From the Knowledge@Wharton today blog.

Those who may chuckle at the cutting phrase “no good deed goes unpunished” might appreciate how it fits today’s banking crisis in one respect: Regulators who, post-crisis, devised so-called stress tests to uncover – and ultimately repair – bank weaknesses, could inadvertently spark a bank run by disclosing the test results. Yet, without some level of public disclosure, the stress tests might not have the intended market disciplinary effect.

But there is a path away from this dilemma, according to a recent paper by Wharton finance professor Itay Goldstein and his colleague, Haresh Sapra of the University of Chicago Booth School of Business. In the paper, titled “Should Banks’ Stress Test Results be Disclosed? An Analysis of the Costs and Benefits,” the two argue that some fixes to the stress test process could beef up weak banks by identifying problems before they blow up and also guard against damaging disclosures that could trigger a bank run.

“The disclosure of stress test results can be beneficial because they promote financial stability,” says Goldstein, and they can be “quite useful in providing market discipline for individual banks and helping with the accountability of regulators.” That all provides the right incentives.

But given banks’ deep vulnerability to the disclosure of financial deficiencies, indiscriminant disclosure can cause problems. If depositors and investors lose confidence, they will withdraw their money and possibly cause a bank to fail. And when disclosure makes bad news public, markets tend to amplify it, Goldstein points out. Even those who may believe a bank under fire is actually sound will abandon the institution because they must account for “what others may think.” A bank-run scenario can become a self-fulfilling prophecy, so regulators must carefully consider what information to release.

What is more, publicly disclosing stress test results can have an adverse effect on the behavior of bank managers, who may game the system by putting too many resources toward passing the stress test, rather than doing what is best long term. “If a manager does not know [the test criteria] there is less room for manipulation or gaming,” Goldstein says.

The authors’ recommendations? Any disclosure of problems with an individual bank should be precise – to avoid misunderstandings – and should come with a prescription for corrective action, so that markets can see that the situation is not necessarily dire. “The danger arises if we just say we found that a bank is in trouble, and don’t follow up with action,” Goldstein says. Instead, the message should be “We found a problem and now we are taking these steps to make things better.”

If regulators cannot meet that bar, then they should instead issue a system-wide evaluation offering aggregate results, and avoid singling out any one bank. While stress testing can be good for the banking system as a whole, regulators have to be “more careful with individual banks,” Goldstein points out.

System-wide disclosure can also moderate a more subtle challenge, where disclosure can adversely affect the inner workings of the market – specifically, how investors trade based on information. Market prices reflect the total information held by market participants, who trade on it. Once regulators provide more information via disclosure, some participants may feel they are losing their information advantage and thus could lose interest in trading in the area. That makes it more difficult for regulators to learn about the market from price signals, which in turn could degrade the regulatory effort. Aggregated disclosure can also help sidestep that problem.

So, could stress tests, introduced after the financial meltdown, have prevented the disaster? “They potentially could have made banks more prepared and reduced the extent” of the crash, Goldstein says. “But it’s always a challenge. We are prepared for things that happened in the past,” not in the present. “People talked about subprime and fragility for some time before the crisis, but the common thought was that it was a local problem that could affect some banks, but any damage would be contained and so it was not a big problem. They failed to understand the macro or general equilibrium implications — once one banks folds, it affects others that are connected to it and this contagion was hard to predict…. You can’t predict everything.”

Once a crisis is underway, however, full disclosure is the best course. “There is no choice but to disclose during a crisis.” There already is so little confidence that not disclosing at that point could cause more damage, though disclosure probably “will not help much.”

This post previously appeared in the Knowledge@Wharton today blog: Avoiding the Slippery Slope toward a Bank Run

From the Knowledge@Wharton today blog.

Is India heading towards the end of its much-touted growth story? A report by global credit rating agency Standard and Poor’s (S&P) released on June 11 seems to suggest so. Titled “Will India be the first BRIC fallen angel,” the report cautions that India may become the first so-called “BRIC” (Brazil, Russia, India and China) country to lose its investment grade rating.

According to the report, slowing growth and political road-blocks in policy making could lead to Indian paper being relegated to junk bond status. The report notes that “the division of roles between a politically powerful Congress president who can take credit for the party’s two recent national election victories, and an appointed Prime Minister has weakened the framework for making economic policy.” It further warns that “setbacks or reversals in India’s path towards a more liberal economy could hurt its long-term growth prospects and, therefore, its credit quality.”

S&P’s latest statement on India is in line with its earlier move a few weeks ago. In April, the agency had lowered India’s rating outlook from stable to negative and warned that further action would follow if India did not get its act together. India’s sovereign rating by S&P is BBB-, which is the lowest investment grade rating among the BRIC countries. It is also the only BRIC country with a negative outlook. S&P’s rating for China is AA- with a stable outlook. For Russia and Brazil, it is BBB with a stable outlook.

S&P’s newest warning spooked the markets — the stock market went down and so did the rupee (although they did recover the following day) — but the government seems unfazed. In a statement, Finance Minister Pranab Mukherjee said: “Between April 2012 and now, there are no significant events to indicate that the economy’s vulnerability to shocks has increased, though growth numbers for the fourth quarter [of] 2011-2012 have come below expectations.” Barely a few hours before the S&P report was released, while addressing a function in New Delhi, Mukherjee had said: “I do not accept the prophecies of self-styled Cassandras that GDP growth will go down.”

How much of this is bravado — and what measures the government will take to get back on track — will be clear in the coming weeks and months. For now, there is not much to cheer about. India’s GDP growth for the January–March quarter at 5.3% was the lowest in nine years. For the year 2012-2013, growth estimates now are at around 6% — way below the 7.6% the government had projected at the beginning of the year. The country is also facing fiscal and current account deficits.

According to Rajesh Chakrabarti, assistant professor of finance at the Indian School of Business, the possibility of a downgrade by S&P is not surprising, since the India brand has been taking a hit on many fronts for the past several months. However, he is not convinced by the reasoning offered by the agency. “While there is indeed a slowdown on policy initiatives and growth has slowed down, the fact that a country [could lose] its rating because some of the anticipated things did not happen is a rather strange argument. Normally, a downgrade would happen because of adverse events rather than non-happening of positive events.” He adds that growth slowing down per se is not a risk factor. “While [slower growth] may reduce the prospects of future gains, it does not make the country more risky.”

At the same time, Chakrabarti believes that the move by the rating agency could be a timely warning for the government. “If the government wakes up [as a result of S&P’s warning] it will be great for the country and the economy. But of course to what extent the government reacts to it remains to be seen.”

Others, too, believe that S&P’s move could have an upside. “I see it as a positive development for the economy and the market. This will push the government to move faster on reforms, with the RBI (Reserve Bank of India) helping through rate cuts,” said Dharmesh Mehta, managing director – institutional equity at Enam Securities, talking to the daily newspaper Times of India. Samiran Chakraborty, chief economist and head of research at Standard Chartered Bank, told business daily Business Standard: “Getting growth on track assumes more importance than ever, and a pro-growth policy stance will be critical.”

Over to the Indian government.

This post previously appeared in the Knowledge@Wharton today blog: Is the India Growth Story Over?

 Tim Harcourt | The Airport Economist

A recent visit by a pop icon can demonstrate the vast cultural diversity of the region we simply lump together as ‘Asia’ despite its amazing mix of ethnicities and cultures. When Lady Gaga visited Japan, she was the first high profile foreign female to visit the country after the twin natural disasters of the Earthquake and the Tsunami. Her visit was considered good for morale for a grieving Japanese public in aftermath of the disasters that shook the community literally and psychologically. In fact, Australian Prime Minister Julia Gillard also visited Japan after the disasters and was the first foreign head of government to spend some time there (then French President Nicholas Sarkozy only touched down briefly).

But Jakarta is not Japan. In Indonesia Lady Gaga was gagged and concerts cancelled. Is this surge of political nationalism related to the upcoming elections and parties jockeying for position? Several foreign observers of Indonesian politics say it isn’t anything to do with elections but just the need to respect the values and mores of the world’s largest Muslim population. And in any case many touring acts come through Indonesia and the rest of South East Asia without incident.

But political nationalism is one thing what about economic nationalism? With elections coming up, Indonesia is no different than any democracy with parties calling for tariff changes and protection of local industry. This is important for the Australia-Indonesian economic relationship too given our strong trade and investment links in Indonesia. I realised how important the bilateral ties were when I was recently the co-host of the the distinguished Australian Alumni Awards in Indonesia with Frida Lidwina, the host of Metro TV in Jakarta, and saw how many Indonesian business and political figures were Australian educated and very close to Australia. In fact, this was at the time of the live cattle issue on Four Corners, and one of Indonesia’s most famous Australian alumni was the Mahendra Siregar, Vice-Minister for Trade (now Finance who went to Monash), and there was plenty a tension in the room. But the Vice Minister was gracious in his remarks and it took a very skilled and professional performance by Australia’s Ambassador to Jakarta, Greg Moriarty to steer us through the issue. If anyone ever wanted to see the skill and professionalism of our diplomatic corps, I’d point to that performance by Ambassador Moriarty and his team in the Embassy in Jakarta as a great example of excellence.

But despite the headlines of Lady Gaga and live sheep, when I interviewed Australian businesses in the country most have found Indonesia to be quite accessible with a prosperous, growth story despite the political economy challenges of dealing with such a massive population on a diverse archipelago. For example, in financial services, according to the ANZ’s Joseph Abraham, the Bank has expanded from “2 to 28 branches in 4 years, which would be harder to do in alternative markets like China and India.” Abraham describes Indonesia as “a good growth story, with high rates of return, estimated to be around 30 per cent higher on average than other markets.”

Justin Collings of Leightons in Jakarta agrees. “Rates of return are healthy in Indonesia, there are risks but you must understand the risks and put a value on it,” he explained. Collings, whose operation with Leightons is 80 per cent in mining, is also building crucial rail and road infrastructure, does refer to changing governance in Indonesia but says that: “Regulations change a lot and are a challenge, but they can be managed effectively and the negative aspects minimised.”

Collins points to strong education levels as important to business practice in Indonesia. “Many of our Indonesian staff are Australian educated, and/or trained in Australia. For managers, the International schools in Jakarta are excellent, including the Australian and New Zealand schools.” Collins says that “they know you are living the life of a contractor because your kids are sick and your furniture is broken, but we’ve has none of those issues here in Indonesia.”

Another Australian executive in Indonesia, Greg Patching, of Orica, also regards education relationship between Australia and Indonesia as crucial to the business expansion that Orica is undertaking in Indonesia. “We regularly send Indonesian staff to Australia for technical and cross cultural career development, they learn a lot there and we certainly learn a lot from them as a result.” Patching, a Fremantle Dockers supporter and currently on the playing list of the Jakarta Bintangs Australian rules football club (a notable fixture of the club was the late Craig Senger, a wonderful Australian trade diplomat in Indonesia and friend of the author), says that “life does have its moments in Indonesia, but it’s nothing like the hardship of following the Fremantle Football Club.”

Speaking of football, another Australian business figure in the region, Andrew Glynn of agricultural company Agspec Asia, has forged a partnership with the world famous Liverpool football club’s International Academy and Soccer Skills to bring sport and recreation to rural Indonesia. Together with the Liverpool Football Club International Academy and Soccer Schools (Indonesia), Agspec has set up a community programme for the kids of farmers in the poor rural parts of West Java. According to Glynn, “I grew up in rural South Australia, near Mount Gambier, so I wanted to do something for farm kids here in Indonesia who really do do it tough. The generosity of the mighty reds – the legendary  Liverpool Football Club – is making it possible for these kids to reach their potential.” Indeed, Liverpool legend Bill Shankly would be proud.

So Lady gaga is not in Indonesia, but Liverpool is in, along with many Australian businesses. Given its still only a decade on from the Asian crisis of 1997-99 which saw IMF intervention and real problems for the nation, Indonesia has performed solidly. Indeed, with its new found robust democracy and economic growth rates, Indonesia continues to surprise us on the upside. But cultural sensitivity still matters on the world’s largest Muslim nation. So to think, probably the only thing Lady Gaga had to succeed in Indonesia, which should not have been too much of an effort, was to put on some pants.

A version of this blog post recently appeared in the Australian Financial Review.

Tim Harcourt is the JW Nevile Fellow in Economics and an adjunct professor in International Business Strategy, at the Australian School of Business, the University of New South Wales (UNSW) & author of The Airport Economist:  www.theairporteconomist.com. He recently co-hosted the distinguished Australian Alumni Awards in Indonesia.

John Taylor

The government is proposing to reform income tax transfer pricing, with the aim of increasing the amount of tax paid by foreign companies.

The issue became inflamed when Google published its annual results to the Australian Securities and Investment Commission, which showed that it had reported a loss for its Australian business in 2011, and paid a total of AU$74,176 in tax. Some commentators expressed surprise at this.

The government argues that Australia needs to ensure there is not what it calls an “erosion” of the tax base owing to the multinational nature of the Internet sector and the ability of technology companies to shift profits around the globe among different tax jurisdictions. Although governments around the world are belatedly trying to claw back lost tax revenues from the digital economy, their ability to do so may be marginal at best.

Transfer pricing relates to intercompany transactions within multinational companies. Tax authorities can make judgments on whether multinationals are paying the requisite amount of tax on revenue actually earned in the local jurisdiction, with the aim of preventing the company shifting profits to lower tax jurisdictions.

Australia only taxes foreign resident companies on income that is sourced in this country. Australian advertisers booking ads with Google are mostly billed by its Irish subsidiary, and Google Australia hasn’t earned any income on which it should pay tax.

Therefore reforming income tax transfer pricing won’t do anything. It might be that Google Ireland invoices Australian advertisers for advertisements placed on a website on a server located outside Australia. Google can structure the transaction so that Australian law will regard the income as not having an Australian source and hence not being taxable here. There is not likely to be a transfer pricing issue at all, because transfer pricing involves dealings between entities that are connected with each other – under tax treaty rules – or that are not dealing at arm’s length – under domestic law. If Google Ireland and Google Australia are legally at ‘arms length’ there is no transfer pricing issue.

Therefore changing the transfer pricing rules won’t fix the issue with the amount of tax that Google pays in Australia. If Senator Conroy really thinks it is a solution, then he doesn’t understand the problem. The only answer would be for Australia to either change its rules for determining when income has an Australian source or to tax foreign residents on some basis other than their income has an Australian source. Either course would be inconsistent with current international norms.

Professor John Taylor is the Head of Taxation and Business Law at the Australian School of Business

Rumours surfaced last week that Facebook is gearing up to launch its own smartphone. According to Facebook employees and others who spoke with The New York Times, the firm has begun recruiting former engineers from Apple to bring its existing plans for a Facebook phone — codenamed “Buffy” — closer to fruition.

The Times article notes that Facebook is not the only software maker looking to develop its own hardware: While the social network giant was dealing with the fallout from its inauspicious late May market debut, Google quietly completed its US$12.5 billion acquisition of Motorola, “which could lead to the search giant’s making its own smartphone.”

And while integrating software and hardware may be the ultimate goal for many tech companies in a post-Apple world, some observers are not convinced that introducing its own smartphone would be the right move for Facebook. “[It] makes no sense at all — slightly more sensible than a Facebook dishwasher, but not quite as sensible as a Facebook toaster, which would alert all your friends every time you make toast,” says Wharton marketing professor Peter Fader. “I can’t imagine why they would want to get into such a competitive, commoditised market, and what they would hope to get out of it.”

But Wharton marketing professor Eric Bradlow, who co-directs the Wharton Customer Analytics Initiative along with Fader, takes a different view. Bradlow notes that firms like Facebook “are realising that today, the ‘point of entry’ onto the web plays a big role.” As an example, he cites Amazon’s Kindle device, which the company sells to consumers for a price that is below its manufacturing cost. Why? “Because then the portal to Amazon products is at the touch of a finger — and the [customer lifetime value] for the person, despite the loss leader on the device, is still very positive.” Moreover, Facebook needs to protect its long-term consumer base, he adds. “Imagine that everyone starts walking around with Google phones, then all of a sudden Google+ becomes the social network hub.” 

The bottom line, according to Bradlow and other analysts, is that as users increasingly rely on their mobile devices to connect to the web, Facebook needs to follow suit — or be left behind. In fact, prior to its IPO, Facebook conceded that the challenges of gaining traction in the mobile market pose a potential risk for the firm — an admission which some analysts believe partly accounts for the stock’s dismal performance.

According to Kendall Whitehouse, Wharton director of new media, it isn’t clear that hardware is the only way for Facebook to balance the equation. Instead, the firm might simply need stronger mobile app development. He points to Twitter as one example of software that translates exceptionally well to a mobile environment, “because its interface is simple and elegant.” That’s not the case for Facebook, which is crammed with features and has an interface that is anything but simple. His advice? “Use the employees at Instagram” — the mobile photo application firm that Facebook recently purchased for US$1 billion — “to develop a really good mobile app.”

This post previously appeared in the Knowledge@Wharton today blog: Calling Facebook: Do You Really Need a Phone?

Rafal Chomik | CEPAR Senior Research Fellow

Birthdays are a good time for self reflection. This month’s tenth birthday of the first Intergenerational Report (IGR) – an account of the long term fiscal sustainability of Commonwealth policies produced every 3-5 years – was no exception.

The occasion was marked with a conference in Canberra, bringing together leaders from the civil service, academia and industry to reflect on ten years of projections and policies coming out of the IGR, as well as some of the remaining problems. CEPAR Director, Professor John Piggott, spoke about pension policy and Deputy Director, Professor Peter McDonald, presented on population projections.

Of course, evaluating the past is easier than projecting the future, but instructive nonetheless [1]. The projections are for forty years and include the impact of population ageing on the retirement income regime.
The current picture looks positive. Australia’s retirement system compares well internationally. Spending on age-related pensions, the aged dependency ratio, and old-age poverty (measured after housing costs) are low by international standards. Super assets are approximately equal to GDP, one of the highest ratios in the world.

And the IGRs have shown successively less severe population ageing and less dramatic increases in related spending. The 2002 report projected that in 2041-42, the cost of pensions would be 4.6% of GDP. By the 2007 report, this was 0.3 percentage points lower. The 2010 projection was 0.6 percentage points lower still.

The first thing to note about these figures is that improvements in the projections within the three reports are not necessarily because of policy reforms, though there were many. Much of this is due to the underlying, long-term demographic and labour market assumptions. For example, the long-term fertility rate assumption increased from 1.6 to 1.7, and then to 1.9 births per woman; net migration from 90,000 to 110,000, and 180,000 people per year; and mature age participation saw dramatic upward revisions.

In most cases, Treasury was taking very recent experience and keeping it constant for 40 years. While IGR projection methodology is commendable on many counts, these examples suggest some assumption myopia. Increases to participation, for instance, have been variously predicted and documented [2]. Longevity assumptions also need careful analysis. Recent mid-life longevity increases took most people by surprise, particularly in Australia: between 1950 and 1980, life expectancy at birth and at 50 increased by 7% and 10%, respectively, but between 1980 and 2007 the increase was 12% and 26% [3]. CEPAR is looking at this by fitting a mortality model with data on reductions in smoking, a key explanation of the trends.

Other assumptions could be changing too (e.g. decumulation of Super) but the IGR does not make this clear. The reports already provide a lot of background information, but there is a case for still greater transparency, or even, as suggested by Adrian Pagan, that an independent body such as CEPAR be tasked to formally provide analysis for the IGR.

The second thing to note about the figures is that while they are less severe than in other countries and than was previously expected, they still show that demographic shift remains a challenge. IGR 2010 projects that, without policy change, ageing pressures will result in a fiscal gap of 2.75% of GDP by 2050. Policy measures implemented over the last decade addressed various objectives of a well-designed retirement income system to different degrees. But at times reforms were piecemeal and poorly balanced the competing objectives. The 2009 increases to Age Pension level (an adequacy measure) were balanced with a tighter means test and higher eligibility ages (to address sustainability), a sensible balance. By contrast, the 2012-13 budget savings sought from Super meant that the objectives of economic and administrative efficiency were undermined through greater complexity and uncertainty. As a consequence some issues remain unresolved, including those related to decumulation, taxation, early retirement, and choice.

A final point about the IGR process is that its methodology is seldom used to demonstrate specific policy impacts. This is a shame, because an important reason for predicting the future is in understanding how it can be shaped. It could answer questions about what changes will keep budgets balanced despite the demographic shift. One reading could be that if the IGR and the projected fiscal balances are tools to evaluate the fiscal sustainability of current policy then, by their own measure, successive Governments have failed to implement policies that will keep budgets sustainable.

The tenth birthday of the Intergenerational Report is also the twentieth birthday of the Superannuation Guarantee. These are a cause for celebration, but also a reminder that much remains to be done to shape policy structures for an older Australia.

[1] See the working paper initially prepared for the conference
[2] McDonald & Kippen, 1999; McDonald & Ultomo, 2011
[3] Author’s calculation based on www.morlity.org data

Rafal Chomik is a Senior Research Fellow at the Arc Centre of Excellence in Population Ageing Research at UNSW.

This post first appeared  on the CEPAR Blog, May 2012 under “Better policy needed for an older Australia”.

Vic Edwards

Read virtually any newspaper at the moment, and you’ll be told how China could be about to witness a sharp economic contraction, which could impact on Australia’s AAA credit rating.

New figures show China’s export demand has moderated and orders in construction and real estate have contracted. That has compounded fears China is mirroring a slowdown in the global economy.

Many commentators have indicated that China will have a hard economic landing. My view is that this is wrong, and China is more likely to have a soft or cushioned landing provided that the USA does not slip into a steep recession or depression.

A sharp slowdown in China would cause problems in Australia because of its large exports in minerals, pushing Australia’s current account into deficit.

The ratings agency Standard & Poor’s has warned that Australia’s AAA credit rating could be at risk – and losing ­Australia’s top sovereign debt rating would threaten banks ability to borrow offshore. These concerns have seen the Australian dollar falling almost one US cent, and the ASX trading below 4,000.

I attended the Fitch Ratings Credit Forum, and found its assessment of China’s future outlook was much more pessimistic than my view. I am optimistic about the future for China, and while the rate of growth may slow down, any threat to Australia’s credit rating is unlikely to come from the booming Middle Kingdom.

The Chinese purchasing managers’ index fell to 55.2 in May from 56.1 in April, according to new figures from the China Federation of Logistics and Purchasing. A reading above 50 still indicates expansion.

On my visits to China over the past few weeks it has become clear that China is successfully making the transition from an export oriented nation to one that is much more based on domestic consumption. Certainly, this will cause a drop in its growth rate from 11% per annum to around 8%, but this is still a favourable outcome.

The change to a domestic economy is one that is good for Australia, with China still importing many raw materials. A factor not accounted for in most of the recent analytics of China is the fact that the enormous effort in developing infrastructure has been greatly misinterpreted. Western analysts and some of the investment banks have pointed to what seems to be excess capacity in having empty office blocks and highways leading to nowhere.

However the massive construction projects that are going on in the second tier cities such as Qingdao, Tianjin, Changsha and Chengdu are pulling people back from Beijing and Shanghai and providing a future base for decentralisation. New very fast trains are now permitting rapid and cheap transport. This is a real plus for China’s future. It will decongest the cities of Beijing and Shanghai and lead to future growth and development of the poorer western regions. Throughout my latest visit, I have seen that the investment in infrastructure is paying off.

Vic Edwards is a Visiting Fellow in Banking and Finance at the Australian School of Business.

A temporary exit from the eurozone by Greece would go a long way towards adjusting trade and other imbalances that would relieve pressure in the current eurozone crisis and quickly restore growth to the country, Wharton finance professor Franklin Allen said. The problem with many of the other fixes being suggested for the eurozone at present: They take too long to work, and would allow the crisis to escalate, perhaps dangerously. The quickest solution is temporary leave from the eurozone — in this case by Greece – that would lead to normal growth within one to two years, and allow Greece to rejoin the group in “five to 10 years,” Allen said.  He made his comments in a keynote address at the recent Wharton Global Alumni Forum in Milan.

A video of the full presentation is available below:

This post previously appeared in the Knowledge@Wharton today blog: A Temporary “Grexit” Is Just the Right Respite.

Dr Mehreen Faruqi

In 2012, the focus of the 40th World Environment Day and the UN Conference on sustainable development, Rio +20, is on greening world economies.

The United Nations Environment Program (UNEP) defines a green economy as one “that results in improved human wellbeing and social equity, while significantly reducing environmental risks and ecological scarcities”.

However, despite a focus on sustainability, we are currently in the midst of an economic crisis; our environment is under threat from the significant looming effects of climate change; global forests are shrinking; rates of species extinction are higher than ever before; and although health and wealth may have increased on average, these benefits are unevenly distributed, and the divide between rich and poor nations and individuals is deepening.

So why is it that after decades of environmentalism and sustainable development, we live in a world where environmental degradation is worsening and poverty and hunger increasing?

It would be unfair not to recognise that effort has been put into minimising human impacts on the environment. Governments have instituted environmental legislation and regulation, progressive businesses place increasing emphasis on social responsibility, and individuals are adopting environmentally friendly practices.

However, much of the focus has been on discrete, easier to manage issues such as industrial air and water pollution, and some ‘trophy‘ projects such as green buildings, renewable energy, water, and waste recycling. Progress on resolving harder to manage ‘wicked’ problems such as global climate change, increasing water scarcity, and inequalities of wealth distribution has been slow and patchy.

Traditionally, environmental problems have been framed as narrow, isolated bio-physical phenomena with linear cause and effect chains which have been ‘fixed’ using technical solutions such as pollution control e.g. air filters on factory stacks. This has resulted in short-term, band-aid solutions that treat the symptoms only while underlying causes persist over a much longer-term.

A complex systems view of the world where our economies, societies and the earth’s ecological systems are inextricably linked and form a dynamic interdependent system has challenged these traditional notions of a mechanistic and fragmented world.

More and more, sustainability problems such as climate change, natural resource depletion, and social and economic inequities are seen as multidimensional, having many interconnected causes and effects, uncertain and unpredictable consequences, and no clear-cut solutions.

Addressing such problems requires not just scientific and technological solutions but also significant, and some even argue radical, changes in societal systems, values and lifestyles as well as in government and corporate policies and practices.

If we are serious about greening our economies and achieving sustainability, this chasm between traditional and contemporary views of the world will have to be bridged urgently, so innovative and creative thinking can be unleashed.

But this requires making fundamental changes to the way we approach problems, rethinking business as usual models of growth and development, and shifting away from unsustainable patterns of production and consumption.

These changes have to be underpinned by ‘strong sustainability’ recognising the intrinsic value of the environment and the dependence of our society and economy on our natural systems.

Our neoclassical economic systems of accounting such as cost-benefit analysis favour short-term profits and do not accurately reflect the negative social and environmental consequences that occur over the longer-term.

We measure growth and development using GDP, which in fact only measures economic activity. Measuring long-term sustainable growth and wellbeing requires indicators that reflect social, environmental and economic growth. Failing to do this could mean another half a century of rhetoric about green economies without any appreciable change.

Such profound change that contests long-held views of ‘thinking and doing’ essentially requires a ‘new’ and courageous model of leadership in government, organisations and communities. Rather than leading through individual power and authority, new leaders prefer distributed leadership and are collaborative, flexible and adaptive.

Changing dominant mindsets is no easy task, and exercising new leadership is risky and dangerous as it requires stepping out of the security of business-as-usual practices into unknown situations to confront conflict, uncertainty and unpredictability.

The choice of not taking this risk, however, may leave our future generations with no choices at all.

Mehreen Faruqi is academic director of the Master of Business and Technology (MBT) Program and Associate Professor at the Australian Graduate School of Management (AGSM) within the Australian School of Business at UNSW.

This article first appeared on the Drum, 5 June 2012.