Richard Holden

Much will be written in the coming days about the turbulent political times in which Malcolm Fraser ascended to the prime ministership. But it is worth remembering that they were terribly turbulent economic times as well.

A simple chronology will note that Fraser’s prime ministership was wedged between the chaos of the Whitlam years and the seismic reforms of the Hawke-Keating era. But there’s more to Fraser’s economic legacy than that.

Fraser came to power amid a shocking economic occurrence: stagflation. Until the early 1970s it was thought by economists that high inflation and high unemployment could not occur at the same time.

This belief came from the prevailing Keynesian models of the era which posited a stable trade-off between inflation and unemployment. Rev the economy a bit faster and you got more employment and output but stoked inflation. Take the foot off the pedal and the opposite occurred.

But from 1973 onward this all changed. In 1975, inflation hit an alarming peak of 16%. In the decade that followed, Australia’s unemployment grew five-fold, spiking in 1982 as high as 10%.

At the same time, wages shot up, putting pressure on prices, which in turn put pressure on wages. This so-called wage-price-spiral was hard to break.

The Fraser government took a pragmatic, if not principled approach. Serious downward pressure was put on wages, but the spiral was never broken until the prices and income accord of the subsequent government.

Fraser’s “razor gang” cut back on commonwealth spending in a serious way — spending that was completely out of control under Whitlam. The Campbell report on financial reform – a watershed in Australian economic history – was commissioned, though not implemented.

Yet he didn’t go nearly as far as many members of his own government wanted in cutting back the role of the state and advancing free enterprise. The “dries” of the Liberal Party wanted a much more Thatcherite approach to the problems facing the Australian economy.

Yet Fraser resisted. He certainly pushed in a more free-market direction: government spending was cut, trade became more free, huge wage claims were curtailed. But he didn’t go all the way to Reagan’s “government is the problem” or Thatcher’s radical individualism.

In many ways Fraser approached the economy like a wise family doctor advising on dieting and weight loss: enjoy a little of everything, in moderation.

When Fraser became prime minister, the economic theory that would replace radical Keynesianism — the rational expectations revolution — was still being formulated and refined by Robert Lucas at the University of Chicago, along with others.

There was no clear path for what to do, and Fraser neatly steered a middle course. He did no harm to the patient, and laid the groundwork for the recovery to come.

In hindsight, could he have done better? Sure. His treasurer, John Howard, intimated as much in his recent interviews with News Corp columnist Janet Albrechtsen.

From my perspective we could have used a bit more Lucas and a lot less Keynes. More understanding of the virtues of competition and free trade. But Fraser lived economic events forward, without the benefit of hindsight, time to assess and reassess, and without the sophisticated number crunching that policy-makers have today.

Of course, Fraser’s legacy was arguably chiefly outside the economic sphere. Others will no doubt point to a variety of principled moral stands: against apartheid, for indigenous land rights, and in his post prime-ministerial years for a range of humanitarian causes.

Fraser was clearly a very decent human being.

But it would be wrong to think that he wasn’t also a good economic manager. In many ways he laid the groundwork for the Hawke-Keating years.

He certainly wasn’t a visionary like Keating, nor did major reforms take place on his watch. But he did steady the Australian economic ship for long enough that Keating had something to work with.

Australia can be justifiably proud of an approach to economics that is squarely between Europe and the US. The US, on the whole, champions free enterprise despite the social costs; Europe sees a much larger role for the state, even if that inhibits free enterprise. The Australia in which we live today is somewhere in between.

When Fraser became prime minister that was all up for grabs. We could have become “old Europe” or veered on to a radically individualist path in response to the debacle that came before.

Fraser helped us chart a middle course, and we should be very grateful for that.

Richard Holden is a professor of economics at UNSW Business School. A version of this post appeared on The Conversation.

Richard Holden

In the wake of the Queensland state election, and in the run-up to the election in NSW, privatisation is, once again, a hot topic.

Predictably, Labor is running a scare campaign that makes Henny Penny look like an optimist. If we privatise electricity distribution in NSW then not only will the sky fall in but the ground on which we walk will be in trouble, too. We will rue the day we deigned to discuss it.

The Liberal Party is no slouch in the scare stakes either: privatisation is so obviously right that we’ll tie building roads and basic infrastructure to it. No sell the poles and wires, no good stuff.

I’m not so sure.

There are sensible arguments on both sides of the privatisation debate. We just haven’t heard them yet. So here goes.

Most people would agree with the following statement: there are some things that government should pay for. National defence, primary and secondary education, basic healthcare – these are things that almost all of us acknowledge that government should pay for.

But what should government own? After all, we could give students (or their parents) a voucher for primary and secondary education. The same goes for healthcare. Just because government should pay for some stuff doesn’t mean they should own it.

After all, the government can outsource all sorts of functions to private-sector companies which face competitive pressure to do a good job at a low cost.

Yet sometimes government should not just pay for things, it should own them, too. Not often, but sometimes. And it’s useful to understand when and why.

The most insightful example is prisons – as Harvard economists Oliver Hart and Andrei Shleifer pointed out in 1997, along with Robert Vishny of the University of Chicago, in a now classic academic paper in the world’s oldest and most highly regarded economics journal: The Quarterly Journal of Economics.

Imagine privatising a prison. The downside of public ownership is that the warden who runs the prison has terribly weak incentives to cut costs and find efficiencies. He or she is just an employee, after all.

In contrast, private ownership will provide strong incentives for cost reduction because the private provider gets all the benefit of cost reductions.

But if quality – such as how prisoners are treated and what rehabilitation services are provided – is hard to describe in a contract, then these incentives might be too strong. Private prisons could cut costs by providing substandard treatment and insufficient rehabilitation services.

This is hard to dismiss as ivory-tower academic waffle. There’s plenty of evidence about how privatised prisons treat prisoners. And it ain’t pretty.

In a world of perfect foresight and perfect contracts none of this would matter. But in the real world there is a trade-off. Private ownership provides big incentives for cost cutting, but it typically comes at the expense of quality. Public ownership provides weak incentives across the board.

The key question is how hard it is to contract on what the government wants from a private provider.

The public debate that I listen to right now involves pretty silly arguments on both sides.

On the Left: “These are essential services” – subtext: “I wish the government could run everything, but we’ve lost that fight, and this is the last asset standing.”

On the Right: “Business is more efficient than government” – subtext: “I don’t trust public-sector-types to run a bath, let alone a $20 billion business.”

The key in all of this is that privatised entities will respond to incentives – they will cut costs. But experience teaches us that they will cut costs across the board, and there are some things we, as a society, want more rather than less of.

“Quality” and “innovation” are chief among those things.

So what about poles and wires in NSW? To make a serious case against privatisation requires pointing to big issues that the government cannot contract on in the process. It’s hard to see what those might be. This is a simple business with easily measurable outputs.

We all know what quality electricity provision means and the technology is well understood. Privatisation would provide incentives for cost reduction and free up much-needed capital for the state government.

Government should own things when, and only when, it is hard to describe what “quality provision” means and hence residual rights of control are important. Poles and wires in NSW is not such a case.

Both sides of politics would do well to drop the ideological pronouncements and get pragmatic.

Privatising these assets is neither “right” nor “wrong”. It’s just efficient and sensible. Like most things in life, it involves a trade-off. But this one is clear. The NSW government has no business being in the electricity business.

Richard Holden is professor of economics at UNSW Business School. A version of this post appeared in The Australian Financial Review.

Richard Holden

If you want a recipe for a really bad public policy debate, combine the following ingredients: taxes, government spending, children’s welfare, gender equity and jobs.

However, there is one simple answer to the debate on childcare in Australia. Taxation.

The Productivity Commission has now delivered its long awaited report on the matter. Its answer? It’s all terribly complicated. According to the commission, we need sliding scales and means tests, carve outs and exemptions. It’s all a balancing act that can only be performed by a bureaucrat’s Excel spreadsheet.

I’m not convinced. It’s much simpler than that. Just make it tax deductible.

The reality is that childcare subsidies are not very complicated. We don’t need big, thick reports to get to the right answer. And we can do away with most of the agonised commentary as well.

So let’s take a deep breath and get back to first principles about childcare subsidies.

Why does the government subsidise some things and not others? Two reasons. The first is dignity. We believe that everyone who lives in Australia should have a basic level of human dignity.

So we provide a basic level of services for health, education, housing and other things. And so we should. It’s part of what makes Australia a great country. In some cases, this will also include the provision of childcare. For disadvantaged parents, affordable childcare can be essential to the ability to earn a basic living.

Existing policies on childcare also reflect this understanding, though rising costs may be putting access of this kind under pressure.

The second reason government subsidises things is because free markets – though great – don’t always get everything right. In the language of economics, sometimes there are “externalities”. Government subsidies are a way of “internalising” those externalities – a way of preserving the magic of the market, but getting the price signals right.

And so it is—or at least should be—with childcare. The market, left to its own devices, would provide too little and parents would consume too little childcare.

Why? There is a swathe of evidence – such as that from Nobel prize-winning economist Jim Heckman – that quality early childhood care has particularly large benefits for disadvantaged children.

Formal childcare can be essential to addressing the needs of disadvantaged children in ways that mean they also require less support from society later in life. This is the whole idea behind “head start” or early intervention.

Affordable childcare is also important to supporting job-market participation by parents, and particularly women. This has important gender-equity implications, which society as a whole should care about.

But it also has critical economic implications in terms of job-market participation and overall workforce productivity. Remember that G20 pledge Tony Abbott (correctly) made?

With taxes on income and a free market for childcare, parents rationally under-consume childcare. The playing field is tilted in favour of them doing more of it themselves because they are not taxed on the labour they provide in taking care of kids, but have to pay in after-tax dollars for market-based childcare.

Tax deductibility of childcare levels the economic playing field. Case closed.

There may be good arguments – based on dignity and the needs of disadvantaged children – for providing childcare subsidies. Those subsidies should also keep pace with changes in the costs and structure of the industry in ways that may warrant some form of government Excel spreadsheet.  But the key challenge on childcare is about economic participation.

In this context, we subsidise childcare not because it’s like healthcare, or a basic right, but because income taxes distort people’s decisions about how much time to spend at work versus at home.

Those  income taxes are vital for a whole range of reasons, but when they distort other decisions – such how much to give to charity – we fix it by making things tax deductible. And that’s precisely what we should do with childcare.

There is, of course, a complicated set of questions about who should provide childcare, and standards and accreditation. Sometimes, we might have good reason to want to insist that children be cared for in a formal setting: there are strong arguments for the educational and social benefits of formal daycare.

These benefits may also be especially important for disadvantaged or socially isolated children. In other contexts, we might think that parental flexibility, or individualised care, is more important.

But just because the government pays for (part of) something doesn’t mean they need to set up a separate agency to oversee how it is provided. In most cases, we think that parents are well placed to decide how best to spend any subsidy, or tax-deduction, they receive for childcare.

Anyone who has children knows that caring for them is a joy, a privilege, and a responsibility freely taken up. Work is also important. It gives people another sense of purpose, affords the dignity of providing for oneself and a family, and produces tax revenue for the government.

How to balance those things is perhaps the greatest challenge a working parent ever faces. The choices can be wrenching at times. But for government, the answer is simple:

Make childcare tax deductible. Provide a subsidy for those who earn below a certain income. Then stop.

Richard Holden is a professor of economics at UNSW Business School. Twitter: @profholden