Minimum wage decision and the textbook response

Economists like to promote the idea that increasing the minimum wage results in fewer jobs. The law of demand states that when the price of a good goes up, demand goes down. But a welfare State has a role not just to encourage people to work, but to improve overall welfare.

The job loss textbook response is only fair if we cling to the unreasonable ceteris paribus assumption – that minimum wage increases and all else stays constant. But that is not reality.

For example, offsetting effects of an increase in the minimum wage include

- people choosing to study instead of work
- businesses investing in capital equipment to improve labour productivity

Both of these indirect effects of the minimum wage are good for society’s welfare in the long run via increased productivity.

Apart from being a good long run policy, I see the minimum wage as a tool to control possible market power of employers. Uninformed and low skilled workers are easily vulnerable to manipulation, and are unlikely to access legal guidance or negotiate their wage with vigour. Not all people are fully informed, perfect knowledge homo economicus. Asymmetric information and the resulting market power of employers of low skilled workers are justifiable reasons for government intervention.

One needs to exercise extreme caution when applying economic principles to reality. Most mainstream economic theories are based on completely unreasonable assumptions (an upward sloping supply curve and an ignorance of time for example).

The Noble Lie?

In his book The Noble Lie: When Scientists Give the Right Answers for the Wrong Reasons, Gary Greenberg challenges conventional wisdom to suggest that many social vices have become labelled as diseases, without evidence, but for the betterment of society.  His book delves into the grey areas of science, politics and philosophy, conveying a line of reasoning that presents a picture of positive self-delusion on a grand scale.

This review summarises some of the challenging points in the book.

For instance, Greenberg explains how alcoholism's transition from vice to disease was a welcome one, especially following Prohibition. It was long viewed as an allergy, though the specific allergen persistently failed to appear. Even today, neither its disease-nature nor any possible cures have manifested themselves. Regardless, people are happy to accept the idea that addiction is a medical illness, perhaps, Greenberg suggests, because of our ambivalence towards the role of pleasure and our uncertainties about free will and self-determination. “With the disease model we have an answer,” he writes, “one that has the imprimatur of science; addiction isn't wrong, it's sick.”

In the absence of scientific proof that addiction is a disease, is it wrong for medical professionals to perpetuate the idea? Not necessarily, Greenberg says – there are times when what is scientifically wrong, or at least uncertain, is morally right. “There can be no doubt that the disease model has helped millions of people. If a made-up disease can be of such immense value, then we must consider the possibility that the truth is not what it's cracked up to be. Perhaps, in the republic of medicine, the fiction that addiction is a disease is a noble lie.”

Sometimes the noble lie works the other way round. In a chapter on homosexuality, Greenberg shows how humane concerns first led people to prefer a medical to a criminal definition, but conflict followed concerning the disrespect a medical definition implied toward what should perhaps be viewed as a free life choice. In 1973, following the Stonewall riots and the start of the gay rights movement, the American Psychiatric Association deleted homosexuality from the Diagnostic and Statistical Manual of Mental Disorders (DSM), a move decided not by scientific facts but by political and moral attitudes. “It may be the first time in history that a disease was eliminated by the stroke of a pen,” Greenberg writes.

Mining on a pedestal?

The proposed Resource Super Profits Tax (RSPT) has received both scathing criticism, and reserved admiration. Critics proclaim that the mining industry is almost a fundamental necessity, without which Australia would grind to a halt. Otherwise respected firms are making contradictory claims of social benefits, including increased wages, while also arguing that there is little impact on wage rates in other parts of the economy, and denying that other investments are being 'crowded out', as most capital is raised abroad. They indirectly state that foreigners are reaping the most benefit from Australia’s resources providing an intangibly small flow-on effect to other sectors of the Australian economy.

Such is the confusion about the true social and economic benefits from mining and the likely impact of the RSPT on Australia's welfare.

This type of confusion in the debate over the RSPT and its likely impact is widespread, possibly even within the government itself, which is still to make decisions on exactly how to implement the proposed tax. While I agree with the principle of the tax, which has the same theoretical basis as the Petroleum Resource Rent Tax, certainty of the details is required – particularly the rate at which the RSPT will begin to apply (currently 6%).

But one thing we can examine is the claim from miners that their industry brings great benefits to your average Australian. A recent report by David Richardson from the Australia Institute does just that and makes surprising conclusions:

The mining boom would have had a major stimulatory impact on the Australian economy but for two factors. First, the Gregory effect saw the exchange rate appreciate, which caused a contraction in the rest of the economy. Secondly, the Reserve Bank of Australia increased interest rates in an attempt to offset the stimulatory effects of the boom.

Anyone owning resource stocks would have benefited from the enormous paper gains, which peaked in May 2008 but had largely disappeared by the end of 2008. However, to the extent that the gains persisted, the benefits would have gone to the top 20 per cent of wealthy households where share ownership is concentrated.

Overall, it is hard to identify the benefits to ordinary Australians of the mining boom. The estimated 9 percent increase in real incomes from the terms-of-trade changes do not appear in the figures for wage earners or recipients of government income-support payments. It seems that the benefits of the boom barely went beyond the mining industry itself.

Further, in Ken Henry’s Senate testimony he claims that the mining industry is not a source of economic stability, but a highly speculative and cyclical business that did not contribute to Australia’s economic stability in recent years, having dropped 15% of their workforce in response to the financial crisis.

Just because mining is a large industry when compared in terms of dollars of investment, does not mean that it is more productive than other forms of investment. Only improvements in productivity lead to broad social gains.

We can plod along happily talking about number of people employed in mining, the dollars invested into mine projects, or any such figure, but unfortunately any number is rather meaningless without an alternative with which to compare.

One could be tempted to brag, for example, about the contribution their farm makes to the regional economy by stating how many people they employ, how much they invest in capital works, and how much food they produce. But if their next door neighbour employs more people, invests in more capital works, and produces more food per hectare, the first farmer is performing poorly and is a burden to the nations’ productivity.

The contribution of mining to Australia’s welfare is determined by its productivity gains, and simple investment numbers say nothing of the opportunity costs of labour, land and capital.

All comments/criticism welcome.

Interesting news

Developers using cows to reduce land tax burden.  One of the defining traits of rule makers is that they rarely foresee the extent of gaming likely to occur.  It seems Australian agricultural policies are not immune to the type of manipulation seen in Japan.

History repeats (must see video).  BP's deep water oil spill in the Gulf of Mexico is almost identical to a spill in 1979, where the same inneffective and oddly named 'solutions' were tried.  That spill lasted months and was only brought under control by drilling relief wells to take the pressure from the oil bed.

Melbourne Cycle Scheme up and crawling.
Users will have to bring their own helmets as they won’t be available for hire with the bikes. However, those joining the scheme will be issued with a free helmet, while hotels and other city outlets will have cheap helmets available for hire or purchase. (here)

A cycle by-pass is also proposed in Melbourne - a step in the right direction for urban transport planning.

A lesson on being sceptical about statistics in economics (warning: technical content)

Organic farming – a closer look.

Bakfiets – is Australia ready for the cargo bike revolution?

Note: I bought a Bakfiets long cargo bike in September 2010 from Dutch Cargo Bikes and couldn't be happier. A follow-up (3yr) review is here.  I am now a local ambassador for Dutch Cargo Bikes. If you would like to test ride this bike in Brisbane (or a three wheeler) email me at cameron@dutchcargobike.com.au  

Recent discussions on cycling culture and the imminent arrival of our second child have resulted in an obsession with cargo bikes or Bakfiets (Dutch for boxbikes). These bikes are taking the world buy storm, and have now made their way to Australia, with the market well served by DutchCargoBike.com.au, who offer a variety of models.

I want one, exactly like in the photo above, but I don’t know why.

Economists generally believe people know how to make decisions that maximise their welfare. But in many cases we can’t know how much we will enjoy our consumption decisions in advance, since we have never experienced them before – such goods are known as experience goods.

Having already test-ridden one and been impressed, I am now attempting to evaluate the bike's worth by first itemising the pros and cons. Any assistance or insight or suggestions are appreciated.

Pros
Can handle a load of groceries plus children for short trips
Can pick up hitchhikers
No parking or fuel costs and only minimal maintenance
Fun

Cons
$3150 for the bike
Over $4000 if you want electric motor assistance
Plenty of hills in Brisbane
Size and manoeuvrability
Extreme summer heat (can buy a shade for the kids though)

More importantly, to determine the value to our family of the bike I have been thinking in terms of marginal utility. Instead of thinking how good or practical the bike could be in isolation, I think in terms of how much better having the bike would be compared to our current situation.

Japanese farming: A tale of incentives and externalities

On my first trip to Japan I was astonished by the prevalence of rice paddies in dense urban areas. A friend I was visiting mentioned that he occasionally had to cycle around a rice harvest from the plot next door on his apartment driveway. Throughout the city little patches of green space were being used for some kind of vegetable farm or rice paddy.

Why is this? What is so peculiar about Japan that people would forgo higher value urban land development to grow rice?

Induced traffic, super profits, and 3D TV

Induced traffic (a type of rebound effect) should be a major concern for Campbell Newman’s TransApex money pit. One would think that the need to duplicate the Gateway Bridge just 19 years after its completion was evidence enough that road space does not improve travel times for very long. We don’t want a city that looks like the picture above in another 20 years.

On that topic, I drove across the William Jolly Bridge on Monday at 4.30pm, and Thursday at 9am. I was alone on the bridge. I fear that the Hale St Bridge, at $1.50 then $2.70 each way, will be completely empty except for maybe a couple of hours each weekday – surely not a good way to spend $370million.

Ken Henry defends the Super Profits Tax on mining against a wave of political and media misunderstanding and misrepresentation. Whether the government adopts Henry’s ideal version of the tax, or some other politically modified version (or none at all), remains to be seen.

An interesting history of the private provision of public goods

3D Cinema and TV – how does it work and why can’t a normal TV project images that trick the eye into seeing 3D?

Update: Tax me, please

Last year I wrote about the important social benefits of land taxes compared to other forms of taxation. My headline was Tax me, please (also cross-posted at Online Opinion).

Maybe it is just a coincidence, but Mark Carnegie’s outstanding piece on the best recommendations from the Henry Tax Review, including the land tax as a substitute for transactions taxes such as stamp duties, is entitled Tax me!

Carnegie’s article sums up my thoughts on the Henry review and is worth reading in its entirety, but here is a taste.

“… economic growth would be higher if governments raised more revenue from land and less revenue from other tax bases.”

“When a government builds a new railway line and the value of the surrounding property soars, surely it is right that this wealth be taxed.” The same is true of people who get dairy farms on the edge of cities rezoned as residential land in quarter acre blocks. As Churchill said, “To not one of these improvements does the land monopolist, as a land monopolist contribute, and yet by every one of them the value of his land is enhanced...”

We all hate paying more tax than we have to but Ken Henry has written a document that is a compelling argument for how to build a better country given that someone has to pay to run the country.

If I had my way, I would abolish the states and cut billions from the cost of running the country. But I know that will never happen because Australians would never vote for a referendum to do that and so we are pretty much stuck with the bill as it is. Can’t we at least come together for the good of the country and put aside our personal interests for long enough to capture this powerful vision of a better, fairer, more productive tax system?

One percent realty – a revolution in the making

Real estate agents have a poor reputation.  The cynical side of me would say that they get paid a lot for doing very little.  Unspoken collusion results in an unwillingness to negotiate commission from the maximum allowable, which, under the Property Agents and Motor Dealers Regulation 2001, is $900 plus 2.5% if the price is over $18,000.  Almost ten years on residential property prices have increased is many areas by 300%, yet agents still typically charge this maximum amount in a 'take it or leave it' fashion.

But things are changing fast. 

Housing and population updates

Australian housing finance is falling rapidly with prices likely to follow.

This graph of historical prices and housing finance approvals deserves a look. Also, the graph below was part of the RBA's Luci Ellis' speech on housing last week and was referred to as follows:

Australian housing debt is higher relative to housing assets now than in the past (Graph 4). We should expect this ratio to be higher than in the 1970s and 1980s. The financial regulation of that period artificially restricted household borrowing. For example, unmarried women found it hard get mortgages back then. The question is whether this measure of leverage is higher than can be sustained. After all, it is much lower than in the United States, even before their boom-bust cycle. But we should expect that to be true. Because they can claim home mortgage interest against their tax, American owner-occupiers have less incentive to pay their debt down than their Australian counterparts.
...
Recent data suggest that we do not have a credit-fuelled speculative boom on our hands.

I wonder what data would be required for Ellis to conclude otherwise? If it was so easy to see a speculative bubble in the data, none would ever form.

Finally, a word of caution about the graph. It is the ratio of debt to value. Therefore a rise can be caused either by an increase in debt or a decrease in home values. Clearly the dramatic lift in the US ratio in 2008-09 was caused by declining asset prices, not increased debt.

Strangely Ellis concludes that a 40% aggregate debt ratio was a massive bubble in the US, but 30% in Australia is not apparently, even though we should expect this relationship due to differential tax treatment of mortgage interest.

The RBA is sounding very confused these days.

On another note, the 'population growth increases house prices therefore the Australian market is safe' point of view is looking very shaky. Latest BIS Shrapnel report forecasts significant declines in population growth in the coming years.

BIS Shrapnel says annual net overseas migration - which includes permanent migration and longer-term but temporary stays - will fall from its pace of 298,900 in the year to June 2009 to 240,000 in the year to June 2010. It will fall more dramatically to 175,000 in 2010-11 and 145,000 in 2011-12.