Wine Equalisation Tax, microbreweries and the grape glut

Subtle examples of the unintended consequences of government intervention in markets are not hard to find. Today we follow a path from the introduction of producer rebates for the Wine Equalisation Tax on wine makers, to the grape glut of 2010, to the call for tax relief from microbrewers.

The Australian government introduced a Wine Equalisation Tax (WET) to smooth out price changes when sales tax was abolished and the GST was introduced [A New Tax System (Wine Equalisation Tax) Act 1999]. However, small wineries receive a rebate on the WET for the first $1.7 million of production (a rebate of up to $500,000). Enshrining this rebate into law sheltered small wineries from the rigours of market discipline, and could be a key contributing factor to the current grape glut. At least 1,250ha of vines were abandoned in SA in 2008-09.

Did the rebate contribute to the glut, and should we offer a similar rebate to brewers?

Friday quick links

My childhood street is famous for building cubby houses in trees on council land

Obesity epidemic growing for a century - much longer than ever thought before….
and now Jamie Oliver does his best to tackle obesity the ‘old fashioned’ way, but faces strong resistance in the US, even after success in the UK. He faced tough opposition on the Letterman show:

'I don't care how much ground up sea grass you eat or wheat germ - or stuff you find in your pocket. As long as they are selling 160 different types of cookie what hope do you have?'

Oliver appeared to become resigned to the fact he wouldn't convert Letterman to his way of thinking, turning to the audience and saying: 'As you can see ladies and gentlemen, my challenge is big.'

Does this support a 'sin tax' on junk food, or are we aware of the obesity externality and simply don't care, making obesity an optimal outcome?

China housing bubble and government intervention
Beijing recently introduced much tighter rules for home loan lending. The discount on the mortgage rate for first home buyers has been cut, while discount for second-time home buyers has been scrapped altogether. In addition, second-time home buyers have to make a deposit of 40 per cent of the value of their home, while people buying their third home have to come up with a 60 per cent deposit.

A bit of social engineering for home ownership that just might work? Would there be any major problems implementing such restrictions in Australia (we could start a company to buy the investment property, but then only have tax beenfits in the 30% corporate tax bracket, and face the costs of company reporting requirements)?

Interest rate gamble
Looks like my bet was closer to the mark than it first appeared with weak lending data (a leading indicator) pointing to house price declines. Will the RBA let that happen?

More support for a National Resources Fund (this time from RBA chairman Warwick McKibbin)
RBA board member Warwick McKibbin suggests that Australia follows Norway’s lead and sets up sovereign wealth fund that goes beyond the narrow ambition of the Future Fund to finance public service pensions. Norway’s 4 million souls now own a fund worth more than $US400 billion, throwing off a big contribution to national income every year.

The plastic brain: a theory of human experience

Norman Doidge has written a book that encapsulates the latest research in neuroplasticity and delivers it to the curious mind in an intellectually stimulating and satisfying read. The Brain that Changes Itself: Stories of personal triumph from the frontiers of brain science, is a book that had me raving to family and friends after each chapter. I could only put it down to ponder the significance of the subject matter to human society before reading on.  I want to take this opportunity to highlight a few titbits that stuck with me.

Economic arguments against population growth

While Population Minister Tony Burke may be new to the debate, the population debate itself is certainly not new to politics. In 1994 the Commonwealth commissioned an inquiry (the Jones inquiry) into Australia’s population and carrying capacity, yet the inquiry failed to make firm recommendations. One of the inquiry’s authors then wrote a book in protest of the ‘government’s timidity’ and concluded that

... a sensible population policy for Australia would be to aim at stabilising the population within a generation or so and that this was quite feasible if net immigration of something below about 50 000 a year (say 100 000 migrants in gross terms) could be maintained. Population would then more-or-less stabilise somewhere between 19 and 23 million (depending on actual immigration) sometime before 2050.

Now, Tony Burke is faced with twin challenges of developing a policy position on population that keeps enough people happy to keep him in government.

We can easily run through some of the options available to Minister Burke – stimulate or dampen population growth. I suspect he would also like to encourage migration away from capital cities due to the ‘obvious housing shortage’, but as far as I can tell the Federal Government has little power to influence such regional migration (maybe an income tax relaxation depending on how remote your residence?)

To stimulate growth we could increase migration intake, and encourage higher birth rates – maybe $15,000 per child would do it? Or Burke could moderate population growth by reducing immigration quotas and discouraging high birth rates (by removing the baby bonus or even having a ‘child tax’).

But which option is best for Australia? Are there strong economic arguments in favour of either higher or lower population growth? I would argue that on balance, economic principles strongly favour a declining rate of population growth (even a negative rate of population growth not a problem).

For a start, we need to discredit some of the nonsense economics floating around. Bigger is not better. China and India both have plenty of people, while countries with the highest per capita incomes and standards of living generally have fewer people. China has greatly reduced population growth with its one child policy and seen vast economic growth – shouldn’t China have failed to grow because its population stabilised? The map above shows a pretty clear inverse relationship between population growth rates and standards of living.

Nor is a comparison of population density meaningful in this debate, or we could argue that any region with a low population density is ‘underpopulated’ (like Antarctica or the Simpson desert) because we have compared the region to Hong Kong or the Netherlands.

One core economic argument in favour of a greater population is that utility theory suggests that a trillion people living in poverty and slavery are better that one million happy and fulfilled people, leading lives directed by their own desires. It is known as the repugnant conclusion. I doubt anyone believes this is a good outcome, nor is claimed to be a good reason for greater population – it just happens to be at the heart of economic theory and can spawn unusual conclusions.

A second argument appeals to economies of scale and suggests that with greater domestic consumption industries can expand to a point where they have economies of scale that make them internationally competitive. Why domestic population is currently a barrier to industry development is beyond me. If there are no artificial constraints on trade, shouldn’t the world be the marketplace of any industry even in its infancy? This argument only works if you couple high population with protectionism (the infant industry argument, which itself is often challenged).

A third argument, that may be the focus of this debate, is that the demographic shift towards a flat population pyramid means that the proportion of people in the workforce will be much lower, and that public welfare support for the elderly will become a burden on a smaller workforce. However, one does not need to think too hard to realise that stimulating population growth simply delays this inevitable demographic shift. We have known this shift was coming for decades yet have failed to act. But it is not too late to implement solutions more practical than stimulation population growth.

Another argument is that of national security. Unless we have enough people, we won’t be able to defend our borders. To truly defend Australia from all others, how many people would we really need? 150million? More? This is a ridiculous argument and a reason we have strong allegiances with countries with large defence capabilities.

Apart from these arguments for high population growth over low growth or declining populations, Chris Joye cites the following reasons for a population minister, all of which have confusing and possibly contradictory implications

1. Australia’s long-term human capital requirements
2. The ramifications of those population projections for real GDP per capita and public finances;
3. The infrastructure that will be required to support the population base;
4. How that infrastructure will be funded by the public and private sectors;
5. The consequences of the population expectations for the nation’s housing needs;
6. Where we expect to locate this new housing (i.e. in which cities), and hence our long-term urban plans; and
7. The inextricable linkages between new housing supply and infrastructure investment, where the latter is a condition precedent to ‘enabling’ new shelter.

My response would include such lines of questioning as:

• Why would our human capital requirements ever be greater than our human capital?
• Why would population change have ramifications on per capita measures of GDP?
• Would not points 3), 4), 5), 6) and 7) suggest a slower rate of growth is preferable?

My last challenge leads to the heart of the arguments against high rates of population growth. My (and many others) argument is that providing basic services for these new people diverts investment from new technologies that improve per capita productivity. Population growth inflated by policy wonks is a burden many of us would choose to live without.

Like my argument that housing investment does not improve productivity, simply expanding the scale of capital infrastructure (such as roads, water supply, electricity supply etc) to match the scale of the population does not improve our per capita productivity. This investment diverts labour and resources away from actual productive capital investments such as new manufacturing technologies.

A second economic argument against stimulating population growth is that a high fertility rate will keep women (and some men) out of the workforce for longer. If we are worried about the welfare burden on a smaller workforce, we should also be worried about so many parents out of the workforce, and the increased welfare burden from the children (their education and health costs).

My final argument against high rates of population growth is that environmental impacts of new land developments are difficult to assess. The faster our rate of population growth, the lower we will be our standards of environmental controls. New mines, new housing, new industrial areas and ports will all have environmental impacts. To preserve environmental amenity for the current population, we should be careful about these impacts and adopt a cautious approach.

And what of a declining population? Traditionally a population decline was the result of war or famine, but, as suggested here, that doesn’t mean population decline should always be in the disaster basket.

But if the causes are benign, what about the consequences? If the decline in the number of people is slower than the natural growth in productivity (or output per person), then the economy will still grow. For example, a modest population decline of 0.25% a year would reduce Britain's economic growth rate of 2.25% to just 2% a year. That's hardly a recession. The number of consumers may decline, but the growth in incomes-and export markets-will ensure that demand stays buoyant. Nor will there be a demographic crisis, with huge numbers of old people overburdening those of working age. Population decline also leaves fewer children to support, train and educate for the first 20 economically unproductive years of their lives. The dependency ratio of workers to non-workers is virtually unaffected whether the population is growing 0.255 a year or falling 0.25%. Adjustments to an ageing society-discouraging early retirement, moving from pay-as-you-go to funded pensions-will be necessary in any case.

A high rate of population growth, stimulated by policy wonks on the back of fallacious economic reasoning, is a social burden I am sure we can do without.

The Norwegian solution to Dutch Disease

If you are unfamiliar with the term Dutch Disease then read on, because Australia has it, and needs to address it for our long term prosperity. 

Interest rates up

The RBA maintains its credibility today by following through with their threats of a rate rise, and in the process, making my forecast look ridiculous.  I still maintain that declining asset prices will pressure the RBA to decrease rates in the near future.

The combined impact of the cessation of the FHOG boost and the interest rate increases of 2010 paint an interesting picture for Australia's housing market.  Obviously my bearish outlook remains.

Why not a fixed money supply?

I would appreciate thoughts on the matter as this is a bit of early brainstorming on the issue.

I asked this question in a macro-economics class at university once. It seemed simple enough at the time, and seemed to me like a pretty simple and effective way to control a country’s monetary system.

The question was side-stepped quite successfully. So I went to my knowledgeable friend instead.

While there are some interesting conversations happening, I have yet to find a solid overview of the fixed money supply idea and the implications in practice. 

Thinking out loud here, as a general rule technological change and capital investment will enable a given society to produce more goods in future periods. With a fixed money supply, that means that prices will decline over time – deflation.

So the relevant question becomes - how does an economy function with persistent deflation? And my friend has a lot more to say on that. 

Just quietly, imagine you lived in a world with persistent deflation, you would be blogging about a how crazy it would be to propose a world with persistent inflation – how on Earth would it function with the value of money being destroyed each day?

This interesting article outlines a number of tangible problems facing an economy with deflation, including sticky nominal wages and the inability for a central bank to have a negative nominal interest rate. However, past deflationary periods have not curtailed our passage of economic growth, nor do we often read about deflationary periods of prior to the Second World War. The graph below shows the number proportion of inflationary and deflationary years pre and post WW2. The ‘old fashioned’ long-run has almost equal periods of inflation and deflation - a time when money supply was far slower to grow than at present.



One problem is that deflation rarely recovers to mild inflation but springs back to hyperinflation, as suggested here. Because people hoard money during deflation, the government response is typically to increase the money supply, then, when deflation looks under control, these hoarded funds come back into circulation in the real economy leading to rapid inflation. With a fixed money supply, this effect should be dampened.

Maybe then the best thing for governments to do is live with a little deflation, rather than actively responding by increasing the money supply. From the Austrian School we get these insights into the money supply, and why a little inflation might still be a bad thing, and find this conclusion:

... to Mises even a monetary policy that would pursue a pre-determined rate of money supply expansion (as proposed for example by Milton Friedman's k-percent rule) for stabilizing a broadly defined price index would remain a potential source of crisis which, in turn, bears the risk of undermining the value of the currency. This explains why Mises, in an effort to reduce that very risk to the ideal of a free society, argued for stopping the expansion of the money supply, thereby arguing for a concept quite different from today's state-of-the-art monetary policy.

With a fixed quantity of money maybe we could end up with less volatile swings in the value of the currency because behaviour would not be influenced by expectations of monetary policy changes. The expectation of a standing by the fixed money supply would lead less uncertainty, less hoarding, and potentially far more confidence in the currency.

However, we are still left with detailed questions about how debt or could work in this environment, whether people can perceive negative nominal gains as positive real gains (maybe there is a behavioural bias), and whether such a system provides a strong incentive for innovation and capital expansion.

Glenn Stevens' predicament: He wants us to believe interest rates are heading up without actually putting them up

I imagine it is a tough job being the nation's central banker. But the recent television interview with Glenn Stevens, RBA Governor, has made it quite clear the predicament he currently faces.

Stevens warned that property speculation is not the path to riches (the Real Estate Institute of Australia was apparently surprised by this statement). Obviously he is very worried about the stability of Australia's massive residential property market.  But to achieve the desired outcome, he needs to fool us all.

Is it all about GDP and growth?

(Guest post from Christian)

So if you believe the numbers, in the recent downturn, Australia managed to avoid 2 consecutive quarters of negative GDP growth and therefore had no recession.  This is an often proudly quoted fact by various Australian politicians and economists as a sign of the strength and resilience of Australia's economy and its wise management.  But what exactly does it all mean for the people of Australia?

Friday quick links

1. Most findings of statistical research are false, and can be easily demonstrated to be so.  If I haven't convinced you to scrutinise statistics carefully, then this may. Warning: the linked paper is a little nerdy and mathematical.

2. Is prescribing a placebo a good idea?

3. One laptop per child and a computer on every student's desk - some evidence that computers help children learn computer skills, but detract from their learning of other more basic skills such as maths and English. 

4. My interest rate bet looks shaky - straight from the horse's mouth.

5. Moral self-licensing is when doing something good in one part of your life helps you justify doing something bad in another part.  This 'green' consumer experiment is a classic - ..green shoppers, however, earned on average 36¢ more, showing that they had lied to boost their income.

I must say that in moments of raw self-reflection I can see myself issuing a subconscious (sometimes conscious) moral licence.  'I've been good for a while, now I can justifiably do something bad" 

Maybe it has something to do with our upbringing.  I know that I often reward my son with otherwise 'bad' foods (he loves Jatz crackers) when he has behaved well.  It would be nice to conduct a cross-cultural comparison on this topic. 

It is also a example of actively reverting to the mean.  People think they are at the extremes of socially normal behaviour, so they do something that is at the other end of the spectrum to keep themselves in line with others.