Geoff Harcourt and Anne Junor

Focusing on growth, the Brisbane G20 leaders’ summit has not grappled with three key issues. How much more growth can the planet survive? How can poorer nations raise their living standards to parity with the “developed” world? And within both rich and poor countries, how can a fairer distribution of the benefits of growth be realised?

The key problem of our time is the possibility of pursuing three goals simultaneously – ecological sustainability, economic development and a more equitable distribution of wealth within and among nations.

Harvard economist Stephen Marglin argues affluent nations must limit further increases in their standard of living. Priority must be given to the development goals of poorer nations and to addressing poverty in the affluent world. But even this cannot be done within present wasteful approaches to growth. A radical rethink of the foundations of economics is required.

Six economists and sociologists from Cambridge, The Hague, India, Italy and Australia debate this challenge in the December 2014 issue of The Economic and Labour Relations Review.

Macquarie economist Wylie Bradford questions the need for a root and branch alternative to mainstream economics. He argues existing theory is soundly based in a view of humanity and nature that has continually been adapted since the ancient Greeks. Bradford argues it can be adapted further to address the present circumstances.

Conversely, Shachi Amdekar and emeritus professor Ajit Singh from Cambridge University UK argue global warming mandates a new starting point for economics. The conventional self-interested individual is no basis for conceptualising what’s needed to tackle the terrible threats to human survival resulting from modern economic processes.

Andrew Fischer, from Erasmus University, Rotterdam, says poor nations can develop, even while the world economy decarbonises.

Poorer nations need to accumulate capital to reduce poverty, and Fischer explores how the “developed” world can make environmentally friendly changes in the composition of its consumption expenditure, to maintain effective demand in the world as a whole.

Stefano Bartolini, from Siena University, provides empirical evidence that declining social capital underlies rich nations’ current unsustainable economic growth. He paints a picture of isolated people in gated communities, protected by security systems, spending their leisure on over-consumption.

Bartolini provides alternative models of institutions, cities, social spaces and lifestyles, reversing the trend decline in social capital, creating benefits for both human wellbeing and the environment.

Wendy Harcourt, from Erasmus University, provides examples of academics and grass roots activists changing the ways in which communities function, building links between neighbourhoods in rich and poor countries and regions. She outlines a new community economics, based on “meshworks” – loosely connected networks of learning.

In response to the UN call for post-millennium development goals, emeritus professor Amiya Bagchi of Kolkata Institute of Development Studies proposed the following:

(i) More effective regulation of global capital, through host country requirements for local procurement and utilisation of innovations; more effective regulation of pharmaceutical patents; and closure of tax havens.

(ii) Stronger environmental protection through restriction of environmentally risky oil and mineral exploration and more public funding for research and investment in renewable resources and organic farming.

(iii) Inter-regional measures such as a global fund to support the viability of small island nations; and enforceable international conventions on asylum seekers, with maltreatment of migrants justiciable in international courts.

(iv) Intra-country redistribution through legislated minimum wages; gender equality in education and healthcare; pro-peasant land reforms, recognising women’s agrarian role; and communal models of property rights for forest-using people.

Whether or not economic theory moves beyond the utility-maximising individual, the survival of the planet is likely to depend on a new growth model based on social cohesion. The blueprints exist: the planetary risk may galvanise their adoption.

Geoff Harcourt is a visiting professorial fellow at UNSW Business School, where Anne Junor is an associate professor, deputy director of the Industrial Relations Research Centre and editor-in-chief of The Economic and Labour Relations Review. A version of this post appeared on The Conversation.

James Morley

Australian Treasurer Joe Hockey and billionaire Rupert Murdoch recently made impassioned speeches expressing their deep concern about the problem of rising inequality – the rich are getting richer, while the poor are suffering from stagnant or even declining real wages.

I was surprised when I heard about these speeches. For some reason, I had a preconceived notion that Ayn Rand’s Atlas Shrugged would have a more prominent place on Hockey and Murdoch’s bookshelves than Thomas Piketty’s Capital in the Twenty-First Century.

Some semblance of order was returned to the universe when I later read that Hockey and Murdoch were arguing that lower taxes and smaller government are the best ways to address inequality. Rand could still be proud of these highly talented and successful individuals, despite their heartfelt and possibly religious-motivated concern for the poor.

However, Hockey and Murdoch did not just provide a predictable ideological policy solution to rising inequality. They went out of their way to articulate a new and genuinely surprising economic theory as to why inequality has been increasing in the first place.

According to their theory, rising inequality is driven by the quantitative easing (QE) programs undertaken by the Federal Reserve (the Fed) in the US and some other central banks after the global financial crisis (GFC). Hockey and Murdoch believe the expansion of money supply associated with QE resulted in inflated asset and real estate prices, making the rich richer and leaving the poor behind.

This might sound plausible on the face of it and, if true, it is certainly a good thing the Fed just announced the end of QE. However, it is unlikely that inequality will suddenly start to decline because this theory doesn’t hold water.

QE has actually mitigated rising inequality, rather than caused it, because QE prevented deflation. Deflation is an ongoing decline in prices and wages which occurred in the Great Depression in the 1930s and Japan in the 1990s.

Basically, no one likes deflation, except for those lucky few people with no debt and lots of assets. The rest of us with some of both and even those with neither would have been much worse off had the GFC led the world into what macroeconomists call a “debt-deflation spiral”.

To understand this grim-sounding descent into macroeconomic hell, let’s say I borrowed $10,000 from Murdoch just before the GFC to help me buy a house. I would still owe him $10,000 afterwards, but if the crisis had led to deflation, my wages, assets and the value of the house would have fallen. So it would be much harder for me to pay back the $10,000 even if I liquidated my assets by selling my house.

I would have to cut back on my spending and save more to bring my real debt burden back under control. Meanwhile, if everyone (except Murdoch) tried to deleverage in this way at the same time, it would result in a deeper economic depression. Overall, there would be more deflation, more unemployment, and a larger increase in the real burden of debt.

This debt-deflation spiral is a pretty good description of what happened in the Great Depression and, to a much lesser extent, Japan in the 1990s. Fortunately, former Fed chairman Ben Bernanke and other central bankers facing the GFC applied lessons from the past. They didn’t tailor their policies exclusively to the needs of debt-free lenders who just want a high real return on their assets and so don’t mind deflation.

Instead, during the GFC, Bernanke and others undertook QE to stabilise inflation expectations. By avoiding deflation, QE prevented borrowers from getting poorer and lenders getting richer.

To be clear, monetary policy can have large distributional effects, but only when it leads to unanticipated deflation or inflation. For example, high inflation in the 1970s was a surprise and resulted in huge benefits for the baby boomers who borrowed to buy houses before the worst of the inflation hit.

They still owed the amount borrowed, but their wages and the nominal value of their houses went up considerably with inflation. For example, the median house price in Melbourne went up from A$12,800 in 1970 to A$39,500 in 1980 – a 200% increase over the decade, meaning the real burden of debt declined dramatically during the period. This was just the reverse of the debt-deflation spiral in the 1930s, a spiral avoided during the GFC due to the QE policies implemented.

If QE and monetary policy didn’t cause rising inequality, what did then?

Technology has shifted the nature of work dramatically during the past century from farms to factories to office buildings. It has also increased the returns to certain specialised skills and cognitive ability.

This technological change has greatly improved standards of living. However, it has left many people who do not have higher-education degrees with stagnant real wages or long-term unemployment. As a result, inequality has increased.

This skill-biased technological change has been going on for a while, as has the resulting rise in inequality. Bernanke highlighted its role in driving inequality in a speech back in 2007. By contrast, QE has only been on the scene for the past five years or so (not counting the Bank of Japan’s sporadic and generally limited forays into such policies since 2001), further undermining its potential to explain rising inequality.

But if rising inequality is due to skill-biased technological change rather than QE, what can be done?

Improving access to higher education seems like an obvious answer. But this is far from a panacea, especially to the extent that higher education serves more as a signal of high cognitive ability than it actually develops skills. We could give everyone in the world a PhD, but there would still be a lot of inequality.

Instead, fiscal policy, rather than monetary policy, can reduce inequality via progressive taxes. Fed chairwoman Janet Yellen said as much in a recent speech on inequality, targeting inheritance in particular as a source of persistent gaps in economic opportunities for the rich and poor.

Hockey may try to advocate that higher taxes kill the goose that lays the golden egg. Yet there is surprisingly little evidence of this, at least not at the level of taxes presently in place in most advanced economies. Countries with higher and more progressive tax rates have less inequality, but still grow just as fast or faster than countries with lower taxes and more inequality.

For example, despite higher taxes, Australia, Canada, and Sweden have all grown faster than the US during the past two decades.

So next time a Treasurer, a billionaire or anyone else tries to argue that QE is responsible for rising inequality and the best solution is lower taxes, I recommend being more than a little sceptical.

James Morley is a professor of economics and associate dean (research) at UNSW Business School. A version of this post appeared on The Conversation.

Joseph Cheng

The Australian government has released a discussion paper – Boosting the Commercial Returns from Research – to further its innovation agenda. It seeks comment on “turning good ideas and research breakthroughs into commercial results” – such as, changing funding criteria to encourage university/industry collaboration and improving assessment of research impact.

The  paper is linked to the Industry Innovation and Competitiveness Agenda, which aims to promote innovation through collaborative efforts among university, industry, and government to strengthen Australia’s competitiveness.

The broader agenda underpinning this debate is an important step in the right direction; but it is selling Australia short on four key aspects which need to be corrected.

As the largest Western society based in the Asia-Pacific region, Australia has both the location and cultural advantages to perform the strategic role of an “innovation broker” between Asia and the West.

The agenda’s focus on the rapidly growing Asian economies obscures the fact that most of the high-income markets are still in North America and, once it recovers, Europe. This focus on Asia is selling Australia short.

Australia can out-compete other countries by leveraging innovations from the West and Asia to create unique and superior global products for the world markets. To build this competitive advantage, we need to attract the best and brightest researchers from the West and Asia to work in Australia.

We also need to recruit multinational firms to set up labs here to conduct high-end R&D. Singapore has pursued this dual-track innovation strategy for the past 30 years with great success, creating new businesses and boosting employment with high wages along the way.

The agenda places a strong emphasis on small and medium-sized enterprises (SMEs). While SMEs can be innovative in many ways, most of their innovations are incremental (with some being disruptive) due to limited resources.

By contrast, big firms such as IBM and Apple have the economy of scale and slack resources to conduct the full range of R&D, including work aimed at producing incremental innovations for the short term, disruptive innovations for the medium term, and breakthrough innovations for the long term.

To not sell Australia short, we need policies to encourage big firms to invest in both medium and long-term R&D, in addition to supporting innovation among the SMEs.

The agenda also focuses primarily on economic infrastructure, neglecting the research infrastructure needed to ensure breakthrough innovations.  Many such innovations, such as the magnetic resonance imaging (MRI) machine, are produced through interdisciplinary research that combines ideas and methods from multiple fields of study.

This is where the commercialisation of research agenda needs to be carefully thought through. Mechanisms to bring together experts from different disciplines and to facilitate joint research among them are in short supply in Australia.

We need to build the physical, professional, and institutional infrastructures both within and outside the scientific communities (including those housed in university, industry, and government settings) to encourage and support interdisciplinary research, with the goal of developing breakthrough knowledge that leads to high value-added revolutionary products and technologies.

There is the perception among some Australian politicians that research-intensive universities such as UNSW do a lot of basic research that has little application value.

We should all know that research which may seem esoteric can often be applied in unexpected ways. For example, the MRI machine would not have been invented without basic research done in mathematics, physics, computer programming and imaging science.

To not sell Australia short in our quest for innovation and competitiveness, we need to support both basic and applied research.

Industry Minister Ian Macfarlane has floated the idea of a fundamentally different way of awarding grants for research. Previously, funding has been tied to a scientist’s track record – generally, papers published in high-quality journals. Now he wants research funding tied to patents rather than scientific papers.

Writing scientific papers is an integral part of the research process to solve complex problems facing society. Just as politicians hold town-hall meetings and make speeches to get feedback on ideas before they introduce new legislation, researchers write papers to get feedback from the scientific community to help refine their study to solve important problems for society.

Not supporting researchers writing scientific papers is like not supporting politicians travelling around making speeches and holding town-hall meetings. The end result would be the same – new ideas not being discussed and evaluated in an open forum. This would be selling Australia short on innovation.

As the world moves toward a more balanced tri-polar global economy with anchors in North America, Europe and Asia, coupled with a parallel shift in the basis of economic competition from efficiency to innovation, Australia is well positioned to become a global leader in technological and business innovation if we aim high and target our efforts in selected areas where the country already has or can build a competitive advantage.

Joseph Cheng is a professor of management and the Michael J. Crouch chair in innovation at UNSW Business School where he directs the Australian Innovation and Competitiveness Initiative.

Nick Greiner

One of the fashionable new positions at a senior level in universities is the head of engagement, or some variation on the title. There’s clearly a perception that relationships with the world outside the academic community are not as developed as they could be.

So is there an engagement issue for universities in general, and business and economics schools and faculties in particular? I would say, yes.

Take the top public companies. Across the boards of the ASX100 there are about 700 directors, but only four are current business or economics professors, and in each case they’re on a single board.

Given the quality of thinking and research experience of our business school academics, their board representation is much lower than one would expect. There are also four health and life science professors on ASX100 boards.

Among large government-owned enterprises, there appear to be no practicing academics on the boards where surely the complex regulatory and economic issues could benefit from their expertise.

Of course, academics frequently conduct public policy research as consultants for governments, make submissions, and do joint studies with corporations, but that’s quite different from having a seat at the table where decisions are made.

Going the other way – from business back to academe – I looked at how many directors of the same ASX100 companies say on their CVs that they’ve got anything to do with universities. The answer is nine, who hold honorary appointments as adjunct professors.

There are also a number of business leaders on university advisory boards, but that’s mostly about helping to raise money.

The era of board vacancies being filled via an old mates’ network has passed. Placements are now made using executive search firms, which comprise a large professional group. My theory is that these headhunters overwhelmingly do not know who exists in universities – such as the brightest people in marketing or finance – and consequently don’t put their names forward.

We need to somehow get the existence and merits of our top academics exposed to the executive search community. They are obviously relevant. For example, there’s a lot of work being done in business schools on risk and risk assessment, which is an issue the banks are very worried about.

Is it that academic is a dirty word at the higher levels of Australian business, and that the instinct about what’s needed is “people who have met the payroll” – basically, CEOs? Perhaps there’s a prejudice against those whose life experience and success has been academic, and they’re seen to be more about theory and process while the business world is more about results.

On the other side, it’s possible academics aren’t putting themselves forward for fear of not doing well, or that they may suffer reputational damage because companies occasionally go broke or are the subject of controversy.

In the US, it’s seen as a badge of honour for an academic to be accepted on to the board of a company that employs tens of thousands of people, a positive thing in terms of promotion and reputation. It may well be that in Australia it’s not.

Much is written about diversity on boards, how it’s very important, yet at the moment it’s mostly defined as gender diversity. True diversity would have different relevant backgrounds. University experts on the boards of our major economic institutions would clearly add to the diversity.

One way of connecting academe with business is through case studies. We could look to the Harvard model which teaches by sending its academics out to firms and writing real-world cases, such as why something may have succeeded or failed. It puts the academics inside the company. This happens to some extent in Australia but not as much as it could.

And then there’s the question of our research programs. Are they sufficiently relevant to industry? It’s appropriate that research is put through the academic filter of peer-review, but could it also be put through a real-life filter? Is the research answering a question that anyone cares about, or just a theoretical question that nobody outside of universities thinks is important or interesting?

Recent data from the Australian Bureau of Statistics on innovation-active businesses revealed that only 10% had a collaborative arrangement with universities. Figures from the level of start-ups, venture capitals and SMEs revealed that only 3% saw universities as a source of innovation.

It highlights that universities are right to be concerned about a lack of engagement with the outside world, and the business community in particular. The disconnect is coming from both ends – we’ve got academics that are probably not putting themselves forward and companies that are not actively trying to attract  them.

It amounts to a missed opportunity all round.

Nick Greiner is a former premier of NSW and a distinguished visitor at the Australian Graduate School of Management at UNSW Business School. A version of this post appeared in The Australian Financial Review.

Tim Harcourt

The recent death of former prime minister Gough Whitlam at the grand old age of 98 was a significant event in Australian history, but also in China. After all, it was Whitlam who took the risk of visiting Peking (now Beijing) as leader of the Opposition in 1971, despite domestic pressure to shun China.

At the time, Whitlam took a lot of heat from the incumbent McMahon government – but only for about a week, when it was revealed that US secretary of state Henry Kissinger had been in Peking, too, paving the way for president Richard Nixon to recognise China.

After winning the 1972 election, Whitlam returned to Peking as prime minister in 1973 when he and his independent and equally charismatic wife Margaret were feted as great friends of China. It was a triumph. In many ways Whitlam was the first Western leader to recognise China. When talking to him – and, later, his chief of staff John Menadue – it was explained that the decision to recognise China was part of the Whitlam vision to engage Australia more comprehensively with the Asia-Pacific region.

Whitlam and South Australian Labor premier Don Dunstan had already fought hard to get rid of the White Australia Policy from their party’s platform. For most of the 20th century, Australia restricted immigration to ‘white’ people (that is, mostly the British and northern Europeans) despite its proximity to Asia and the presence of an indigenous population who were not white.

Whitlam and Dunstan took the principled view that if you wanted to trade and invest with people, or sell education services to them, you shouldn’t prevent them from immigrating because of the colour of their skin or racial origin.

It was part of the big picture, diplomatically to engage with Asia, and to allow the exchange of ideas, art and culture as well as goods and services – to feel more confident in the region, particularly after the difficulties of the Vietnam War.

Since 1971, China and Australia have gone from strength to strength and China is now our number-one trading partner, number-one export destination, and number-one import source (the two-way trade relationship alone is worth almost A$142 billion). China and Australia have gone through different phases in our economic partnership. First, we had the trade of commodities phase, where we exported ‘rocks and crops’ (resources and agriculture) to help China’s industrialisation and urbanisation as it pulled millions of people out of poverty. For Australia, this was both a ‘mining boom’ and a ‘dining boom’.

Then we developed advanced manufacturing and professional services, and foreign investment started to flow both ways. The second and third-tier cities of China, such as Chengdu, Chongqing and Wuhan, began attracting Australian builders, architects and designers as it invested in infrastructure for its rapid rural-urban migration and growing middle-class consumerism. Brisbane planning and design consultancy Place Design has a Chengdu office to build landscape gardens for the urban middle class. It’s a long way from the rice paddies of the poor rural areas.

We are seeing a new phase with the development of financial services and other forms of co-operation, such as the conversion of the Chinese currency to Australian dollars, a new free trade agreement (FTA) and potential Australian support for a Chinese development bank, following on a tradition of strong Australian support for China on major international issues, such as support for China to join the WTO, and support in APEC and the G20.

But what of the future? Recently Australia was surprised to see China, under pressure from local producers, put through tariff hikes on coal targeting  Australia exporters. While this won’t derail the FTA, it does warn foreign observers how many decisions can be made by fiat in China, regardless of the economic logic.

Some have called for the Australian government to leverage its support of the Chinese development bank to try and reverse the tariff decision but it’s likely the two issues will remain separate. There are also more controversial measures to allow ‘purchase’ of permanent Australian residency via real estate investment which may pressure the local real estate market and provide incentive for party officials to invest (which could entice corruption).

On the other hand, Australia has supported the strong anti-corruption stance taken by the Fourth Plenary of the Party Congress and has vowed to co-operate with China on extradition of corrupt officials. These measures are directed at strengthening mutual trust between Australia and China because China now knows that to succeed in the 21st century, the country’s future progress is as much about corporate governance as it is about growth.

Whitlam was often criticised for his lack of interest in economics, compared with his interests in foreign policy, constitutional reform, urban issues, equal pay, the rights of Aboriginal Australians, and his support for Asian immigration.

But ironically, his brave call to go to China in 1971 was perhaps the most important economic decision made in Australian history during the past half century.

Tim Harcourt is the J.W. Nevile fellow in economics at UNSW Business School.

Richard Holden

THE founder of modern economics, Adam Smith, pointed out that the “invisible hand” of competitive markets leads to an efficient allocation of resources. When markets are competitive government should just “get out of the way”.

Yet most markets are not perfectly competitive – the extreme case being where there is a single monopolist.

This opens the door to government interventions making markets work better. But which interventions are best? What tools should be used? Which markets should be targeted?

This year’s Nobel Prize in Economic Sciences was awarded to Jean Tirole for “his analysis of market power and regulation”. Tirole’s work provides answers to these vexing questions – it has deepened our understanding of how markets actually work, and provided policymakers with a playbook for how to make them work better.

As one example, imagine you are a government regulator of a monopolist, such as a power company. The large fixed costs involved might mean that having multiple competing firms is not sensible, but one large monopolist will charge high prices and hurt consumers. What do you do?

One answer is to control the prices they charge. But to do this effectively means knowing what their true costs are – something that is typically very difficult for a regulator. Worse still, you would like the firm to work hard at lowering their costs, but this won’t happen if they don’t capture some of the benefit of those lower costs.

In path-breaking work in 1986, Tirole and co-author Jean-Jacques Laffont (who might have shared the Nobel award had he not sadly died, too young, in 2004) showed how a regulator can best balance providing incentives to reduce costs with the use of public funds – perhaps raised through inefficient taxes, since incentives cost money.

Remarkably, Laffont and Tirole showed that offering the monopolist a menu of possible regulatory schemes does the trick. You, the power company, can have a cost-plus contract or a fixed-price contract, or something in between. You choose.

And just like a good magician’s carefully designed scheme, you will always choose the card he expects. This cunning trick makes it in the interest of the monopolist to implicitly reveal its costs through its choice of regulatory scheme.

Part of what makes Tirole’s work so remarkable is that he has been able to analyse complex markets such as credit cards, telecommunications and banking, yet use a general analytic approach from which broad lessons can be learned. It is social science at its absolute best: using mathematical rigour to illuminate real-world problems and provide effective policy prescriptions.

And it’s not just academics and students who might benefit.

As Australia embarks on its second great competition policy review, with Ian Harper due to report in March next year, Tirole’s Nobel provides a timely reminder of the importance and power of good competition policy. In many ways there are parallels between the evolution of the economics of regulation, and the competition policy reform process in Australia.

The year Tirole defended his doctoral dissertation at MIT was 1982, the same year that University of Chicago professor George Stigler won the Nobel prize.

Stigler – a towering figure both intellectually and physically – was a pioneer of the study of how firms interact, and how competition policy can achieve efficiencies by driving down prices. In many ways Tirole was his natural extension and intellectual heir – incorporating strategic decision-making and hidden information into the picture.

So, too, might it be with Harper and Fred Hilmer. The 1993 Hilmer report, and the reforms it heralded, was a watershed in Australia. It took a hard line against monopolies and anti-competitive practices, and the results have been hugely beneficial to Australian consumers.

Harper’s Tirole to Hilmer’s Stigler would be to bring Australian competition policy into the 21st century. To deal with complex markets with complex problems – such as firms that know a lot more than regulators do, markets that are hard to define, and markets involving complicated networks of players such as credit cards.

Tirole’s work provides a road map for Harper. But he could do well to use Tirole’s work as a touchstone, much the same way that Stigler influenced Hilmer.

Tirole is a scholar’s scholar – thoughtful, careful, creative and genuinely the smartest guy in the room. He has inspired a generation of young economists around the world. But his work has had impact far beyond the classroom, seminar room and academic journals. He has described how real, complicated markets work, and helped policymakers to make them work better.

Tirole is a kind of engineer for the social sciences. And in highlighting that, the Nobel committee has displayed impeccable taste.

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

Richard Holden

If there is one iron law of economics it is this: people respond to incentives. Offer an “all you can eat” buffet and people eat a lot. Double the demerit points for speeding on a holiday weekend and fewer people speed. And if you make school funding contingent on achieving threshold numeracy and literacy test scores then those thresholds will likely be met.

The trouble is that it might not be because of genuine improvements in skills.

The Business Council of Australia’s recent report on innovation suggested tying federal funding of education to the achievement of threshold NAPLAN literacy and numeracy standards. It argued that a well-educated workforce is crucial for innovation and economic growth.

I couldn’t agree more about the need for an educated workforce. And I’m not one of these metricphobes who thinks that measuring performance is inherently evil, or that all league tables are bad. Far from it. But I do worry a lot about how incentives for teachers and students in schools work. There’s a swath of evidence that incentives in education lead to unintended outcomes – or even outright fraud.

Put yourself in the position of the person who is the boss of all school principals in a state and who is faced with the Business Council’s scheme. Some portion of those principals run schools whose kids are presently below the literacy and numeracy thresholds. What do you do? Faced with the possibility of large losses of funding you probably put pressure on those principals to get better results.

What levers do they have available? They can’t change the selection of kids in their schools – and if they did it would just shift the problem elsewhere.

They can’t change the kids’ parents or their classmates and the important influences they have. They can’t easily change the teachers in their schools.What they can do is have teachers focus on testing outcomes rather than holistic ones. They can “teach to the test”.

Teaching to the test badly misallocates the most precious educational resource: teacher time. It focuses students on how to mechanically perform a small number of tasks.As one illustration of how details matter, consider giving students cash incentives to do more homework. Setting aside the cost, this seems like a no brainer – but in fact it can lead to negative outcomes.

Research I conducted with Roland Fryer of the Harvard University economics department was designed to document this difficulty. We provided incentives to 5th-grade schoolchildren in Houston, Texas, to do mathematics homework problems. They got $2 for each mathematics objective they mastered, using take-home worksheets and in-class computer software to assess performance.

Because we randomised which schools got the software and incentives, and which schools just got the software, we could determine the causal effect of the incentives. Just like a randomised, controlled pharmaceutical trial with a treatment and a control group.

The answer? Kids with incentives did way more maths homework. And they did significantly better on end-of-year standardised tests in mathematics.

Great news? Not so fast. These gains in mathematics were, alas, almost exactly offset by a decline in performance on standardised reading tests.

Interestingly, measures of intrinsic motivation did not drop – financial incentives did not destroy the “joy of learning”. Instead, it was what economists called “effort substitution” – incentives in mathematics shifted effort away from reading and to mathematics.

High-stakes testing for whole school districts or even whole states of Australia raises the disturbing possibility of outright test fraud.

Just last week the trial of 12 former educators accused of fraudulently inflating test scores began in Atlanta, Georgia. The group includes teachers, testing coordinators, principals and administrators.

At least one Atlanta school held pizza parties where they erased incorrect answers on tests and filled in the correct ones to boost kids’ scores. And not just a few. The prosecution claims that across the Atlanta public school system, in 2009 alone, 256,769,000 incorrect answers were “corrected”. Yep: one-quarter of a billion!

But surely that wouldn’t happen here in Australia? Perhaps not, although I’ll bet that’s what folks in the great state of Georgia thought until recently.

Steve Levitt (of Freakonomics fame) has also documented widespread teacher cheating in Chicago public schools: from changing answers, to getting tests ahead of time, to teaching answers to precise questions. Atlanta is not a one-off.Incentives are incredibly powerful – and in many settings carefully crafted explicit incentives can do a lot of good.

But education is a very complex environment, one in which explicit incentives have the potential to do more harm than good. If you pay for better NAPLAN scores then better NAPLAN scores you will get. But they won’t necessarily mean genuinely better literacy and numeracy. And you probably won’t like the side-effects.

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

James Morley

Six years after the dramatic collapse of Lehman Brothers, the US economy is finally showing signs of a stronger recovery from the global financial crisis. The Federal Reserve (Fed) is winding down its quantitative easing (QE) programs and all eyes are on it to see when there will be “lift-off” of the federal funds rate from the zero lower bound.

In its last policy statement, the Fed used the phrase “considerable time” in describing how long it will continue its zero interest rate policy. Indications are that most members of the policy committee believe the first rate hike should occur in 2015.

The amount of digital ink spilt over the phrase “considerable time” has been striking (many news articles have considered the subject, including Marketwatch, The Wall Street Journal and CNBC). And it begs the question, why does everyone care so much about what the Fed says in its statements?

If the Fed were entirely unpredictable, then we would expect anyone worried about future interest rates (such as financial institutions, homeowners or small businesses) to care a lot about any hint as to what the Fed might do. But the Fed is not unpredictable in this way.

The Fed and other central banks behave in a fairly systematic fashion – sometimes referred to as the Taylor rule. This can be characterised as a mathematical adjustment of the policy interest rate in response to changes in inflation and the unemployment rate (or an estimate of the output gap). If this mathematical formula implies a negative interest rate, then the Fed will be constrained by the Taylor rule in applying a zero lower bound rate.

But do we pay attention to the Fed’s policy statements just to discern when its policy committee thinks inflation and the unemployment rate will imply a positive rate based on the Taylor rule? And does the Fed have some special information about when this will happen?

The answer to these questions is “probably not”. Yes, the Fed has good forecasters. But the reason why analysts study its statements is that it also has the ability to keep the interest rate at zero, even when the Taylor rule implies the rate should be positive.

Why would the Fed want to keep rates at zero in the future? The short answer is that perceptions it will do so can stimulate the economy in the here and now. And forward guidance about future rates can be used as a policy tool even when current interest rates are constrained by the zero lower bound.

By signalling that interest rates will be lower for longer than under their “normal” policy, the Fed is hoping to convince households and firms to increase their debt-financed spending.

Specifically, lower future short-term rates should lead to lower current long-term rates, which stimulates current expenditure on durable goods and capital investment.

There has been a lot of academic analysis on the effectiveness of unconventional monetary policies. The evidence for QE is mixed. It does seem to influence the prices of targeted assets. But it is less clear if it does so without an offsetting effect on the prices of other assets.

QE has been most effective when the Fed’s announcements about it have changed expectations about future monetary policy. QE can be seen as a signal that the Fed will do whatever it takes to prevent deflation, including keeping interest rates lower than would be implied by their normal policy.

As for forward guidance itself, there are challenges in identifying its quantitative effects on the macroeconomy.

In recent research, Mariano Kulish, Tim Robinson and I studied expectations of the length of time interest rates would be kept at zero. We found these expectations increased when the Fed significantly changed its statements about future policy.

For example, in mid-2011 the Fed’s policy statement became explicit about the timing of the expected lift-off. It moved from outcome-based to calendar-based guidance. In response, estimates of the expected duration of zero interest rates increased significantly. Output growth and inflation also seemed to react to the guidance at this time.

This case study demonstrates how forward guidance can work when the Fed makes its intentions clear.

The success of the Fed’s forward guidance policy is also supported by the recent stronger growth for the US economy. And it explains why everyone watches the Fed so closely for any indication of when lift-off will actually occur.

James Morley is a professor of economics and associate dean (research) at UNSW Business School. A version of this post appeared on The Conversation.

Peter Swan

Almost everyone in a study soon to be published in Perspectives on Psychological Science thinks CEOs are paid significantly too much – almost everyone it suggests, except Australians.

The study, by Chulalongkorn University’s Sorapop Kiatpongsan and Harvard Business School’s Michael Norton uses survey evidence to discover “what size gaps people desire” when it comes to pay, comparing estimates of the wages of people in different occupations – CEOs, cabinet ministers and unskilled workers – with their ideals of what those wages should be.

They measure the gap by the ratio of CEO pay to average unskilled worker pay, finding quite a high degree of consistency across people from 40 different countries and from diverse backgrounds.

Nonetheless, there is a surprising outlier – Australia. Responding Australians would like to see a ratio of 8.3 times. The average across the countries is nearly half at 4.6 times. Australia’s ratio is the highest in the 16 countries for which the authors’ have actual pay data.

Perhaps not so surprisingly, it is more than 400% higher than the desired ratio in egalitarian Nordic countries such as Denmark.

One country in particular outside the group of 16 outdoes Australians in tolerating inequality — Taiwan — with a desired ratio of 20.

Apart from revealing a general desire for equality, the study also reveals how out of touch with reality most respondents are. For example, the mean estimate across 40 countries of the respondents’ estimate of the actual pay ratio was ten-fold, about twice the average desired ratio. By contrast, the actual ratio across the 16 investigated countries is 101, ten times higher.

For example, for the US respondents the estimated pay ratio was 30, compared with the actual ratio of 350, meaning they believe the worker at the ideal ratio would be earning US$1.8 million, when in reality the average CEO earns US$12.2 million while the average unskilled worker earns US$34,645.

In the face of such ignorance, these survey results make the case for abolishing the survey profession itself.

Australians (and South Koreans) by far topped the list in guessing average CEO pay with estimates of 41 times. This is almost half the actual ratio for Australia and thus closer than respondents in most other countries who typically had far higher error rates.

Perhaps we should be relieved that for most countries these pay ratio estimates are substantially lower than the amounts company leaders actually earn. Would the truth stimulate more French Revolutions and huge hikes in tax progressivity?

Sweden, for example, once had a magnificent marginal tax rate of more than 105% for high-income earners. This lasted until voters discovered that their most beloved best-selling author had lower take-home pay the more she earned.

Actually, ignorance is not a monopoly possession of the respondents. Some of the “credit” must be attributed to those who did the survey and published the results. For example, it is meaningless to talk about CEO pay ratios without considering the size of the company.

Typically, the larger the company, the higher the pay. Using raw pay numbers, each doubling of firm size increases pay by 30%. Since on average Australian companies are far smaller than in the US, our pay ratio falls way short of the US’s 350 times score.

This means we miss out on the “bargain” to shareholders constituted by the highest paid CEOs at the largest US companies. Since pay far from doubles with each doubling of firm size, large-firm CEOs cost shareholders very little relative to market capitalisation and earnings, in contrast to small-firm CEOs.

In fact, some prominent CEOs – such as the late Steve Jobs of Apple fame – choose to be paid a notional salary (US$1 in the case of Jobs) rather than the hundreds of millions they contribute to shareholder value.

Do they do this because of their love for shareholders and the average unskilled worker? No.

George W. Bush reduced the tax on dividends from the personal marginal rate to a maximum of 15%. But he still retained the double-taxation of company and personal income (unlike Australia). It then became more tax advantageous to receive dividends when one owned as much of the company as Jobs did.

Why does CEO pay go up with firm size at all? Actually, this relationship largely exists because size becomes a proxy for success and thus managerial talent. Such talent, the Steve Jobses of this world, is in limited supply. If one controls for talent then pay only increases by about 22% for each firm-size doubling.

My research with Jaeyoung Sung shows that firms compete for talent largely by raising pay for performance sensitivity, that is, by encouraging stock and option ownership. The reason for this is that typically only the manager is aware of his or her own talent. With more “skin in the game”, the highly talented manager’s effective take-home pay is much higher and can in some cases amount to billions of dollars.

Smaller firms in particular cannot afford to pay as much in direct cash pay. Hence, we see sensitivity falling rapidly with increases in firm size. Larger firms can afford to pay more. For them, talented CEOs are a bargain.

The real message of the survey study for Australians is that we are more tolerant of inequality, including pay outcomes, than are most other nations. This makes it easier for us to attract talented managers out of the limited global pool.

Importantly, it means that outcomes for most Australians will be better than is the case in the rest of the world. We can expect our economy to continue to outperform.

But this will be true only for as long as the Abbott government restrains its enthusiasm for raising marginal tax rates — much to the nation’s long-term detriment.

Peter Swan is a professor of finance at UNSW Business School. A version of this post appeared on The Conversation.

Richard Holden

In the year ahead there will be a national discussion about the future of our taxation system. It will have important implications for economic growth and social policy. The discussion will only be productive if all options are on the table, and if participants don’t resort to what Robert Kennedy called “obsolete dogmas and outworn slogans”.

The quintessential such move in tax discussions is to label a change “regressive”. Raising the rate or broadening the base of the GST is regressive. Increasing the top marginal rate isn’t.

Case closed? Not so fast. To properly assess any tax proposal it’s vital to examine where we are now, and where we are heading.

First, let’s look at the baseline. Australia’s top 10% of earners pay 46% of total income taxes. The top 2% of earners pay 26%; the top 1% pay almost 18%. The bottom 20% pay 2.5%. This makes Australia’s income-tax system among the most progressive in the world.

And income taxes are just one component of the broader taxation-benefit system. There are other taxes and benefits designed to redistribute income, such as the Family Tax Benefit, the Schoolkids Bonus and the aged pension.

Then there’s a range of ostensibly free services such as healthcare. Finally, there are other taxes, such as the GST. The Australian Bureau of Statistics estimates that when all of this is factored in, only the top fifth of households ranked by income pay any net tax. This makes Australia’s taxation-benefit system among the most progressive in the world.

I’m for this. It’s part of what makes Australia a great country. But it can only continue if the system produces enough revenue. That’s what the debate will be about: how to maintain progressivity by taxing in the right way.

One deeply regressive thing that can happen to income taxes is bracket creep – where the dollar cut-offs for marginal tax rates do not keep pace with rising incomes. This pushes lower-income earners into higher and higher tax brackets.

Those earning a very modest A$40,000 a year are forecast to pay 25% more tax in just four years’ time because of the fixed cut-offs. By contrast, those earning A$200,000 a year would face a less than 2% increase in their tax bill. That’s the epitome of a regressive change in taxation.

Yet perhaps the most regressive part of the whole system is the reliance of many states on poker-machine and other gambling taxes. The NSW and Victorian governments get roughly 10% of their revenues from gambling taxes — pokies accounting for about two-thirds of that. This is staggering, and provides horrible incentives to pander to special interests (that means you, Australian Hotels Association).

But much, much worse is the impact that what may be the most widely available gambling in the world has on lower-income earners. It is estimated that as many as half a million Australians are problem gamblers — each losing about A$21,000 per annum. For three-quarters of them, poker machines are the cause; and lower socio-economic groups are vastly over-represented.

State governments have to pay for schools and hospitals. They need revenue, and they can’t tax incomes. So I understand why they resort to moribund, distorting, socially destructive taxes such as pokies and stamp duty.

But from a system-design perspective it makes no sense to deprive states of the revenues required to fund their mandates and then stand idly by while they use the worst kinds of taxes. To paraphrase Steve Jobs, it is “insanely stupid”.

Taxation-benefit systems are just that – systems. They are made up of many different parts – and looking at any one part in isolation is dangerous and foolish. Those who shriek, “But that’s regressive”, whenever a change to the GST is mooted should think harder.

Doing nothing is regressive because of bracket creep. Doing nothing is regressive because it leaves poker-machine “taxes” on the poor in place. Doing nothing is regressive because benefits that redistribute money to lower-income earners will inevitably shrink without a proper tax base to support them.

Our tax system needs to be reworked to provide the right incentives, to grow the economic pie and to redistribute money to the less well off. To keep Australia’s taxation-benefit system truly progressive means thinking about it holistically. Dogmatically invoking the “R-word”? Refusing to change one component to fix the system? Now that’s regressive.

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