we must raise money in this way for this spending.

Gene Tunny 12:06

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

Female speaker 12:12

Gene Tunny 12:41

Now back to the show. I liked how you wrote about this off balance sheet trick or the off balance sheet tricks, the basic idea of the half. So that’s the housing Australia Future Fund is to create an off balance sheet accounting trick whereby the debt associated with the fund and the assets in the fund are considered as a bundle and hence not counted in measures of public debt. So I mean, I haven’t seen exactly how they’ll what the accounting treatment of this will be in the budget, it seems to me what they’re doing is they’re setting this up as a, it’s an SPV, or some sort of public Financial Corporation so they can get it outside of the traditional balance sheet measures. They put in the budget, which is for they have it for general government, but then they also have public non financial corporations, but they don’t have public Financial Corporation. So I’m wondering if that’s what they’re going to categorise it as

Cameron Murray 13:34

I think, yeah, that’s part of the intention. And we actually see those types of budget tricks a lot, I think, New South Wales rail, you know, they tried to shift things off balance sheet, but at the end of the day, you know, we as economists should be looking through that, right. Oh, yeah. And saying, Look, you know, debts debt, but, you know, these are all assets, we can bundle them all together, you know, doesn’t matter where you’ve accounted for them. And the way we’re going to assess whether that debt was, you know, justified or efficient or productive is what, you know, what the investments made in general are, so whether it was on budget or off, you know, it should be the same, right, and you’re borrowing money to buy these assets. Doesn’t matter how you account for it. And that’s the that’s what sort of leads me to my other point is that houses are assets. Yeah. Australia’s property market is the hottest market every property every investor wants to own some. Yeah. So why doesn’t the Future Fund build new houses to expand this pool of property assets in the process, that equity can be on its balance sheet, but instead of, you know, bumping up the prices of BHP shares that you’re going to buy, you actually expand the housing stock in the process, and you can still have your off balance sheet tricks. I actually looked historically and since the Future Fund started in 2006, that’s the current investment fund Australia hands. They’ve made 7.8% average return annually, the average Australian dwelling increased in value by 7.7% per year since 2006. So just the capital value increase of owning a representative sample of Australian property would have got you the same returns as the Future Fund. So it’s not clear to me why we’re recycling this money via other assets, before we build housing assets, we can look at the balance sheets of state, public housing managers. Yeah. And when they value their land and their property portfolios every year, they got to bump it up, you know, 5 million billion. So here 10 billion here, because all this portfolio of properties they own, you know, it’s a valuable asset that rises in value. So So I’ve proposed quietly to a lot of people involved that if you want to have your financial trick and your Future Fund, get the border of the future find to only spend the money, building new dwellings, and then put the equity that you have, yeah, into the fund, you can keep your financial track, but at least you’re you know, keeping the housing construction going. And you’re immediately accumulating a pool of houses that you can allocate to the people who need it at a cheap price.

Gene Tunny 16:13

Yeah. And so is this been driven by the State of the Commonwealth budget, they, they want to make sure that they think they’re gonna get some earnings from this housing Australia Future Fund that can then offset the spending that they’ll have to make on public housing. So they want to get that they’re hoping they can get that. Because if they just go ahead and start building public housing, then they don’t have that revenue to offset that. Is that what they’re thinking?

Cameron Murray 16:39

I think you’re right, I think that’s what the thinking is. But at the end of the day, you know, having those houses supplied to people at a cheap price offsets are the spending on those people already. So the benefit is there, either in the form of the rental, or in the form of the income from the other assets. So, if I was to put on my cynical, political economist hat, I would say the reason this programme has gained so much traction and is probably going to be the law few months, is because it doesn’t change the housing market, it’s going to pass because it doesn’t achieve anything. And that’s what is truly desired. By, you know, the political parties involved is that they want to look like they’re doing something without actually doing it. I’ve had conversations with politicians who’ve told me what’s wrong with the housing market? You know, prices went up, because we dropped the interest rate, that’s good. And rents went up, because incomes went up. That’s good. There’s no market failure here. government shouldn’t do anything. So if that’s what they say to me, how is it then that they passed this bill that’s meant to do something, the only coherent story there is that this bill is to look like you’re doing something, but not doing something because you genuinely think the property market is doing what it’s doing? Well? Yeah, that’s my super cynical. Political Economy hat.

Gene Tunny 18:08

Yeah, you may well be right. I mean, it’s the Sir Humphrey Appleby type of approach where people actually don’t care about whether a problem solved, they just want it look as if something’s being done.

Cameron Murray 18:21

I’ve had a lot of people message me since my testimony to tell me their experiences of this. And I don’t know what I’m going to call this pattern, you know, does it have a name? I’ve tried to call it something like pre compromising. Where you take a good idea, you turn it into a bad idea, but it’s still got the same words in the bill. While so it looks like you’re still doing something. Yeah, you push that. And you’ve totally compromised the content, or the effectiveness, just so you can keep the name because the name is what people will talk about. And it looks like you’re doing something. It’s a what’s it called housing Australia Future Fund? Yeah. Sounds like something important is being done. Right. Yeah. And the more that gets in press headlines, the more we give credibility to the current government, who is trying to, of course tread this line of keeping prices up for people who own property, and pretending they want to keep prices down and rents down to people who don’t own property. And that’s a real interesting political tightrope. That happens a lot in this country.

Gene Tunny 19:23

Yeah, I really liked your submission, Cameron, because I thought it. I mean, it highlights our governments are increasingly doing these sorts of things. And they don’t really make a lot of sense when you think about it, because I remember when I was in Treasury, we had to set up these buildings Australia fund education investment fund, that’s I forget the name of the other one. And it didn’t really make a lot of sense because you’re just taking money and we ended up I think we ended up having to borrow money to put into them, because of the time you know, but the original idea was that there was Yeah, and they were gonna stick them in these funds, but then by the time On had to transfer the money, it was the financial crisis. So the timing wasn’t very good. And then they we see they constrain your ability to get cash. I mean, because you’re saying, Okay, we’re going to lock up all of this money in these funds, even though we don’t need it at the moment. So it can it can constrain your budget flexibility. So I don’t like them for that reason. And the other point that you’re making is your your, if you end up having to borrow to invest in it, well, you’re, you’re borrowing money just invested in the share market. And it’s not necessarily achieving the public policy objectives that you that you want to achieve. So yeah,

Cameron Murray 20:43

that’s exactly the way to put it, you’re gonna borrow 10 million to build houses for people and give it to them below market? Why do you need to recycle that money through the share market? Why don’t you put it through the pokies, there’s also a chance of making more money there, you know, it’s high risk. Why don’t you just take your half million, that half billion that you want to spend each year and spend it for the next 20 years, and just start a construction programme? Like, the really bizarre thing? To me, I read this bill. And in Part Seven H or whatever it is, it says, The Treasury will credit the housing Future Fund with $10 billion. It just doesn’t. And I just think to myself, How does where’s this 10 billion coming from? Aren’t we having this fund to get the money that we don’t have a now you’re saying we have 10 billion? If we have 10 billion? We don’t need the fund? Right? Yeah. And, you know, no one else seems to pick up on that, oh, we just credit with 10 billion. I’m like, why don’t you just build houses, credit them? Credit, the builders is 10 billion. Yeah.

Gene Tunny 21:45

So this is where they’re hoping that by doing it, you know, essentially gambling or well investing with borrowed money, they can get enough of a return on that, to then help fund this additional expenditure. And that’s going to lessen the budgetary impact. So that’s essentially what’s going on. And I just think it’s interesting, because it’s an interesting example of one of these. These things, these clever financial vehicles, the Polly’s and the advisors, I think, in particular, they love it, they think they’re geniuses, but it’s not really solving the problem.

Cameron Murray 22:20

Yeah. And let me just talk you through what I think is the best case scenario. They put money in this fund, sometime in the middle of this year, after we’ve had a big asset market correction, and they they’re near the bottom. In the next 12 months, there’s a real big boom. And in 12 months time, the ministers say, Oh, look, we’ve been making all this money. I’m gonna make this happen. Yeah, that’s the best case. The worst case is, you know, we’ve just seen a bank collapse in the United States, and you know, Swiss government bailout the Credit Suisse bank, the worst case scenario is they put $10 billion into the Future Fund, start accumulating assets in the next six months. And then come September, October, you know, popular time for financial market crashes, the fund loses 10% of its value. And next year, the minister says, oh, we can’t spend anything on public housing, because we just lost a billion dollars on the share market. Yeah, that’s, I don’t know which one’s more probable, but both are potential outcomes. And if the second one happens, you know, I hope the public and the press hold the government to account and say, Hey, this is what you wanted. You were told this is the risk you’re taking. And you still did it anyway. I really hope that opens people’s eyes. If that happens.

Gene Tunny 23:34

Yeah, that’s a good. That’s a good point. So you’re saying that the the level of investment in public housing could end up being dependent upon the returns on this fund

Cameron Murray 23:46

highly likely, implicitly, tells the minister only spend what you make, you know, for funds doing well spend money, if it’s not don’t spend money, the way it sort of described, and it’s got this cap in it as well. I would say there’s a sort of, you know, a built in excuse, yeah. Whereas you kind of want the opposite incentive. You want more public spending on housing during a downturn in the markets, right? You want to smooth out construction cycles. Yeah. Whereas I sort of feel this builds in the opposite political incentive. But the you know, the next 12 months are going to be very interesting if this bill is finally passed. And you know, the markets are very volatile at the moment. And the Future Fund, of course, lost a couple of percent last year, you went down the existing funds. So if that happens again, yeah. Who knows? Yeah.

Gene Tunny 24:40

Just before we wrap up, Cameron, can I ask you what was it like presenting to the committee? I mean, did anyone get it? Did any bells rang? Or what’s the expression? I mean, I imagined some of the Imagine that. There must have been, some of them must be sceptical, or I hope some of the people on this committee worse sceptical. But yeah. What was your impression?

Cameron Murray 25:05

My impression is that this process is a little bit of a charade. So that each political party in the crossbenches can get their sort of own experts on to provide excuses for the political bargain that they want out of this in the Senate. So I think most of the action is happening behind the scenes. And this is just each, each person in the Senate had a chance to call forth their own experts. And so that was done. My impression is that your committee is loaded based on the political party of the day, right. You know, I was cut off from my introduction, when I was saying, you get a few minutes to make introductory remarks. And I was explaining how I can’t believe you’re trying to describe this as a low risk secure, politically insulated funding stream when it seems the exact opposite. Yeah. And they’re like, oh, you know, we only allowed two minutes for these opening remarks get. And, of course, if you if you go and check the footage, everyone bloody rambled for five minutes. So you can sort of see that and, and, you know, I’ve spoken to a variety of Senators offices, as well. And they’ve obviously taken on board what I’ve said, but you don’t see minds being changed. Live during this process. That’s not where it happens. It’s all happening with phone calls and meetings and negotiations amongst each party and independents are

Gene Tunny 26:36

all behind the scenes. Okay. Because I was just wondering, I imagine that the, the greens would probably be pushing the for the government just to build public housing. Right. Yeah. Well, that must be in there. That’s right. So

Cameron Murray 26:50

I think it’s Nick McKim is the green senator from Tassie. And he was, you know, onboard when I started my opening remarks by saying, you realise there’s a scene in the comedy show utopia, right? We started today. That is exactly what you’re doing. But you all laughed with the other side of the joke. And now you’re you are the joke. And so he got a few chuckles But you know, the other the other people didn’t really like it. So yeah, the greens are definitely not keen on these off balance sheet financial tricks at all, which is really puzzling, right? It’s really puzzling to me. I don’t know what the Liberals should be sort of have a similar mind being a bit more honest financially and say, let’s focus on what’s a waste of money and what’s not. Let’s not focus on where you record it in the accounts. So I don’t I don’t know what their views are. But my impression is the Labour Party, you know, they’ve almost got this superannuation brain, or this Future Fund brain like this sort of, yeah, it’s inhibited their ability to go, you know, this is not magic. It’s not a Magic Pudding. It’s just buying different assets.

Gene Tunny 27:57

Yeah, yeah, exactly. So I’ll put a link to your submission in the show notes. I think it’s really good. And you make a good point about how, yeah, I didn’t realise the fees paid by the Future Fund for funds management was so high, but I guess it makes sense, given the amount of funds under

Cameron Murray 28:13

point 2% of the funds under management. That is still half a billion dollars a year, which is of course, again, the maximum that this Future Fund for housing can actually spend on housing subsidies or housing construction. Yeah. So the maximum they can spend is roughly what the average management fee is for the existing Future Fund. Yeah, just to get your orders of magnitude straight of what’s involved.

Gene Tunny 28:40

Okay. And, yes, it has been passed by the lower house, it’s going to it’s being considered by the Senate at the moment, and it’ll probably be passed, I imagine, based on what you were saying,

Cameron Murray 28:51

my understanding is the cross bench has a lot of power in the Senate here to get things changed. My suspicion is that if there are key crossbenchers that take my argument seriously and a couple of other of the submitters as well, they may, for example, put in the legislation a minimum amount of spending out of the fund instead of a maximum to sort of guarantee it. And they may, you know, and that might just be a way of diverting instead of buying bhp shares and Commonwealth Bank, you know, build houses with it and own the equity of those houses with your public housing developer or however you account for that. So that that that may be a realistic change. I don’t think it’s gonna get thrown out or go back to the drawing board.

Gene Tunny 29:38

Right. Okay. Well, again, well done, Cameron. Yeah, excellent submission, lots of very sound, economics and public finance in there. Any final words before we wrap up?

Cameron Murray 29:49

No, I just want to, you know, cross my fingers that the best case scenario turns out if this fun gets passed.

Gene Tunny 29:55

Very good. Okay. Cameron Murray, thanks so much for appearing on the show.

Cameron Murray 29:59

Thanks for having me, Gene.

Gene Tunny 30:02

Righto, thanks for listening to this episode of Economics Explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

Cameron Murray 30:49

Thank you for listening. We hope you enjoyed the episode. For more content like this or to begin your own podcasting journey. Head on over to obsidian-productions.com

Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au.

Tags assets, australia, balance sheet, bill, borrowing, buying, economics, fund, future, government, houses, housing, market, money, people, public housing, spend, submission, treasury

Podcast episode

How to Defeat the Dictators w/ Charles Dunst, Asia Group – EP180

Post author By Alec Krishna
Post date March 23, 2023
No Comments on How to Defeat the Dictators w/ Charles Dunst, Asia Group – EP180

Have democracies failed and is authoritarianism winning? How can democracies reinvigorate themselves? Does the West need to decouple from China? These and other questions are considered in Economics Explored episode 180. Foreign affairs expert Charles Dunst talks about his new book Defeating the Dictators with show host Gene Tunny. Among other things, Charles and Gene talk about the potential benefits of Public Private Partnerships (PPPs), such as Operation Warp Speed, the Trump administration’s COVID-19 vaccine plan.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

About Charles Dunst

Charles Dunst is deputy director of research & analytics at The Asia Group, an adjunct fellow at the Center for Strategic and International Studies, and a contributing editor of American Purpose. He is the author of Defeating the Dictators: How Democracy Can Prevail in the Age of the Strongman (Hodder & Stoughton, February 2023).

For further information about Charles, check out https://www.charlesdunst.com/.

What’s covered in EP180

What is the Asia Group and what does it do? [1:35]
Is democracy no longer seen as the path to prosperity in developing economies? [5:28]
What are the most important organizing principles for a democratic system? [11:38]
Accountability and the lack of trust in government [16:34]
Best practices for running a democratic country in the 21st century [21:36]
Too much money in politics in the US [25:41]
Does the West need to decouple from China? [27:37]
The role of public private partnerships (PPPs) such as Operation Warp Speed [32:27]
How will dictators be defeated if we govern ourselves better? [34:59]
The importance of engaging in the conversation through social media and local governance [38:32]
Inequality and the Dream Hoarders [39:00]

Links relevant to the conversation

Defeating the Dictators (Please buy the book via this link to support the show):

https://amzn.to/3liQrjx

Matthew Engel’s FT article “The foreign states that own Britain’s railways”:

https://www.ft.com/content/e57c5fd0-bf54-11e9-9381-78bab8a70848

Dream Hoarders: How the American Upper Middle Class Is Leaving Everyone Else in the Dust, Why That Is a Problem, and What to Do About It

https://amzn.to/3LvCOrL

Track Nancy Pelosi’s stock portfolio:

https://www.capitoltrades.com/politicians/P000197

https://twitter.com/PelosiTracker_

Transcript: How to Defeat the Dictators w/ Charles Dunst, Asia Group – EP180

Gene Tunny 00:06

Charles Dunst 01:35

Thanks for having me on.

Gene Tunny 01:36

It’s a pleasure Charles. Nicholas grew and passed on your details to me, regarding your new book, defeating the dictators and yes, very keen to chat about that. I understand you’re the deputy director of research and analytics at the Asia group. Could you just tell us a bit about the Asia group and your work there first, please.

Charles Dunst 02:00

Sure, the Azure group is a strategic risk advisor, essentially, for companies looking to do business in Asia, and we’re headquartered in Washington. But with offices in Tokyo, we have an office in Vietnam, we have an office in in New Delhi, I think we had one or one or two advisors at one point in Australia. But basically, it’s mostly companies looking to do business in Asia on things like how do I start selling cell phones in Vietnam? Or how do I start manufacturing something in India and kind of understanding those marketplaces given just challenges of doing business in those markets. And basically, people come to us looking at former US diplomats, people with longtime business experience in the region, who just need a new knee to help and we can kind of provide that expertise. And at the research team, I kind of said to denied point of the firm where I’m not super client facing in terms of on a day to day basis, I’m not necessarily engaging with, you know, X, X company or y company. It’s more so we look at pan indo-pacific issues. So we Lee, I write a daily news wire that goes to clients, that’s basically four stories from overnight, overnight us time, that happened throughout the region that matter for either business, economics or politics. So we do that we lead coverage on things like the Indo Pacific economic framework on the quad issues that don’t directly fall in one country team baskets, there’s something that’s not China’s specific or something that’s not Australia specific, we kind of handle the pan regional issues. And I handle a lot of the public facing media stuff, just given my given my own background as a journalist. So it’s a really interesting, firm really dynamic. And we just, I think our New Delhi office is now under a year old. So really, lots of lots of movement.

Gene Tunny 03:42

Raw. Yeah, absolutely. Okay. That’s very good. And depending on I mean, it’s hard to know what the right stats are. But India could well be the largest country in the world at the moment. I mean, given China’s declining population, so yes, makes sense to be boosting that Indian presence. Absolutely. Okay. Well, we better talk about your book. It’s getting some it’s got some good testimonials, is really impressive. You’ve got a testimonial from the current UK Chancellor of the Exchequer, Jeremy Hunt, you’ve also got one from? Is it McMaster, a former national security adviser? Yep. And then yes, yes, very good. So defeating the dictators. What motivated you to write this? Charles, why did you think this was an important book to write?

Charles Dunst 04:31

Sure. I mean, I’ve spent a lot of time living in non democracies or kind of countries on the on the cusp, as one might say. So I lived in Hungary when I was still in university. And I remember I was kind of a quasi young journalist at the time, and it was writing articles and pitching around articles about Hungary and writing academic work about Hungary. And it wasn’t getting so much attention because it was this was 2017. So kind of right before Orban became an internationally known figure, precisely because of his his illiberal ism. Ah cracy his notion of kind of setting the stage for folks who win elections legitimately come into government, and then do away with the liberal institutions within. And I basically lived in Hungary I then lived in Southeast Asia and I lived in London and I kind of travelled all throughout Eastern Europe, all throughout Southeast Asia spent a lot of time in the Middle East. And something that kept coming up, when you talk to the intelligence is of say, Hanoi, or the intelligencia. In Kabul, maybe less so Cairo, but the intelligence is certainly in the Gulf. There is this notion that democracy is no longer the path to prosperity, there is a sense that you can follow the models of the Singapore’s of the world that you can follow the model of China that you can follow the model of Saudi Arabia. And I think more and more when I travel around the developing world, that was something I heard, and particularly in our little Western bubbles, sometimes, particularly in the US and the UK, I think we don’t do such a great job of communicating the virtues of democracy, and basically answering the question why democracy for people in the developing world, because if you are Vietnamese, and you’ve seen your country’s GDP, and you’ve seen it grow so much, and you’ve seen your, your life expectancy increased so rapidly over the last 3040 50 years, it’s not entirely clear to me why you might look around and say, well, this system’s not working, we need a democracy, when you see January 6, there when you see three prime ministers in three months in the UK, so I wanted to write a book to make a very affirmative case for democracy. Because there are many books, I think, in recent years, kind of lamenting the decline, the decline of democracy and the rise of the Viktor Orban types. But I wanted to say, write something a bit more affirmative. And saying, well, here is what can be done to actually make sure democracy works once again. And when democracy works, once again, most importantly, you can keep democracy where it already exists. democracy works better in the United States. So if democracy works better in the United Kingdom, you’re going to get fewer elections of people like Trump, who may not necessarily be the biggest believers in the democratic system. And once you can kind of tamp that discontent at home, it’s my belief that democracies can serve as a better model for countries in the developing world, well, maybe this, they might not look at the United States and look at Australia, and look at the United Kingdom in five to 10 to 10 years and say, well, those systems are more innovative than the one in China that they’re more solid. I mean, that right now, I think, if you’re sitting in Vietnam, that might not appear to be the case. So I wanted to write a very affirmative case for democracy and looking how do we can advance our values and really practical ways?

Gene Tunny 07:32

Sounds? And we’ll use that affirmative case for democracy. What do you think are the key points in favour of democracy?

Charles Dunst 07:38

But key point for me is study after study still shows, despite the kind of discontent in our democracies that if you live in a liberal democratic society, or even just the democratic society, you are likely to live longer, you are likely to make more money. And I know there are no studies that can necessarily show this, but it is my belief that you’re likely to live a richer cultural life, and you are more likely to innovate, that is true as well, that the world’s best generally still comes from democracies. And this is not to say that Singapore and China cannot innovate. Of course, of course they can. And of course, great art and great movies and all that can come out of non democracies. But there is a reason why when you travel around the developing world, particularly in Asia, that the media is the the music people listen to his Japanese and Korean democracies, or the movies on TV are mostly American, maybe British, maybe Australian, but it’s not like Chinese, Chinese culture has become predominant in the developing world. And that is kind of a silly example. But it’s indicative to me, of the ways in which democracies embrace the kind of tumult and chaos of our systems and we are better for it in the long run. So it’s just about making sure that we are making sure that our systems are providing for our people, while also embracing this chaos that allows for a Jackson Pollock painting, or allows morikami to write when a cue for these are not works, that someone will be able to conceptualise in a non democracy and think that’s a very, very key point that the art and the innovations that are going to be really necessary for the future particularly think about things like climate change. Well, the Evie transition is going to be fixed by innovations that are primarily coming out of democracy, or democracies. And it’s the same thing on healthcare innovation. I mean, where did where did the COVID vaccines come from? Exclusively democracies, not only the United States, Germany as well, of course. So that was my affirmative case for democracy was starting at this point of saying, well, even the things look really messy. Right now, if you look around, you would rather be the citizen of a democracy than an autocracy bar, not

Gene Tunny 09:41

just on Vietnam, and that was an interesting point you made. Do they recognise that? I mean, a lot of their prosperity does come from embracing the market, doesn’t it from embracing the market and as someone who I mean, I’ve read a lot of Milton Friedman when I was younger, and I mean, Friedman used to make the case that the market and democracy were very closely entwined. Or that you can’t have one without the other. I think Friedman’s argument was. So the people in Vietnam recognise that the importance of the market, and then the importance of freedom more broadly,

Charles Dunst 10:17

I think not so much the notion of freedom more broadly. But I think there is a recognition of the need to have liberal ish economics, I mean, Vietnam, China, Singapore, these countries all got richer. I mean, certainly Vietnam is not rich, like Singapore is, but they all got richer by embracing liberal trade. And I think what’s really not troubling, but a little concerning if you’re in a democracy is that those countries and others have proved that you can have mostly liberal trade without liberal politics. And that is a very different scenario than with the Soviet Union, or the kind of Soviet bloc writ large, or China before dung XIAO PING, where essentially, these were the countries that were illiberal politically, and also illiberal economically, so they couldn’t really grow in any meaningful way. So those systems never had a tonne of legitimacy, because they never worked. Whereas now, I’d be hard pressed to say that the Vietnamese system has not worked, or that the Singaporean system has not worked. Clearly, you can get rich without democracy. And that’s a new relatively new point over the last 180 years. It really was this notion that the way to get rich in the post colonial era was to be a democracy. So the fact that you can actually decouple liberal values from liberal trade is definitely a concern. And part of the reason why why I wanted to write the book,

Gene Tunny 11:38

yeah, just on Singapore, you mentioned Singapore quite a few times in the book. And that’s an interesting example. And probably, I mean, that relied upon just that extraordinary figure of Lee Kuan Yew, didn’t it and someone who was, you know, almost just by his background, and by his education could be that benign dictator or authoritarian, that he was an exceptional individual and probably someone you can’t count on having another another kind countries. So I thought it was interesting. You did tackle that question of Singapore, head on in your book. So yeah, just an observation just while I remembered it on Singapore. Okay. In your book, you give a really good summary of your argument early on, and you’re talking about a No BS approach to the future, committing to our values and, and also to the practices but not buying into utopianism. I really like this, but you go that we must convince the world in practical terms why our organising principles remain preferable to those of autocracies both at home and abroad. We need to look our own failures in the eye while learning from the successes of others. You talked before about the affirmative case for democracy, but could you just restate or reiterate? What are those organising principles? What are the most important ones, Charles,

Charles Dunst 13:03

when I was talking about liberal organising principles, I’m really thinking about the things that are necessary to be a democratic system. So things like freedom of speech, things like free and fair elections, broadly open societies space for civil discourse, space for civil rights organisations, for civil society organisations, this notion that it is actually good to have a dynamic and open society where there can be really aggressive, loud debate and disagreement. And that’s not I don’t think that’s a bad thing. I don’t think it’s a bad thing that we can have really heated political debates. I’d rather that than the opposite of kind of no debate at all. So but I think we really do need to convince countries of well, why should I have? You know, why? If you’re Vietnamese, or your, you know, rich, Chinese rich, rich Chinese person, you turn on CNN, you’re gonna say, Well, why would I want that? Why would I want two people kind of debating angrily at each other over on TV? I mean, how is that helpful for my government? So I think we really need to say, well, here’s why. Because that loud debate tends to lead to a society that’s open enough to produce really strong innovations that’s really good, strong to produce the best kind of art. And these are all things that are vital to the future, but clearly just kind of walking around and dropping into annoyance. And well, you shouldn’t be like us, because our systems are open, and they’re so great isn’t enough, when there is a need to demonstrate very practically, well, why is the United States or why is Australia? Why do we offer a better path for prosperity broadly, than do China or Singapore? So that’s really how I how I thought about it.

Gene Tunny 14:41

Gotcha. Right. And what do you think the failure is? You talk about the failures, so we have to look at our own failures in the eye. What failures do you think are most significant?

Charles Dunst 14:53

I think honestly, one of the biggest ones that I talk about very frequently is this is more of a problem I would say in the US in the UK than Australia, but broadly kind of the mismanagement of globalisation in the sense of thinking that we could essentially export manufacturing to places like Vietnam and China without experiencing any domestic discontent at home, that people who would had who’ve had who have had these manufacturing jobs for generations are mining jobs for generations, would lose them turn around and say, I’m all good. Okay, and wouldn’t revolt in one way or another, and particularly in the US the it is this programme designed to kind of ameliorate that loss with some economic assistance, but it’s kind of a mess and doesn’t really work effectively. And that, to me is so indicative of the problem that the United States China, the UK comes through this free trade through globalisation, we all got richer, but the average person did not get as rich as their as the god the government did, or as the kind of top 1% did. So I think there’s this increased frustration, it’s saying, well, people turn against globalisation, because they turn away because they’re mad or with the way globalisation was managed. And I think really pushing back against that is really important and saying, Well, trade isn’t the problem, or liberalism isn’t the problem, the problem was the way it was managed. And that gets into the broader question of inequality, where, particularly in the United States, particularly in the United Kingdom, inequality is one of the major fuels beyond anti immigration politics beyond I would argue, kind of very strong, populist politics, that lead to things like Brexit or elections of people like Trump. So that those are kind of two big ones. And the other, I think, really, really vital. One is a relative lack of accountability and which is fueled a lack of trust. I think there was a notion if you talk to enough people in the UK or the US and even even Australia times, that there are two sets of rules that there’s a set of rules for normal people and a set of rules for everyone else, me everyone else who kind of that top 1% of rich people and rich people in the government. And that view in the US, I think about the example of the fact that there are so many Congress, people who trade stocks, I’m sure some of them are I’m sure many of them are not doing it illegally, technically. But clearly, you’re privy to some kind of information as a lawmaker with a certain type of security clearance that you probably should not be allowed to turn around and trade stocks. And even when a lawmaker is caught either not filing their stock disclosures on time, nothing seems to happen. They pay a little slap on the wrist fine, and then they’re done. And that’s fuel this notion that if that’s a normal person, that person is getting punished very severely. And I think making sure that we’re restoring accountability is key. So it’s about economics, but it is also about things like accountability, which leads to distrust in government. And when when your government lacks trust, it’s really hard to do just about anything.

Gene Tunny 17:50

Wrong. Yeah. Yeah. Good point. I’ll put a link. I think there’s a Twitter account that tracks Nancy Pelosi stock portfolio. So Pelosi has been one of the strongest performers in the Congress. And I don’t think she’s the top performer. But I’m sort of stuck fix, which is, you know, far exceeds market performance. So yes, does does raise some questions there. Charles, do you have any reflections on how democracies fared relative to autocracies during the pandemic?

Charles Dunst 18:22

Yeah, I mean, I think certainly the US performance was was quite poor. And I don’t think that’s anything intrinsic to democracy. And that’s kind of how I would approach the UK as well as there was nothing intrinsic to democracy that made them fail on the pandemic, it was more so we were just the two of those two countries, my country and then the United Kingdom, kind of had not great leaders for pandemic management when a pandemic happened. Whereas certainly, there are other democracies that did much better, certainly South Korea did much better. Certainly, Taiwan did much better. Certainly, Japan did much better for a period. And when you think about the autocracies, Vietnam had a very strong performance for a while. And again, that’s not because Vietnam was an autocracy, it’s because Vietnam had an extremely high level of social trust, that this is trust in government and social trust between one another so in the government, the government was extremely blunt, and extremely honest with its people and said, This is going to be very painful economically. But please stay home, stay off the streets, and we’ll get through it. We’ll get through it as a country and there was really smart messaging of talking about it like it was another war like the Vietnam wars, the another foreign invader was gonna be kind of overstating, but it was another war, the long line of wars against the Vietnamese people, and they banded together. And for a long time, Vietnam, controlled the pandemic extremely well, kind of until the Omicron variant showed up which no one could contain. So Vietnam performed quite well. And I think the the example people go to all the time, and I think kind of wrongly, to talk about COVID and a COVID. Management in a positive light is China where people say, well, zero COVID policy was great. And I think the irony is that The zero COVID policy was maybe very effective and could have been more effective for like a year, in the sense of if you can manage to have these strong lock downs, where you kind of say, well, you know, please stay home, whatever, whatever. And then you get vaccines and you get good vaccines, the Western vaccines and you get your way out, maybe I would sit here and say, well, that’s not a policy I would sign up for. It’s too restrictive, keeping people at home that long. I mean, as a as a democratic citizen, I am not in favour of giving your government that much power. But I do think the irony of the Chinese approach was they kind of demonstrated the efficiency kind of quote, unquote, efficiency of autocracy of saying, well, we can because we have so much power, we can shut everything down for a year, and then we’ll open up it’ll be fine. But the irony is that autocracy was then the reason she didn’t things her personal disdain for the West, was the reason why China didn’t accept the COVID vaccines from the West, that there was no way of reopening, without what models they were probably a million people who died when China reopened. And certainly that’s a lower death fold in the United States. But most of the US deaths took place before the vaccines were if it were available. So I do think at this point, it’s very hard to sit here and say, well, the autocracies managed COVID. So much better than democracy. did. I just don’t think that’s the case. I think it is. Countries with a large amount of social trust in their governments managed COVID better than others. And that’s kind of the Taiwan case. That’s the South Korea case. Those are both democracies, and they manage COVID better than most countries because, I mean, in Taiwan more so people do trust the government raw,

Gene Tunny 21:35

okay. Are they places to learn from? Are they countries and economies to learn from? You mentioned that in your book, you look at examples of good governance from everywhere past and present to detail best practices for running a democratic country in the 21st century could? What do you think those best practices are? And what examples Could you point to Charles?

Charles Dunst 21:58

Yeah, I mean, in Vietnam, I think one example, I’d point to a lot of government’s focus on winning social trust, and the focus they spend on being communicative to their people. And even in a one party state, I think there’s a recognition of what because there are not elections are not real elections, you need to win over that social trust much earlier. And you need to kind of maintain it much earlier, because there is no way at the ballot box of kind of seeing how citizens actually feel. So you need to be a little more transparent and communications at times. And some of the other examples I think about where I would like if democracies had more put on paper and more of these long term plans. People like to make fun of China’s five year plans because they are modelled off the Soviet five year plans, which of course, set these targets Soviet Union was never going to hit. But I do think the idea of democracies happening, well, maybe let’s have a 10 year critical minerals plan, or a 10 year health care plan. Because far too often, those plans are very much focused on security and defence, which are important. It’s important to have maybe a four or five year review of the state of your country’s defence infrastructure, or of your security infrastructure, what are your cybersecurity infrastructure, but I would like that apply to other things I’d like that applied to things that actually matter to normal citizens on a day to day basis. I think the idea of saying, Well, what’s our healthcare sector looking like right now? What’s our infrastructure looking like right now? On what do we want it to look like in 10 or 15 years? And I think that’s something that there are a few autocracies, particularly China and Saudi, spend a lot of time putting out these reliefs, five years to five year plans, or in Saudi Arabia, kind of the vision 2030 plan, and of course, because they’re autocracies, I would argue that they’re probably less likely to actually fulfil many of those goals. And certainly I don’t think Saudi Arabia is on perhaps the greatest trajectory. But I do think the idea of putting things on paper can be really beneficial. And one other example I don’t, I’m not gonna run through all of them. But one good one that I thought the UAE has pulled out in recent years, is they ranked every health care centre in the country, and then publish the results, and said, you know, this one in Dubai is great, this one in Sharjah is terrible. And it I really do think that’s not the worst idea, particularly in a smaller, smaller countries, you can do it state by state or city by city, where I’m from New York City, I can only imagine if New York City, the New York City government, basically brought in an unbiased agency and have them rank the New York City hospitals, and the ones that are at the bottom, clearly, you’re going to be motivated to perform better, because nothing motivates people like a fear of being embarrassed. So I do think that is this kind of odd way of being accountable and transparent. Of course, as a democracy, you can be more transparent in those rankings and and you can be more accountable than an autocracy ever could. So that was kind of the main thesis of the book was well, there may be things that autocracies put out plans or they look to build social trust, kind of in ways that I think are, are okay are kind of they’re interesting, but because democracies are a kind of a superior system, any of those reforms that we look to put in place into a liberal democratic system, I think we can do better.

Gene Tunny 25:09

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

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Gene Tunny 25:44

Now back to the show. Just thinking in the States, one of the things I hear a fair bit is that there’s too much money in politics in the US. And that’s related to that was at Citizens United that decision. Do you have any thoughts on that? Is that an issue that the lobbyists have too much power to sway the the people in Congress, and they’re, you know, they’re looking for donations and all of that. So do you have any concerns over that?

Charles Dunst 26:13

Yeah, I mean, I think I definitely do have concerns about it, even if at times, it’s slightly overstated. I think maybe in the media of how much power lobbyists actually have preside over the reality is perception at one point or another. And people do think that the lobbyists do have so much power in one way around that. And something I suggested in the book is to essentially, make sure you’re being much more transparent about where the money is coming from and who it’s going to where if the Supreme Court made a ruling, clearly the money is going to keep flowing. There’s no way around that at the moment. But what a government can do, what the US government can do is create a really accessible online database that very clearly demonstrates, well, where’s the money going? Who is it going to, and there are efforts to do that. But you know, the current system is so not user friendly, it’s so difficult to go online and actually look at who’s donated to who, there’s certainly some kind of dark money that doesn’t come that doesn’t isn’t clearly registered. And I think it would be very helpful just to have this transparency, it’s a way to kind of mitigate the problem. Because if you’re a politician running for Senate or running for Congress, and you know that every donation you accept from they come from a big corporation, or every lobbyist to meet with is going to be very much public, it’s going to be a very easy to access database, you might be a little bit more hesitant to take those meetings. Whereas now you do have to register those meetings, but no one knows where to find them, and no one’s actually looking. So that’s not a wholesale solution, but I think we could mitigate the problem.

Gene Tunny 27:37

Okay, a lot ask you about how do we think about and how do we deal with authoritarian countries? So at the moment, the major ones are China and Russia? I mean, obviously, we’ve cut off a lot of ties with Russia due to their invasion of Ukraine. But what about China? I mean, in the last five years, there’s this new concern about China as a strategic threat. And they’re increasingly calls to decouple to. I mean, there are some rather extreme proposals out there, almost trying to cut ourselves off from China and not trade with China. Which, you know, in Australia, we’ve actually had some retaliation from China. And that’s affected some of our exports. But I mean, China has been a major destination for our exports. So that would be very difficult for us. How do you think about that? How should we engage with these authoritarian regimes in the future?

Charles Dunst 28:38

Well, I think it’s important not to, of course, lump them all together, where I think approaching China is very different. We’re approaching Russia at the moment, where certainly, I’m in favour of the broad sanctions policy against Russia saying, Well, this is a country that invaded its neighbour, I don’t know if there’s anything wrong with setting this precedent of Oh, you don’t get to evade your damper. I just kind of continued business as usual, at least with with the broader West. When it comes to China. I think the question is, how do you compete responsibly? I don’t think the idea of complete decoupling is, is really workable, if you’re the United States, if you’re the United Kingdom, if you’re Australia, because the economies are too intertwined. I mean, this is not the Soviet Union, where basically our economy didn’t really touch theirs. Whereas every basically every field is these overlap again, do I think there’s anything problematic about selling a refrigerator to China? or selling shoes to Chinese consumers? No, I that’s not a concern for me. But I do think there was a question of, well, where do you draw the line? What kind of tech is to sell what kind of goods are too sensitive to be sold to to a one party state in China, in which basically, the government does kind of oversee everything and it does seem like if you are selling some type of technology to a private firm, you could never be just how sure how private that firm actually is. And if the government could step in and kind of take that tech in one way or another. Every country is going to define a different only, but basically do I think there’s anything wrong with not selling military applicable semiconductor technology to China? No, I think that’s fine. I think basically recognising that this is a country helmed by a government that does not, frankly seem super interested in positive ties with the West. And that, of course, has been more aggressive in the broader Indo Pacific in recent years. Think about the South China Sea, you think about the drills around Taiwan, I think it makes a lot of sense to deny them certain technology. But the broad way I think about relationships with autocratic countries is just to make sure they’re in our own benefit. Where when you think about us ties with Vietnam, the current state of us Vietnam ties seemed very much in America’s interest. You know, you get a trade partner, you get, broadly a security partner, we raised human rights with them privately. I think we’ve successfully made some advancements on LGBT rights in Vietnam has been broadly kind of a success. Certainly Vietnam is not just liberal society, or is Liberal government as we would like them to be. But we don’t have the luxury of saying we’re only going to engage democracies, there are more autocracies than there are democracies today. So we do have to engage Vietnam, we do have to engage Saudi Arabia, we do have to engage Oman, and we do have to engage Rwanda. It’s just making sure that those relationships are in our benefit, and that we’re using them in our national interest, whether that’s trade, whether that’s security, and making sure that we’re not, we’re not giving the autocrats too much credit, if that makes sense. So we’re not overstating well, how important is the US, the US Saudi relationship, when I don’t think we should just sweep, sweep things under the rug, because we think that relationship is important. I think it requires a real reevaluation of well, how important is that relationship? Actually? How much how much do we actually care and it’s gonna be different for every country, it’s gonna be different. Of course, Australia has a different relationship with Vietnam, United States does, but I think that my broad sentiment is, it’s not reasonable to cut off all ties with autocracies, but it is about managing those relationships carefully.

Gene Tunny 31:59

Okay, Rod, I’ve got two more questions, if that’s okay, I’ve got a question about PPP, public private partnerships. One thing I really liked about your book is, is your openness to the potential gains from these arrangements, these cooperative arrangements between public and private sectors? Could you tell us a bit about PPS, please, Charles, and what you see is their merits?

Charles Dunst 32:27

Sure, I mean, I’m in favour of public private partnerships, only when the goals match at the beginning. And one example I talked about here very frequently, is operation warp speed in the United States, which was the development of the COVID 19 vaccines. And basically, the government gave out a pot of money to companies to develop the current vaccines as quickly as possible. And certainly, while some of these companies share, they probably had a profit motive very well. So thinking, well, this is a terrible pandemic, we need to get our vaccines out as soon as possible. And that was the government goal as well. So clearly, the goals were very meshed from the beginning. And even if the companies in the end are going to make profit, the goal was not necessarily on profit, the goal was then actually delivering. Whereas some of the examples that I’ve other people have raised, particularly when I talked to British media, as well, our our PPVs haven’t necessarily worked as well. And I would argue, well, that’s because the goals weren’t aligned from the beginning, where the government wondered one thing, and the other party was much more focused on profit than anything else. So making sure that you’re partnering with responsible private sector actors, he’s really key. I mean, he should not just be throwing money at private sector firms hoping they’re going to deliver, it needs to be a 5050 partnership goals need to be aligned. But when PPP is work at their best level, I think they serve to actually boost trust in democratic governments, because poll after poll shows that and I showed it for last three or four years, that the private sector is actually more trusted than the government. And that’s true across Europe. It’s true in the United States are basically people look at their governments think of them as sclerotic, and think of them as old and not super effective. When they look at Tim Cook and Apple, they look at the company at Tim Cook, they look at something someone like Pfizer and say this, these are great look at these great innovations they’re doing, look at the iPhone, look at the vaccines, look at the pharmaceuticals. And people do tend to trust the private sector more. And I think governments would be wise to leverage that trust in a way that also helps the government’s deliver. And I think it’s just a question of making sure you’re doing that in a responsible way. And I think there’s this irony, I raised it all the time. That’s the study from a few years ago showing that in the United States, when Americans get good public service, they actually believe that it’s coming from the private sector, because the idea of effective government service is like incomprehensible. Because our system doesn’t work. So well at times that people think, well, of course, you know, I got this, I got this great assistance, I got this homeowners assistance, or I got this vaccine, it must be from the private sector, even when it’s actually from the government. So it’s just one way of basically saying well, publicising, that cooperation, I think can actually help boost trust.

Gene Tunny 34:59

Yeah. Yeah. Okay. And you mentioned that there have been failures of P PPS in Britain that have meant that people in Britain have been negative about them. And we’ve had some notable ones here in Australia too. But what I found interesting is you noted one of the great successes or most successful PPS in the book. So I’ll, I’ll put a link in the show notes to your book, Australia’s upgraded the Ballena bypass highway, completed in 1996, along with four private firms, as in conjunction with the government seven months ahead of schedule and for USD 100 million less than estimated. So that’s an impressive example. And so one I’ll probably use in the future. So yeah, good, good work finding that one. Excellent, Rado? So my final question, Charles is, I mean, how do you think this will will actually work? I mean, how, in what ways will the dictators be defeated? If if we in the democratic countries govern ourselves better? What’s the mechanism here?

Charles Dunst 35:58

I think the mechanism works twofold. Where primarily, if democracies are working better at home, you are less likely to elect people like Viktor Orban, or like Donald Trump, or like ei or Bolsonaro, who come to power through liberal democratic means, and then don’t necessarily govern in a liberal, democratic way, who have little concern, I would argue, in most cases for those liberal institutions, particularly in thinking about Orban Bolsonaro, where there’s no sense of respect for freedom of the press, there’s an effort to stack the judiciary, these are all things that can hollow out democracies from the inside. My argument is that if democracies are delivering better on economic issues on issues like the social safety net, and issues like infrastructure, if people feel optimistic about their future, which many people in democracies Do Not at the moment, they are less likely to vote for reactionary people like these that can erode democracy internally. So that is way one to defeat the dictators at home. And point to is only if you can defeat the dictators at home and prevent that autocratic impulse from taking root at home. Only then can you turn around and actually say, well look at how good we are, as a model. Look at how the United States is outperforming China or look at how Australia is outperforming Singapore, and more people in the Vietnams of the world, or people in I don’t know in a rock or in Egypt might actually look and say, well, we would like to be a democratic system. Even if we don’t agree the United States of the West, then everything. We see how well Australia is functioning, or we see how well Taiwan is functioning. Were looking at how sclerotic Saudi Arabia is their kind of messy, messy internal politics, that corruption scandals, we don’t want that. But it’s making sure that we are working well enough to fend off the autocratic impulse, and simply just that we can be the world’s model once again. Gotcha.

Gene Tunny 37:45

Okay. So showing that you’re the world’s model. Okay. Yeah. Any final thoughts? Charles, before we wrap up? Yeah,

Charles Dunst 37:55

the one thing I would just say briefly is one thing is the line, I keep using it over and over again. But I think it’s important is the lack of faith in democracy right now is really troubling to me. But something I want to say that’s positive is faith in democracy is not necessarily the problem. We all should believe in democracy and work for it. The problem is faith and democracy is automatic functioning, and the sense that everything will work without our engagement. I think the key message of the book for citizens for people who are not lawmakers, not politicians, not in government is just make sure we stay engaged. And we keep pressuring our politicians to actually make democracy work for us.

Gene Tunny 38:31

Got you. And that’s through, I suppose social media or in through, I guess, you’re engaging in the conversation? Is that what you mean?

Charles Dunst 38:40

engaging in the conversation, making sure you don’t miss elections, engaging in your local governance? I mean, it can be on a school board in the United States, you can be in your city council, you can all these local thought their town council, I think far too often we look at our messy politics or messy governments, they just write it off and stop being engaged. But I think engagement is really key to making anything work down the line.

Gene Tunny 39:01

Okay, very good. I guess one more thing, just looking back on my notes. You mentioned one of the big issues with inequality was inequality, I should ask before we go, I mean, do you have any thoughts on how that can be addressed? Or use proposing specific measures to address inequality in your book?

Charles Dunst 39:17

Yeah, one of the things I talked about was inequality in terms of education. And the notion that, basically, I think far too many democratic governments are not starting or not looking at the unequal starting points of children. And basically saying, Well, you know, once you get to university, it’s meritocratic. Its meritocratic when you get into your universities. But of course, if you are born into a lower income household, you’re less likely to have certain academic achievements that gets you into one of those schools. And if you don’t get into one of those top universities, you’re less likely to earn as much money as those who do. And I think there’s this increased need to actually look at starting points and say, Well, how do we make sure that we are doing all we can to let the talented children from lower income households actually rise? Is to top tier universities. And that’s how I think about inequality. There are certainly broader economic reforms that other folks have proposed. But I think about inequality in terms of the lack of meritocracy in the way that basically it does seem like we’re perpetuating kind of an elite with the same people and go to the same schools, their kids go to the same schools, because they have a nice starting point. But I want to make sure that we’re kind of giving more believing and more active inequality of opportunity.

Gene Tunny 40:28

Yeah, and there’s probably another episode in that, talking about how we improve that. But yeah, just wanted to check on that. Because that’s, that’s clearly one of the big issues. Yeah, but I hear about the dream hoarders Is that what you call them in the States? Of hurt? That’s one of the terms that’s been applied to your just that self perpetuating elite or whatever? Have you referred to it? So yeah,

Charles Dunst 40:52

I’ve never heard that one. But that’s a good one. Yeah,

Gene Tunny 40:54

I think that’s what yeah, I’m trying to remember who wrote that book. I’ll put a link in the show notes. So yes, it seemed a bit overly negative to me. But, but I think the data do show that the US is not as there’s not as much social mobility, as people might think, and not as much intergenerational mobility as you might like, relative to some other countries. So I think that’s an uneven in Australia, and in Britain, it’s not as high as as we would hope so. Absolutely. Good point. Okay, Charles Dance from the Asia group. Thanks so much for your time. I really appreciate it. And good luck with the book. I’m sure it will go. Well, I think the message is an important one. And I really enjoyed reading it. So thanks so much. Thank you. Okay, I hope you found that informative and enjoyable. I think Charles is someone we’ll be hearing a lot more from in future years, so I’m very glad I could interview him about his first book. I must say I was impressed by Charles’s passionate advocacy for democracy, and his call for existing democracies to provide better examples to other countries. I hope that Charles is right that we can inspire movements for freedom in non democracies by improving our democracies at home. Maybe that’s a vain hope, but at the very least our own countries will be better run. In our conversation, Charles and I touched on a few ways that democracies could be strengthened. I liked how he talked about improving our education system so that all children get the best start in life. I found a link to the book on the dream hoarders that I was reminded of while chatting with Charles and I’ll include it in the show notes. I think it’s worth having a look at. As always, feel free to email me at contact at economics explore.com. I’d love to hear from you. Thanks for listening. rato thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting outlets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

43:46

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Credits

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Tags authoritarianism, china, education, geopolitics, PPE, ppp, russia, usa

Podcast episode

SVB & Credit Suisse | Bank runs & Moral hazard – Bonus episode

Post author By Alec Krishna
Post date March 23, 2023
No Comments on SVB & Credit Suisse | Bank runs & Moral hazard – Bonus episode

Silicon Valley Bank (SVB) has collapsed and now Credit Suisse is in trouble. Should we be worried about Global Financial Crisis 2.0? Have the policy responses been sensible? Economics Explored host Gene Tunny provides his initial thoughts.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

Links relevant to the conversation

Chris Joye’s article on SVB:

https://www.livewiremarkets.com/wires/why-silicon-valley-bank-died-updated-2

NPR Indicator episode:

https://www.npr.org/2023/03/13/1163157993/silicon-valley-banks-three-fatal-flaws

Sebastian Merkel’s paper on narrow banking:

https://scholar.princeton.edu/sites/default/files/merkel/files/narrow_banking.pdf

World Bank paper on Bank Runs and Moral Hazard:

https://documents1.worldbank.org/curated/en/548031537377082747/pdf/WPS8589.pdf

Bloomberg article on policy response:

https://www.bloomberg.com/news/articles/2023-03-12/us-moves-to-help-depositors-offer-bank-backstop-in-wake-of-svb?leadSource=uverify%20wall

Breaking Points video SECRET Fed BAILOUT Pumps BILLIONS Into Banks

https://youtu.be/Lj5BE951aP8

Transcript: SVB & Credit Suisse | Bank runs & Moral hazard – Bonus episode

Gene Tunny 00:06

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 and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the show notes for relevant information. Now on to the show. Hello, welcome to this bonus episode of economics explored. The failure of Silicon Valley Bank happened after I recorded my last episode on central banks and banking and I didn’t get any time to add any reflections on that collapse in In my last episode. So I thought I’d better do that now. This bonus episode is even more timely given. It now appears Credit Suisse is in trouble. Because things are happening so fast, I’d better clarify that I’m recording this Thursday morning, Australian time on the 16th of March 2023. While I’m not panicking at this point, I do acknowledge that there’s an elevated level of risk in the US and global financial systems. So I’m not going to make any definitive predictions, I think it’s just too hard to tell what’s going to happen. Instead, I want to talk about the underlying economic issue an issue which has been challenging us for centuries. This is the mismatch in maturities between the assets and the liabilities of banks. So colloquially banks, they borrow short, they borrow money from depositors, for example, and those depositors may want to withdraw their money at short notice. And banks lend long, so borrow short lend long, they lend money to homebuyers, for example, to buy houses, and those home buyers repay the bank over many years. If you’ve seen the classic film from the 40s, It’s a Wonderful Life. You’ll recall how Jimmy Stewart’s character, George Bailey, he explains to his worried bank customers how their money was invested in the houses of their neighbours, it’s there, he just can’t get it right away. Banks don’t have the cash on hand to pay out all of their depositors, if all the depositors come in to withdraw their money at any one time. They’ve got some cash on hand, but not enough. This is the concept of fractional reserve banking that Darren Nelson and I discussed last episode. In normal times, there’s nothing wrong with this because most people are happy to leave their money in the bank. And deposits and withdrawals are predictable. It’s something that the bank can manage, they can manage the level of cash, they know what they need to be able to, to satisfy the customers at any one time. But when the financial health of the bank comes into question, a panic or a bank run can happen. And there can be this contagion, there can be a panic across the economy. And it’s not just that bank that there’s a run on there could be a run on all banks as people worry about the stability of the whole system. That’s why central banks and regulators are so concerned when banks get into trouble and and we’ve seen just how quickly they’ve responded to what happened with SPV. And now what’s happening with Credit Suisse. SBB got into trouble because there was concerned about the state of its balance sheet, it had a heavy investment in long term treasury bonds. And if these were not held to maturity, and they were sold in the current market, that would result in the bank losing money. And that’s because of what’s happened with interest rates. So because the interest rate and the price of a bond vary inversely as interest rates have increased, bond prices have fallen. The story is that words spread fast in the venture capitalist community in California that they should encourage all the startups they invested in to pull their money out of sVv. Fast. So once they saw the state of the balance sheet word got around quickly, there was a classic bank run, and SVB collapsed. Incidentally, the concentration of SBBs business in Silicon Valley was a contributing factor to its vulnerability. It’s a well connected community. So the panic spread fast. I’ll link to a great article by Chris joy of Coolibar capital, which explains in detail what happened and also to an excellent episode of NPR as the indicator podcast, which also explains the problems faced by SVB. In his article, I think it’s on Livewire markets, Chris joy, he’s shocked that SVB didn’t hedge against the interest rate risk faced on its holdings of long term bonds. He suggests that this would have been standard practice for banks, meaning SBBs financial risk management was was suspect. According to Chris SVB, had exploited a regulatory change that was made during the Trump administration. It’s a change that SBB had lobbied for several years ago. And it meant that the bank could engage in more risky behaviour, so check out Chris’s article for the full details of that. A note that bank runs have happened periodically throughout history. Fans of the BBC TV show Poldark set in the time of the Napoleonic wars will recall how the scheming George Will Ligon brought about a run on Pascal’s bank in Cornwall. And the show’s hero Ross Poldark had to step in as an investor to help save it by restoring public confidence by making people confident that it had plenty of money after after Ross had invested in it. does this all mean? We shouldn’t have fractional reserve banking? Should we move instead toward full reserve banking or so called narrow banking, whereby banks have to ensure they can access enough money to 100% back all deposits. Historically, this was recommended by eminent us economists, as part of the Chicago Plan in 1933, during the Great Depression. This was in the wake of the collapse of the US financial system earlier that year. To me, narrow banking would not make sense. So rather I can’t see how we could move to this system without being without it being massively disruptive and costly. To pause deposits are one source of funding for banks, they they help reduce the cost of capital and they mean banks can lend more money. This is good for private sector investment and economic growth. I found an intriguing working paper by a former Princeton Postdoctoral Fellow and now University of Exeter lecturer, Sebastian Merkle on the macro economic implications of narrow banking and I’ll link to it in the show notes. He’s developed a macro economic model, which predicts that real productive investment and economic growth would be lower in a case of narrow banking. That said his model predicts the near elimination of banking crises with under narrow banking and in his model, people are better off overall because of that. So, look, there is there are pros and cons of fractional reserve banking versus narrow banking. I’ve got the feeling that narrow banking would be just very difficult practically, and I’m not sure we’d be better off. That said, I think there’s an important debate to be had there, and I’ll try to come back to it in the future. The relevant question to me is whether we can get the right regulations in place to maintain public confidence in the banking system. Can we do this in a cost effective way which doesn’t lead to future problems or unintended consequences. various mechanisms exist to help guarantee confidence in banks and to prevent panics and bank runs. These include regulations regarding the amount of liquid assets that banks should hold the central bank’s lender of last resort function, and deposit insurance regarding the lender of last resort function, the US Federal Reserve has been lending money to the US banking system in the wake of the SVB and Signature Bank collapses I’ll link to a Bloomberg article with some of the details. And now we see Credit Suisse turning to the Swiss central bank for emergency support. I think most people expect Credit Suisse will be supported as it’s probably too big to fail. It’s been plagued by scandals, and it’s lost money in recent years, but I expect it will be saved. Indeed, I’ve just noticed the Financial Times has reported Swiss central bank offers Credit Suisse liquidity backstop after share plunge okay, just as we would expect. I should note here that the lender of last resort function is not meant to save every failing bank. Only those which are facing a temporary cash shortage and whose underlying balance sheets are okay. It’s meant to allow good banks to get ready access to cash so they won’t run out of money in the short term, which is something that could spark a panic and a run on banks across the economy. It’s designed to try and stop that panic as summarised by British bankers or Paul Tucker. Walter Badgett famous dictum is that, to avert panic, central banks should lend early and freely that is without limit to solvent firms against good collateral and at high rates. That is, it shouldn’t be a bailout of badly performing banks, and borrowing rates should be high enough that banks only seek this assistance in genuine emergencies. We need to be careful to avoid moral hazard a concept which is also relevant to deposit insurance which we’ll talk about in a moment. Regrettably, it looks like the US Fed hasn’t been operating strictly according to badgers dictum and its new financing facility for US banks appears concessional. There’s a great story from saga and jetty and crystal ball at breaking points on this, which I’ll link to in the show notes. So please check that out. Alas, the Federal Reserve is arguably contributing to moral hazard in the financial system and to future financial instability. Regarding deposit insurance, given what’s happened with SVB, the US Federal Government has now effectively guaranteed all bank deposits, it’s gone well beyond the defined level of insurance of $250,000. As John Humphries and I discussed on the Australian taxpayers Alliance, econ chat live stream the other night, this could create a big moral hazard. Depositors might not care too much, or they might not look closely enough at the banks that they’re putting their money in. And they might be solely attracted by what interest rate they they earn on those deposits. Banks might figure that their depositors won’t care much, and they’ll take more risks to try and earn higher rates of return. So they can pay their depositors more and they can earn more profits. This could be a recipe for future instability. If the US government is going to do this, it will need to charge higher premiums for deposit insurance to ensure the costs of the insurance are explicit and not burdensome for taxpayers. And banks that have riskier balance sheets should pay higher premiums for deposit insurance. We need to avoid or minimise any moral hazard that comes from deposit insurance. There’s a great 2018 World Bank working paper that I’ll link to in the show notes that’s relevant here. It’s titled bank runs and moral hazard. I’ll read a paragraph from it because I think this paragraph nicely summarises the relevant policy issues. It’s now well established in the empirical literature that overall deposit insurance may ensure depositor confidence and prevent bank runs. But it also comes with an unintended consequence of encouraging banks to take on excessive risk. The empirical evidence points out the importance of design features, and shows that poorly designed schemes can increase the likelihood that a country will experience a banking crisis. It is important for deposit insurance schemes to incorporate features to help internalise risk taking by banks, in addition to specific design features deposit insurance that is complemented by more stringent capital regulations and a system in which supervisors are empowered to take prompt corrective action tend to function more effectively in practice. I think that’s that’s a really good summary. In a future episode, we might have to have a closer look at this deposit insurance scheme in the states and what these latest developments mean for that and what it all means for the the incentives facing banks the potential moral hazard. Honestly, I’m concerned that The US government would bail out all the depositors in SVB. I’m not sure it made sense, particularly given that those depositors or many of them should have known better than to have left so much money sitting in one bank. We’re talking about highly successful companies, such as Canva. I was truly stunned by the revelation regarding just how much money some of these tech firms had in SVB. Citadel hedge fund founder billionaire Ken Gryphon argue that with the government fully bailing out depositors, US capitalism is breaking down before our eyes. As he was quoted by the Financial Times, he would have preferred no bailout. The FT went on to quote him as saying, it would have been a great lesson in moral hazard. losses to deposit depositors would have been immaterial, and it would have driven home the point that risk management is essential. Gryphon highlighted that it appears the relevant regulator, the California Department of Financial Protection and innovation was asleep at the wheel. Apparently there were warning signs that should have been picked up. The Shanter clear columnist in the Australian Financial Review has suggested that the regulator might have been too focused on promoting innovation and startups, rather than focused on what should have been its core mission of promoting financial stability. What lessons should we learn from all of this? Well, bank runs will unfortunately occur from time to time in a capitalist economy. We just hope they’re not when they’re not too frequent. That it seems that we haven’t found a way to prevent them from happening entirely. We get a lot of benefits from the capitalist system in terms of innovation and higher living standards. But there’s no doubt the system can be unstable from time to time. It may be that the US needs to impose tougher regulations tougher capital requirements on banks so that they have better balance sheets, and they’re much less susceptible to bank runs. That is they’ll need to be required to hold a higher amount of quality liquid assets which can be converted into cash quickly. One of the reasons for confidence in Australia’s banking system is apparently stricter bank regulations overseen by the Australian Prudential Regulation Authority APRA, which is currently headed by my old Treasury colleague, John Lonsdale. The financial review has reported that APRA had resisted lobbying by local banks to loosen capital requirements on banks. Given what’s happening in the US at the moment, Apple is looking pretty smart right now. It’s hard to know how to compare what we’re seeing today with the past. SVB is the second largest bank failure in US history. But I don’t think it’s the start of GFC 2.0. Or rather, I hope it’s not the start of that. The GFC the global financial crisis, financial crisis of 2008 that involved financial institutions, which were household names, and much closer to the centre of the financial system. Of course, if Credit Suisse ends up collapsing that the story could be much different. My general inclination is not to worry too much over the latest developments as many things turn out to be unimportant. In hindsight, that said, you never know. Okay, that’s how I see things at the moment. It’s still early days, so my thinking may change over coming weeks. I’ll provide any updates to my thinking in future episodes. What do you think about what’s happening with US banks? And now with Credit Suisse? How concerned are you? Please let me know by emailing me at contact at economicsexplored.com. I’d love to hear from you. Thanks for listening.

Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au.

Tags australian, banking, banking crises, banks, cash, collapse, credit suisse, deposit insurance, depositors, deposits, fractional reserve banking, money, regulations, swiss central bank

Podcast episode

Why fiat money means higher inflation & why a radical Reserve Bank review is needed w/ Darren Brady Nelson – EP179

Post author By Alec Krishna
Post date March 21, 2023
No Comments on Why fiat money means higher inflation & why a radical Reserve Bank review is needed w/ Darren Brady Nelson – EP179

In his recent Spectator Australia article, Darren Brady Nelson argues for a radical, not a reserved review of Australia’s central bank, the Reserve Bank of Australia (RBA), which he describes as reckless. In Economics Explored episode 179, Darren provides an Austrian economics perspective on central banks, fiat money, and inflation. Show host Gene Tunny wraps up the episode with a discussion of the historical evidence on different monetary systems and inflation, evidence which confirms economies with fiat money are much more inflation prone. Gene then discusses whether a return to the gold standard would be desirable.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

What’s covered in EP179

Darren’s thoughts on the current review of the Reserve Bank of Australia [1:46]
How the RBA interprets the stability of the currency objective [6:54]
What is the Austrian School? [10:19]
Would the Austrians recommend abolishing the central bank? [21:08]
The Bank of England’s report on modern banking [25:54]
The need for a broader review of the Reserve Bank of Australia [30:35]
Fiat money systems are much more prone to inflation than commodity money systems [34:20]

Links relevant to the conversation

Darren’s bio on the Economics Explored website:

https://economicsexplored.com/regular-guests/

Darren’s opinion piece on the Spectator Australia website:

The RBA (reckless bank of Australia) needs a radical, not reserved, review

Bank of England paper on money creation:

Money creation in the modern economy | Bank of England

Minneapolis Fed paper on fiat money, commodity money, and inflation:

Money, Inflation, and Output Under Fiat and Commodity Standards | Federal Reserve Bank of Minneapolis

US Gold Commission Report

Minority report of the Gold Commission, co-authored by Ron Paul:

The Case for Gold: Minority Report of the US Gold Commission 1982

Alan Greenspan’s autobiography discusses his advice to President Reagan regarding gold:

The Age of Turbulence*

Another great book on Greenspan which discusses Friedman’s views too:

The Man who Knew: The LIfe & Times of Alan Greenspan*

*You can help support the show by buying a copy of either book via the links above.

Transcript: Why fiat money means higher inflation & why a radical Reserve Bank review is needed w/ Darren Brady Nelson – EP179

Gene Tunny 00:06

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 and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the show notes for relevant information. Now on to the show. Hello, thanks for tuning in to the show. This is episode 179. In this episode, I chat with my old friend Darren Brady Nelson about his recent spectator Australia opinion piece on the Reserve Bank of Australia. Darren’s piece is titled The RBA reckless Bank of Australia needs a radical not reserved for review. Although Darren’s article focuses on Australia’s Central Bank, the issue is considered irrelevant to central banks around the world such as the US Federal Reserve and the Bank of England. Before we get into it, I should note that Darren is coming from a non mainstream school of thought known as Austrian economics. While it’s outside of mainstream economic thinking, I think the Austrian perspective is valuable. Nonetheless, it’s forced me to confront some of the things I take for granted about the modern mixed economy, such as fiat money and the existence of a central bank at all. I’ve had to think more deeply about whether they make sense. Please stick around to the end for some additional thoughts from me. Okay, let’s get into the episode. Darren Brady Nelson, welcome back to the show.

Darren Brady Nelson 01:46

Thank you. Thank you. It’s been a while now actually.

Gene Tunny 01:48

It has Yes, I’ve given you a breakdown. And I’ve tried to get here a broad range of guests on the show. But yes, sir. Good to have you back on the show to chat about some recent work that you’ve done. So work in both public finance or fiscal policy, you could say, and monetary policy. Darren, so we’ve got a monetary policy review in Australia at the moment, and you’ve written a piece on the monetary policy review. And could you just tell us what your thoughts are on that review, please?

Darren Brady Nelson 02:21

Well, look, just to step back slightly from that, you know, I’ve kind of been disappointed over, you know, probably the course of a decade or something like that, that, you know, obviously, it’s good to have a variety of different takes on things like the Reserve Bank are obviously, you know, this review, that’s, you know, nearing the end, I believe the reporting to government next month. But, you know, there’s, there’s this never been, you know, look, I’d love to see kind of more of an Austrian take on things, at least once in a while in the Australian media, or even in Australian think tanks. To tell you the truth, I’d settle for a bit of a Chicago take on things and you just don’t get really neither of those takes for the most part, certainly not in the media. You know, look, I’ve never had a chance to read our friend, Tony, Megan’s take on the Reserve Bank. I know, he wrote an article for spectator, just like the article I’ve just written is meant to be published soon by the spectator, Australia. So I’m not sure his his exact take, and maybe you can tell me if you’ve read his article, I’m not sure, Gene, if you can give a little bit of overview of what how he viewed things, but so I just wanted to kind of bring a little bit of a, you know, an Austrian, take two things, in terms of, you know, linking sort of, you know, the Reserve Bank, the money supply and inflation, in a nutshell. And also, I found that people often didn’t kind of step back. And they, they vaguely mentioned what the Reserve Bank is supposed to do, and kind of leave it at that just kind of go into in to have a very different take than what I wanted to give. So, as not only an economist, but also a former law student, I also wanted to kind of start out and go, Hey, this is, you know, this is what, you know, the legislation says, for instance, about the Reserve Bank, and what they’re doing what they’re supposed to do, and then kind of jump in to, you know, like I said, sort of an Austrian economics take on things and, and also kind of stir the hornet’s nest a little bit, you know, by using a little bit of satire at the beginning and at the end of the article.

Gene Tunny 04:29

Right, okay, so yeah, we might get into a few of those things. So what does the law say? What, what does the what was your analysis of the, of the legal underpinnings or what they’re supposed to do under the is it the Reserve Bank act?

Darren Brady Nelson 04:45

Yeah, I mean, some people really just don’t understand what it is, you know, exactly, you know, sort of made that clear this, this is a central bank, you know, they, they basically have a monopoly control over currency in Australia. And you know, people kind of vaguely maybe understand that, but just to make that kind of really clear, you know, this is what it is. It has some other roles, of course, it has, you know, kind of these other banking, regulatory functions, but they really, you know, those are really to support the main goal, which is, obviously, Reserve Bank’s not unusual, it’s a central bank, very similar to the other central banks around the world, like the Bank of England or the Federal Reserve. But just to remind people, Hey, this is, you know, this is a government entity, it has a monopoly on on money, essentially, but at the same time, it’s required to do, you know, in that context, it’s, it has, you know, some of these broader sort of things, it’s three main things, you know, where it goes under Section 10, A, the stability of the currency, the maintenance of full employment, very, you know, 1940s 50s sort of thing that was thrown in, because the, you know, the Reserve Bank act is from 1959. So, you know, very Keynesian sort of thing there. And the other one kind of, you know, somewhat more vaguely, but, you know, still important, obviously, the economic prosperity and welfare, the people of Australia. Now, you know, look, there’s only so much you can say, in an in an article, even though my article is a bit longer than your average op ed, if you like, but there’s even within that there’s so much you could say, and I couldn’t say, but, you know, obviously like to say the audience, I think they got some issues, because these things conflict, or, you know, you can interpret these things and quite different ways. You know, clearly, I think, you know, I would argue, and I do to some extent, at least I think in my piece is, you know, certainly printing the sort of amounts of money that they have, and not just not just recently, and not just since COVID, but actually over a much longer period of time. is, you know, quick, you know, I would question that that really helps the stability of the currency. You know, that seems to me to be at least something questionable. I think it harms the stability of the currency, but I think it’s at least questionable. It also argued that it actually helps out the other two, I don’t think it may help with statistical, full employment. But does it really help with economically efficient, full employment, much less, you know, actual economic prosperity and welfare? Yeah, sorry. Go ahead.

Gene Tunny 07:19

I was just thinking it was an interesting point you made about stability, the currency. And you don’t think that the growth of the money supply we’ve seen that the RBA has overseen is consistent with stability of the currency, they have essentially redefined stability of the currency, they now we now define stability, the currency is not zero inflation, we define it as a two to 3% inflation on average over the economic cycle. So we’ve accepted a certain, a small well – I won’t make any judgement a lower than average historical average rate of inflation as the target. That’s what they’re going for. And over the last 30 years, they would argue that they’ve achieved that. And it’s much better than the performance in the post war period prior to that. So they would argue that they’ve done a good job at achieving stability of the currency in that regard. But yeah, it just occurred to me that when you said that that’s in the Reserve Bank act, that they’ve redefined what stability actually means, in turn, using that inflation target.

Darren Brady Nelson 08:24

Yeah, look, I mean, it’s fairly easy to pull up what, for instance, CPI looks like, and it’s an, even though CPI is only accounting for, you know, something like 40% of the economy, and we, you know, it’s a big chunk of the economy, but people have this impression that accounts for 100% of the economy or something like that. So even in that context, it’s not a pretty picture, you know, and we’re not talking about just like, oh, for a quarter or two, or for a year or two, we’re talking over, you know, quite long, you know, timeframes, you know, we’re talking from the basically the 1970s, with some flattening out, I would argue, do some pretty good counter reforms, if you like more that counter reforms that, you know, reforms that, you know, would counter some of the bad effects of, of just, you know, kind of having fairly loose monetary policy. And that not equally loose throughout that whole period of time. But, you know, it’s really, really hasn’t had a Volcker, for instance, you know, that I’m aware of, in the same sort of timeframe that, you know, since Volcker appeared on the scene in the late 70s, and has since left it. So putting aside, you know, again, my pieces and obviously, to go, so, do some technical thing to go like, Well, did they meet their own sort of technical requirements, and then just criticise them that way? Because there’s plenty of articles like that. You know, my aim was to point to the broader thing that just looks money like this. And if you look, I mean, CPI doesn’t look good over time. But if you start looking at money supply, whichever one you want to pick, it’s not a pretty picture.

Gene Tunny 10:00

right. Okay, so can I ask what do you mean by an Austrian Economics take?

Darren Brady Nelson 10:05

Yeah, look at that. So for those who don’t know, Austrian Economics is, I mean, I mean, a lot of people even economist for some reason don’t fully are aware that there’s actually different schools of thought, quite a few different schools of thought. And one of them is the Austrian School. It started with Karl Menger, in the sort of mid to late 1800s. He’s also, you know, attributed along with a couple other economists is kind of starting the marginal revolution as well. In the end, they call it Austrian School, basically, because he is actually from Austria. And then some of the other sort of people who followed him like Bomba Virk, Mises, Hayek, etc, they were also literally from the country of Austria. So I guess that stuck, obviously, is the name of the school of thought. I mean, I mean, the very free market, I argue that the there’s certainly the most free market oriented, I’d argue that they’re not the most free market oriented because they have an ideological stance. So you can always say that, you know, certainly, like someone like Mises, certainly, you know, went to great pains to go like, this is what I think the logic and even the data, even though they’re not sort of like the, they’re not, they use data, they’re not they don’t think data, without theory tells you anything, but they would argue that, you know, they take a scientific approach to things like, you know, like other schools of thought would also argue, and, you know, they have very, they, they have the most comprehensive take on understanding money, basically, including, you know, I mentioned Bomba Virg actually Menger even before that, that even from the start Menger Bomba, Varick and Mises were, were and still are kind of, you know, the greatest thinkers on money. Some may argue that you could put Keynes in that category, you know, that was one of his, you know, one of his big sort of focuses prior to him writing the general theory. But, you know, the Austrians certainly have a lot to say, and I think, a lot of credible things to say, with the, you know, you ultimately agree with them or not, you know, I just want to get those kinds of ideas, you know, out there in the Australian public.

Gene Tunny 12:20

Okay, and what are those ideas, Darren, and how are they relevant to the RBI review?

Darren Brady Nelson 12:25

Well, look, I mean, in a nutshell, and, you know, I’ve used this quote, a million times, it seems, you know, using Milton Friedman, who’s not Austrian, but Chicago School, who him and Anna Schwartz, you know, sort of took a an empirical approach if you like, I mean, I don’t think you’re setting out to, if you, like, test the theories of Mises, and people like that as such, but they confirm that, you know, inflation, it’s a monetary phenomenon. And it’s always in, at least in practice, you know, you know, maybe the Chicago school don’t necessarily agree that in theory, things like central banks, are really the root cause of inflation. They certainly agree that in practice, that’s what actually happened in history. So but the Austrians, like I said, they go, they go one step further, they go in great detail, to set out the case of why central banks are at the centre of, of why we have ongoing inflation. And the only way you’ll ever solve the inflation problem is to do something about central banks, and they would argue you have to do something stronger than just holding them within certain bounds. As you know, the Chicago school would argue,

Gene Tunny 13:38

Rod, okay, and I mean, fiat money is relevant to isn’t it? So you’re yes, you’re saying the the issue is that you’ve got a central bank that has the monopoly on fiat money, the monopoly control of the currency, which is fiat money, and they can just print it, they can create it out of thin air. And we saw that during the pandemic in Australia, when they finally the RBA, finally engaged in quantitative easing, the Federal Reserve had done it previously, the Bank of Japan and Bank of England and ECB, but we hadn’t actually gone that we hadn’t taken that step yet. But we did during the pandemic,

Darren Brady Nelson 14:15

well, the Austrians were there to drag, you know, central banks always are involved in a process and printing money out of nothing. Now, quantitative easing, took it to new levels, makes the new mechanisms, new levels, and then obviously, modern monetary theory sort of opens the floodgates to go further than, you know, quantitative easing, but if you like allow within that sort of framework of thinking, and we may get onto this later on, but, you know, the Bank of England produced a couple, you know, excellent papers that an Austrian or a neoclassical or a Keynesian or Chicago can all appreciate. It takes something out of just like, you know, just clearly setting out how does the central bank work, but also You know, just as importantly, how does the banking system more broadly, in cooperation, if you like, with the central banks operate, you know, How is money created? I mean, I think the, the title of the paper is money creation in the modern economy, you know, that sets it out quite nicely, they have a different view of that, the course they don’t think that’s an issue as such, you know, it provided obviously, or you stay within certain bounds and all that type of thing. But it does set out the fact that, you know, money is being created from nothing, which is quite a different system, to what, you know, say, for instance, the gold standard, you know, the classical gold standard with all its whatever foibles it had, because Austrians would argue that there could have been a better gold standard, but fine, there was a gold standard, and even central banks. Were part of that system previously, if you like, and the Bank of England also nicely sets that out that history as well. Yeah. So basically, again, coming back, you know, the Reserve Bank’s not any different from the Bank of England Federal Reserve, largely speaking, I mean, there are differences, you know, obviously, you know, the Federal Reserve, obviously, they’re different sized economies, different sides, sizes of the Australian dollar, the US dollar being traded around the world, obviously, the US dollar is special in the sense that it’s still the reserve currency for the world. So you know, their, their prolific money printing, they can get away with it a lot better than, you know, a smaller economy or economies, it’s not the reserve currency of the world, you can get away with Australia being does punch above its weight, and its currency is traded a lot more than you would expect for a small country. Because of you know, obviously, Australia is a big player in commodities, for instance. And that kind of part of the reason is, Australia, punches above its weight if you like.

Gene Tunny 16:45

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

Female speaker 16:50

Gene Tunny 17:20

Now back to the show. Now I’m just on the what the RBA review is doing it’s it has rather than a narrower terms of reference is looking at the monetary policy framework inflation targeting is looking at the governance the board, whether we have a separate Monetary Policy Committee, I think that’ll end up being one of the recommendations. And the way that John Humphrys described it to me on his Australian taxpayers Alliance live stream, he just said, Well, look, there’s an Overton window of what it’s going to look at, right? I mean, there’s things that are in the Overton Window, there’s things that are outside, and I think you are advocating that they should they should go outside of that window, they should go outside of what’s conventional and actually think about the role of the the RBA as a central bank, is that the type of thing we need? Is that working for us? Or Are there alternative approaches? Is that what you’re you’re arguing? Darren?

Darren Brady Nelson 18:18

Yeah, look, I think I’ve I pull out some recommendations I did. When for Liberty works at the request of Senator Malcolm Roberts, you know, did a submission to his rural banking inquiry, because he wanted to get on the record. And so did I just kind of some of these broader issues of monetary policy and how they do impact the kind of the more narrow review that he was doing at the time. And, yeah, basically suggests, you know, kind of a three pronged approach, you know, sort of, in a shorter term, doing something, you know, a bit broader than what this current review is doing, but nothing, you know, something that might still be within the Overton Window, as you say, and then, you know, what I’m suggesting over the medium term in the longer term are certainly things that, you know, I guess the average policy person, monetary policy person would think, would be outside the Overton Window, like, you know, the Overton window. It’s a good thing to understand in terms of what is, but it can be a very big obstacle to what should be, but because, because I can point to, you know, the reforms, the Hocking Kingdom reforms of the 19, mid 1980s were, you know, not particularly within the Overton Window, national competition policy when it came along in the early 1990s. Not quite in the Overton window. There’s been a lot of good reforms that that are not in the Overton window. Obviously, you know, there’s obviously a politics involved and making sure that even though it’s not quite the Overton window that you know, you don’t scare the horses too much. And people who who’ve been pushing things In the direction of more and more government interference in the economy, including if you like the more draconian stuff, you know, the the over the top lockdowns, the the censorship, all these sorts of things. Putting aside the fact that no a lot of censorship are done by private companies, but they’re done by the best of government, they’re done by the best of government, if you don’t do it, you know, there’ll be trouble for you, private company. So, you know, it’s it’s certainly not, I don’t think, you know, the libertarians have suggested that, so it’s private property, so doesn’t matter. That’s not right. So, you know, people on the left, in a nutshell, don’t care, a rat’s butt about the Overton window for the most part. They keep on plugging away. And they are largely winning. So which is why I wanted to point out some of these reforms, if you like, went more in the direction of the right centre, right, for instance, including, you know, a Labour Government and including, you know, some liberal governments in the past, things can be done. So the Overton window, you got to be aware of it, you got to understand it. And it’s something you need to deal with, but it shouldn’t be something that just stops you from doing

Gene Tunny 21:08

something. Right. And so what would, what would the Austrians recommend abolition of the central bank? I mean, what would happen? What would you recommend?

Darren Brady Nelson 21:18

But look, you know, look, the Austrians there’s quite a variety of views, even within the look, you know, there’s sort of a high IQ, sort of, like competing currency approach, there’s the Roth bar, it’s more, let’s do a new and improved version of the gold standard, if you like, obviously, these things are digitised. No one’s ever suggesting that, you know, that we carry hunks of gold. That’s fine. If you want to carry hunks of gold with you. You know, it’s probably not going to be a huge market for that. That’s going to be but I mean, they recognise that centuries ago anyway. So like, you know, the gold standard, really, there were people running around with bits of gold with them all the time that that was never the case. You know, because the goldsmith’s figured it out before the official gold standard came around today, certificates, it seemed to be a little bit more convenient, you know, which that’s where actually money came from your paper money, I should say, sorry, paper came from from those certificates. So have John freeze. It, he always has a bee in his bonnet about Murray Rothbard. In particular, his argument that he considers, you know, today’s system of fractional reserve banking to be fraud. You know, from a, from a common law perspective, you know, is that Rothbard is arguing literally, in the laws on the books, that it’s actually fraud. He’s saying, under common law, this would be considered fraud. Yeah, okay, maybe, maybe not. But certainly the market would allow a whole lot of fractional reserve banking, I’m sure there won’t be like a one to one alignment all the time, you know, between, you know, reserves and loans and all that sort of stuff, that’s fine. But there wouldn’t be such a huge disconnect that we have, you know, we’re talking 90% and above disconnect between, you know, safe savings and what’s being lent out, getting back to sort of Rothbard is not given sort of credit for being more practical than he was. Yeah, he goes like, here’s the ideal I want. Yeah, you get rid of central banks, and fractional reserve banking. But any little step in that direction, could be pain. How about is a start? What’s just what’s just audit this thing? And, you know, like they talked about in the US sometimes, so let’s just audit the Federal Reserve. Yeah. What are they up to? How do they do things, but the public know, this is what it is, you know, are you happy with this? Is this make sense? You know, yeah. Do you? Are you happy with the consequent the inflationary consequences? Are you happy with the fact that I mean, this thing is very inexorable. You know, like, it causes the booms and busts as well, at least from an Austrian perspective, because inflation and bubbles, it’s the same thing. Inflation doesn’t uniformly happen. It goes, it ends up in asset bubbles, it goes over here, it goes over there. Some people can make a killing out of really not being very good at what they do. They just, they’re just in the right place at the right time. Now, we’re not talking about discouraging proper entrepreneurialism, sometimes, you know, this is kind of like, you know, sort of not very good, sloppy, property oriented sort of entrepreneurialism. And there’s a lot of it, there’s a lot just, it’s a lot of just kind of transfers from, from the poor to the rich. I mean, let’s just get that all out there and report, I’ll be happy with multiple views, you know, red versus blue type of project, Hey, what are the Keynesian think of this, you know, what are the Austrians think of this, whether neoclassical think of this, you know, you know, get it all out there. And, you know, just make it more transparent would be a great start, rather than this kind of, you know, tweaking at the edges. There’s basically a lot of people in political and business power, who, who obviously liked the system as it is,

Gene Tunny 24:55

or they or they don’t want to, I mean, yeah, they haven’t really thought too deeply about Got it? Yeah, they don’t want to rock the boat too much, perhaps. I think we might have to come back to Rothbard views. That sounds interesting. And because it’s probably we probably don’t have enough time to go into it now. That yeah, I think it’d be worth coming back to that. Because yeah, I’m all for a more wider ranging review. I think it’d be fascinating. I think we chatted about this last time we caught up, but we hadn’t seen the terms of reference yet to the review. And I think you’ve predicted that it’d be quite narrow. And it’d be very, you’d get standard sort of mainstream economists on it as we ended up doing, as we ended up doing. I’m not critical of any of them. I think. But yeah, they could have had a broader terms of reference. For sure.

Darren Brady Nelson 25:44

Just one thing to say that the Rothbard you know, some people go look here, you’re kind of in your libertarian utopia, you don’t understand how the system works. He wrote the very best book on how banking works. modern banking, what’s the book called modern banking, is it? No, it’s called the mystery of banking, the mystery of banking. Okay. It’s in great detail exactly how so it’s basically the Bank of England, you know, they they don’t refer to the mystery of banking, they, but they did a very good job of doing something smaller. Got some really good graphics, you know, in the Bank of England report bits, they’re very much aligned. They just have different conclusions. You know, obviously, they don’t come to the same conclusion that Rothbard does.

Gene Tunny 26:26

Right. Yeah. I mean, that’s the article where they describe how the banks essentially, they’re at the vanguard of creating money, or they’re the, the money supply is endogenous to an extent, because the banks are extending credit. And when they’re extending more new loans and paid back then that’s an expansion of the monetary money supply. Now, the central banks involved, the central bank can influence the money supply. But the banks are heavily in the private banks are heavily involved in it. And I think that’s what they’re arguing with they it’s that endogenous view of the money supply. And yeah, I think it is worth reading. What What was the main takeaway for you out of it, Darren, what the Bank of England wrote, I’m just trying to remember what they what was in those articles.

Darren Brady Nelson 27:16

The main takeaway wasn’t like, wow, I’m surprised. This is how they do it. My main takeaway was, Wow, I’m surprised he said it. And I guess another WoW is Wow, thank you. That’s, you know, they explained it really well. It was a really clear, I mean, rock bards. Book mystery. bankings really big, you know. So, you know, it’s, it’s a tome, it’s huge. So, you know, the Bank of England’s report has both an introduction, if you don’t want to redeem read the more detailed report, but even the more detailed report is nowhere near the size of the mystery of banking, but they’re all saying the same thing in terms of like, describing the process, right. You know, you know, what is central banks do what do the commercial banks to? I mean, so basically, the thing, you know, when right away when someone gets gets a loan, that’s money already. So you’ve just increased the money supply right there. Yeah. They don’t need things to happen. It’s right there. They whack it in your bank account. Obviously, people do all sorts of different things with that. Yeah. But yeah, the right there. So there is one thing I must admit, I figured, you know, fractional reserve banking, or those banks creating money, I knew that I was, you know, over time, I was trying to understand that they were actually printing most of the money. It wasn’t the central banks themselves. But when I saw when I saw the Bank of England, I didn’t realise the percentage was quite as big as it is. They said, 97% 97% of all money. Yeah, in the UK. And it wouldn’t be very different from you know, going to any Western country, it’s probably all gonna be the 90s to some extent, was this, you know,

Gene Tunny 28:54

they actually used the term fountain pen money. Yeah. Okay. So I guess I was even surprised at the size. Right. Yeah. Okay. And so you see that as a, as a confession or just acknowledgement of the Bank of England by the Bank of England of, of how the money supply can grow. And in you’re taking from that, that the system that we have naturally leads to expansion of the money supply into inflation. Is that what you’re inferring? From that, Darren?

Darren Brady Nelson 29:27

Yeah, but basically, it’s, it’s that it’s even more than that. It is literally inflation. But, but obviously, there’s certain levels of inflation, the other can be vary quite a bit. I think it incentivizes, you know, high inflation or certainly, it’s certainly incentivize booms and busts. Yeah, I wouldn’t say necessarily there was a confession or anything like that, but they do actually, early on in the report. Take the method that I certainly read in my economic textbooks, you know, that basically banks are just purely these intermediaries who get savings and then lend them out. Obviously take a little bit of a cut. Okay, fine. That’s, that’s, that’s fine. I don’t have a problem with that as a business. Yeah. They basically knock that on the head. Yeah. But interestingly enough, they don’t do it in a way that they say this is bad. But for me, I read it and go, you know, because of my kind of Austrian take on things I go, Well, that’s not good. You know, they’re just kind of, they’re just saying, This is what it is basically, it’s not this. They’re not just simply intermediaries. This is what these banks are. And this is how we, as a central bank, interact with those banks. Again, I think any any economist of any school of thought would find it, you know, an informative paper.

Gene Tunny 30:42

Oh, absolutely. I’ve talked about it on the show before I’ll put some links in the show notes. I think it’s good paper. And yeah, I’ll link to your spectator article. Once it’s out. Gee, Darren, there’s so much to talk about. Really appreciate your time, we dealt with some big issues, and we’ve still got more to talk about. Certainly, I want to come back to Rothbard. Yeah, that’s, uh, I’ll have to have a read of his of his book, and mystery of banking. And, yeah, I really appreciate your time. So thanks once more for coming on to the show.

Darren Brady Nelson 31:15

Thank you for having me.

Gene Tunny 31:26

Okay, I hope you found that informative, and enjoyable. I welcome Darren’s call for a broader review of the Reserve Bank of Australia. Given the importance of the Reserve Bank in the economy, we should be thinking about what presuppositions were making about the bank, and we should subject them to critical thought. The current review of the bank appears to take for granted that the reserve bank should continue as an entity and it should retain its extensive powers under the Reserve Bank Act. The review focuses on the appropriateness of the inflation targeting regime and the governance of the bank, but it should be much broader. The reviews Terms of Reference noted explicitly that the review will exclude the RBS payments, financial infrastructure, banking and bank note functions. Arguably, it would have been desirable to review even these functions of the RBA. So I think Darren is on the right track here. Even if I disagree with him over what a broader review would recommend. There are at least two big related questions that a wider review would consider. First, do we need a central bank? That is Do we need a government owned or authorised bank which acts as a bank for other banks and is ultimately responsible for the currency. Secondly, would commodity backed money where money is convertible to gold at a fixed rate? Would that be preferable to fiat money, where money is decreed to be the legal tender of the land by the government and the money supply is the responsibility of the central bank. In a Wi Fi at money presupposes a central bank or an arm of government such as the Treasury which effectively acts as a bank. But a central bank can exist in a commodity money system too, and indeed several such as the Bank of England and US Federal Reserve. They did exist during the years in which the gold standard was in place or some of the years in which the gold standard was in place. A central bank can perform an important role regardless of the monetary standard in place. As the 19th century British polymath Walter Badgett illustrated in Lombard Street, a central bank and perform an important role by acting as a lender of last resort. That is lending to banks when they temporarily get into trouble. And, you know, saving those banks from collapsing and causing lots of hardship. My view is that a central bank is an indispensable part and an unavoidable part of a modern economy. Regarding the second big question, I wouldn’t recommend a return to commodity money by say reintroducing the gold standard. But I will concede that advocates of a gold standard have some good arguments on their side. These arguments are even more appealing in times of high inflation such as the time we’re now living in. Most importantly, in my view, it is clear that fiat money systems are much more prone to inflation, then commodity money systems. A 1998 study by economists at the Minneapolis Fed found that the average inflation rate for the Fed standard observations so this is observations and the data set they’re analysing the average inflation rate for the Fed standard observations is 9.17% per year. The average inflation rate for the commodity standard observations is 1.75%. That’s a big difference. The data set they use contain data on 15 countries including In the US, UK, France, Italy, Germany, Spain, Argentina and Brazil, among others. Every country in the data set had a higher rate of inflation under a feared standard than a commodity standard. What’s going on is that obviously, there are physical constraints on the amount of commodity money available. It’s limited by the rate at which it can be discovered dug up and produced. Under a feared standard, new money is virtually costless to produce. As Darren and I discussed, the central bank and commercial banks are both involved in new money creation. And it’s possible for the money supply to expand faster than the productive capacity of the economy, leading to inflation, there can be too much money chasing too few goods. This is not to say that you can’t have inflation in a commodity money system. For example, there was prolonged inflation in Spain in in the UK in the 16th and 17th centuries, due to new silver mining and Mexico and Peru following European conquest. Still, as the Minneapolis Fed economists point out the average inflation rates over the period in these countries, it was only around one to 1.2% over 100 to 150 years. That’s one to 1.2% per annum. I’ll link to that study in the show notes so you can check it out. To me, it really clearly shows that fiat money systems are much more prone to inflation and you end up with inflation at higher rates than under a commodity money system. While a commodity standard would yield better inflation outcomes and a feared standard, it would be very difficult to return to say the gold standard. US President Reagan appointed a Gold Commission in 1981. To consider whether the US should return to the gold standard. The majority of the commission rejected such a move, and prominent economists such as Milton Friedman and Alan Greenspan, they advised Reagan against the return to gold. GREENSPAN did, however, suggest issuing some US Treasury bonds backed by gold, something which would provide some fiscal disciplined. He did not, however, advocate a full return to the gold standard. GREENSPAN thought that a return to the gold standard would be impractical given the nature of the modern economy with a large role for government and a welfare state. A gold standard requires fiscal discipline for several reasons, which I might have to cover in a bonus episode. One of these reasons is that under a gold standard, a government can’t rely on future inflation to erode the real value of the debt it owes. In his 2007 autobiography, The Age of turbulence, Greenspan wrote the following. I have always harboured a nostalgia for the gold standards inherent price stability, a stable currency was its primary goal. But I’ve long since acquiesced in the fact that the gold standard does not readily accommodate the widely accepted current view of the appropriate functions of government. In particular, the need for government to provide a social safety net. The propensity of Congress to create benefits for constituents without specifying the means by which they are to be funded, has led to deficit spending in every fiscal year since 1970. With the exception of the surpluses of 1998 to 2001, generated by the stock market boom. The shifting of real resources required to perform such functions has imparted a bias toward inflation. In the political arena, the pressure to make low interest rate credit generally available, and to use fiscal measures to boost employment and to avoid the unpleasantness of downward adjustments in nominal wages and prices has become nearly impossible to resist. For the most part, the American people have tolerated the inflation bias as an acceptable cost of the modern welfare state. There is no support for the gold standard today, and I see no likelihood of its return. Austrian economists would say that Greenspan gave into big government into inflation, and there may be some truth in that. But Greenspan’s position is entirely pragmatic. I’ll put some links in the show notes so you can learn more about this fascinating episode of the Gold Commission, and about Friedman’s and Greenspan’s advice to Reagan. I’ll also add a link to the minority report of the Commission which recommended a return to the gold standard. It was co authored by Ron Paul, the noted libertarian politician. I’ll leave it there for now, but I recognise there are several aspects of monetary economics that I need to explore and explain some more. I think the process of money creation and how the central bank can influence the money supply would be good to go over in some depth, as it’s challenging to understand. My conversation with Darren also reminded me that it would be good to look at how we ended up with inflation. targeting in the first place? Why do we think it’s sensible to have a two to 3% inflation target rather than a zero target? I hope you’ll forgive me if I leave these questions to a future episode. Among other topics in coming episodes, I’ll have a closer look at the growing US China tensions and the rise of authoritarianism around the world. geopolitics obviously can have a big impact on economy, so I think it’s important that I cover it on this show. If there are topics you’d like me to cover in future episodes, please let me know. As always, feel free to email me at contact at economics explored.com Thanks for listening. rato thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economicsexplored.com or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

41:26

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Credits

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Tags austrian economics, central banks, fed, fiat money, gold standard, inflation, monetary policy, money, rba

Podcast episode

Crypto arbitrage searcher Dave Belvedere on crypto and dApps such as Wizards & Dragons – EP178

Post author By Alec Krishna
Post date March 8, 2023
No Comments on Crypto arbitrage searcher Dave Belvedere on crypto and dApps such as Wizards & Dragons – EP178

Dave Belvedere is a software engineer who searches for opportunities to make the crypto market more efficient and to make money at the same time – e.g. by exploiting arbitrage opportunities. Dave gives show host Gene Tunny and his colleague Tim Hughes an overview of cryptocurrency and also talks about NFTs and decentralized applications (dApps), such as Wizards & Dragons.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

What’s covered in EP178

What is Dave’s role in the crypto market? [1:10]
What is a chain and how does it work? [3:39]
How long does it take to make a transaction? [9:26]
What does a crypto exchange (e.g. FTX) do? [15:30]
What do we know about miners? [20:20]
What’s the future of crypto currencies? [25:44]
What is Ethereum and how does it work? [45:57]
What are the pros and cons of crypto? [52:07]
What are dApps? [57:01]
What are the use cases? What would motivate you to have crypto? [1:06:33]

Links relevant to the conversation

Bitcoin creator:

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

Wizards & Dragons game:

https://dappradar.com/ethereum/games/wizards-dragons-game

Transcript: Crypto arbitrage searcher Dave Belvedere on crypto and dApps such as Wizards & Dragons – EP178

Gene Tunny 00:06

Tim Hughes 00:43

Hey, Gene. Good to be here mate.

Gene Tunny 00:44

And Tim, thanks for introducing me to Dave, who is involved in crypto and crypto is something that Tim and I have chatted about before, and we’re conscious that we need to know more about it, we’re at a certain level of understanding of it, and it’d be good to increase that understanding. So to kick off with Dave, could you talk about your involvement with crypto, please?

Dave Belvedere 01:10

Yeah, so I’m what I do is I’m classified as a searcher within cryptocurrency. So a searcher is somebody who looks for opportunities to make the market more efficient. So one of the classic examples is arbitrage. So when somebody adds a cryptocurrency to one side of a pool, so those get created by automatic market makers, which we can talk about, so yeah, yeah. So if they add, say, you know, 20,000 ETH to one side of the pool, and the other side of the pool holds USD t, then there’s an offset of the balance of how much USD T costs versus what the general market says.

Tim Hughes 01:48

So David, USD t is,

Dave Belvedere 01:50

it’s so sorry, yeah, the USDt is tether. It’s backed by sort of the organisation that runs it to maintain a level pay going against the US dollar. So it’s one to one to the US dollar. Okay. So there’s a couple of coins like that, that are referred to as stable coins. So this is within Ethereum, which is USD T and USDC. So us coin but it’s not the US market coin. So it’s not connected to the US government at all. Okay, so ETH is Ethereum and if there’s a theory, okay, and then you’ll have BTC, which is Bitcoin? Yeah.

Gene Tunny 02:29

And is there a simple way to explain the difference between Ethereum and Bitcoin?

Dave Belvedere 02:34

Yeah. In essence, the cryptocurrencies. So it’s cryptocurrency really is just a digital asset that’s backed by a cryptographic hashing algorithm. Digital Asset is something just like a bank account, or something like that. So yeah, we see it every day. Yeah, technically, all Australian dollars, when you start to pay with your credit card, that’s really just a digital asset. In this case, it’s a digital asset that is then secured by cryptography. So when you go visit the bank, you’ll usually see HTTPS, that s stands for secure, and that’s backed by cryptography. So same sort of mechanism. And in this regard, when we talk about Bitcoin and Ethereum , they’re actually two independent cryptocurrency chains. So they’re not really connected together. And what that means is that they operate a little differently. So Bitcoin was the first one, they came in around 2009. So a lot of people would have heard it, because, yeah, that the market value quite, quite hugely, I think, a couple of years ago, it was up to like 80,000, US or 80,000, Australian. And it’s come back down now. But yeah, head has gained a lot of popularity. So when we get into a chain, there’s a couple of things when we talk about what a chain is. So we would have all heard of the classical blockchain. And that’s what sort of secures Bitcoin and Aetherium. So blockchain is really an ledger, we probably always, always heard it. So transactions just get added, and you can’t go back and modify the transactions. And one way, well, the guarantee for that is the consensus mechanism that gets used. So let’s just say I make a couple of transactions on Bitcoin. So I’m sending some bitcoin to somebody else, that transaction gets added to a block. So there can be many transactions or none, no block. Yeah. And then that block then goes through all gets consensus with the rest of the network. So one of the differences are that, I guess one of the big differences with blockchains is that for most of the blockchains, that distributed systems, so nodes all around the world make up the actual blockchain. So there’s no one entity that can control the blockchain itself.

Tim Hughes 04:53

So this is the decentralised term when it’s used. This is what the what they mean by that.

Dave Belvedere 04:57

Yeah, yeah. So that’s sort of like you can shut down, say everything in the US, but the chain will still operate because you know, it’s in Europe, it’s in Asia, it’s in Australia. So you can’t really shut the chain down.

Tim Hughes 05:09

And is that just on that subject, is that one of the reasons that so much energy is needed for a transaction? Is that where that consumption comes in?

Dave Belvedere 05:17

So to a degree, there’s a couple of things that will maintain the security of the blockchain. So a couple of blockchain. So in this case, Bitcoin itself is actually vulnerable to a degree to the 51% attack. So when we talk about distributed systems, it’s different control most of those systems, you can do whatever you want in the system, which is classified as the 51%. Yeah, so I haven’t heard that term before. So if I control 51% of all miners, and let’s just say in Bitcoin, then I can make any transaction valid, because I control the majority. Yeah, the consensus mechanism that gets used as always a majority, if the most of the nodes agree that this transaction is valid, it’s valid, and there’s no going back once that transaction, that transaction has been committed, there’s there is a couple of nuances to that. So you can challenge a block if it hasn’t been finalised. But for the most part, we you can always just assume, as soon as that transaction gets committed into a block, and it’s on the blockchain, it’s there forever.

Gene Tunny 06:19

Yeah, but because it’s so decentralised. And there are so many 1000s I don’t know how many 10s of 1000s of people around the world who are they’re mining or whatever they’re doing. They’re overseas, so they’ve got a stake in it, then the probability of having that 51% attack is extremely low, isn’t it?

Dave Belvedere 06:40

Yeah, you need sort of a lot of a lot of materials and a lot of money, honestly, to get to that point. Yeah. So when something small, obviously, it’s easy. But yeah, given its past sort of popularity, and its nature, yeah, it gets gets very hard. And yeah, so the Yeah, it’s, it’s extremely hard to try and try and get that in a bunch of, there’s a collection, so you might not be able to create the block. So when we, when we talk about these miners, yeah, suddenly, to I guess sort of to lead up to is why miner are unnecessary in Bitcoin, now and previously, in Ethereum, is that they are looking for the next block. So they’re trying to get consensus on the block. Yeah. So when somebody commits a transaction that doesn’t get added to the blockchain, automatically, it goes to the miners. And what they’re doing is running the consensus algorithm. So the algorithm is just really cryptographic hash. And what it includes is the hash of the header of the previous block, plus all the transactions plus a random number. And what they’re trying to do is run that hash it such that they get a viable block, the block is valid in accordance to the consensus algorithm. That is where all the power is spent all that time, because you’re running a cryptographic algorithm, which is usually quite computationally heavy. Yeah, in the best of times, and they’re trying to beat everyone to the block. Because if you create a block, you get a reward for it. So you might get one Bitcoin, or something like that. So it is viable to try and create as many blocks as you can to get those rewards.

Tim Hughes 08:16

That’s the reward for being a miner. Is that right?

Dave Belvedere 08:20

That’s the reward for creating a block. You spend all your time mining, not create a block and get nothing. Yeah, so one of the things that they’ve done, because obviously, that sort of starts to lean towards people with more money, more resources can deploy more things, is they’ve created these mining pools, such that you can contribute to the pool, and it might make up say, 25% on the network. And then if the pool itself creates a block, you get a you get a little piece of that based off of you know, how much you contribute to the pool.

Tim Hughes 08:57

Quick, quick question with that. So with the people who don’t manage to mine the block, is that part of the excessive amount of energy needed for a transaction because it’s basically wasted energy, they resource is a bit like an Olympic bid or how it used to be. So all that money is spent was for nothing, because it went to wherever

Dave Belvedere 09:18

Somebody else. Yeah, so they’re basically you know, running these things as quick as they can and they might get beaten by nanoseconds.

Tim Hughes 09:26

Yeah. And how long would a transaction normally take roughly?

Dave Belvedere 09:29

So it depends on the on the chain being used, I think at the moment with Bitcoin because they’ve like they’ve mined so much it takes you know, 10s of minutes to actually create a new block in Ethereum. They switched from proof of work the consensus of proof of work, which is what Bitcoin still operates on, to proof of stake which is less computationally heavy consensus mechanism and it also you can argue it distributed through the miners a lot cleaner to, and they’re fairly quick. So compared to Bitcoin, so they generate a new block, I think, every second pretty much and the transactions that get included are just transactions there.

Tim Hughes 10:14

Because yeah, this sorry, Jamie, because this is something like last year or isn’t it when Ethereum. So this is the change that they did way? I think it’s only 10%? Or is it like a 90%? reduction on 99.9%. Wow, okay, of their power, which is enormous. I mean, that’s because that was the we’ve talked about it before with outrageous amount of energy spent. And to hear it, they’re like is completely wasted? Any delegates not necessary for that transaction. So it’s wasted energy. Yeah. So Ethereum have made this quantum leap, basically, to make it far more efficient. Yeah, pretty

Dave Belvedere 10:46

well, efficient in terms of memory. Sorry, in terms of power. Yeah, like the contestants. So proof of stake, the way it works is like a scheduler just goes, you’re going to create the next block. And so only one person is effectively going, here are the valid transactions and pushes the block out, you still got validators that will be like, That’s a good job or challenge to do it. So I guess sort of a little difference between proof of work and proof of stake as the consensus mechanisms. Proof of Work is just really run, like find that cryptographic hash match. Proof of stake is you put up X amount of capital, or for this, in this case, it’s 32 ETH, which is about 80,000 Australian, and you say I will behave correctly and properly. And if I generate a block, you get sort of the rewards for that. Now, in order to avoid bad actors, or just somebody coming in with a massive amount of ETH. And being like, I’m just going to do this, they have challenge periods. So if somebody like, let’s just say, misbehaves as the node and puts in a bad transaction, somebody, anyone on the network, so like, you could be just a little guy on the network and these big, big mining groups around you can challenge the block. It’ll force everyone to go through and actually, like, compute this at a sort of hashing level. And if you’re right, and they did misbehave, they lose all the capital that they put up. So they get slashed, 32. And so the node gets bounced, and then that 32 ETH comes back to the network. Because you challenged it, I think you get like, 90% of that, and a bunch of it gets burnt offs. Yeah. So it’s sort of the that’s the mechanism to make sure everyone is behaving correctly.

Gene Tunny 12:39

Don’t can’t ask a basic question. Yep. Say you bought a couch off, Tim. And you wanted to pay Tim in cryptocurrency? I mean, maybe bitcoins the example to use, since that’s what most people are familiar with? How would it work? I mean, would Tim have to have a wallet, a crypto wallet?

Dave Belvedere 13:01

Yeah, so crypto will only really send to what we call wallets are really just public keys and private keys. So it’s the public key infrastructure that sort of backs a lot of lot of internet, mobile, a lot of sort of infrastructure around the world at the moment. And you have a public key and a private key. Okay, so most people might have heard this, like, somebody’s private key got lifted, and crypto got drained. If you’ve got a private key, you can decrypt anything that gets encrypted with the public key. So in this case, I’m sending it to Tim’s public key, and then only Tim will be able to, to get that from his public key if he’s got the private key.

Gene Tunny 13:43

So who sets up the public key? Tim need to do that?

Dave Belvedere 13:46

And Tim needs to do it. So in order to generate a wallet, you’ll get both the public key and its private key.

Gene Tunny 13:51

Okay. And who are the players that do that for you that is that a an exchange? A crypto exchange?

Dave Belvedere 13:56

Yeah, there’s, there’s a, like, you can do it through an exchange. But then typically, like, there are exchanges out there, okay. They might like to hold the private key or, you know, be able to recover private keys and things like that. Yeah, you can do it through a bunch of, sort of specialised applications. So we call them just wallets. So the most common one in Ethereum is Metamask. So it can you can just plug it in, it’s just a Firefox Chrome app, and you go create new wallet, and it’ll generate that those keys for you.

Tim Hughes 14:29

Is that user-friendly Dave or is that something that you’d need someone like yourself to help set up?

Dave Belvedere 14:36

No, it’s it’s it’s pretty easy. User friendly now. So yeah, like a couple years ago would have been like, what’s going on what’s up, but now, you know, they’ve made many changes has been very user friendly, like to go through you instal it. It’ll be like, how you like recovering your existing wallet. And if that’s the case, you got to provide the private key, or the seed phrases to generate the key Um, ball. It’s just like, okay, cool. Finding a new wallet, you click a button creates the wallet for you. Yeah, it stores the like, you won’t see the private key, but I’ll give you the seed phrases that are used to recover that private key and record these because if you don’t have the private key, this is the only way to get this back.

Gene Tunny 15:20

Okay, so who would do the transaction? Is that through the exchange? If you understand money to Tim, or is the exchange doing is FTX? I mean, what did a company like? FTX do so

Dave Belvedere 15:33

FTX was primarily changing, like currency for cryptocurrency. So they, they act as the middleman. Okay, so you know, I’d give them Australian dollars from the bank, okay, and then I could buy on their market at their rates, x amount of crypto that they’re holding in their wallet, okay. And then from that I can either like so as a part of that, typically, you’ll find an account with the exchange that will have like an embedded wallet associated with it, or whatever their infrastructure needs. And then I can transfer that to say, my wallet, and then I can transfer some to Tim or I can use that exchange to transfer it to Tim directly. Okay, so exchanges are primarily there for transferring currency. So, so transferring dollars to currency, or transferring between cryptocurrency across chains, or transferring between cryptocurrency on the same chain. So when we talk about an Ethereum is not just ETH it has a bunch of coins on the same chain. And yeah, you can use an exchange to say transfer one Eth to USD C or USD t. So the two stable coins you’re talking about before. Or I can, you do that what they call on chain through DEX’s. Okay, decentralized exchanges. Okay. So they create pools or what we call automatic market makers. Yeah, so they usually have a pool, which is, this is a 50/50 pool. So it has Ethereum and USDC. So the pool itself, ideally, at any point is trying to maintain half of its quantities Ethereum and the other half is USDC. And now what sort of I look for on chain is when somebody then dumps 20k Ethereum into that pool, means there’s an imbalance between the side. So yeah, who would automatically want USDC or getting rid of ETH. So it’ll make eath very cheap to buy, so wants to get rid of it to maintain the balance, yeah, or give me a really good price to put USDC into the pool, because it wants more of that to try and maintain that 50/50. And that sort of is the classical arbitrage from that I can buy low at some other pool or on the decks itself, and then put it into this. And what makes that possible is decentralise exchanges. Don’t look at you know, a fee that says the market price for ETH is x to what exchanges use. So exchanges will typically have, you know, the current market price of ETH is whatever $1,600 And that’s based off of, you know, what’s happening now what’s happening on other exchanges, like Binance and things like that, and they sort of get a get a market price for that. Whereas decentralised applications, their market price is literally what the pool says. So yeah, you can sort of get really good deals. And yeah, when you sort of try and make that market efficient on the decentralised side it Yeah, can can open up a bunch of opportunities.

Tim Hughes 18:55

Can I just ask Dave? So with winning that transaction in your, you know, for that particular situation, is that all about speed? Or is so what are the factors in being able to get that transaction?

Dave Belvedere 19:06

Yeah, so there’s, there’s a couple of things that will impact that transaction. So on Ethereum, it’s not necessarily about speed, you certainly have to be there when they’re trying to create the block. So let’s just say the timing window for creating a block is 100 milliseconds. So as long as my transaction to do that is in that block time creation window, I have a chance to potentially win that transaction. And what it comes down to on Ethereum is you can tip the miner to be like, you want to put my transaction first. So let’s just say I’m going to make three ETH. From this transaction, I can tip the miner 2.5 of that ETH so I get half of that if I can give the miner 2.5 If they put my transaction first, so which means the Miner is getting more money to make sure that my block Isn’t there first my transactions in there first, and then they can put the rest of the transactions. And so that’s sort of making up what we, you know, sort of what gets identified as MeV. So mine extractable value. So they’re looking for the most profitable transactions to put inside their block in order to make the most money. Yeah.

Gene Tunny 20:20

So what do we know about these miners? There are professional miners aren’t there? And are there amateur miners? I mean, is it guys in the basement? Or is it? I know there are some dedicated companies aren’t there that are doing the mining and they’re all around the world? Do we have any here in Brisbane, I’m just fascinated with these miners are.

Dave Belvedere 20:40

Ya know, it’s really it’s, it’s anyone that has the computer with the resources and is running the algorithm, you can be a miner at that point. Yeah, mine is there to operate the chain it does. Under proof of work, it is better to be with other miners, like around other miners, because you want to broadcast the block that you find to the network as quickly as possible, because two people might come up with the same solution or like different transaction orders. But both of the blocks that they produce pass the consensus algorithm, it’s whoever can saturate the network or saturate 51% of the network they’re blocked in is the next block. So you might do all this work, find a block, create the block and then still miss out.

Tim Hughes 21:29

Right, which was the original problem, anyway. So yeah, just is it? Well, as far as energy consumption goes. So with the changes that Ethereum made, it’s the same process, but just quicker, and with fewer people vying for it. Is that right?

Dave Belvedere 21:41

Just just one person vying for it. So it’s like, with proof of stake, it’s like, it’s your time to create the block. And you have to answer within a certain timeframe. If you don’t, there is a little bit of a penalty, like you lose, start to lose some of your stake, and they just go to the next person.

Tim Hughes 21:56

And how do you be in that little group or chain? Or?

Dave Belvedere 22:00

Oh, it’s just really running the node software, So the actual node software is executing, you just connect to it. And and you’re pretty much in it.

Gene Tunny 22:09

Yeah. What do you know about the profitability of the mining? Because is it something where there’s such low barriers to entry, there’s just, you know, lots of people have come into it seeking the profit. And then that gets, you know, that those opportunities get dissipated? Or? I mean, I’m guessing there are some players in the mining game who have, they’ve just got such great computer capability, or there, they’ve got a better algorithm, that they could get a lot of the winnings, but what do you know about the profitability of mining? And the, I guess, the market structure, I suppose you call it?

Dave Belvedere 22:48

Yeah. So um, under proof of work, mining profitability, I think sort of, when we talk about Bitcoin is starting to fade away very quickly, because you need to spend all this energy. And I’m, I’m pretty, pretty sure that they’ve dropped the block rewards, quite recently. So what you get for actually creating a block that’s come down, so you’re getting less and less, sort of Bitcoin for creating that block now, right? So the profitability is starting to go away. In Ethereum, it’s still kind of there, it’s sort of like a random random shoot, if you get a really good block, where let’s just say something skewed pool a lot. And you’ve got these searches, trying to like get money out of the pool to make it market efficient, you might end up with a block that might pay you say, 50 EtH, in those tips. So that’s random. But the problem is, is that there’s a lot of like, nodes around the world for a theorem, because now it’s just super, super, super basic to set up and those sort of requirements are starting to fall away a little bit. That yeah, it is hard to like, get to that block, like it is pretty much a random chance. Okay.

Tim Hughes 24:04

But, Dave, you mentioned a couple of terms, actually, you have Bitcoin operate and how Ethereum operate, which is essentially then the difference that made it possible for Ethereum to use so much less energy. What was that again?

Dave Belvedere 24:18

They’re their consensus mechanism. So proof of work versus proof of stake.

Tim Hughes 24:22

Yeah, right. Okay. So Bitcoin have proof of work, Bitcoin and proof of work? Yep. Is it possible for them to do the same thing as a theorem and move to proof of steak?

Dave Belvedere 24:33

It is they would have to change how the chain would not have the chain, well, how the miners would operate. So the actual software that the miners run. One of the things with Bitcoin is there are very big miner groups now. So there’s a lot of sort of power in these groups because they don’t want the status quo to change. Because they they’re making they’re making money. So proof of work, works for those miners. Yeah. And so you have to convince like majority of the miners or like 90% of the miners that this is the way forward. Otherwise, what will happen is you’ll get a hard fork. So you’ll potentially see if you’ve looked at sort of some of the crypto you’ll see like, Bitcoin classic and a theorem classic. Yeah, these are hard forks of the chains where miners have just disagreed. Okay, and so, you know, a group of miners went one way. And other group of miners went the other way. People yeah. Always soiling it.

Tim Hughes 25:34

Humans always do. Okay, so, um, because with that, I mean, it looked like such a big change for Ethereum that Bitcoin might have its days numbered, like, Is that a fair assumption?

Dave Belvedere 25:44

I think so. Like, I think bitcoins done really good stuff and trying to like break into the businesses and operate as like, Hey, here’s a digital asset coin and sort of challenge the status quo that was previously that it’s days to look, you know, pretty, pretty bleak. In terms of future it is just a coin, and it’s just a digital asset. And you’ve got other sort of crypto currencies like Ethereum that operate as a coin, but then also have these decentralised exchanges, as you know, on chain games that you can play and like, do stuff with, they’ve building out an entire ecosystem over top of them. So they’ve now got what what gets referred to as layer two chains. So chains that operate on Ethereum. So you can bridge assets, I can take what I’ve got on a theorem and hold it up to this layer two chain, and that layer two chain is secured by Ethereum. So typically, you’d like to take arbitrage, for example, it’s a really popular layer to chain on a theorem, what they do is they’ve got their own. They’re a centralised chain. So the way that they validate and sequence blocks is controlled by off chain labs. But what they do is when they’ve got a bunch of blocks, they roll them all up. So they have a rollup mechanism. And they send that data back down as a transaction on layer one. And so when it gets committed into layer one, I can essentially rebuild the layer two chain from just layer one. And that’s where I sort of think Ethereum is going to head towards the future, is that a Ethereum , what we call layer, layer one will end up being more of a security mechanism, rather than sort of what exists today with DEXIS and coins, that will still be around, but I think the majority of us will start to go towards layer two and potentially even layer three, because they can upscale the amount of transactions they can handle. So that’s, that’s the other one. That’s pretty key, if this was going to take over sort of like, a digital asset is how many transactions you can compute per second. So you know, take Visa, for example, I think can do like, what 4000 transactions a second. And so yeah, that sort of puts a minimum requirement on how many transactions you can compute per second, in order to like, not really notice, it’s like you don’t notice, like when you tap a credit card to go pay a delay of like, hang on, gotta mine that block.

Gene Tunny 28:22

This is where we need quantum computers. And are they, are they something that will actually happen?

Dave Belvedere 28:28

Potentially, yeah, it depends on like, what gets used. So hashing is always a weird one for quantum computers, because hashes are typically not vulnerable to, I guess, you know, Shor’s algorithm, which says, basically, sort of at a high level, anything that’s secured by, say, just a cryptographic algorithm, you can break with Shor’s algorithm. Yes, yeah. it all up. So cryptography today depends on the fact that when I make like input equal output, if I have to break that output, it’s a brute force attack. So I have to just iterate through all possible inputs to try and find what input gave me that output. It depends on that that is pretty much impossible. You need a lot of resources. And it’s going to take a lot of time. Not to say it’s not impossible, but it’s so far out of just, it’s 100 years to like, try and work out what this input equals that output, that it’s just not worth it. So that’s what fundamentally secures all cryptography today in those sort of algorithms. What the concern with quantum is, is that you’ll be able to do that a lot quicker. Yeah, but with hashes, not so much. It’s still just run through how the hashes work.

Gene Tunny 29:56

Right? Okay. Yeah, fair enough. I had another had another question about this proof of work versus proof of stake. One. Criticism I heard at the time when this merge occurred was at the merge, like the merge. Yeah. Was that Well, the great thing about Bitcoin and I think I had Yeah, I had a guest on the show, who was a Bitcoin enthusiast, and he was also a writer of thrillers. Lars Emmerich. I think it was, yeah. It was interesting. Guest fun. Yeah. All right, is excellent. And former fighter pilot and oh, yeah, writes thrillers. And he’s, we talked about crypto among other things. And he’s a big Bitcoin enthusiast because he sees the risk of he’s concerned about the US dollar hyperinflation, etc. So we had a good conversation on that. But he was saying the great thing about Bitcoin is decentralised, the proof of work means that there’s benefits from having proof of work, and it is, I guess what I’m asking is Ethereum still crypto, is it still, I mean, there’s moving to proof of stake move away from the benefits of having to do that proof of work.

Dave Belvedere 31:23

I mean, oh, yeah. Yeah. No, not Not really. So okay. It is still crypto. It’s still cryptographically you know, okay, locked in and secured, as is still decentralised, still decentralised.Yeah, so absolutely. So it’s even some people can argue it’s even becoming more decentralised than say, Bitcoin. So Bitcoin itself is moving towards centralization, because you have the big miner groups that start to control more and more of the chain, sort of moving towards a centralised figure. And so that’s that 51% attack that we talked about earlier, with moving to a proof of stake in order to control or sort of start to centralise the chain, I have to control 51% of all Ethereum. So every single ETH that’s ever been issued, I need to hold 51% of that, which is, you know, starting to become trillions and trillions of dollars. Yeah, so it is less viable for me to actually try to attack at the network. And yeah, it’s sort of proof of stake kind of starts to push more of a distributed type of feel to it doesn’t stop big groups coming together and like, obviously, trying to pull the chain towards centralization. But I’d probably argue that proof of stake makes that harder than say, proof of work.

Gene Tunny 32:51

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

Female speaker 32:57

Gene Tunny 33:26

Now back to the show.

Tim Hughes 33:31

Can I say what would happen with layer one, layer two, if someone was to get that 51% ownership? Do they then become the layer one? They’ve got their? They’ve got the conch as it were, you know, so is that where the layer one status is? Is like yeah, because the majority.

Dave Belvedere 33:49

so yeah, pretty much like yeah, if somebody can control, you know, the, the layer one and you’ve got layer two, and layer three is built on top of it. They call the shots, they call it. Yeah, they effectively have the control of the network.

Tim Hughes 34:02

Because it’s an interesting part of how this seems to be unfolding is that the decentralised nature seems to be one of the big attractions and I’m sure it still is. But as far as confidence in the currency, it seems to be the downfall of, so it’s it looks quite possible that so for instance, Reserve Bank of Australia or Bank of England may want to bring up their own cryptocurrency which would then be centralised that would be layer two as you were saying so if they did it with Ethereum it would for instance, you know, hypothetically will come on as a layer two and be centralised. Yeah. What are the is that the direction we’re heading in? Is that seem to be most likely?

Dave Belvedere 34:47

Yeah. Maybe. I think because they would want to control the chain. So one of the reasons I guess that a lot of people are still You know, fairly excited is that cryptocurrencies do bring some anonymity to the game. You’re just identified by a wallet, not by name, address or anything like that. Yeah, right, sort of what the banks need. So you don’t get KYC in exchanges, KYC so know your customer.

Gene Tunny 35:19

Yeah, that’s the stop money laundering. Dodgy transactions, technically, they’re supposed to know their customers. And this is where some banks have got into trouble. Yeah, he is that they actually didn’t know their customers and all of the money laundering through the Westpac ATMs. I don’t know if you remember that.

Dave Belvedere 35:39

It was it Westpac? There was a little I remember stuff with Commbank, they’ll doing.

Gene Tunny 35:43

maybe it was Commbank, I actually have to check that in the show notes. So I don’t get sued. But I thought it was Westpac is one of those four. Yeah. So

Tim Hughes 35:58

Good to know, because I’ve got to deliver a CAPTCHA apparently. So. Good thing to know.

Dave Belvedere 36:03

Yeah. So So currently, sort of government regulations, sort of say like, Okay, if you are transferring currencies and things like that, you have to KYC. So you have the customer have to provide details. Yeah, and one of the great things about digital coins is, you know, you just identified by a wallet on the network. So, you know, is that really you? I don’t know. So, you know, this is where, yeah, recently I had to go through tax in a year, which is, which was always fun. And yeah, you got to provide like, his wallet addresses, these are all the wallet addresses I touch. These are all the transactions I made to, obviously, ATO, so they can make sure that you are getting taxed correctly.

Tim Hughes 36:48

That’s a really good point. I hadn’t thought of that. So how does this work with a tax return? Like, you know, with your transaction, what you own what you dont own.

Dave Belvedere 36:56

Every transaction is considered an investment or sell, buy or sell order, basically. So cryptocurrency still is considered, well, it’s a high risk investment, right? It is extremely volatile. And yeah, and there are many dodgy things that do happen on chains. And, you know, one of the classic examples is you can’t even trust exchanges, because FTX, for example, they were messing around with customer funds and things like that.

Tim Hughes 37:27

So yeah, sorry I was always going to ask at some point, now is obviously that time, I guess, what happened?

Dave Belvedere 37:33

So sort of the story that we got for the collapse of FTX customers are obviously putting in the money FTX I believe that the time offered, you know, futures options, traditional sort of trading markets that people could play around with. However, they also sort of had a behind the doors deal with one of their sub companies, I think is Ella Mira or something, something similar to that, where they will lend them a bunch of money at them was backed by customer money from an FTX, FTX perspective. And they played around with it and lost, I think it was they lost billions and billions of dollars. And so when customers started to lose confidence in FTX, I can’t remember what the particular event was. And they tried to withdraw their money. They couldn’t, because FTX didn’t have that money anymore. So and that’s sort of what led to the collapse. And what Yeah, ultimately forced the US government to start to step in. And that’s where I think we’ll start to see more changes. I think crypto is here to stay. But in its current form, probably not. I think governments will start to get involved. And yeah, you’ll start to see sort of a traditional securities market approach, I think, come over the top of it. So yeah, whether you’re more KYC or, you know, more rules around what you can and can’t do in particular countries, which makes it quite hard because there is no one thing controlling crypto, and it’s all decentralised. So it’s like, well, if we see you’re coming from the US, you gotta use this. If we see you’re coming from Australia, you got to do this, which, yes, is it’s hard to make that work well.

Tim Hughes 39:27

So that was a failure of the exchange, not the currency.

Dave Belvedere 39:30

Yeah, that’s, that’s purely a failure of the exchange. So the people running the exchange are doing Yeah. Yeah, questionable. Questionable things.

Gene Tunny 39:38

Yeah, because they should have just been exchanging or holding that money on behalf of their customers. And they were going to use that to purchase cryptocurrencies were they?

Dave Belvedere 39:51

Yeah, so effectively, like, yeah, they would purchase cryptocurrencies and then they would sell it on so they, you know, if starting up they would prop we’ll be running at a bit of a deficit or like have a raw, somebody’s given them a bunch of money too, and have that initial crypto. Yeah. And then yeah, as people come in, and they, like, give money for that crypto, obviously at a particular market margin. Yeah, they start to be able to add more crypto and sort of become profitable in that regard.

Gene Tunny 40:22

Yeah. But they went in, did they go and lend that money that they should have held in trust, or they shouldn’t they were looking out for customers to that. That other company was run by his ex girlfriend. By Sam Bankman-Fried’s ex-girlfriend. Yeah. Yeah, it was a daughter of an economist, economist. MIT economist, I think, I think he’s a professor at MIT or one of those schools. Really good school. Yeah, that was a debacle. The other thing I hear about is the rug pull. Rebuild, goes on about rug pulls. And when coffees Zilla, you probably follow Him or you say he’s really sceptical of crypto. Have you seen coffee Zilla? I will flick you some videos.

Tim Hughes 41:07

I love the fact that rug pulled got a conversation. I’ve never heard of this. About this.

Dave Belvedere 41:13

It’s a funny term. So obviously there with with anything new and like, Give somebody a little bit of anonymity, they just go wild. You know, there are at the moment, a lot of yeah, a lot of good actors that people are trying to, you know, accomplish and create new things. But there are also a lot of bad actors. So classical pump and dump schemes are not uncommon. And yeah, one of the other ones is what gets what got its own name, which is a row pool. So let’s just say, you know, there’s, there’s a, there’s a token that I’m releasing, people buying that token, so they’re sending me money, and I’ve given them the token back, and then on the owner, cool, I can just like swipe all that money out of the account, and then that token is now worthless. That’s, that’s effectively a rug pull. So the people who created that, that have control of that sort of asset, because the assets on an Ethereum are controlled by contracts. So if you’ve got the private key to the contract, you effectively control the contract. And you can just take all the money that’s in that contract, and then the token then becomes worthless.

Tim Hughes 42:20

Actually, on that note, so this, this brings up the question I was going to ask, who started these? Obviously, they’re, you know, whoever is behind bitcoin or Ethereum? Are they known?

Dave Belvedere 42:33

So, Bitcoin, no. There is a famous paper that is written but no one knows the true identity. Within Ethereum, it’s Vitalik. So he traded a theorem and then it’s now run by the Ethereum foundation. So the people who sort of operate and try to improve the chain and things like that are known as a foundation whereas Bitcoin it’s, it’s murky, who started.

Tim Hughes 43:00

It’s very James Bond, the whole thing of like, you know, having something like Bitcoin with, you know, who’s behind it is fascinating that it’s anonymous at that level with potentially a lot of power.

Gene Tunny 43:11

Well, it was this person with a pseudonym was it’s a Satoshi

Dave Belvedere 43:16

Satoshi. It started with Okay, yeah, but yeah, Satoshi, something

Gene Tunny 43:19

like that. I’ll put links in the show notes. And what they did I think they published a white paper. So they publish the code or the rules for Bitcoin and then people read it and thought, actually, yeah, this would, could work. This is a great idea. Let’s go ahead with it. So it’s obviously a computer scientist of some kind, potentially. Yeah, I think is there an Australian who claims that he invented it? I think, as well?

Dave Belvedere 43:44

Yeah. There are claims that the Australian is Satoshi. Ah, right. Yeah, so sort of he released the white paper with the chain already there. So one of the things that you have to do to I guess, you know, start a chain, is you got to create the Genesis block. So the first block that then things build on top of, and typically, if you’re going to create the Genesis block, well, you might as well just create a good fundamental base. So I think, I think Satoshi has like, a ridiculous amount of bitcoin, because you’re effectively controlled. The base asset right at the start, and then you sort of like, give yourself as much as you need as you’re building these blocks, like you might release the chain to the public, say, and it’s got like, 200-300 blocks. So you’ve got all the rewards for those blocks are doing no work, no competition, but now you’re going to release the chain. And so I think, from memory, reading papers, like everyone knows which coins because obviously the coins effectively get numbered based on the block that they were minted in.

Tim Hughes 44:52

And on that note, Dave, there’s a certain number of Bitcoin and then that’s it. Is that right? And was that determined at the very beginning?

Dave Belvedere 45:00

yeah, so that would have been determined by the actual algorithm that that got generated for Bitcoin.

Tim Hughes 45:05

How many other?

Gene Tunny 45:07

21 million, isn’t it? Yeah, I’ll put it in the show notes anyway.

Tim Hughes 45:14

So that’s part of the strength of it, though, that it’s a finite number.

Dave Belvedere 45:18

It is a finite number. Yeah. So it’s like it is the strength. So once everything’s been mined, you know, that’s it, then it just becomes transactions passing between to and fro.

Tim Hughes 45:28

You need a level of scarcity for it to have a value.

Dave Belvedere 45:31

Scarcity will drive the wealth of the actual element up, or potentially not, depending on which way it flows. But yeah, that’s, that’s the sort of appeal for it is that it’s running out, so if you’re going to grab it.

Tim Hughes 45:45

And Is that comparable to how many Ethereum there are in the in circulation? No. I knew as I was asking the question, this is not right.

Dave Belvedere 45:57

So what gets classified as Ethereum? Has, it does have a max value, but it’s quite big.

Tim Hughes 46:05

So sorry, I mean, this is coming from a very base level of understanding. But I’m sort of fascinated by this. So how does that work? Then with Ethereum? How many? Like what do you call? So Bitcoin is a Bitcoin? Because Bitcoin isn’t what Ethereum? Worked with? ETH. So yes, okay. Yes. So the number of ETH isn’t determined, it’s not finite.

Dave Belvedere 46:28

It, there is a there is a finite, but they can always add more. So it’s, yeah, it’s backed by a contract. And you can always change that contract. Sort of as an example. Like, right at the start, it was ETH. So ETH, is the classical. Everyone knows, sort of what gets defaulted to, technically, it’s not ETH anymore. It’s actually wrapped ETH. So three or four years ago, I think, the foundation or or one of the one of the partners that works with Ethereum, closely, they published the standard that every token should follow, because a token is really just a contract on chain, and you’re calling methods on that contract to say meant, you know, how many does this address have? If everyone is, you know, everyone just goes, I’m going to create a new contract, that API of like, what do I call to, like mean to what do I call the burn could change from token to token. So what got published was what was being classified as ERC. 20 So it’s a standard that every token follows. So an ERC 20 token follows that standard. ETH at the time, didn’t meet that standard. And so they created a contract that did create that didn’t meet the standard called wrapped ETH and you can transfer ETH and wrapped ETH at a one to one. So I can have like eight ETH and automatically make it a wrap ETH, okay? It’s just like taking that asset and making it different. But it’s still what you know, it’s still what we call ETH on chain.

Tim Hughes 48:13

Yeah, okay. Yeah.

Gene Tunny 48:14

Here’s another basic question that just occurred to me. So a Bitcoin. I’m not sure what its value at the moment, but is it around 20,000 USD?

Dave Belvedere 48:23

26,00US.

Gene Tunny 48:27

Okay, yep. Yep, can I have a fraction of a Bitcoin? Can I or, but I How does that work? I mean, all because I thought if it’s in a wallet, does it have to be one Bitcoin? Or can it be gonna be a fraction?

Dave Belvedere 48:40

It can be a fraction of Bitcoin. So typically, with the tokens they’ll have? Like, we call it decimals on chain, but it’s really just precise. Okay, gotcha. So like, I think Bitcoin has a precision of six, I think six or eight. I’d have to double check that. So which means I can have point 000001 of a bitcoin. Right. Okay. Yeah, as long as it’s within that, that precision element, it doesn’t matter. You can you can still operate and work on it. Gotcha. Yeah, so as an example, ETH has a precision of 18. Right. So one eath, actually on chain is one times 10 to the power of 18. That’s what it looks like on chain.

Tim Hughes 49:23

Okay. And what’s a ETH worth nowadays? I think it’s around 1600 USD at the moment. Okay. So, as far as affordability goes in a single as against a Bitcoin.

Dave Belvedere 49:37

An ETH is more affordable.

Gene Tunny 49:40

Okay, can I ask you about smart contracts? So as an economist and speaking with other economists, and just reading about crypto and, and all of that, I mean, there seems to be increasingly there’s a view that will crypto might that There’s a lot of scepticism about crypto itself, but they’re saying, well, the blockchain is great, and smart contracts are great. So, can you explain what a smart contract is? And it’s linked to Ethereum? Is that correct? Yeah. How does that work?

Dave Belvedere 50:13

Yeah. So, um, a smart contract is really just code that’s on the chain. And so one of the one of the sort of, I think, very fundamental things that makes a theorem quite good is that I can store more than just the coin on the chain, I can create code, I can put it on chain, and then that’s the code forever. And so that code can no longer be changed, which does lead to some interesting problems, like, Oh, crap, that’s a bug. How do I actually, you know, patch and fix that bug? And you know, that’s, that’s kind of, we’ve seen consequences of that already. Yeah, somebody’s found a security flaw and just like, stolen millions and millions of dollars from contracts, or from DEXIS in particular. So they’re sort of the common hacks that are in theorem. So whenever you see somebody’s hacked, say, a bridge, or a Dex, that’s typically somebody’s found a flaw in the code and been able to exploit that code. Yeah, so a contract is written in solidity for the most part. So solidity is the most common language used for writing smart contracts. And it’s just, it’s just really code at that point. It’s just structured code. So similar to obviously different but like, similar to as if I was to read a C programme. So well, you know, a Ross programme or anything like that. It’s just common, it’s just code. So that’s why if you’ve ever heard coders law on some of the sort of the defences of hacks, that’s, that’s where that’s coming from, is that this is written as code. And the code allowed me to take millions of dollars, therefore, am I really responsible for it? My view is yes.

Tim Hughes 52:07

That is not a strong defence.

Gene Tunny 52:12

It’s like, if you get a million dollars deposited into your bank account, you can’t go out and buy a Ferrari.

Tim Hughes 52:20

The doors open, so I went in and took what I could carry. With that, as well, because I was zooming out a little bit as well. Dave? Yeah, you know, financial markets. There are so many issues like that may influence like a human emotions, like greed, panic, fear, these things happen all the time, you know, cyclical, or whatever it may be. And banks get robbed, you know, like, you know, cash was stolen, whatever. This doesn’t seem to be answering too many sort of problems, you know, they can get hacked. Yeah. So as far as, as a few questions that I guess, because the number one thing with all of that is trust, in my view is like, you know, if people trust something more and more, then it’s a stronger sort of system, and less likely to be driven by greed, panic, fear, etc. What was the pros and cons, if you like, of crypto, like if we ultimately heading towards something where we might be able to have more trust in a financial system than we currently have?

Dave Belvedere 53:23

Yeah, potentially. So I think if the people in on this so you know, sort of Ethereum, you know, who’s who’s running the show to agree.

Tim Hughes 53:35

So there’s trust there as well, compared to some phantom person with a white paper? Yeah. is less, less trustworthy, I guess. But yeah. Yeah.

Dave Belvedere 53:44

Sort of, yeah. Human nature, we sort of trust. If we can see somebody like that. That’s actually a real person. Yeah, there rather than like talking to a computer screen, we’ll be like, Yeah, who are you actually really talking to on the other side of that? So I think inherently, we will trust, obviously, the traditional market setups more because they are run by people. And that’s where, hopefully, you know, something like Ethereum can start to come in and sort of do that. But while you still have people who can misuse, I guess, the environment of like, these rug pools, and, you know, just doing pump and dump schemes and things like that, it does get hard to trust. Yeah, is everything on there. Really a scam or not? Yeah, yeah. Yeah. So it’s sort of a double whammy where it’s like, you know, for myself personally, it’s like, yeah, I trust a theorem like I don’t think the Ethereum ecosystem or anything like that. It’s going to go away anytime soon. The changes that they’re making to it a sensible and things like that, and you can actually see and talk to the people at conferences. However, that contracts and like opportunities that then can be a part of Ethereum, yeah, that’s where it gets a bit dodgy. And that’s where you need to sort of like, okay, I trust this exchange more than the others, you know, uni swap, for example has been around on Ethereum for so long. Well, probably since, uh, since it started, right. And they’re, they’re a decentralised automatic market maker. I trust that, you know, they’ve been around for so long, you know, probably so many people have tried to hack their pools. Nothing’s really happened to it. So if I’m dealing with any swap as a DEX, I’m pretty, pretty confident that nothing’s bad’s going to happen, other than I might not get the best price on chain for my tokens.

Tim Hughes 55:45

But that’s the most likely weak link in that chain is the exchanges or that the middle the people in the middle between the consumer and the Ethereum safe using us?

Dave Belvedere 55:56

Yes. And so sort of the users of Ethereum people are actually creating their own what we call DAPS. So decentralised applications. Yeah, that’s that’s where I think that that trust will start to fade. And and because crypto itself is, you know, it’s it’s quite volatile hasn’t had the best sort of, sort of time it’s been ups being down. It’s dumped to come back and don’t again. Yeah, a lot of people I think a lot of people look at and go cool, that might be a good way to, you know, make easy money because it’s just like going left, right and centre. But it can also backfire very quickly. Yeah. Where, where it sort of blurs the line is that it’s not treated as a traditional investment. Like because it is digitalized. And I can interact with it. And I can like, spend money on it. Like people treat it as money. But it’s really volatile money.

Tim Hughes 56:51

If you’re willing to take advice from Matt Damon and Kiefer Sutherland. I mean, like, it’s so you know, yeah, they are very confident of it being a good move.

Gene Tunny 57:01

Yeah. I’ve got a couple of two more questions. Dave. We’re probably getting close to time. Have you got a couple more Tim?

Tim Hughes 57:07

I’ve? No, I’m good. Thank you. I’ve been I’ve been enjoying as it’s gone on. And my big ones are gone. Thank you.

Gene Tunny 57:16

Yeah, I’ve learned a lot. It’s, it’s great. Would you have any examples of DAPS? That what are some daps that we might want to look at just so we can understand what what they are?

Dave Belvedere 57:28

Oh, yeah, um, a couple of pretty, pretty fun ones. So there’s a game called wizards and dragons. Okay, it’s a it’s a decentralised application, but it’s also a game. It’s pretty fun. It released, I think, a couple of years ago. And what it is, is, you meant an NF T, and it has a chance to be a wizard, or dragon. And then based off of, if it’s a wizard, it can, like interact with, you can stake it. So you can actually say to the contract, hey, here’s my wizard, which is staking, and it might earn certain rewards. So there’s a coin that’s associated with the game as well. So there’s a coin called windy. So it’s wizards and dragons. And that coin can then be used to spend on the contracts to interact with the actual game and stuff like that. So it’s not like I’m continually having to feed ETH it’s just like gas fees at that point. Or if you get a dragon like you have chances to steal wizards when they go and stake and non stake . It’s, it’s it’s pretty, pretty fun.

Gene Tunny 58:36

This is a computer game, is it?

Dave Belvedere 58:38

Yeah, it’s a game on chain. Yeah. So it’s a game that actually happens within the blockchain again, So the game is happening per transaction. So I send a transaction to do something with the game, like the contracts that make up the game are there. And then I like create a transaction to say, stake, my wizard, and then there’s a chance if dragons are staked, that my wizard goes to a dragon.

Gene Tunny 59:08

But okay, I’m gonna ask a really dumb question. But do I see a wizard on the screen? Or do I see dragons?

Dave Belvedere 59:15

Yeah, you can see both. So like, depending on what you’ve meant it, you get an NFT, which is a type of token so a non-fungible token so yeah, they were the ones that got talked about, I think, why the last couple of years because like, yeah, okay, and then the punks and the apes they’re all worth stupid amount of money.

Tim Hughes 59:37

So these are basically like, it’s an in the form of like having something that’s identifiable as being unique, even though it can be copied. So taking the Mona Lisa as an example of one painting, but there’s millions of copies. And so it’s basically a digital form a non fungible token or nifty I’ve heard them called Tim Ferriss calls them nifties. But so base Having something that can be identified as being the original and owned by a person.

Dave Belvedere 1:00:06

Yeah. And so we see that as like a token. It’s just really like a coin is not quite an NFT. Because there are many coins. But it’s like an NFT, sort of superset. There’s only like one coin that represents this thing. And so yeah, so like, it’s just a token. And yeah, that that has things. So like, I can go interact with the contract, you know, meant for a bunch of ETH. So that’s sort of how they get their startup is like, hand over like point zero seven ETH or point zero five ETH, to mint and have a random chance to generate a wizard or a dragon. And then they all sort of give you that NFT. So you’ll get that token back. And then yeah, you can use that token to then interact with the rest of their contract on the actual Ethereum chain.

Gene Tunny 1:00:54

Right. Okay. And are they used in these massive multiplayer games as well, online?

Dave Belvedere 1:01:01

The coins could be. Yeah. So I think they’re starting to come out. I think I read recently with like, digital coins. Yeah. But to sort of looking to go to be fair, that sort of already was kind of going there place anyway. So like, I could pay a bunch of money to the Microsoft store and have like, xbox credits. That was sort of already the lien. And then yeah, what, you know, one of the good things that has come about sort of what’s happening with blockchains? And things like that is Yeah, sort of companies are realising, actually, that’s, that’s a pretty nifty way of like, dealing with this sort of securing that data and making sure like, oh, okay, we can’t accidentally do something. Like, you can’t go back and try and change those records. It’s sort of there permanently. And you can follow a transaction at a time. For bookkeeping purposes, or, yeah.

Gene Tunny 1:01:59

I’m gonna have to come back to smart contracts in a future episode, because I think that’s probably its own episode, is it?

Dave Belvedere 1:02:07

There’s a lot yeah, there’s a lot, a lot of things to talk about, I guess, in contracts, and yeah, sort of, you know, that’s how that how they get built, you know, how they sort of interact. And you know, that’s where these bugs can can arise. And, you know, people might accidentally do something and somebody takes money.

Gene Tunny 1:02:27

Yeah. And I’d be fascinated to know who the parties to the contract are. I mean, could Tim and I have a smart contract where if certain conditions are met or if the then Tim transfers Ethereum. To me, so if, I mean, is there a way of programming, it’s so that if it’s, say, let’s take the weather, for example, if the maximum temperature for Brisbane ends up being over 35 degrees on one day in the future, then the smart contract, picks that up, and then transfers, I don’t know, one ETH from me from Tim.

Dave Belvedere 1:03:01

Yeah, it can do. So there’s, there’s a bunch of things that need to happen and be in place for that. But yeah, you can store like money. So you can store ETM with the smart contract, because it is itself really just an address. And then yeah, you like a transaction is usually always going to be the trigger just can’t do stuff automatically. You always have to trigger it with a transaction. And yeah, you can just be like, Oh, okay, cool.

Gene Tunny 1:03:27

All you have to trigger it with a transaction. Okay. So it’s not, it’s not going to automatically. It’s not a way of automating transactions. And I understood that.

Dave Belvedere 1:03:35

Yeah. Yeah, everything that happens on the chain has to have triggered from a transaction. Okay, so transaction might trigger a bunch of things to happen. Yeah, and interact with a bunch of stuff on chain. But yes, every everything will come through from a certain transaction has triggered this thing, which might then trigger events, but, you know, cascade of roll on.

Gene Tunny 1:04:00

Okay, I might have to look at that in a future episode. I promise. I’ve only got one more question. You got any more, but,

Tim Hughes 1:04:07

you know, I just want to comment, um, not surprisingly, to hear that wizards and dragons entered the conversation seems to be a natural progression from the smartest of the smart in, you know, the 80s or whatever it is, whatever they’ve come through to this point. And no doubt behind some of this technology or this, these theories.

Dave Belvedere 1:04:31

We’re all we’re all nerds on the inside. Right. So

Tim Hughes 1:04:33

yeah, but it’s great. It’s sort of like a bit there’s a human element to that as well, which is nice to see.

Gene Tunny 1:04:39

Great. Final question, Dave. For you. What are the use cases for crypto Why do you think it’s good to for you personally to be in crypto?

Dave Belvedere 1:04:51

It’s it’s a fairly exciting field. So I’m I’m a software engineer by trade. I studied as a computer systems engineer And it’s can be difficult to try and see how technology technology progresses through the years. So that, you know, unless you’re sort of, say deep in with Google and working on their, you know, bleeding edge stuff. For the most part, it’s all kind of pretty much the same. And so it’s pretty cool to see something. So you know, there’s this whole blockchain theories and the cryptographic proofs and stuff. I think we’re around since I think the 80s. So it’s always interesting to see how that is getting transformed and evolved into something new. And then yeah, then being used and sort of one of one of the cool things, I think that’s coming, a part of this, it’s sort of attaching itself to sort of a wider push of everyone should be and I think, you know, I think if you look at the world today, most of the kids growing up today are very computer literate. And it is sort of continuing to push that, like, computers are just going to become more and more part of it. And I think the common school like programming, or reading or writing code, should be sort of start to become one of the fundamental things just because of the heavy involvement that we start to have. So understanding why things are doing things, right. Yeah.

Gene Tunny 1:06:21

Now, the other part of that is your you personally, so assuming I may be incorrect, but I’m assuming you own some crypto of some kind. So do you what are the use cases? Why? What value do you see in having it all? So Lars Emmerich, for example, he’s concerned about the value of the US dollar, he’s concerned about all of the money printing, he’s concerned about hyperinflation, what are the what are the use cases? Or what would motivate you to have crypto?

Dave Belvedere 1:06:52

Yeah, it’s, I guess, you know, personally, I’m pretty, pretty basic. For me, it’s just a fun, high risk investment. So I see it as something that that might pay off. Or it might not. You know, personally, I don’t have a lot of money in it. But it also, because I’m in the area, it helps me like interact with chains. And yeah, play around with like, games, such as, like wizards and dragons. sort of have

Tim Hughes 1:07:18

There as a confession. Yeah. But

Dave Belvedere 1:07:21

I still see it as a very high risk asset. Yeah. Yeah. I’m still relatively young. So to me if I lose, lose what I’ve got, personally, I’ve only got about 20k. There. It’s not gonna hit me hard. Hit me hard in terms of I’m gonna make that back over my lifetime of work. Yeah. But you know if it if it goes and like, whoo, and yeah, all of a sudden that 20k goes to 100k. Yeah.

Gene Tunny 1:07:47

Right. Yeah.

Tim Hughes 1:07:49

But that’s actually a good point. Because none of this is in any way. investment advice from us. Oh, goodness, exactly. You know, like, it’s not investment advice. And the one thing that gets mentioned all the time, it’s like going to the horse races or something like that, you know, if you’ve got something that you can afford to lose, then go for it, because there’s a high risk investment and see what happens.

Dave Belvedere 1:08:09

I honestly look at this and go, it should be treated as a casino like, yeah, you gotta walk into a casino going, like, I have money. If I lose it, I’m not gonna, like get carried out by security. Yeah. Sounds like you can afford to lose the money. It is. Yeah, extremely high risk. And I think, like, especially now with the sort of scenarios that happened, like the FTX collapse, and you know, some of the other things that are happening there. And like the US government sort of taking notice, or like the SEC, taking notice more parts and like, pulling out rulings and stuff, it will become a little bit of, like, no one is really certain what’s going to happen in the area. Yeah. So it’s probably, you know, at this point still, quite, it’s probably riskier than it was before, because, you know, the SEC might turn around and say no, crypto goodbye, and like, you shut out the entire US market, like, that’s not gonna play well, for crypto.

Tim Hughes 1:09:07

Sec? The Securities

Dave Belvedere 1:09:08

and Exchange.

Gene Tunny 1:09:10

Okay, that’s been terrific. I mean, we’ve learned so much. I mean, I’ve never I’ve been blown away with all this info. And I think it’s helped me understand more what’s going on and it’s dispelled some, or it’s got rid of some ideas or misunderstandings I had. So that’s been really good. Are there any final thoughts? Any final words before we wrap up?

Dave Belvedere 1:09:37

No. Like, yeah, I encourage everyone to like, play around with it. Obviously, I think it’s an interesting technology. I think it’s going to be around for a long time. But in its current form, hard to say. I wish I would probably say I’m confident that as we know crypto today is probably not what we’re gonna see in the future. Yeah, this is sort of the first building block towards something that will become widespread.

Tim Hughes 1:10:08

Terrific. Now Dave, I really appreciate it because so we’ve often talked about this gene and I and it we we have fumbled in the dark somewhat. And I’ve been looking forward to the time where we can get somebody on and talk in depth, as we have done today. So yeah, I’ve really enjoyed that and got a lot from it. So thank you for coming in.

Gene Tunny 1:10:28

Dave Belvedere, thanks so much for your time. Thanks. Right. Hi, thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@economicsexplored.com, or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

1:11:19

Thank you for listening. We hope you enjoyed the episode. For more content like this. To begin your own podcasting journey head on over to obsidian-productions.com.

Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business, www.adepteconomics.com.au.

Tags bitcoin, bitcoin mining, blockchain, chain, crypto, crypto exchange, cryptocurrency, dapp, decentralized, DEX, ethereum, ftx, miners, nft

Podcast episode

How performance-based pay can motivate employees, but there are risks – EP177

Post author By Alec Krishna
Post date March 1, 2023
No Comments on How performance-based pay can motivate employees, but there are risks – EP177

Can we get people to work harder and perform better if we make their pay performance-related – e.g. with performance bonuses or commissions? Does this work? What does the evidence say? We know that people respond to incentives, but, as Gene Tunny and Tim Hughes discuss this episode, getting those incentives right can be tricky.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

What’s covered in EP177

What is performance-related pay? [0:41]
The types of jobs in which performance-based pay works and doesn’t – e.g. fast food vs real estate [8:09]
The importance of getting incentives right and having transparency [23:16]
Performance-related pay is a difficult thing to put into practice [28:24]
Group-based incentive schemes – evidence from a recent European study of the Hydrema manufacturing business [52:54]

Links relevant to the conversation

IZA World of Labor – Performance-related pay and productivity

How group-based incentives increase worker performance | CEPR

Does Group-Based Incentive Pay Lead To Higher Productivity? Evidence from a Complex and Interdependent Industrial Production Process

The Use of Reward and Incentive Systems: A Case Study of McDonald’s – ToughNickel

McDonald’s Restaurants puts motivation and reward at heart of business strategy – Employee Benefits

Give and Take – Adam Grant

Performance-related pay | The Economist

Real Estate Agent Commissions: How Does it Work and How Much Should You Be Paying

Learn the Truth About Real Estate Commissions | PropertyNow

Transcript: How performance-based pay can motivate employees, but there are risks – EP177

Gene Tunny 00:06

Tim Hughes 01:30

Gene, good to be here.

Gene Tunny 01:31

Excellent Tim, I thought it’d be good for us to have a quick conversation on performance related pay. I’ve been thinking about this following on from this whole debate between Steven Crowder and the daily wire, which I talked about with John Humphries on his Australian taxpayers Alliance Econ Chat, earlier in the week, and I thought it’d be good for us to have a chat about a related issue, which is performance related pay I got starting to think about this. Well, when John and I were talking, we were talking about well, does the actual form of the contract matter? Or is it just all about the dollars that are being paid? Or that they expect to earn out of the contract? I mean, obviously, the money is important, but how do the contractual terms affect the amount of effort that you put in, in your work? And so I was thinking about that in the context of the debate between Crowder and daily wire, and then it reminded me that I should cover this issue of performance related pay on the programme, because I think it’s an important, an important issue.

Tim Hughes 02:36

Yeah, sure. It’s an interesting area for sure.

Gene Tunny 02:38

Yeah. I mean, did you have any thoughts on that whole crowder and daily wire?

Tim Hughes 02:41

I’d never heard of it until you mentioned it. So I didn’t even know if, so he’s a comedian, that guy?

Gene Tunny 02:47

Yeah. Yeah. So he’s on the right wing in the US. He’s more of the Magga type, Crowder, whereas the daily wire and more of the traditional Republican, and I think Ben Shapiro was originally anti Trump. So yeah, the different parts of the conservative movement in the States.

Tim Hughes 03:09

I think I know now, I haven’t heard of him. But as we often talk about like, it’s it’s good to be exposed to different areas and different views. So yeah, looking forward to hearing about it.

Gene Tunny 03:23

It’s just all over YouTube and social media, people are commenting on it and say, John went through it. And John’s view is that well, all they’re arguing over is the amount of money involved. And it’s not necessarily about, you know, the concern Crowder had was that daily wires just doing the bidding of big tech.

Tim Hughes 03:42

But so what was what’s the what’s the juice? Like? What was the story? Between those two guys? It was a it was a contract. Yeah.

Gene Tunny 03:49

It was a contractual dispute. Well, they were trying to recruit, Crowder to their platform, and they offered him $50 million over four years, but the payment that they have for you, yeah, but what they would pay would step down if he was demonetized on different platforms like YouTube and Okay, Twitter, or Facebook, or whatever. And he was saying, well, you’re doing the bidding of big tech. But look, it costs the money. So it makes sense to, to scale the contract down. And so in John’s saying, look, it’s just all about money. These contractual negotiations are just all about money, ultimately.

Tim Hughes 04:26

Just out of interest. So when he says you’re doing the bidding of big tech, what does it mean by bidding? Like, I can understand that, like big tech may affect that income? So if it’s monetized that’s basically the issue. Yeah. But how can they be doing the bidding of big tech? I don’t understand that.

Gene Tunny 04:43

Well, maybe I haven’t expressed that very well. But the idea is that, well, a lot of these conservatives think that big tech is trying to censor conservative voices. Yeah. And so he’s saying, well, you’re just going along with what they want. Alright, okay. I’m accepting that in the pocket. Yeah, no. Yeah, maybe that’s I don’t know. That was his concern. But look, as John said, it just all comes down to money and at what price you’re willing to, to work for Daily Wire and also to give up the IP because he would have to give up IP and the shows that are produced while he was at. At Daily Wire, they would get the copyright in that. Yeah. So yeah, ultimately, it all came down to money, but it did get me thinking well, okay, well, how would you structure a contract? To get the best performance out of a person was daily while we’re designing the contract, they were proposing a contract in a certain form to get the best outcome from their point of view. And then also, as possibly was from Crowder’s point of view, too, because there’s going to be more money available for both if he’s not demonetize, right, yeah. Yeah. I mean, he may think that, well, that’s bad for his brand. Or maybe he’s playing the longer term game. And he’s thinking well, yeah, I mean, I’m all about being edgy. I don’t care about whether I’m monetized on YouTube or not. But then again, he should have appreciated that if he wasn’t monetized on YouTube, then that’s less money overall. So the Daily Wire is trying to design a contract, where it’s essentially trying to encourage him to be monetized or as monetized as much as possible so that there’s more money for them. Now Share, They Share part of that with Crowder, and depending on what the share of the total revenue that YouTube was of the total revenue that comes in from Crowder, he may well have been better off with the deal they were offering, because he was I think they’re only going to dock 25%. Well, they’re going to dock 25% If he gets demonetized on YouTube, okay, I thought this was an interesting case. And it just got me thinking about incentives and how do you structure contracts.

Tim Hughes 06:56

yeah, yeah, it’s an interesting area, because I know we talked a little bit about this. And certainly, from my experience, like, you know, if you’ve got an incentive, as an employee, or if you can give incentives as an employer to get the mix, right is the tricky thing, because you know, you want something that’s attainable, and sustainable. So if it’s too easy to get the reward, you know, the employer can lose out. If it’s too hard, then the employee loses out. So it’s a bit of a fine balance. And obviously, this is used pretty successfully with commission based work, you know, where there’s a base salary plus commission, and they’re usually done over a period of time, so they can get that amount, you know, pretty much right? And some people can do really well with that. Particularly in real estate. Yeah, well, and with salesmen, it’s a big one for sales, of course, of all sorts of industries where no sales are used. And it makes a lot of sense, you know, if you’re a really good salesperson, then you can be rewarded for that. And if you’re not so good, then, you know, you, you don’t get so much. And so sort of a fair way of doing it. So I think now, wherever possible, it makes a lot of sense to have that involvement in the company. You know, that’s, that’s properly rewarded.

Gene Tunny 08:09

Yeah, exactly. So I thought this would be a good topic to, to talk about. So in the great majority of employment agreements, I would think would not involve any performance related pay that there’s really isn’t any incentive there. But they rely upon, well, the incentive is if you do the job, then you’ll keep your job. But if you don’t, we’ll get rid of you. So I guess that’s the that’s how it works, right? And but if you can monitor how people are working, and you’ve got a good, a good eye on that you can, you’re able to properly understand the contribution output and the profitability of the firm. And in many cases, I suppose you can, you can do that. If someone’s working at McDonald’s, they’ve got a sense of whether that person is able to prepare the number of Big Macs an hour that’s required or whatever they need to do. So you can monitor that sort of activity. And in those cases, there’s no real need to provide any incentive, if they do a better job, or if they suppose they will have to meet a particular level of service or or do so much an hour. And if they do more than that, well, it doesn’t really lead to more money or more profitability for McDonald’s because basically, McDonald’s ends up serving everyone who comes in and tries to buy something off them anyway, doesn’t it?

Tim Hughes 09:39

I mean, that I know people who’ve worked in McDonald’s and they seem to have obviously it’s all about systems have completely been the leader in that kind of business for a long time. Many people, many businesses have incorporated, that whole framework of heavily systemized but of course, it means that the expectations of what needs to be done? Pretty accurate, but I think they do have, you know, opportunities to sort of move within McDonald’s. So the scale or the pay scales quite clearly set out.

Gene Tunny 10:12

You’re right. And just after I gave McDonald’s as an example, I thought I better check that McDonald’s doesn’t actually have performance related pay. Because that was just the first thing that occurred to me. But I think most of the people are working there, they’re just going to be getting paid the award rate or whatever it is, or whatever. Yeah, the agreement. But it turns out, it looks like there is some performance related pay. This is in the UK, McDonald’s restaurants put motivation and reward at heart of business strategy. So I’ll put a link to this. This is for the the top restaurants and it looks like they give a bit of a bonus a small bonus in some cases. So each month, all employees in the top 10% of restaurants based on mystery shopper scores receive a bonus of 50 P for each hour, they have worked in a two week period. Okay, so that seems that seems okay. But it’s not related to your individual performance. It’s related to how the whole store goes. And that’s probably not as strong an incentive as if it’s an individual performance pay performance related pay measure?

Tim Hughes 11:26

Yeah, and I guess put put a big part of that, because they work as teams, obviously. So to pick out an individual for having particular performance would be hard, but collectively, for that branch, you know, there might be incentives, if not, with McDonald’s with other similar kind of fast food chains. But I know, for instance, in the states, if you work in hospitality, a lot of the jobs are paid, not very much on the understanding that they’re going to receive, you know, pretty good amount of tips throughout the week. Yeah, because it’s customary and traditional to do it in most places. As I understand over there, I worked in Austria, myself in ski resorts years ago. And that was a big thing. There was you lived on your tips, it was fantastic. You know, it made a big difference. And you could save your wages, which weren’t high, because of it. Whereas in the UK, it was less likely you’re gonna get tipped, you know, you’re gonna be hungry. If you’re, if you’re working in hospitality in most places in the UK, and probably in Australia, too, to be fair. It’s not as customary here, either. So.

Gene Tunny 12:30

That is because we have high award wages, or well, maybe not high. If you’re, if you’re working in these jobs, you probably don’t think they’re that high. But yeah, relative to what you get paid elsewhere in the world, we’re doing the same job. It’s quite, it’s a bit higher than that. Yeah.

Tim Hughes 12:44

I mean, yeah, you get to the high end of that kind of scale, you get the concierge is at top hotels around the world. And who knows how much those guys make and women, of course, like in those roles of being in really flush hotels, where a lot of people have a lot of money and just dropping $100 bills everywhere.

Gene Tunny 13:04

Yeah, exactly. And I’ll put a link in the show notes to some of these articles I found on McDonald’s. So just put some clarity around exactly what they’re doing. That was just the first company that occurred to me, but my contention would be, and I think the evidence shows this as the majority of jobs out there. There’s no real performance related pay. Say, if you’re in the public service, generally not. Some public service agencies will offer bonuses, there’ll be some there’ll be some assessment of how you’ve gone through the year, and maybe they’ll pay you a little bit of a bonus. So a lot of that’s, I think that’s rare in the public. Yeah.

Tim Hughes 13:48

I would imagine it’s industry specific. So they’re probably like situations like that with? Well, certainly with government employees, where it will probably be difficult to put any of those kinds of things in place. Maybe not with all departments, but certainly with most we were talking earlier about it clearly is more suited to certain industries and others. And one of the interesting areas at the moment, because there’s a lot of people doing side hustles side gigs, doing their own kind of little business, while they’re still working for, you know, an employer. So their main employment is earning X amount of money every week, but putting time and energy into their own little gig, which is a tricky one, because like, you know, again, depending on what the work is, but if it’s not easily quantifiable, people can be putting less energy and time into their main job. So it’s a problem for the employer, where it’s like, clearly people aren’t getting satisfied from their roles or the work that they’re doing in that main job. And something that we both heard Phil Dibella talking about fairly recently was being an intrapreneur like so. Basically an entrepreneurial spirit within a company so you can be an intrapreneur and what you might be able to offer to that company. So, if a company is open to different sorts of ideas and innovations from within the company, then there might be a space and place for someone to grow within that company. Yeah. And and share their ideas and use that energy within within the business.

Gene Tunny 15:19

Yes, certainly. So if you can demonstrate that you’re, you are making a material impact on the profitability of the firm beyond your normal job, or what you’re doing at the moment and your job or what your role is, and you’ll make your contributions much greater than what you’re getting paid for, then that’s an opportunity to redefine your role to get a better better pay from your boss. And you can be this is what Seth Godin calls the linchpin be indispensable in the business you are and you can be a linchpin in your own business, but you can also be a linchpin in someone else’s. Yeah.

Tim Hughes 15:55

And of course, that that comes down to a symbiosis where obviously, the manager or your superior needs to be receptive to that. I mean, they need to be good ideas, of course, but if it’s a receptive environment that encourages that, they would need that to work. So there’s a few things obviously that have to come together. And again, that would be industry specific. And, you know, within guidelines or, you know, whatever, I think forward thinking companies can certainly take advantage of that, you know, with the event of encouraging intrapreneurship within their own company.

Gene Tunny 16:30

Yeah, exactly. So with, let’s think about the economics of, of all of this. So we’ve identified that there’s performance related pay in more sales and, and in real estate and in in other sales jobs. And that’s because it’s a way of compensating the top salespeople, and it motivates them, it motivates them to hustle or to work harder to make more phone calls or to aggressively go after properties to sell. I mean, what’s going on there? I mean, why is real estate different from, say, working behind the counter at office works or something?

Tim Hughes 17:10

I guess, with real estate, you make a significant sale less often. Whereas like with most retail, it’s going to be a less significant sale? pretty often. Real estate is a bit of an outlier, I think, isn’t it? Because depends where it is. And like, you know, it might be a handful of sales for some people who can do extremely well. Yeah. But you know, that it comes down to, yeah, just very few sales that are really significant. And, of course, are a big, dry periods. There’s not much happening in real estate. So it’s a very, up and down kind of market.

Gene Tunny 17:44

Yeah. So it’s obviously because or, or this, this is what I’m thinking is because this is so competitive, and there are big gains to the people who win, but the people who make the actual sale happen. There are big gains to to that company because of the commission that’s involved. And that’s shared with the agent, isn’t it? And that’s because it can’t just always observe what the agents doing because they’re often out and about, and it’s a job where they may have to work more than the usual hours, they often have to work after hours. There’s a lot of hustling involved, though, to get the sale. They might have to really go above and beyond and sharing the commission or having commission based pay. That’s a way of incentivizing them.

Tim Hughes 18:38

Glengarry Glen Ross Yeah. Like coffee’s for closers is the same. Is that same thing? Like, I can only imagine. I mean, I haven’t worked in that area at all. But I can only imagine it’s, well, pretty stressful. I mean, because if you’re not selling you’re not earning. And there’s a lot of jobs like that where its base salaries is either non existent, or it’s just minimal. So you really, the incentive is you have to you have to sell. Yeah, with real estate, it’s feast or famine, it would appear.

Gene Tunny 19:06

Yeah, I have to look more into that just exactly how they compensated. So if you’re a real if you’re an agent working at the Ray White, you’d be getting as a base salary, wouldn’t you? And then they’d be paid, you’d be getting a bonus or you’d be getting a share the commission that’s charged on the transaction, would you I would imagine, but I can’t say I’m not sure. I don’t know either. But I know I’ve got the sense that it’s related to that because Yeah, real estate is one of those industries where the high fliers the top real estate agents are just yeah, they’re they’re making a lot of money. Yeah, they appear to be making a lot of money. I know that having the BMW that’s part of the act out of the bottle. Yeah.

Tim Hughes 19:52

It’s definitely a regional thing as well. Like, depending on where you were, you’re an agent. You know, obviously the the margins are bigger in the The more expensive suburbs more competitive I imagined to. Yeah. But is that is that thing like sales is definitely the most common way of having incentives. And it makes sense from all sides and employers and employees, there’s a margin that can be shared. And it makes sense. If you haven’t made that sale, then the margin is not there. So it’s probably the most common one, and the fairest one too.

Gene Tunny 20:29

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

Female speaker 20:34

Gene Tunny 21:04

Now back to the show. The places where I’ve seen performance related pay is in consulting. So consulting firms often have a bonus scheme run bankers in banks, for their investment bankers, they’ll have a bonus scheme, hedge funds, they have bonus schemes for their for their people. And they’ll have their salary, but they’ll also be a bonus on top of that. And the idea is that if you’re a better performer, then you can get a generous bonus. And some of these bonuses can be pretty generous, like some of the bonuses that they’ll have in the City of London or on Wall Street for some of these bankers. I mean, that can be millions, millions of pounds or millions of dollars. Yeah, because a really good year. And if, if that particular banker, or trader, if they’ve done well, or it looks like they’ve performed well, like they’ve done incredibly well in the deals that they’ve signed, or on the trades that they’ve been executed. So there’ll be some link there, and I suppose why the bonuses work there to to incentivize people as well. If you’re working in that sort of industry, you’re probably you may be highly motivated by money to begin with. And so the prospect of more money is going to motivate you to work harder. And there’s also that the inability or the, it’s something where you can’t really closely monitor what they’re doing. And you’ve got to rely upon the person putting in the effort going, they’re going the extra mile, so to speak, to get the best outcome for the business or for the for the bank or for the for the consulting firm. So billing more hours getting projects done more quickly. So you can then get another project in, send the invoices out.

Tim Hughes 22:56

So actually, I mean, to be fair, this is where a lot of problems come though, wasn’t that the foundation of the GFC with mortgages been given for properties that shouldn’t have been mortgaged? And so a lot of a lot of deals been done that shouldn’t have been done on paper were worthless, and then that started the whole GFC process. Isn’t that correct? Like? Yes, yeah, absolutely. Like it was basically. And it was that incentive to yeah, get the Commission’s that was driving those deals, you know, so if, if it’s a bad deal, then yeah.

Gene Tunny 23:30

Yeah. The mortgage originators, who were signing people up. And the story was there all these people who had who were getting loans who had no income, no job, no assets, the ninja loans they called? Yeah, yeah, yeah.

Tim Hughes 23:45

Yeah. So it’s that thing of like, getting incentives right, is really important and having transparency as well. Yeah. So clearly, there wasn’t enough transparency with that.

Gene Tunny 23:56

Well, I guess the, the incentives weren’t there, they weren’t designed well, from the point of view of the of the company or from society. I mean, they it was all about the short term, it was all about, just sign as many people up as possible, right, as many loans or get as many loans approved. And regardless of who these people are, and so, yeah, it’s people who shouldn’t be getting loans. And then you’ve got the people in the bank. So the investment banks who, then they’re bundling up all of these mortgages, some of which, the people who, who have the loans, they’re going to be the first people to just walk away when things get tough, and they can’t service their mortgage, they just walk away and then this, this was part of the problem. What was happening is that all of these mortgages that weren’t worth as much as nominally they were worth they’ll be packaged up and then sold as a financial product, the mortgage backed securities and you know there were people making money out of that. The the investment bankers who were selling that to pension funds. And yeah, they were doing well in the short term. But it was there from a longer term perspective and for the companies themselves. And for the society, it really wasn’t. It really wasn’t great. Yeah, it’s terrible.

Tim Hughes 25:23

So it can see how it’s important to get all those elements, right. Clearly, there was a lot of people, I’m sure the writing on the wall was visible for a lot of people, but they’re just getting in there and doing it while they can.

Gene Tunny 25:34

Yeah, one point I should make, I think for the companies that fell over. So if you think about Lehman Brothers, and Bear Stearns, certainly what happened, those bad short term incentives did cost them in the long term. But one of the problems with the financial crisis was that some companies that probably acted, you know, that acted pretty sketchy, pretty badly in the lead up to the crisis. Ended up getting bailed out. Yeah, yeah. So and, you know, that’s, that’s a problem.

Tim Hughes 26:07

That’s a different, a different episode as well, I guess there’s a there’s a whole.

Gene Tunny 26:10

Yeah. Too big to fail episode. This is part of the problem. We’ve got that this is what happened during that episode. During that the financial crisis that’s caused a lot of the political problems we’ve had since then, I think, because people see Wall Street getting bailed out. So Bernie Madoff went to jail, but probably a lot of other people who should have gone to jail.

Tim Hughes 26:38

Well, yeah, and it’s, it’s difficult not to be cynical, when you see people getting away with, with things where, in other circumstances, people would be sent to jail. And so yeah, having being accountable and taking responsibility should be across the board for sure.

Gene Tunny 26:57

Yeah, exactly. I was just thinking team with the consulting firm example, because that’s what I know a lot better because I was working for a consulting firm before I went out on my own. Now, I mean, my pay is purely performance based. It’s just, it’s purely performance based. Rather, there’s no salary that doesn’t, there’ll be maybe I do effectively pay myself a salary, but I’ve got to generate, yeah, I’m gonna generate the revenue. Whereas if you’re working for a firm, you can the link between the work you do and the amount of money will the salary you get is indirect. There is a bonus scheme to try to encourage people to work harder. And that certainly does motivate a lot of people in consulting firms. And that can make sense, I think, because when you’re in a consulting firm, there’s a lot of extra effort or a lot of a lot of additional things you could do that it’s hard for the employer to hold you accountable for or monitor how you’re going with those things. I mean, we’re talking about well, how well are you really putting yourself out there to try and bring in new business? Yeah, how well, are you trying to get the deals done that sort of thing? How hard are you really working? How intensively are you working when you’re working on jobs to try and do them as quickly as possible, so you can bill as soon as possible, that sort of thing can be difficult to observe. And so therefore, it can make sense for some performance related pay. And so it can benefit the employer too, because they can pay you a bit less than you expect to earn if you’re a high performer, because you’re counting on the getting a bonus. So from the employers point of view, it’s they like it because okay, it’s some of the risk has been taken by the employee. And if they’re a dud, well, if or if they have a bad year, well, we don’t pay him as much. And then okay, if they make money for us, and you were happy to share some of that profit. It’s a difficult thing to put into practice, though, in consulting firms, I think, because the amount of money in the bonus pool and this is a problem with banking to what can happen is if you could have a really great year, and you could be a star, but if overall the whole firm doesn’t do well. Say the economy has a downturn, the economy, but say you might have had a great year, if you if you’re if your bonus scheme, and I think one of the problems in practice is that many bonus schemes are like this. They’re linked to the last financial year profitability or last quarter profitability. If the firm has a bad quarter or a bad financial year, you’ll suffer even though you’re a star, right? So you’ve really got to be careful how you design these bonus schemes because that sort of thing will cause resentment because the person who thought they did really well that year they’ll be mad because they had a great year, but because the firm didn’t have a great year, they didn’t get as much money. And then the other things that can happen is that if, if you don’t design your performance related pay scheme properly, then you’re gonna have all sorts of disputes between your staff, it doesn’t necessarily encourage a collegiate environment, because you may be trying to maximise your billable hours as a share of the total billable hours on a project. And therefore you might not want to bring someone else in the firm to take part in it because you’d have to share any upside with that person. And attribution. So say someone often, often there’ll be performance related pay linked to whether you’re bringing in projects or bringing in jobs. But then how do you attribute the contribution of bringing in the job? Does the fact that my cousin your consulting business, that he knows the person, he’s got a contact in the energy business and then the person there rings up Mike and says, Oh, Mike, do you know anyone who could help me out on on this job? And Mike goes, Oh, yeah, Janine over there. She could probably do it. She’s got the skill set. And then Janine talks to I didn’t give the guy in the energy business, and I did a berry berry. Berry. And then Barry goes, I’ve got this problem, I need this, this issue analysed. And Janine goes, Oh, yeah, I can do that. I can build this sort of model. And Janine does this really big pitch, she does this really great proposal, which convinces Barry that she’s going to solve his problems. And then Barry goes, Oh, that’s great. I’ll give you this big contract to deliver that. And then she goes, oh, that’s great. And then, and then Mike goes, hang on. I’m the one who introduced you to Barry. Yeah, yeah, I want 50% of that, if any profit on that job.

Tim Hughes 31:53

And Janine did 90% of the work? And yeah, it gets tricky, for sure. And I think this is where it’s industry specific. And also, you don’t want to create an environment where people are jealous, and and sabotaging other people that you don’t design it. Well, that’s exactly. So this is the thing. And I think this is where it gets industry specific. Because and this is also where intrapreneurs can help because you have to come up with your own solution, you have to come up with your best design for the situation that you’re in. There’s not one that sort of suits all.

Gene Tunny 32:25

Well, I think the best thing is, is actually to be generous. And you you win overall, you win the long game by being generous. Yeah, it’s that it’s a win, win and grand he’s got that give and take is that Adam grants thesis, I can’t remember. I’ll put a link in the show notes. But I think you do better in the long run by being generous and not being greedy.

Tim Hughes 32:49

Isn’t it one of Stephen Covey’s Seven Habits of win win? That’s, I think so. So because that’s, that’s basically what it is, isn’t it? Because, yeah, one you want it to be any incentive shall be a positive thing within a team with, you know, for an individual within a team within a department and company. Yeah. And you can have friendly competition and everything. But it’s so easily done, where it can be a negative force, you know, like, yeah, tricky, tricky thing.

Gene Tunny 33:17

And I must admit, I mean, I’d probably, maybe I wasn’t as collegiate as I should have been in jobs where I’ve had a bonus where there was a bonus scheme. And I look back on that and think, Ah, I probably wasn’t always being a team player. And I regret that. But that’s just the way it’s set up. So you got to set up the system so that it does encourage collegiality, and it doesn’t just rely on people doing the right thing out of the goodness of their heart, because when money’s involved, they won’t necessarily do that. It’s a good boy,

Tim Hughes 33:48

it’s a good point, actually, like you can design this around the behaviour that you want to encourage, you know, so if you can imagine that, it might encourage negative behaviour, like, you know, if it’s not a fair system, then you can end up with someone that happy employees.

Gene Tunny 34:04

Yeah, so I’m gonna have to try and dig up some examples of bonus schemes that work because I’ve seen various bonus games, not necessarily, I’m not necessarily making a comment on any organisation I’ve worked in. I’m talking generally about consulting businesses I’ve seen because I’ve known a lot of people who do consulting work, and I’ve heard of various different models. I haven’t heard of one that seems to get everything right. There seems to be issues with all of them. I don’t know how you design it, but you certainly have to have your bonus linked, not just to the short term results, but to the longer term outcomes, they maybe have to have it linked to profitability over several years. Yeah. which avoids the issue of well, what if someone has a great year but the whole company doesn’t do very well? And then they don’t have there’s no money to pay the bonus. And you also want to see whether, okay, maybe this person, you don’t want to pay someone a bonus if they’re actually making things worse in the long run, because they’re because they’re really toxic to work with, like, they might be a high performer, they might be generating a lot of sales or doing a lot of work. But they could be a nasty piece of work. And that’s no good for your company’s morale of other team members for your reputation.

Tim Hughes 35:19

It’s actually interesting, because it would be very hard to imagine a perfect system for any scenario. So I would imagine that any good incentive scheme would be constantly evolving, constantly being receiving feedback and, and changing because of all those reasons that we’ve mentioned, you know, like people who might just be a passenger and thinking I’ll just do as little as possible and, and try and, you know, right off the back of other people’s hard work, if it was a team incentive, you know, so it would have to be a very flexible, mobile kind of incentive system, you would imagine.

Gene Tunny 35:53

Yeah, I might look more into this. What are some examples of schemes that have done? Well, because there’s been, there must be a literature on this. So there must be people must have written about this. But what I’ve done is to prepare for this conversation, as I’ve looked up, or what is generally what does the economic literature tell us about the you know, the effectiveness of performance related pay? And? Well, as you probably expect, given that we do see examples of performance related pay out there, it must work, right? Companies wouldn’t be adopting it if it if it didn’t work in some way. And so there’s a great article on the IZA website. So that’s an institute that looks at labour market issues, I think it’s German. So the Z must mean something, mister, must be some German words, starting with Z. I could be wrong about that. I dont know why its IZA, I don’t know exactly why it’s IZA. But there are a great think tank that looks at labour market issues. There’s a great article by these two Italian academics performance related pay and productivity, I’ll link to it in the show notes. And what they find is, so the pros of performance related pay, linking paid or performance is expected to increase worker motivation, effort and loyalty to the firm, pay incentives, raise job satisfaction, lower absenteeism and turnover rates and have a sizeable effect on company performance. Right. So they’re actually finding that their review of the literature tells them that it’s a positive thing. They’re saying that this is a good point, I think the diffusion of remote work may involve a shift from input to output based compensation schemes such as performance related pay, I think it’s a really clever point. What that saying is that as more people are working from home, we really have to start thinking about performance related pay, because there’s less well, in the old days, I mean, where you had to go into the office, then that was how you were signalling your contribution of the firm, wasn’t it? That was your you were you were visibly in the office or you weren’t there. And then the boss could come and give you the tasks to do. And so I guess, just hourly base pay made more sense in that environment than if people are working at home where we’ll really when, when we’re during COVID. And afterwards, we’ve made this shift to working from home and now the boss isn’t really observing whether you’re turning up for work or not, are they they’re just they just expect you to get a certain amount of work done. Yeah. And to be contactable, generally, I mean, available. So it’s a different sort of thing. And so I guess it would force us to think more about how we could design a performance related pay scheme for jobs where in the past, maybe we didn’t have a performance related pay scheme, even though possibly they were amenable to one or they could have, there could have been a performance related pay scheme. But because of the power of debt, well, the status quo inertia, perhaps we didn’t think about that. It’s an

Tim Hughes 39:03

interesting point. Because in that situation, if it’s task based and say somebody’s working from home, it’s performance based, you’re not getting paid any more necessarily, or that might be part of the deal. But if you can do your work in six hours instead of eight, your bonus is you get two hours to yourself to do something else. So I think it’s really interesting point because I think looking at work to be quantifiable by tasks done and those kinds of things if possible, again, it’s an industry specific kind of thing, then absolutely. If you get the balance, right, where the right amount of work is fair within a certain period of time, then yeah, allows people to do that work well within that timeframe or not.

Gene Tunny 39:47

Yeah, another point they make is that digital technologies may improve performance measurement, thus improving the targeting and performance related pay. So how to think more about that in In professional services, jobs, that’s probably less relevant because you do see, I mean, you’d see the the effectiveness of their work in terms of how well, their their products or whatever they’re doing. They’re, you know, are they completing jobs on time? Is the customer satisfied? I’m not sure exactly what that points getting out there. Maybe I’ll have a closer look at the article. But I suppose if you guess you could really, you could monitor what they’re doing. If you mean, that sounds awful. But if you’re recording their screen, or their time spent on the computer, perhaps I mean, I’d hate to do a job like that if someone was doing that.

Tim Hughes 40:42

Yeah, I guess, if it’s tasks, down to what tests are being done, then you can quantify it that way. But for sure, I mean, to be fair to employers, like there’ll be employees milking, you know, the opportunity to work from home, you know, so it’ll be, it’ll be sort of a bit of give and take from both sides, I imagine as to the benefits of that. And again, industry specific, the creative industries. I know, for instance, I got a good friend who is in architecture, and that kind of industry is very collaborative. And so the value of having people in the same place and the interaction is and that energy is really valuable to that kind of industry, where you lose that when everyone’s working from home. So it does, it does have different impacts for different industries, for sure.

Gene Tunny 41:33

Yeah. So I’ll go over the cons are trying to get through these quickly. The effects of performance related pay schemes differ significantly, according to their design and the types of firms. Okay, so we were talking about before about how like performance related pay is going to make more sense in some circumstances and others in terms of the design, one of the points they make here, in the author’s main message. So they say that individual schemes linked to performance have been shown to be associated with higher firm productivity, while group performance related pay and financial participation generally exhibit smaller effects on performance. Right. Okay. It’s the individual incentive that matters. I mean, that that makes sense. Because if you’re say there’s a group incentive, there’ll be people in the group who are thinking, Well, I mean, I can end up working a lot harder. But if Jack doesn’t pull just doesn’t do work as hard as the others don’t, you know, they really don’t work any harder than I could do all this extra work, and we’re not going to get the prize anyway. So why should I bother? That’s what’s gonna happen, isn’t it?

Tim Hughes 42:42

Every scenario you can imagine will be happening somewhere. So yeah,

Gene Tunny 42:45

yeah. I mean, that’s a, I think that’s the issue, or it’s less likely that you’re the relationship between the performance of the firm, and you’re relying on the other group members to perform. Whereas if your incentive is linked to how you perform, then I think that’s more of an incentive to work harder, because it’s not, you know, it’s not contingent on the others working hard as well.

Tim Hughes 43:14

I hadn’t thought about it before. But the ultimate incentive scheme that works, the fairest is when you’re self employed. And you, you know, whatever work you you do and bring in is, that’s your income. Well, that’s the fairest of all incentive schemes, you know, and anything beyond working for yourself, like with more people just gets trickier and trickier, I guess, you know, like, there’s more things to consider as to how it might be fair. But yeah, if you’re working for yourself self employed, that is the ultimate payment incentive scheme.

Gene Tunny 43:45

Yeah, you kill what you ate. Now you eat what you kill.

Tim Hughes 43:49

Well, to be fair, if you’re gonna eat it, it’s probably gonna die in the process if you haven’t already killed it.

43:54

I think that’s what they say. You eat what you kill. Is that it? Yeah, that would make sense. Yeah,

Gene Tunny 44:00

I think so. Yeah, I’ll go with that. I’m pretty sure I’ve heard that it’s some of the consulting firms have worked in.

Tim Hughes 44:06

But it’s fair. And that would be the thing of like, you know, you you get out of it, what you put in and that’s pretty much every case of being self employed, you know, a very fair and reasonable way for for things to unfold.

Gene Tunny 44:19

Yeah, yeah, exactly. Okay. Now, some of the other cons. When pay incentives are real design, the effects can be perverse and counterproductive. And I think we’ve covered that. Yeah, about the problems that can happen. If you have badly designed schemes. People don’t work together. I mean, you could even have some people who are deliberately they could sabotage the work of others to make themselves look better. It’ll be happening, that hoard information. Yeah.

Tim Hughes 44:49

But that’s where I think the flexibility and you know giving allowing people to contribute towards these schemes, I think would be a good thing. And you can only imagine that that would make for a better scheme if people had a little bit of autonomy or choice in in how they worked.

Gene Tunny 45:08

Yeah. Another couple of good points on the cons when performance is difficult to measure or when employees intrinsic motivation is relevant, performance related pay may generate distorted incentives and have unintended consequences on worker morale. So I think that maybe that’s the case where somebody thinks that, well, I’m actually making a huge contribution to the company, but because of the way that the incentive scheme is structured, and what what it measures, so particularly if you’re in a support role, so say the, it’s the, the bankers or the consultants who are getting the bonuses, but someone who’s in a support role, maybe they’re an executive assistant, and they’re not getting, they’re not getting a bonus, because their output is less the contribution they make to the profitability, the firm’s less recognisable, then maybe they get their morale starts to suffer. I don’t know if it’s exactly what they’re if that’s what they’re driving out there. But I think the point, that point makes sense to me that the other con that they identify is that linking pay to performance may generate excessive stress and be detrimental to long term performance. Now, I guess that’s correct. So this is where you got to get the balance, right? Because if you’ve got a lot of your workers compensation linked to performance related pay is also linked to performance. So a big part of their compensation is expected to be the bonus. And their normal salaries lower than that could put a lot of pressure on them. That could create a lot of stress for the worker.

Tim Hughes 46:46

Yeah, for sure. I mean, because there’ll be, again, industry specific, but depending on seasonal, or, you know, upturns downturns in markets, you know, can be things out of their control. So there’s certainly situations where you’re willing and able to work, and there’s no work there to be done. So, you know, real estate’s a good example of that, you know, when, when no one selling well, no one’s making commission, you know, so that would certainly be, you know, relative to the real estate market. But yeah, you know, yeah,

Gene Tunny 47:17

I’ve got to look more into exactly the compensation schemes there. I thought I understood it. But when I started talking about it with you, it was clear my level of understanding was not at the level it should be. So I’ll try and clarify that. But I think yeah, that’s a good example, where there is performance related pay, okay, well not try and wrap this up. I will end with the author’s main message, their final words here. So performance related pay is a relevant policy to improve firm performance, and competitiveness. Although the adverse effects on work intensification and employees physical strain and psychological stress should not be overlooked. Looking forward, new patterns of work from home and remote work will increase the relevance of performance related pay. Yep, yep. I think that’s probably true. Because it’s not about how many hours you turn up to the office for. I mean, one of the issues I had when I was in the workforce many years ago was because I, I like to walk around. And I mean, I like to think I did a lot of work when I was working for companies, or for public service, or whatever. But one complaint, and maybe this happens in every workforce, but there was one, at least one or two times when there was a complaint made that I wasn’t at my desk enough, or I wasn’t in the office, because I was that was walking around thinking about a problem, or I was out trying to hustle. And yet, I’d be someone would criticise me because I wasn’t actually at work. And that’s the wrong way to think about it, isn’t it? I mean, it’s, it’s what you’re achieving, ultimately.

Tim Hughes 48:59

Completely, I mean, I guess, you know, that would be a good case for, you know, what work has been done, you know, and who cares who’s walking around, it’s, you know, it’s very good for you. But if you’re getting the work done, because, I mean, that’s definitely a thing where people might be busy, they might be work for many hours, but they’re not necessarily being very productive. And when there’s presenteeism, where people can be at work, and just not very good. Yeah. And especially when they’re side gigs happening, you know, because their energy and thoughts are being put to another, another pursuit. So in containing that, now, if any managers out there looking to encourage intrapreneurship, you know, this is possibly worth looking into.

Gene Tunny 49:43

Yeah, we’ll have to get Phillip Di Bella on the show to chat about that, because Phil’s just around the corner.

Tim Hughes 49:49

Yeah, he’s got a lot of good stuff. And that was when I hadn’t heard that term before, intrapreneur. But it makes a lot of sense because it’s an outlet for people who have ambition, but don’t Uh, you know, you don’t necessarily have to leave your job to have ambition. So yeah, it’s, um, depends on the culture within that company whether they can allow that to happen or not.

Gene Tunny 50:10

Exactly. Okay. Do you have any other thoughts, Tim, before we wrap up?

Tim Hughes 50:14

No, I just got to make sure that whatever I’m eating is dead before I eat it and hopefully, hopefully I can bring something in to keep me sustained.

Gene Tunny 50:20

Fanastic. Tim, thank you so much.

Tim Hughes 50:25

Thanks, Gene. You’re welcome.

Gene Tunny 50:33

Okay, I hope you found that informative and enjoyable. My main takeaway from looking at performance related pay is the importance of getting the design of the scheme right. So you actually motivate good behaviour. You end up with some bad behaviour if you don’t get the incentives right. As Tim and I discussed, on balance performance related pay schemes can be beneficial and boost overall business productivity and profitability. But that’s not guaranteed. We see that individual incentives work better when teamwork is limited, as in real estate, but they can be problematic when teamwork is required. One thing I should have noted in the main conversation is that rewards don’t have to be monetary. In a 2009 article on performance related pay, which I’ll link to in the show notes The Economist observed in their 1982 book In Search of Excellence, Tom Peters and Robert Waterman mentioned the great variety of non monetary incentives used by the excellent companies that they studied. They said that excellent companies actively look for excuses to hand out rewards. at Hewlett Packard, for instance, they found members of the marketing team who would anonymously send one pound bags of pistachio nuts to salesman who sold a new machine. That’s a bit of a quirky example, but it does illustrate that rewarding high performance and then be complicated. Celebrating wins with a team dinner or pizza night could be good for team morale. For example, I’ll put links in the show notes to articles mentioned in the episode, including to the eyes at a article on performance related pay and productivity. It’s really good and it’s easy to read. I’ll also add some links on how real estate agents get paid and on performance related pay at McDonald’s. This is how you can check out what McDonald’s has tried in Australia and in the UK. The Australian scheme does look better designed than the British scheme, because the Australian McDonald’s employees get extra benefits based on the individual performance rather than their team performance. My suspicion is that a group based incentive may be too weak to motivate performance. That said individual incentives can be difficult to apply when people have to work very closely together, and where it’s difficult to assess individual contributions. And in many businesses, teamwork is probably something you want to encourage. So it may be that you need to have a group incentive scheme of some kind, or an incentive scheme based on a mix of individual and group incentives. I’d say that you need to look at businesses and their workforces on a case by case basis to work out what’s right for that business. For now, I’d note that one of the major concerns with group based incentives is the free rider problem. Some employees may try to freeride on the efforts of other team members. However, there’s an intriguing new quasi experimental study which suggests the free rider problem may not be a big deal for some companies. The study was done by Anders Frederickson, Daniel Hanson and Colleen Flaherty Manchester, from Office University Siemens Gamesa in the University of Minnesota respectively. The researchers have written about the study in an ice at a discussion paper and an Avox EU article that I’ll link to in the show notes. They took advantage of the fact that a European dump truck manufacturer, high dreamer, introduced a group based incentive scheme and it’s planned in Denmark but not in Germany. Hence, they could treat the workers at the plan in Denmark as a treatment group, and the workers in Germany as a control group. The researchers then use what’s called difference estimation to establish that the group based incentive scheme increased performance by 19%. The researchers note that, despite free writing concerns stemming from group based incentives, being part of a group may have influence workers paid based on the performance of the group will naturally not tolerate that team members shirk, which leads to peer pressure. And team members even without peer pressure may feel some kind of internal pressure such as guilt or shame if they do not deliver in a team context. Okay, that sounds like a fair point to me. This new study adds to a small number of existing studies that actually suggest group based incentives can be beneficial in some businesses, particularly whereas there’s a close knit group which can prevent members from free riding How widely applicable is this finding? It may be too hard to say based on the limited number of studies so far, I might have a closer look at the evidence regarding performance related pay schemes and return to the topic in a future episode. But for now, I hope the discussion in this episode helps you understand the relevant issues and trade offs. Okay, please let me know what you think about this episode. What were your takeaways or thoughts on performance related pay? Do you have any experiences with performance related pay that you’d like to share? Where you’d like me to take a closer look at some of the issues covered? I was thinking that it may be worthwhile having a bonus episode discussing the methodology of the hydrangea study, as the difference in differences method can be very powerful. Let me know what you think. Feel free to email me at contact at economics explore.com. I’d love to hear from you. Thanks for listening. rato thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@ economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

56:43

Thank you for listening. We hope you enjoyed the episode. For more content like this. To begin your own podcasting journey head on over to obsidian-productions.com

Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au.

Tags employment, motivation, performance-related pay, productivity, wages

Podcast episode

Superforecasting w/ Warren Hatch, CEO of Good Judgment – EP176

Post author By Alec Krishna
Post date February 23, 2023
No Comments on Superforecasting w/ Warren Hatch, CEO of Good Judgment – EP176

What are the characteristics of superforecasters? How can a superforecasting team be developed? Hear from Warren Hatch, CEO of Good Judgment, a leading global forecasting business based in NYC. Accurate forecasts from Good Judgment superforecasters have included the scale of the pandemic. In early 2020, Good Judgment superforecasters estimated the United States would have over 200,000 deaths from COVID-19 with 99 percent certainty, an estimate that was considered by many as excessive at the time. Warren gives show host Gene Tunny and his colleague Tim Hughes some valuable tips on how to become a superforecaster.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

What’s covered in EP176

The Good Judgment forecasting business [2:41]
What are the characteristics of superforecasters? [6:47]
How to identify someone who is good at pattern recognition? Raven’s matrices [9:24]
Link between subject matter expertise and forecasting ability [10:40]
What are some of the techniques that are used to help super forecasters rid themselves of prejudice and bias? [12:57]
How large does a super forecasting group need to be to be successful? [20:35]
Tips for being a super forecaster [25:59]
Using the percentages to retrospectively see how you’ve gone [27:56]
Bayes’ Theorem [31:41]
The importance of being open to a range of different views [42:47]

About this episode’s guest: Warren Hatch, CEO of Good Judgment

Warren Hatch is Good Judgment’s second CEO, succeeding co-founder Terry Murray.

Before joining Good Judgment, Hatch was a partner at McAlinden Research, where he identified thematic investment opportunities in global markets for institutional investor clients. Previously, he co-managed a hedge fund seeded by Tiger Management and was a portfolio manager at Morgan Stanley.

Hatch holds a doctorate in politics from Oxford, a masters in Russian and international policy studies from Middlebury Institute of International Studies at Monterey, and a bachelors in history from the University of Utah. He is also a CFA® charterholder.

Links relevant to the conversation

Good Judgment’s website and Twitter:

https://goodjudgment.com/ and https://twitter.com/superforecaster?lang=en

BBC Reel featuring Warren Hatch:

https://www.bbc.com/reel/video/p0dwntct/can-you-learn-to-predict-the-future-

Warren’s talk on YouTube which Gene quotes from in the episode:

What is Superforecasting? – Warren Hatch, Good Judgement

Article by Nicholas Gruen:

Making better economic forecasts

Links regarding foxes versus hedgehogs:

https://longnow.org/seminars/02007/jan/26/why-foxes-are-better-forecasters-than-hedgehogs/

https://goodjudgment.com/the-cost-of-overconfidence/

Transcript: Superforecasting w/ Warren Hatch, CEO of Good Judgment – EP176

EE_176_Superforcasting_FINAL

Fri, Feb 17, 2023 7:01AM • 47:45

SUMMARY KEYWORDS

forecasting, forecasters, warren, question, people, economists, judgement, probability, super, good, recession, models, world, economics, bias, episode, views, bayes, thinking, big

SPEAKERS

Tim Hughes, Gene Tunny, Warren Hatch, Female speaker

Gene Tunny 00:07

Tim Hughes 02:03

It was a BBC real little eight minute video, which is really good. And we’ve discussed these kinds of issues before ourselves. Gene mentioned all that sounds like the super forecasting book by Philip Tetlock and Dan Gardner. And of course, as it was, it was exactly that, you know, your association with those. And so we came full circle. And I reached out and thank you for making the time to talk in an area that we’re really interested in.

Gene Tunny 02:29

Yeah. And so to kick off, Warren would be keen to understand what’s your work, good judgement involved? What are you doing there? And, broadly speaking, can you give us some insight into how you work, please.

Warren Hatch 02:41

By all means, and by the way, it’s not just Australia with central bankers that don’t have a very good track record recently, when it comes to forecasting by any means. Our own Federal Reserve here, had some pretty spectacular misses, as well. And they’ve had to do some pretty severe course corrections. There’s, as you know, and the good judgement project itself came out of some pretty spectacular forecasting failures on the part of the US intelligence community where they had forecast weapons of mass destruction that weren’t. And then they missed 911, of course. So after that experience, they did some very deep soul searching to genuinely try and find ways to improve the forecasting skills of the intelligence community. And they ran a big competition. And as you know, that good judgement team did very well defeated all of the other university based research teams. And then four years after it started, it came to a conclusion, and they wanted to commercialise those findings. And the government, US government supports that kind of initiative as a way of showing the taxpayer dollars are being well spent. And so what we set out to do was to break down this big research initiative into smaller pieces that could be useful out in the real world. And we do a few things we do consulting for some more deeper engagements. But then we also provide a lot of workshop training. So organisations that want to improve the forecasting skills of their analysts and their teams can do so. And then we also have the super forecasters themselves, who are available to forecast on client questions. And we also have a public dashboard where we contribute to the public discourse in our way. And the questions are basically posed by organisations in the private and public sectors to improve their own decisions. Having probability estimates about uncertain events, that’s what we’re all about, is to come up with a number in our forecast rather than a vague word that lacks accountability. But then we also provide the context for those numbers. So it’s not just a dataset that we’re generating, we’re generating the stories that go along with it.

Gene Tunny 04:58

Okay, so buy in Number rather than a vague word, are you talking about a probability? So you’re saying that we are forecast is that within the next 12 months, there’s a 60% probability of recession or something like that? Is that what you suggest?

Warren Hatch 05:16

That’s it? That’s, that’s exactly the way we can frame it is, what is the probability of a recession in the next 12 months, or by a particular date? Or in different time spans? Will there be a recession this half of the year or the next half of the year, and so on?

Gene Tunny 05:32

And that’s about keeping forecasters accountable, is it and if you’re a forecaster, and you give a forecast like that, you can assess your track record, so to speak and adjust your forecasts in the future? Is that correct?

Warren Hatch 05:44

That is correct. And I am using a number it does, it does a lot of really good things. That’s one of them as you get feedback, right? So if you say maybe there’s going to be a recession next year, you’re not gonna get feedback from that. The other thing is that allows us to communicate in a shared language, right? If I say, Well, there’s a possibility of a recession, and you say, maybe there’s a recession? How do we kind of compare our thinking, how do we come up with something that reflects our joint wisdom. And that’s what this is about as having a wisdom of the crowd approach with a shared language with accountability with feedback, and a way to compare forecasts on different topics.

Gene Tunny 06:21

Okay. It’s amazing the type of work that you’re doing. So I had a look at your website a few days ago, and I saw that some of the things you’re forecasting, you’re providing advice to clients on this, you’re providing advice on, what’s the probability that Putin doesn’t survive, or like, what’s happening in Ukraine and all of that? So it’s a wide range of things that clients are interested in? Is that right?

Warren Hatch 06:46

That is correct. And what we’re looking for is the topics that affect decisions. And where there’s a lot of information and conflicting views out there, where our panel of super forecasters can take all of that publicly available information, and filter out a lot of the noise because there’s a lot of noise out there these days, and try and find the signal through their process, and then turn that in into a number on things like Putin’s future on things like Will there be a ceasefire between Russia and Ukraine? These are all quite consequential? Yeah.

Gene Tunny 07:19

And what, how do you get on this super forecasting panel? Who’s a super forecaster? What are their characteristics?

Warren Hatch 07:26

That’s a great question. And that’s something. And something to keep in mind, too, is that in the research project, that wasn’t part of the research plan at all. They just observed that in the first year, there were some people who are consistently better than everybody else. And being researchers that caused a new research question, what would happen to ask themselves? If we put them on small teams? Would they get better? Or would they revert to the mean, and they did not know at all, a lot of people thought there’d be a mean reversion, turns out, no, they continued to get even better. And so we still do the same process now with our public side, where we’ll just take within the top 1% of the forecasting population there, and other platforms to invite him to come and join the professionals and they have certain things in common, for sure, they gave us a lot of psychometric tests, hours of them before we got to do the fun stuff, you know, and forecast on elections in Nigeria in the light, and then to see what kinds of characteristics correlated with subsequent accuracy. And there are certain things that really pop out. One is being really good at pattern recognition, right? So you can think of, you know, you got a mosaic about the future that we’re trying to fill in, and see what’s coming faster than anybody else and fill in those tiles. And being good at that is a fundamental characteristic of a good forecaster. Another is being what they call cognitively reflective. And basically, that means that if you’re confronted with a new situation, you don’t automatically go to what first pops into your head, because what first pops into your head might not be right, you might be overfilling the mosaic too quickly, and getting the wrong picture. So you want to slow down in economy in terms let system to be your friend, you know, it’s hard work. But that’s the way you get a better a better result. So those are two very fundamental characteristics that good forecasters have.

Gene Tunny 09:24

Right? And how do I tell someone with good pattern recognition is that someone who maybe they excel at Pictionary or at certain games or certain board games and trying to understand how would you actually judge that

Warren Hatch 09:37

being good at Pictionary is a good quick and dirty way to do the more formal way is it’s called ravens matrices. And this comes from the UK originally, during World War Two. They used it as a way to identify people who would be good pilots during the war, because when the war first started, they went to you universities grabbed everybody put them in a in a cockpit or in a submarine. And of course, that means their life expectancy wasn’t very high. And they needed to be able to replenish pilots and submariners. And this was a way to go out to the countryside and identify people who perhaps didn’t have a formal education to an extent, but we’re very sharp, very good. And it turns out, that was a great way to spot good forecasting talent, and you can look them up to Ravens. You can see them out on the internet. And it basically what it does is it tests your ability to see different patterns and what rules there are to anticipate what those patterns will become.

Gene Tunny 10:40

Okay, I’ve got one more question. I’m gonna hand over to Tim, because I’ve just got one bill burning question. This is fascinating. What’s the link between subject matter expertise and forecasts inability? Is there any correlation? Because the best economic forecasters actually economists, for example, are? I mean, I’m guessing the best weather forecasters are meteorologists? Is it different across disciplines? Do you have any insights into the relationship between subject matter expertise and forecasting ability? Warren? That’d be great. If you could respond to that plays?

Warren Hatch 11:12

That’s a wonderful question. And what we have found, and the research shows is that there isn’t necessarily a connection between being a subject matter expert and a good forecaster on that topic. Subject Matter Experts are very good at telling us how we got to where we are, they’re also very good at asking the questions, we should be asking ourselves about the future. But they’re not always so good at saying what the probability of one outcome might be relative to another. And one reason for that is that experts, by definition, have models of the world. They have, you know, heuristics, they have shorthand, ways of interpreting what’s going on in the world. And in moments of a lot of flux, there might be small, subtle things, that their models and their expertise will just filter out as a matter of course. And by having a skilled generalist as part of that activity, then they don’t have those blinkers. They don’t have those fixed models. And they might detect something subtle that they go, Wow, this is actually something potentially quite significant. And so what we found is that rather than have experts versus skilled generalists, you have them both and and let them interact with one another on a forecasting platform, one way or another, and then you get really positive strong results we want but our favourite Boolean a good judgement is

Gene Tunny 12:48

and yeah, it’s not either, or, is that what you’re saying? It’s a no. Yeah, exactly. More crisply. Gotcha. Okay, good. Excellent. That makes sense. So just just wanted to make sure I understood it. Tim, do you have any questions?

Tim Hughes 13:00

Yeah, I do, actually. Because I remember in a little bit of research, seeing what you said about experts and skill generalists, and also the diversity in a group of super forecasters, which helps bring different perspectives to a decision, or a forecast. And I was gonna ask about the we’re all influenced by prejudice and bias, whether we’re aware of it or not. Some of it is hardwired survival biases, and, and others, we have more control over. I was interested to ask Warren, what your thoughts were on prejudice and bias and with super forecasters, what kind of techniques or if there are any sort of habits that are encouraged with those guys, to be able to rid themselves of those prejudice and bias to be able to make better decisions or forecasts?

Warren Hatch 13:53

Yeah, good question. And is goes to the foundations of what we’re trying to do. And we might usefully think of two categories of bias. There’s the kind of the bias that we all have the cognitive biases, the things that interfere with our judgments that are just built in to our wiring, right? Most people are overconfident, it just is built right in. Most people will get anchored on a high status individual, for instance, who was the first to speak at a meeting and everybody gets anchored on that it just happens. And for those kinds of cognitive biases, well, the psychologists debate a lot, whether you can eliminate those sorts of things. Some say it’s impossible. Some say there are things you can do. What we do know is that for that category, being aware of them, at least can let you counteract their effects, like being overconfident. You can measure and getting that feedback can get your over confidence in check. So if somebody asks you what your confidence about a particular forecast you might be making, you might say, oh, yeah, I’m 90% sure about that, or 90% sure about some particular fact, in the you can measure that. And it turns out, well, maybe more like 50%, right? Not 90%, right in those situations, so you can recalibrate yourself. Those sorts of cognitive biases, we can identify spot, and do at least some mitigation techniques to rein in their effects on our judgments. The other category is the kinds of biases or prejudices that we might acquire, as we live life, and we have different life experiences. And that will shape the way we interact with others think about issues in all kinds of different ways. And that can be a lot tougher to be sure to deal with, what are the two things that we can do is one, we can level the playing field so that we know as little about each other, when we’re forecasting as a team as possible, right. So if we were on a platform, we would all adopt made up names, we’d have no idea where we came from, we’d have no idea, ethnicity, or gender, or religion, or political beliefs or anything, as much as possible. And all that’s going to matter is, is the quality of our comments that we can contribute. And by doing that, we can at least hold those things at bay, we don’t eliminate them. But we kind of, you know, we put on our white lab coats when we go to the forecasting platform. The other kind is some issues are just really difficult. Because they are, they’re emotional, or they deal with very troubling topics. And that’s a difficult thing for forecaster to deal with. For instance, a lot of the work we did when COVID was was running rampant, is really tough. And a lot of forecasters just said, Look, I have a really hard time with these questions. I’m going to step aside or election questions, I’m gonna just step aside because my personal beliefs are interfering with my judgement. Yeah, the one little tool that you might do. And this comes from the head of our question team, and a super forecaster that I thought was just great to try and create at least a mental distance on these kinds of issues, is imagine you’re an Anthropologist on Mars, observing everything through a telescope, right? By doing that, at least for him. And for some others, too, it makes it easier to engage with these more emotional issues, not all the time. But it can be a helpful tool.

Tim Hughes 17:41

So a level of detachment as much as possible, and that self awareness to to not be involved from what your previous experiences may have been in those areas,

Warren Hatch 17:50

as much as possible. When you’re making your forecast. Then once you’re done, you take off your lab coat, you can go down to the pub, have a beer and just, you know, let it rip.

Tim Hughes 18:01

It’s really good. Like, because it’s come up in conversations we’ve had before. Along the same lines were softening the language around. Like we’ve had conversations around the truth. For instance, like politically and everywhere, like since the beginning of recorded history, there’s always been questions about what’s true and what’s not true. It’s certainly no different nowadays, like, we know, there’s still the same issues of like, is that true? Or is it not? And softening the language around what we consider to be true or not seems to be a good approach, which seems to be something that is adopted with using probabilities and percentages to say, the probability of something being true or not or happening or not. So that seems to fit in with being receptive to new information that may come in that allows you to change your position more freely. Is that sound familiar with what happens at Super forecasting?

Warren Hatch 18:53

Yeah, yeah. And a lot of our process is trying to think about how well do we know what we know? Right? So epistemic uncertainty, is the phrase that they that they use so and being humble about how much we really know. And being aware that there are pockets where we may not be able to quantify uncertainty on certain issues, we run up into a wall of irreducible uncertainty and we should respect that that is something that’s there and not get carried away and go beyond it. And because on that other side, there may be a different kind of uncertainty with a call Alia Tory uncertainty, right? And that’s the kind of randomness that’s just there. And we’re not going to be able to rationalise it away. It’s just, it’s sets a limit on what we can and what we can know. Now, what’s really fascinating, of course, is part of what all of this research project and a lot of what we do do is, is that for some topics, that wall is farther out than we had thought before, right? That irreducible uncertainty, that zone is maybe not as big as we might have thought. So we can quantify more than we had previously recognised. And we can also quantify it with more precision than we had been able to do so before. And putting those two things together means that we can come up with forecasts where we can have a much better informed judgement than we could before.

Tim Hughes 20:35

When you put the left code on the ego, it can’t be there as well, I guess,

Warren Hatch 20:39

as much as possible, right? Yeah, then you can only go so far, of course. But having that kind of an approach, at least gives you a shot at coming up with something that’s that’s good. And you’ll find out of course, because if over a lot of questions, your ego was actually creeping in, after all, it’ll show up in the feedback, you’re receiving the scores that you get on your forecast.

Gene Tunny 21:02

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

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Gene Tunny 21:37

Now back to the show. Warren, I’m just wondering, from what I’m hearing, it sounds like yeah, you need to it’d be good to have a diversity of views. You need people who question who act as a counter to other people’s biases? How large does a super forecasting group need to be? I mean, do you have a sort of, is there a rule of thumb you need I need at least half a dozen people, you need a dozen or you need dozens? I mean, is there a is there a rule of thumb about that,

Warren Hatch 22:06

you pretty much got a good rule of thumb is six to 12 is a good number to have, especially when you put your thumb right on it, you’ve got a diversity of perspectives and play definitely want to have people with different approaches, different philosophical views, different different life experiences, too. And they’re all bringing, you know, different pieces, right? So we’ve got that mosaic that we’re trying to fill out. And if we all went to the same schools all have the same backgrounds, we’re basically all going to be bringing the same tiles to our mosaic. What’s the point? What we want is people who have different experiences different perspectives, who can fill it out as quickly as possible to get the best possible result. And that’s one thing we see time and time again, is that working on teams is going to deliver a superior result over time. Even the best single super forecaster will not do better than a team of forecasters over time,

Gene Tunny 23:08

Ron, another question, and this will probably be my the final one I want to ask are prepared for? are you competing with mathematical or numerical modelling? Or is what you’re doing? Is that a compliment to it? Because, like I see in meteorology, for example, I think they’ve made some impressive improvements over the last 20 to 30 years, I see the huge range of data that they’re ingesting into their models, and they’ve gotten better economics. I mean, our models have actually not got any better. And if you rely upon a computerised, like a computer model for an economic forecast, you’re going to end up with something silly. So there’s always judgement involved in any economic forecasts that come out from treasuries or central banks. Just wondering how do you see the role of, of modelling? Is it compatible with what you’re doing?

Warren Hatch 23:59

Absolutely, yep, it is very much complementary. And a lot of individuals super forecasters have models that they build, and they craft and they put together. So on that side of the forecasting, process models are very integral. Also, when we put our forecast together and aggregate them, we have a model to help us do that with a machine learning element that will monitor for the accuracy of the forecast so that we can deliver the best possible signal. And then on the user side, what we create that number will go into into different models like quant funds, or regular users of our of our forecast because we’re quantifying things that they couldn’t otherwise get in the form of a number. And looking ahead, I certainly see that’s something that’s going to continue, where there’s a lot that the machines can do that models can do, and they can do it fast and they can do it better in increasingly doing the heavy lifting, that we would other why’s have to do and I love that the word computer itself used to be a person, right? When somebody would be added adding machine typing away furiously? Isn’t that a fine thing that a machine can now do that which lets the human go off and do things that the machines still can’t. And there’s a lot that the machines still can’t do when it comes to judgement when it comes to forecasting, especially how people will interact in an uncertain world. The machines are not there yet, maybe they’ll get there. But what we’ve seen in the research and the results is that right now, there’s a nice division of labour to be had, where the machines can really tell us a lot about a history of a particular forecast area, the base rates, right? So the comparison classes that we should have in mind when we’re thinking about a new situation, but then synthesising them, and converting that into something about the future is something that we do. So it’s a nice division of labour.

Gene Tunny 25:59

Yeah. When you mentioned base rate I just remembered in your, you gave a great talk. It’s on YouTube, I’ll put a link in the show notes for you mentioned, a few tips for how to be a super forecaster and one of them was starting with the base rate. So looking at, well just look at what in the population, what’s the probability that that this would occur? I think it was with Harry and Megan, I’m trying to remember if that was the example, if you’re thinking about what’s the probability that their marriage will, will last, then you know, just look at the start with a base rate for the population itself, and then go from there. I thought that was a good tip. If I remember that example correctly, and then record your forecast, compare with others, update it with new information and keep score. So look at how you’ve gone over time. So I thought they were really good tips. And I’ll put those in the show notes. So yeah, I really enjoyed that. That presentation. Yeah, no, no, that wasn’t a question. Just that observation is, that was really good. But if there were any thoughts you had on that, Warren, feel free to throw them in?

Warren Hatch 27:00

Yeah, that was a great distillation. So it’s all about process, right? And you want to have a checklist, and you’ll have your own checklist. But the five things that you just went through are really important things to have on anyone’s checklist to to come up with a better forecast, there’ll be other things that might be useful from time to time. But even just going through that in your head for a minute, right, can give you a better result, especially when things are you’re confronted with something you don’t know anything at all about. Oftentimes people will say, Well, I don’t know. It’s 5050. And they’ll say, Yeah, I’m 50%. But you know, pause, how often really, is 50% being neutral on something? Not very often. And by just going through a few steps like those, you can maybe come up with something that gets you in a better position than you otherwise would? Yeah, yeah, for sure.

Gene Tunny 27:55

Tim,

Tim Hughes 27:56

one of the things with using the percentages, I remember, hearing you say as well with, it allows you to retrospectively see how you’ve gone. So you can, if there’s something for instance, that is a regular prediction, you can then start to see how you went as a super forecaster, not necessarily yourself, but like anyone who’s trying to forecast to see how they went. And yeah, have a sort of checks and balances, so that you can see how accurate you’ve been. So an interesting thing that came up along those lines was, for instance, if your football team is 80% chance of winning a game. Our inbuilt prejudice and bias, I guess we refer to before would say, well, we’re pretty much home in house. But the reality is, there’s a 20% chance that they won’t win, which of course, is still possible. And so we we sort of edge towards what we want. And also we take something over 50% as being a bigger likelihood, then maybe it is. So it’s really interesting to sort of think in these terms. And it’s a very honest way of assessing situations. And there seem to be a lot of other benefits from approaching decisions and forecasts this way. It was along the lines of what I was asking about before, I guess. But is there a big influence of philosophy in what you do? Because I can see parallels with stoics. And I think you mentioned pragmatism as an influence in what happens that good judgement.

Warren Hatch 29:22

Yeah, and epistemic theology. Yeah, we were talking about earlier is how do we think about uncertainty, all very essential. And one other really important element is, of course, Bayesian ism, where recognising that you can better understand the world with probabilities of this sort, is something that’s very critical if you’re going to be using this kind of a process. And there are those who really genuinely believe that that approach is not useful in it for people like that, that are not going to be very good forecasters, and in this sense, but as you go around and you’re looking for tools to To help think about the world, those are very important touchstones for most people, whether they have studied formally or not, they certainly acquired a lot of those principles through experience and the feedback that they have, that they have received. So epistemology

Tim Hughes 30:17

is how we know what we know. So the other one was, did you say Bayesian theory? Yeah, so

Warren Hatch 30:23

b Yeah, Bayes Thomas Bayes?

Tim Hughes 30:25

Could you explain that one, please? Yeah, I think Gene knows everything. So. But I’m not familiar with that one. So could you would you mind explaining that one, please?

Warren Hatch 30:33

Well, gene can probably do a better job than I can. But at its foundation, it’s just that when you’re thinking about the future, that you can think about probabilistically. And you will identify different variables along the way, that would affect that probability that you have shaped that you’ve started with. So if we are thinking about if there’s going to be a recession in Australia in the next 12 months, there are things that we might be looking for along the way that would get us to update our forecasts of that probability. And identifying what those might be in advance. For really important things like that means that we can attach different probabilities to those different factors today. And then as we move forward into the future, and we find out more about how those variables are actually playing out, we can update those pieces. And that will inform our update of the bigger question as we go. How would you say a gene?

Gene Tunny 31:39

Yeah, that sounds fair enough for me. It’s an A. Yeah, it’s yeah, the Bayes is there. And there’s a good book on the theory that wouldn’t die. I might have to cover it in another podcast episode. So we can go deep on it that Yeah, I think that’s, that’s great, Lauren. Oh, yeah, really, really appreciate that. I was I was thinking of Bayes theorem, but whether I should ask you about that. But that was good that you brought it up independently. So that’s excellent.

Tim Hughes 32:05

That was gonna say it’s good. Common sense, though, isn’t it like it means that you’re less entrenched in your views, and that you’re open to change your mind, because anybody’s opinion is only as good as the information it’s based on. So as you receive more information, your opinion should be more well informed and be a better opinion. Ultimately, I guess that’s based in theory work.

Warren Hatch 32:26

Yeah. But here’s the thing is that not everyone subscribes to that view, for sure. There’s some people who genuinely believe it’s better to stick to their guns, you know, the people who are very fixed models of the world, that tell them how things will unfold. I mean, Karl Marx, not so much of a Bayesian, really. And people like Nouriel Roubini, not so much of a of a Bayesian either when it because he has a view of the world. And we and we kind of hear the same thing over and over. And this new incremental information is something that they will tend to dismiss rather than bring in and update their own views.

Gene Tunny 33:03

Yeah. And I’d target you’re familiar with the John Maynard Keynes, quote, aren’t you, Warren? Yeah, it’s a wonderful one. Yeah. When the facts change, I changed my mind. What do you do, sir? I think that was it. It’s very good.

Tim Hughes 33:17

I mean, the the tragedy with this is this is how we vote in governments around the world. And they often come from entrenched beliefs, with a lack of willingness on all sides to listen to new information. So it has a massive impact at a very individual level in how we vote. I think, you know, if we could all adopts Bayesian theory and in how we vote, then it might make give us better politicians and better outcomes.

Gene Tunny 33:44

To we might have to do a deep dive in a future episode on Bayes theorem and look into it for the intricacies of it. So we might go into that in a future episode. Yes. All right. You’ve been generous with your time has been fantastic. Do you have any final thoughts before we wrap up,

Warren Hatch 34:01

maybe a couple that might be useful, just based on what we were just talking about? One is, and this can be useful for, as we, as we think about politics, and debating issues of the day, right is that most of the time, these really important issues involve people yelling and screaming at each other. Right? It’s very adversarial. And one of the things that can be done with the sort of framework we’re talking about here is if we can get adversaries on opposing sides or multiple sides to come together and identify what are the really important things that they think would support their view, but be very difficult for the other side? What does that look like? Right? And once we’ve identified what those issues might be, we can then collaborate the ideas adversarial collaboration, and say, Okay, well, here are the things that matter for these different worldviews and And then we can, you know, let time unfold to see whose position is supported by the data by events as they unfold. But then we can take the extra step and pose those in the form of questions to a population of forecasters. And by applying that process, we can bring that future into the present and get a better sense of how those issues are going to be unfolding. From here with the input of the adversaries in a much more collaborative framework. I think that’s a wonderful approach. We’ve done a little bit of that others have to, we look forward to doing even more. And I think it can also very much apply in the world of economics, where there are very strident competing schools about what causes recessions. And so let’s get the Keynesians and the monetarists together to have some collaboration in that way, engage on a real world issue, like what’s the probability that there’ll be a recession in Australia in the next 12 to 24 months is a wonderful thing to do. The other thing that I think are useful to maybe think about is economists themselves, why they don’t do better. And I think one reason is that many of them continue to practice their craft, using state of the art techniques from the 19th century, in the way they model things and think about things and exchange things. And the sort of process that we’ve been talking about here, much more dynamic, much more nimble, and much more team based might be really interesting. So for instance, it’d be really, I think, potent, to do a survey of economists about the probability of a recession in the next 12 months, where we just take their snapshot like all these surveys already do. But then put them together and have them compare notes and probe one another’s reasoning. Yeah, and have an opportunity to update as a result of those different views, even anonymously. So their official forecasts could still be the same. But they could have kind of a informal forecast that they make through this process with kind of a shadow version of themselves. And I’ll wager that the number that comes out of that informed crowd is going to be better than any one single economist, Rod.

Gene Tunny 37:31

Yeah, that’s a good idea. I mean, we do have the economic society runs a poll of economists, but I’m not sure it forces them to give answers in a consistent numerical format on these questions where they are asking a question like that. So yeah, I’ll have to have to think about how that could work. Have you seen that work in economics or any other discipline anywhere in the world? Warren, that type of approach?

Warren Hatch 37:54

It’s happening at organisational levels. Okay, that’s, so we definitely see that, where were the things that are important to the organisation, they’ll use that kind of a framework to think about things, we also do it on our public site. And that’s one way to do this is that they could all just go and invent names, Mickey Mouse, whatever, and make a forecast on that very question on that platform, completely anonymously, and see how they do. The other thing, too, that I think is really interesting, is that often it’s rare, where even the word recession gets defined with some precision. Yeah, so one problem is that we all interpret it in different ways. We think of different thresholds, different, you know, different ways of defining what it is. So right from the starting gates, we are forecasting different things, and just having a shared understanding of what that means itself would do a world of good.

Gene Tunny 38:55

Yeah, exactly. I mean, there’s the is it two negative quarters of GDP? And I mean, you can get some odd results if you use that or is it is that the NBR declaring a recession? Yeah, you have to be very specific. I think that’s a good point. I just want to ask about the organisations that are doing this is is one of those organisations is it Bridgewater Ray? Dalio is Bridgewater, I’m trying to remember I read that in his principles book that he, he really tries to get people to be very specific and about what they’re forecasting or predicting.

Warren Hatch 39:26

They definitely do. They don’t work with us. But they’re doing it on their own. And obviously very successful at it by applying a lot of the same things that we’ve been talking yeah, here with with a lot of rigour

Gene Tunny 39:39

I might have revisit that book and just check whether that’s what exactly what they’re doing, but it just, yeah, it rang a bell in my mind that Oh, is that what Ray Dalio is doing? Because he’s very rigorous about in his thinking and questioning his judgement because he got something spectacularly wrong in the 80s and it almost destroyed I think it just destroyed his business at the time and so he learned a big lesson from that. Yes, yes. Okay,

Tim Hughes 40:03

wasn’t it 11 economists predict 11 out of seven recessions is that right?

Warren Hatch 40:13

Yeah, that was a great quote from an economist. Samuelson was his name. And he was writing in Time magazine in the 1960s. And and he that’s when he made that statement, that economist, I think it’s have predicted nine of the last five recessions and the ratio holds.

Tim Hughes 40:33

That’s, um, I love the idea of adversarial collaboration. I think that’s such a smart way to go around things and get better outcomes. And I think there’s so much to take from this. For everybody, like, way outside, the area of forecasting just seems to be a way to be a better human and to a good way to approach life. But so yeah, I’d really like to hear more about that. As you guys do more of that. We’d love to speak again, on the on that regard.

Gene Tunny 41:02

Yeah. Yeah, it’s been terrific. Warren, we really appreciate your time. So I’m really happy with that. And yeah, just incredibly grateful and excited. That was a really learned a lot. And I think it looks like you’re doing some great work there in the methodology or makes all makes sense to me. And it’s, from what I’ve seen over the years, I’ve understand why I’m thinking, why I’m forecasting or predicting certain things or what could be wrong with that question and trying to get other opinions. So yeah, and partly those because I read Philip Tetlock book, partly because I’ve seen the problems we’ve had with forecasting financial crises and recessions in the past. Yeah. So all great stuff and keep up the good work and really appreciate your time.

Tim Hughes 41:47

Just to finish off, I just want to say So one good judgement does work for people, if they want to work on a project, they can approach you guys how to how does that work? Warren? Is there a particular areas you guys work in? And how do people contact you.

Warren Hatch 42:01

So the way to contact us is we can just go to our website, good judgement.com And reach out there. And we do we do consulting work on projects, where organisations may want to bring in some of these things and customise and adapt their own processes. They may also just want to have training workshops. And we do an awful lot of that, especially in finance and economics. That’s a big part of what we do globally. And the third thing is the super forecasters themselves, where we’ve got a subscription service on a lot of topics that are nominated by the user. So it’s a crowdsourcing of the questions as well as the crowdsourcing of the forecasts, as well as doing custom question work for organisations, as well. And I very much look forward to that.

Tim Hughes 42:50

Once I get going. It’s hard to get me to stop. You’re in good company at all,

Warren Hatch 42:54

I’ll look forward to to picking it up again, in due course, and perhaps even meet up. I’m working on a way to do a project over in your neighbourhood.

Gene Tunny 43:03

Oh, very good. Yes, definitely. Yeah, we’re in Brisbane. Yeah. If you get up here, that’d be great. So if you have an event in Sydney or Melbourne, just let us know. So yeah, we’ll have to talk more about that. Yeah. Good one. Yeah. Well,

Warren Hatch 43:16

we have super forecasters in Australia, including a couple in Brisbane.

Gene Tunny 43:20

Oh, very good. Okay. I wonder if I know them. It’s a it’s a little secret. Is it so hush, hush.

Warren Hatch 43:28

Ah, no, no, I’ll put you in touch with a male.

Gene Tunny 43:31

Very good. Yeah. Be very interested. Orrin Hatch from good judgement. Thanks so much for your time. We really appreciate it.

Tim Hughes 43:37

I predict that we’ll have another talk in the not too distant future. Okay,

Warren Hatch 43:42

I look forward to it. Thank you, Tim. Thanks. Good. Thanks, Ron.

Gene Tunny 43:51

Okay, I hope you enjoyed our conversation with Warren hatch from good judgement. To me the big takeaway from the episode is the importance of being open to a range of different views. Think critically about your own forecasts and be open to changing them if you hear someone making a compelling argument for a different forecast. I really want to put some of Warren’s ideas into practice, including the idea of a super Forecasting team. It wasn’t explicitly mentioned in the episode. But one important concept is the wisdom of crowds. good judgement is relying on groups making better forecasts collectively than any one individual. But as Warren mentioned, you need to set up a process or a forum for doing so which is meritocratic, so the group’s forecast is only influenced by the quality of arguments presented rather than by any biases. I must say I was glad that Warren said there is still room for numerical modelling as an input into super forecasting. I really liked his advice about the importance of getting subject matter experts and non experts together to come up with better forecasts. One thing I wished I’d asked Warren about is the distinction between hedgehogs and foxes. This distinction comes from the philosopher Isaiah Berlin. According to Berlin, the fox knows many things. But the hedgehog knows one big thing. Philip Tetlock who popularised super forecasting, he’s observed that foxes make better forecasts than hedgehogs. Someone who’s more widely read and thinks more creatively can be a better forecast. And then someone who has deep expertise in a field but who doesn’t take in a lot of inputs and views from outside of the field. This reinforces the needs to be open minded to think critically about your own thinking and to actively seek out other views. If you’re a subject matter expert, you need to make sure you’re open to other perspectives, and that your thinking isn’t constrained by the conventional wisdom of the discipline. Arguably, this was a problem for many economists in the lead up to the 2008 financial crisis. In my view, economists need to go out of their way to become more like foxes and hedgehogs. I’ll put some links in the show notes about the foxes versus hedgehogs distinction, along with links related to concepts covered in our conversation with Warren. One of the links is to a great article making better economic forecasts by my friend and colleague, Nicholas Gruen, who’s appeared on the show previously, next, a big fan of the super forecasting approach, and he wants central banks and treasuries to adopt it. In his article, he also writes about the potential benefits of running economic forecasting competitions. So please check out that article of next for some great insights. Okay, please let me know what you think about this episode. What were your takeaways? Would you like to learn more about Super forecasting? Would you like a closer look at some of the things covered in the episode such as Bayes theorem, feel free to email me at contact at economics explored.com. I’d love to hear from you. rato thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economics explore.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

47:32

Thank you for listening. We hope you enjoyed the episode. For more content like this where to begin your own podcasting journey head on over to obsidian-productions.com

Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au.

Tags economics, forecasting, geopolitics

Podcast episode

Values-based Capitalism: What is the Aussie Treasurer planning? w/ John Humphreys – EP175

Post author By Alec Krishna
Post date February 18, 2023
No Comments on Values-based Capitalism: What is the Aussie Treasurer planning? w/ John Humphreys – EP175

Australian Treasurer Jim Chalmers argues for values-based capitalism and against neoliberalism in a January 2023 essay in the Australian Monthly magazine. In this episode, show host Gene Tunny discusses the Treasurer’s essay with Dr John Humphreys. John is the Australian Taxpayers’ Alliance (ATA) Chief Economist and the founder of the Australian Liberal Democrats. Gene and John discuss just how literally we should take the Treasurer, the risks of the so-called co-investment approach, and whether the Treasurer is arguing for socialism (or a different -ism).

This episode features audio from an ATA Econ Chat livestream broadcast on 31 January 23. You can watch the whole thing here:

https://www.facebook.com/AusTaxpayers/videos/509950911277607

You can follow the ATA on various platforms including Facebook and YouTube.

You can follow John Humphreys on Twitter.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

What’s covered in EP175

Jim Chalmers’ idea of co-investing with the private sector [4:21]
Regarding superannuation funds increasingly having social goals that they aim to meet as well as financial goals [9:12]
The Australian stage 3 tax cuts and values-based capitalism: are they compatible? [12:37]
ESG, stakeholder capitalism, and socialism [15:24]
How does the Treasurer intend to direct investment? [23:28]
How a poor government policy can lead to another poor government policy [27:31]
The social impact investment bank expected in the 2023 Australian budget [32:34]

Links relevant to the conversation

Jim Chalmers’ essay Capitalism after the Crises

Clean Energy Finance Corporation Financial Outcomes 2021-22

Australian Government principles for social impact investing | Treasury.gov.au

Impact Investing Won’t Save Capitalism

Transcript: Values-based Capitalism: What is the Aussie Treasurer planning? w/ John Humphreys – EP175

Gene Tunny 00:06

John Humphreys 09:12

Interesting points on that today. I think this is part of the problem that we’re sneaking up on the situation several ways. Super funds increasingly have social goals that they need to meet, as well as financial goals. You make a good point that, well, that needs to show that they’re going to meet the financial needs of the super investors. Increasingly, the super funds feel the need to meet their social KPIs, rather than their financial KPIs. And if they are required to meet social KPIs, then they’ll very easily get away with it. Remember, it’s not like this super is optional. We’re forced to give it and if the government gives the super funds who have guaranteed access to our money, social KPIs, you must do something social. By the way, here’s something social we want you to do. You can imagine it happening, even if it doesn’t have financial risk. I think the point Nick can correct me if I have not expressed her concern accurately, please jump into the chat again, Nick. But that’s my understanding of your point.

Gene Tunny 10:09

Yeah. So the whole thing with this values based capitalism, one of the concerns is that you end up with this very odd relationship between the government and banks and super funds. And in a way, it’s very odd for a Labour leader or an aspiring Labour leader. And this is a point that Matt Canavan made that he was very critical, as you probably would expect of this sort of thing. And I mean, he was saying that the treasurer seems to have been spending too much time in the boardrooms of banks and super funds. So yes, it’s, it’s very strange, but what I think might be going on, and this is, this is one thing that I’m wondering is, is this because he really doesn’t have many other options due to the state of the budget due to the high amount of debt, and due to the fact that he’s committed to the stage three tax cuts? Katherine Catherine Murphy on the Guardian podcast asked him, Okay, if you’re talking about values based capitalism, does this mean or she, she was basically asking me if you actually, given what you’re professing about values based capitalism and your concerns about inequality, etc? Does this mean you’d revisit those stage three tax cuts? And other there was a good question, and he just gave the standard line? I look, we’ve already dealt with that. And we’re, you know, my position on that. I think she probably could have pressed him more on that because it is a legitimate question, if in terms of traditional Labour government, some people have been saying that with this essay, Jim Chalmers is channelling Whitlam or it’s going back to the Whitlam government, I’m not entirely sure about that, because the Whitlam government was big spending on social welfare programmes, I really ramped that up. I mean, I know now we are spending more on that sort of thing. But there’s, I don’t know if there’s a capacity for this government, given the fiscal situation to really increase those welfare payments, or expand the welfare state much at all. And so he’s really falling back on this sort of thing, because he may not have any other option. And to an extent, that’s because the government’s had to go along with the stage three tax cuts for political reasons to win the last election. And now they can’t go back on it. So you know, this could be the only shot he’s got in the locker, so to speak. That’s one thought I’ve had on this, this essay.

John Humphreys 12:47

It will be interesting to see what they do in the next budget in terms of tax, I suspect, I’ll sneak that tax rate up, they are going into that. Look, I think that was politically hamstrung with their previous commitments. And quite frankly, I think they made the right decision to stick to their promise, both because I’m a big advocate of the stage three tax cuts, but also politically, if you want to keep any political capital, you can’t just line up lie after lie after lie in your first year in power. So I think it was the right political move and the right economic move. I suspect they also know it’s the right political move. They think it’s the wrong economic move, but they’re stuck with it. And so I’m happy about that. You’re not just a couple of quantifications. I haven’t thought about this article as long as you have, but I think you’ll write in one very important point. There’s been a lot of furor about the words. And I think the words of what Jim says, if taken literally, we shouldn’t be worried if they can, literally. But you pointed out, I think that it’s not necessarily true that we should take it literally, because there’s a lot of fluff and waffle in the middle there, that could be interpreted multiple ways. And to a large degree, what we have to do is go back to them and say, what does that mean, exactly? Exactly what I’m suggesting here. And I suspect what’s happening is there’s two things it’s worth responding to both. I suspect he’s the policy recommendations coming out of this, I suspect will end up being tinkering. I don’t think it’d be good tinkering. But this is probably a lot of grandiose statements. I’m not sure if they’re going to follow through on grandiose actions. I gotta say, as I say that, if I’m right, that would be a good thing. Because if they followed through on all the grandiose statements, I think it would be a supreme mistake for the future evolution of our country. So I am hopeful that this is a lot of bluff and bluster. But also if history is anything to go by, politicians are often full of bluff and bluster and grandiose statements. And then once they actually sit down and work out, what does this mean? It can be a tweak here and tweak there.

Gene Tunny 14:46

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

Female speaker 14:51

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Gene Tunny 15:21

Now back to the show.

John Humphreys 15:24

I do worry about them targeting the super funds, I do worry about what they when they say race, it just sort of interaction cooperation between the government in the corporate sector, that could be done in several different ways. Some of them supremely damaging, and some of them rather mild. And some of them perhaps useful, we really need to know the details first, but I worry that what he’s talking about is not the mild version. But hopefully what he does is the mild version. But what he’s talking about here has echoes of a lot of things that have been growing over the last couple of decades. Some people have actually said it in the chat and see if I can find some here. I think Percy said this twice. It’s the ESG goals. A lot of the language here is also the language of ESG, the environment, the social and governance systems. And it’s steadily in being embedded through several different means fair and foul into the goals of a lot of companies sometimes basically being shoehorned in there by governments, sometimes by industry super funds, which as was also pointed out by Percy, I think, that they are closely related to the union’s so you are getting lots of deviations from normal capitalism for ESG. Another term that’s been thrown around a lot by people that are it looks like Jim Chalmers is influenced by the stakeholder capitalism, and stakeholder capitalism, it sounds so benign, but if you scratch the surface, it’s a very worrying idea. The whole point of capitalism is that corporations are supposed to represent the owners and benefit the owner, it is capitalist who make a profit and the profit goes to the people who made the investment. That’s the idea. Stakeholder capitalism basically means all you know that ownership thing we told you about, yeah, not so much. Right? I mean, you don’t have to be an owner to have a stake, you could be a consumer, or a worker, or a neighbour or just anyone with a pet dog that ran across someone’s front yard. And that basically means society, if society is the owner, where that’s not a real thing, right? That’s always code word for government. If society is the owner of the business, i.e. government is the owner of the business. That does not, that system and economics does not have a good track record at work. There’s a couple of things here. The Chalmers thing has been likened to out and out socialism. I don’t think that’s quite right, because what he’s talking about is this incestuous relationship with big business and big government and big unions. And now socialism, just what’s the leaders of big business up against the wall, shoots them and takes their property. This is like traditional socialism. It’s been likened a bit to Whitlam. And you already mentioned that before, but it’s not quite that either. Because what Whitlam wanted to do was have the government take over all of the realms of how you help the massive welfare state, massive redistributions. He’s not really talking about changing the welfare state. He’s talking about changing the way business operates. So it’s not quite socialist. It’s not quite Whitlamisk, what I call it an eco socialism. It’s instead, this incestuous mix of big government, big corporations, big unions, and we need another word for that. There was a word for that this is not a new idea. This is the thing I’m seeing showing up by some of the op ed writers look at this wonderful new idea. It’s not Whitlam. It’s not Marx, it’s a new idea. It’s actually not a new idea. These ideas have been around for quite a while they were quite prominent, about 100 years ago. I believe, Jim Chalmers is the follower of an Italian economist at the moment. These ideas were very popular amongst a certain Italian politician. From about 90 years ago, if anyone knows their Italian history, El Deus, the Mussolini ideas were basically exactly this. But we don’t need to get rid of business. What we do is we need to have a really close relationship between big government, big business, big unions, we all work together. It may be better than for more efficient for socialism, but it’s a bloody dangerous system. And of course, if you actually call it fascism, everyone gets upset because they say no, no, no, Jim Thomas doesn’t hate the Jews. But fascism isn’t only the economic system of fascism isn’t just about being a Nazi. The economic system of fascism was quite literally the idea that big business can exist, but they just have to cooperate in bed with big government. That was literally the idea of the fascist model of the economy. And it’s not a new idea. I don’t think it has a good track record is actually working as an economic idea. And I’m not trying to say Jim Chalmers is a fascist, I’m just simply saying that we can look at how this has worked in the past. And I don’t think it’s been pretty. The other thing to note about this is they talk a big game about how much they want to cooperate with big business and integrate with them. It’s as if they that they’re unable to draw a distinction between the markets and a business. Right. I mean, most people on my side of politics we believe that a market is a better way of cool donating things, then bureaucrats and politicians. That’s true. That’s not from a love affair with business. Indeed, business are often also the enemy of markets. Like I am not pro business, I am pro markets and markets happen to have business in them. And it seems when a lefty stumbles across this idea and sees markets working, they think markets work, because there’s a couple of nice businesses. So they Co Op those businesses. But it’s not the existence of those businesses that make the market work. It’s the nature of the dynamic nature and the competitive nature of the market. That helps the market system to work. And sometimes a good market needs businesses to fail. If businesses make enough bad decisions, they fail this idea that markets defending markets are about defending businesses. Some people on outside of politics need to get out of that way of thinking, bad businesses should fail. We’re not here to defend businesses, I’m happy to defend people who make good decisions and get ahead and are rewarded for that, whether they are in any field of Endeavour. But it’s not just about defending businesses. And this approach the Chalmers has seems to be pro business anti markets, whereas I am pro market and indifferent to any individual business. And that’s some of the things I do notice in some of his language. He talks about redesigning markets, and that markets need to be carefully constructed. So I think once again, that shows a fundamental misunderstanding of what we mean with markets. Markets are evolutionary concepts. They’re not design. They’re not constructed at all. They happen sort of spontaneously out of the interaction of a bunch of voluntary interactions between consenting adults, it is a it is an evolved system. And one of the most dangerous things we have is these politicians that lack the humility to realise that they can’t design such a complex system meddling in a hugely complicated evolved system that is probably beyond their capacity, it’s beyond their can to actually understand the dynamics. It’s beyond the understanding of most people. Leonard Reed famously wrote a book saying no one knows how to, it’s called “I pencil”. And he pointed out that no one knows how to make a pencil, seems like a crazy statement. But if you unwrap each part of making a pencil, someone has to know how to cut down the wood, which means they have to know how to use a chainsaw, which means they have to know how to make the chainsaw, which means they don’t have to know how to get the metal for the chainsaw, which means they have to know how to make the iron, which the steel which comes from the iron, which comes from the mining. So you go back through all the parts of making a pencil, no one person can do it, but it comes together spontaneously, seemingly spontaneously without any central controller. That’s the important point. There’s no central controller in that. And yet, you can go and buy a pencil now for 10 cents. It involves the cooperation of literally 1000s of people around the world who speak different languages, and may not even like each other, they may hate each other. And yet 1000s of people around the world all coordinated and managed to bring you a pencil at your local store for 10 cents. That is insane. And there is no controller. It wasn’t designed, it wasn’t carefully constructed, as Jim Chalmers seems to think, it was a spontaneous order coming together. And that is the dangerous thing. I think there is when these politicians decide that they need to redesign markets in their own image. And often they have wonderful goals, right? I mean, their vision of the world, that vision of the future is not some dystopian nightmare. That’s just the accidental byproduct of their arrogance and their lack of humility. So anyway, that’s my rant on this. Now, I haven’t spent as little thinking about it as you, so maybe I’ll have to duck into it a bit more over the next week.

Gene Tunny 23:28

But I want to have a closer look at just what these vehicles are and how they intend to direct investment. I mean, he talks about, well, we’re not going to pick winners. Okay, that’s great. Oh, but we’re just gonna set the priority. So it’s like this state directed model that the French had, I think in the 50s or 60s, I wouldn’t call it fascism. I’d call it corporatism, or, or whatever the French used to call their system back in the day, the government’s got an idea of where the investment needs to go broadly. It’s sort of national economic planning. That’s the type of mindset and one thing I’m waiting to see is will they try and revive this idea of an infrastructure bank? So this was something that was raised during the time of the Rudd Government but got knocked down. Turnbull criticised Kevin Rudd has been Kev Lonnie, with reference to Kim Lonnie and there was the people were talking about well is this gonna be the new transcontinental I don’t know if you remember it was it transcontinental, the tri-continental, the, the Merchant banking arm of the state bank of Victoria that went bust in the late 80s. Victoria, when it just got into, you know, just made all these crazy loans during that, that colossal boom in the late 80s. There’s a real risk to government balance sheets here, and I just want to wait and see just what they’re proposing. And whether there is some bold scheme like that, that the treasurer could be announcing. That’s what I’m going to be looking out for.

John Humphreys 24:58

I think on the retail politics that is the right thing to look for I should reiterate, I don’t actually think Jim Chalmers is intended to be a fascist, because I don’t think he intends to follow through on the logical consequences of his own article. But I still think it’s worthwhile pushing back on the substance of the article, even if I don’t think you’ll follow through on it. I don’t want people to think of it as an ideal, because I still think the ideals in there are very dangerous. And look, I also take your point, in reality he’ll be whether it’s fascism, or corporatism, it’ll be a watered down version of that. And we need to see the details I agree. But still, the steel man version of that is worth addressing, in case it seduces the thoughts of any young people that stumble across these ideas. You make a good point that perhaps corporatism is the better word for it than fascism. I’ve thought about that a bit lately, that could work. I wonder though, whether there is a difference between the two, they both involve this incestuous relationship of big business and big government. Perhaps the difference is who has the upper hand. And I think in corporatism, perhaps the idea is that big business has the upper hand, and they kind of use big government as their tool for success. And in fascism, it’s the government has the upper hand, and they use big businesses, their tool for enforcement, or getting things done. But anyway, that’s a thought bubble there on what the potential difference could be. I don’t know which one Jim Thomas hopes he would achieve. Probably not corporatism. But I’ll cheekily put that aside for the voters. What he

Gene Tunny 26:17

wants to achieve is he wants to get enough votes from the labour left by imagining he’s can remake capitalism, where, really, he’s going to get some he’s going to create some investment vehicles. There’ll be some additional money into into renewables and housing. But is it really going to make much of a difference? And I don’t know, I mean, in housing that, you know, that’s one of their big challenges. I mean, that housing affordability is a massive problem now. And the number of people who can’t find accommodation, particularly in Brisbane, I mean, I go for a walk along Wickham terrace in Spring Hill. And I mean, the usual homeless people, you see, but now you see there are people living in cars, they’ve got all their worldly possessions, in, in the back of their vehicles. And it’s just tragic. And it’s because for years, we’ve just stopped people from building houses where people want them. So we’ve got, we’ve got problems that have been created, in part through government regulation. And now that’s going to be used as one of the excuses for remaking capitalism and providing, I don’t know, whatever, they’re going to do subsidised housing, there’ll be some money for that social housing, but it’s not really going to be enough to solve the problem, in my view.

John Humphreys 27:30

But it’s so often the theme, isn’t it? A government programme goes wrong. And the lefties turn around for capitalists to say, Why did you do that? And then they use that to justify another government programme that also goes wrong. And the whole cycle repeats itself. I do like the fact that every time I try to get us distracted in a conversation about the grandiose philosophy of the implications of Jim Chalmers article, he brings us back to the real retail politics, which I think is entirely correct. I think your read on this is true that his grand philosophical statements, they’re mostly just fluff and waffles so that he can try to get the Labour leadership and it’ll mean a bit of tinkering. I think you’re right. I just still enjoy rebutting the actual words. Anyway, that this has been a fun discussion.

Gene Tunny 28:13

Definitely John. Okay, I hope you enjoyed my conversation with John Humphrys about the Australian treasurer’s essay on values based capitalism. I’d say the takeaways from the episode include firstly, that there’s clearly been a big change in the intellectual climate since the financial crisis, and treasurer Jim Chalmers has picked up on this making some of the standard criticisms of so called Neo liberalism. Secondly, it’s important to consider specific policies and to weigh up their costs and benefits and the likelihood that claim benefits will be achieved in my view. If we do so it’s understandable why there’s been such a negative reaction to Jim Chalmers essay by economists and financial commentators here in Australia, I should say, I don’t want to be too negative. I have met Jim Chalmers in the past when he worked for treasurer Wayne Swan, and he struck me as a nice person. He clearly thinks a lot about economic issues, and I respect that. And the treasurer did say some say on things in the essay, for instance, he writes, in the wider world, the contest between democracies and autocracies is economic as well as military. Despite deep disquiet about our own economic models. The reality is that democracies largely work. As of 2021 GDP per capita is around 60%, higher in democracies than in autocracies and the gap isn’t closing. Thankfully, Chalmers is a Social Democrat rather than a revolutionary. But he argues that to protect democracy, we need to have greater economic inclusion. That’s fair enough, but we need to think critically about the measures he proposes to promote it. obvious questions include, will they actually achieve greater economic inclusion, what will they cost? What are the risks to the government’s balance sheet and to taxpayers who will ultimately bear the cost of any bad investments? As I suggested in my conversation with John, history tells us we should be wary of governments owning banks or other financial institutions that don’t have a great track record. The failures of the state banks of South Australia and Victoria were big news in the early 90s. But now three decades have passed and the lessons may have been forgotten sadly. Also, as I noted, when chatting with John the results of the body that the treasurer calls a great success, the Clean Energy Finance Corporation, well, they’ve been pretty ordinary and they don’t appear to be meeting the target of return. The presentation of the financial results for the corporation is rather confusing, but it looks to me that they’re underperforming. I’ll put a link in the show notes so you can see for yourself. One thing I should have covered in my chat with John is the concept of social impact investing. This is an investment where there are both financial and social returns, such as in a profitable social housing development. Social impact investing is one of the concepts that Jim Chalmers is fond of. In a recent financial review article, John Keogh referred to an example from New South Wales in 2013, a social impact bond which raised $7 million from investors to finance the new PIN programme. N E W P I N. New PIN stands for New Parent Infant network. It appears to be a programme to support new parents so they look after their children properly and the children don’t end up in foster care. It looks like the Queensland Government has tried something similar. Typically, impact investments require government involvement of some sort to ensure that the private sector investors get a return. For instance, governments could pay performance bonuses if certain social outcomes are achieved. There’s a handy note from the Treasury which summarises the Australian Government’s principles for social impact investing, which I’ll link to in the show notes refers to such things as payments by results, contracts and outcomes focus grants, that’s how the investors will be rewarded if the investment achieves its social objectives. These payments could be justified because successful programmes could result in budgetary savings in the future. For example, if programmes result in healthier children, that could reduce health costs in the future. You could also imagine programmes resulting in savings in welfare spending, or cost of the justice system. I’d say that such savings are possible, but we should think critically about the likelihood of such benefits and follow up to make sure that they do actually occur. That is, so we’re not paying nonprofits and investors additional money for results that they don’t actually achieve. It looks like treasurer charmers might end up announcing a social impact investment bank in his next Australian government budget in May 2023. James says that the Financial Review gave a good summary of what this bank could do in an article in October last year, which I’ll link to in the show notes. He wrote, the new body would work with investors to supply capital to intermediary funds, which would direct private investment into social housing, aged care, early education or disability services alongside government funding. This could take some pressure off the government budget for providing these services alone. Okay, that’s the point I made in my chat with John, that some of the motivation for what Chalmers is proposing is the poor state of the government budget, they just don’t have the money to undertake traditional programmes. He’s talking about impact investing because he doesn’t have a lot of options. With his social impact investing bank, he can support things that he wants to do off budget, so to speak. James Ayers continues, the institution would make returns when service providers who would typically be receiving some government funding make predetermined improvements to social outcomes such as housing, education or caring for more people under agreed service standards. Apparently, there’s a body like this already in the UK called Big Society Capital. There’s a fair bit to explore with impact investing, so better return to it for a closer look at a future episode. There are a lot of players involved and I’ll do my best to get someone familiar with impact investing on the show for a deep dive. In the Australian model, it looks like there’ll be a government backed social impact investment bank referred to as a wholesaler. Major commercial banks could also provide capital for this bank. It appears based on reporting from the financial review. There’s talk about 200 million coming from the government and 200 million from the private sector. I expect the social impact investment bank will provide finance at lower than market rates for social impact investing funds. These funds then invest in nonprofits or so-called Social Enterprise causes which are delivering programmes under government contracts. An example of a social impact investing fund is the $91 million social impact investment trust, established by social ventures Australia, a nonprofit and Hester a superannuation fund. How the performance bonuses are shared by the nonprofit, the investors and the government back bank will need to be defined by various contracts between the players. This all seems very elaborate to me. There are no doubt a lot of investment bankers and fund managers earning healthy fees along the way. Does this lead to better results? It may do so if the investors push the nonprofit to deliver superior services. As always, I’m open minded but sceptical. I’ve seen that the consultancy firm Airbus has undertaken a positive evaluation of the New South Wales new ping programme. So it could be good to go through that in a future episode. I haven’t had a real chance to dissect that one yet. I do wonder just how much we can rely on impact investing to solve social problems compared with other measures. As I noted with John, I doubt it will solve the housing availability shortage, which to me appears related to restrictions on housing developments. And it’s not going to replace welfare state programmes such as Australia’s various support payments and the National Disability scheme. Maybe you can do positive things at the margins, we have to wait and see because it’s still early days when it comes to impact investing. For a sceptical take on impact investing, which I’ll link to in the show notes, I’d refer you to a 2020 Harvard Business Review article by Ruben Finnegan, who I know well and Alan Schwartz is a prominent Australian businessman. Impact Investing won’t save capitalism. Okay, that’s all from me on values based capitalism for now. If you’d like a closer look at impact investing or any other topic, please let me know. Thank you. Right oh, thanks for listening to this episode of Economics Explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting outlets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

37:41

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Tags australia, capitalism, climate change, corporatism, esg, impact investing, inequality, socialism

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