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.

Friday quick links

Latest research suggests that government owned banks are better for growth than private banks.

Another potential rebound effect - encouraging snus instead of cigarettes might lead to another avenue for nicotine addiction and potentially more cigarette use.

A belief in supernatural communication with the dead must surely be evidence for irrationality

One reason (not) to get an iPad - freedom from porn

Lower bound problems of hedonic indices

Prices are a fundamental feature of modern economies, yet measuring a true price change is exceedingly difficult due to the constantly changing quality of goods and services. I have previously discussed the use of hedonic price indices, where adjustments are made for quality changes using regression techniques, and the potential pitfalls when interpreting the results of this method. I apologise for raising this issue again, but I hope to clarify my message with an example.

While a hedonic index is a useful tool, and when part of a package of price indices can clarify our understanding of price and quality movements, many unresolved issues persist. One issue that attracts little attention is how to interpret and apply results from hedonic price index calculations.

Today I want to further elaborate upon, and demonstrate using the table below, what I call the lower bound problem of hedonic price indices. Quality improvement does not imply that prices faced by consumers have dropped, especially if lower quality goods are no longer available. Buyers of cheaper products will not see the price declines measured by a hedonic index, and may even see price increases.

The above table has been constructed to show how different methods for determining price changes can produce significantly different results. This hypothetical market could be computers, cars, or any other market where quality changes noticeably over time.

The animal names are the models. For car markets, it could be Corolla, Landcruiser and so on, or for computers, Dell Latitude, Apple MacBook or any other model. The reason to include models is that one method for determining price changes is called the model-matching technique. Because models typically have fewer quality changes than the market as a whole, and that they typically represent a segment of the market (budget or premium), compiling prices over time for the same model can give a reasonable measure of price changes for similar quality products. In the table above two models are highlighted, Kangaroo and Echidna, to show how their prices have changed over the period. If we take the average price change of models we can match over the period (the model matching technique), we get a price change in this market of -42% over the eight-year period.

The number beside each model is a measure of quality. I have used a single number in this situation, but typically there would be a number of associated quality measures. You will note that the quality of each model improves over time, thus if we use a hedonic (quality controlled) method for measuring price change, it will show a more substantial price decline. If we were to buy a ‘quality level 9’ product in 2001 it would be $3,000, while in 2009 it would be $1,000 – a 67% decline in price.

Using a median price index, where quality is not considered, the data in this table shows a median price increase of 14% over the period (assuming an equal volume of sales in each price category). In this scenario, this measure more accurately shows the price movement of the market as a whole. If you wanted to stay at the same level in the market, this is the price change you would experience.

Finally, and this is the main pitfall when utilising quality-adjusted prices measures to make policy decisions, the price change for the lower bound market entrant has increased 33%. The cheapest computer/car/shoe/phone/appliance, or whatever good this happens to be, has gone up in price significantly while the quality-adjusted measures show large declines.

Measures such as the CPI (a price index) and the Analytical Cost of Living Indexes do consider quality change, yet we apply these measures as a way to adjust welfare payments, even though most welfare recipients will be lower bound market entrants for much of their consumption bundle.

In an ideal world, a selection of price indexes using different methods would be produced for each major consumption category to show paint a clear picture of the situation being faced by different members of society. Not only would we measure ‘pure price change’, but also changes to the cost of living which can more easily guide policymaking.

A Rum Thing

Guest post by Stephen Hogg

This Business Spectator article gave me pause for thought. It is discusses how ASIC recently made a ham-fisted attempt at reigning in rogues in the market making a buck off spreading a rumour and then profiting from inevitable price movements. It’s called rumourtrage, and is the practice of spreading false or misleading information in respect of securities in order to take advantage of artificial changes in market prices.

Now don’t get me wrong, it’s a cunning idea. I know a lot of people who wish they had thought of it some years ago. But I became stuck on one point made by ASIC. At the end of the article it is made plain that when ASIC was figuring out how to put a stop to all this, that:

"The principles were developed noting concerns that confidence in the integrity of Australia’s markets could be undermined if investors believe rumours are actively spread in the market to distort proper price discovery"

I think is a flawed statement.

Barefoot running: The transition and Vibram Five Fingers

Economic instinct initially held back my enthusiasm for Vibram Five Finger (VFF) shoes.  At first glance getting less shoe for your money is bizarre.  At next glance it feels like a step backwards - expensive well-cushioned running shoes, the result of countless hours or research and design, should be the pinnacle of human endeavour toward running excellence.  There are so many people running in this world, both amateur and professional, that you just expect the current technology to be supreme. 

But there are a few reasons I became convinced that making the transition away from traditional running shoes (and shoes in general) to VFFs or barefoot was not a step backwards, but a simplifying step forwards.

- I generally prefer to be barefoot where possible
- The book Born to Run by Christopher McDougall was very persuasive
- Harvard researchers have been analysing the difference in running techniques between barefoot and shod and now running with shoes just looks wrong
- I saw a guy wearing VFFs at an adventure race (about 4hours running, kayaking and mountain biking) and thought he must have got the wrong information about how much time is spent in the water and worn his scuba shoes. 

I also tried running barefoot in the park a few times a week for a month before buying VFFs (the KSO model).  Apart from getting sore calves for a little while, the toe strike technique felt comfortable.  I considered forgoing VFFs and simply running barefoot.  Nowadays it’s either barefoot or VFFs depending on the distance, my mood, or the weather.

Let me share the experience and comment on the bizarre barefoot running culture that is developing.

Cycling culture through economist eyes

I have been fortunate enough to travel widely in the past decade and sample the breadth of human experience. Today I want to focus specifically on the evolution of cycling culture around the globe.

I have taken note of the popularity of my recent post on the proposed bicycle hire scheme in Brisbane and want to expand some of the points I made about the incentives to (or not to) cycle, and compare the diverse cycling cultures around the world.

The comparison will consider such obvious differences across countries such as speed, cost and safety, but focus on the historical development of cycling culture across countries. I will finish with some ideas about how to cities can embrace cycling as a legitimate mode of transport.

Confusing macroeconomic situation

The Reserve Bank has lifted its stimulatory cash interest ratesetting and showed a willingness to continue to tighten monetary policy if required. At the same time, the Federal government continues to spend into the economy with its Nation Building Economic Stimulus Plan. The RBA started contracting their position when the Government was only half way through its rollout of fiscal stimulus. All data upon which the RBA acted was severely affected by the $25billion spent into the economy as part of the Plan. That’s not forgetting the $17billion still to go in 2010.

Unfortunately we have yet to see what is left of the ‘real economy’ once this artificial situation expires.  But at least the RBA has proved their independence.

The reason monetary policy (changing interest rates) works is because is can bring forward, or delay, consumption. Lower interest rates bring forward consumption, as the reward for saving is lowered and people choose to spend more now rather than save and then spend later time periods. The cost of borrowing is also reduced, and can stimulate debt funded current consumption. Conversely, higher interest rates encourage saving and discourage borrowing.

The Nation Building fiscal stimulus package is bringing forward government spending – the exact opposite of what the RBA is trying to do. The remaining $17billion being spent this year will offset the last 3 interest rate increases – each 0.25% rise increased the interest on Australia’s private debt by $4.8billion/annum; money which would have otherwise been spent on present consumption or investment (of course I have overlooked the impact on savings rates in this calculation).

My gut feeling is that the RBA was far more confident then it should have been, and we may see a repeat of the dramatic change in policy that we saw at the end of 2008 when the cash rate was more than halved in a few short months.  There might be some money to be made in foreign exchange - I expect the AUD to decline between now and the end of 2010.  Another forecast to be tested.

Friday quick links

A new direction for interest rates?

For risk taking behaviours, the rebound effect even has a name – The Peltzman Effect

New Mysterious Cities of Gold cartoons on the way.

Broken window fallacy or just plain old human optimism? Café Hayek is full of gems.

Ever wondered why all news is bad?  A must read on what happens to good news.
...there are huge vested interests trying to prevent good news reaching the public. That is to say, in the ruthless free-market struggle that goes on between pressure groups for media attention and funds, nobody likes to have it said that `their' problem is not urgent and getting worse.

Externalities addressed the Dutch way.
...in the Vondelpark, a delightful reserve in central Amsterdam, it is illegal to let your dog off a leash. But it’s perfectly legal to have sex in the park, so long as it is not in view of a children’s playground. The argument is that the dog may make a mess that imposes costs on the unwary walker, while the couple imposes no costs on other park users.

Steve Irwin's way: Economics of wildlife conservation

At Australia Zoo (I had a lovely time there on the weekend, thanks for asking) there are numerous signs posted to encourage visitors not to buy native animal products – crocodile, emu, and kangaroo meat for example.  I found this very odd, as crocodile and emu are farmed, and most kangaroo species are not endangered – far from it.  So what kind of conservation message was this I wondered?

Steve Irwin expressed his conservation message more clearly on the website:

"Sustainable Use" of native wildlife in so-called modern nations like Australia and the U.S.A. has inadvertently created a multi-million dollar 'bushmeat' industry, where local people kill native wildlife for meat, skins and products. Please don't blame the local people; it's not their fault! They're simply hunting for much needed money. The greatest wildlife perpetrators of today's world are those behind the driving force of "Sustainable Use." 

How are the Tiger Farms in Taiwan and China helping to save Tigers in India, SE Asia or Siberia? They are perpetuating the market in Tiger products, which is the single greatest reason for the endangerment of Tigers.

…If we can destroy the market, we'll destroy the industry. Historically the only reason spotted cats, like Leopards and Cheetahs are still found in the wild, is because of peer pressure. It became 'uncool' and controversial to wear spotted cat fur coats, so the market was destroyed and the industry suffered. Slowly, less and less Leopards and Cheetahs were being shot for their skins, and just as well or they would've been extinct 20 years ago.

The principle behind this message is that if we eliminate demand for wildlife products, we will preserve species.  But there are alternative ways to protect wildlife and biodiversity (a side note: do we really care about an individual species, or do we use iconic mammals as the canary in the coal mine of biodiversity protection?)

In addition to the ‘demand destruction’ technique, economists propose other ways to preserve threatened species – promote domesticated supply (farm threatened species), the Coase solution (give rights to the species to a group who can profit from non-consumptive use of the animals such as eco-tourism and research), and simple land conservation.

Which of these measures work?  Should we try them all, or are they mutually exclusive?

How much is this island worth?

I would appreciate some feedback on a little conundrum I face at work.  The following analogy is close enough for our purpose, and what I want to know is how much the island is worth?

Imagine a large island was discovered in Australian waters in the 1960s.  The government takes ownership of the mostly desert island.  It has little environmental value, with a surprising lack of biodiversity, some small mineral deposits that are uneconomical to extract, and otherwise is of little use. 

The government decides that they may as well put the island to some use, and offer people a licence to inhabit the island, and the rights to the minerals and any vegetation they find.  The licence is offered for free with the condition that the licence holder make use of it within 3 years (by inhabiting the island or making use of its resources in some way).  By 2010 a dozen people have licences and inhabit the island.  The government estimates that they could offer 100 more licences before the islands land is fully ‘developed’.

The government changes its licensing policy and decides that licences will be converted in title of the land in the island - much like it is on the mainland.    It now has 12 blocks of land in private hands, and 100 in government hands.

The government then decides to sell its remaining blocks of land to the market.  At what price could they sell these 100 blocks?

I see two drivers of price:

1. The previously free and seemingly non-scarce licence is replaced with a scarce piece of land, therefore people will be willing to pay something simply out of speculation of future value (because they now don’t have to inhabit the island to keep the block).

2. The price is still worth nothing if people weren’t willing to take the licences for free for 50 years.

How do we estimate the market price, if any, of these blocks of land?

iHate Steve Jobs or Why I Won’t Buy Anything Made by Apple (Yet)

Guest post by Ben today

At the moment it seems that the ascendance of Steve Jobs and the Apple Empire knows no limit. With the media player and smart-phone markets sewn up and their eyes firmly set on conquering the tablet PC market with the omnipresent iPad, it seems that Apple can do no wrong.

But not for me; I can see the Apple vision for the future and it’s a safe, bland, white-chrome corporate hell. Why do I say this? Well maybe it might have something to do with:

• Apple’s restrictive licensing conditions for the sale and development of apps which basically amounts to censorship and discourages innovation;
• Their refusal to allow 3rd parties to sell apps; iTunes is it – monopolistic price gouging anyone?
• Draconian digital rights management – installing unlicensed apps on you iProduct voids the warranty as does ‘jail-breaking’ them;
• Stupid ongoing court antics with Adobe meaning that iProducts aren’t compatible with Flash;
• Rechargeable batteries which can’t be replaced;
• And the thing that irritates me the most: requiring the use of propriety peripherals e.g. iPod shuffles are designed so that you can only use Apple headphones; USB devices or HDMI monitors can’t be plugged into an iPad - you need to purchase a Apple ‘adapter’ first etc.

But these are secondary to my main issue with Apple, which is their pricing policy.

Housing crash makes us winners and the bubble checklist

It’s no secret I am forecasting price declines (or prolonged stagnation) in the Australian residential property market. The intricacies of this topic have led many to the conclusion that the government won’t let that happen - there are simple too many people going to lose in the short run, even if we may all benefit in the long run. While I agree that the government may not let this happen (although foreign ownership rules are being tightened up again), and may produce an arsenal of economic weapons we haven’t even though of yet, I disagree that there are more losers than winners from a significant housing price correction.

The mainstream ‘more losers than winners’ message is aptly summarised in this article:

The only people who would rejoice in a house price slump, it seems, are the young and aspirational. As Willem Buiter put it in his 2008 paper for the National Bureau of Economic Research, 'Housing Wealth Isn't Wealth', “…the young and all those planning to trade up in the housing market are made better off by a decline in house prices. The old and all those planning to trade down in the housing market will be worse off.”

This view is wrong.

Suggestion box and a call for help

After more than two years of blogging I have still not run out of topics to discuss. Like the television series Mythbusters, who seem to find that humanity can produce a constant stream of urban legends, I too seem able to constantly find economic myths, political promises, and social conundrums to pick apart.

However, I would love to hear what topics are currently of interest to readers – anything from social, environmental, and political concerns to the downright nonsensical. Please post a comment if you have any suggestions and I will endeavour to investigate in future posts.

For your interest, some of my favourite topics include:
• leisure time, helmet law and sunscreen rebound effects
• the food security myth
• arguments against population growth
• unintended consequences from maternity leave and child care subsidies
• why preventative health care adds to rather than diminishes the cost of the health system (here and here)
• and of course the many myths surrounding the housing market (here, here, here, here and here)

Finally, I would very much appreciate your help promoting this blog to the world. If you have your own blog site I would appreciate a plug (and will reciprocate).

If you want to be very helpful, you could promote some of your favourite posts by email, twitter, or some other medium to your friends and family, or post a link on your Facebook page.

One final prediction.  Next week's CPI release from the ABS will come in lower than expectations.  The probability of the RBA increasing interest rates again will drop from 70%, and the AUD will drop at least 1c against the USD.

CityCycle scheme, bicycle helmet laws, and a better alternative

In my bio I promise to turn ideas on their heads to gain a better understanding. In this spirit I ask the following question of Brisbane City Council’s proposed CityCycle bicycle hire scheme – is it better for council to subsidise a bicycle hire scheme to stimulate bicycle use, or is it better for council to subsidise a car hire scheme to encourage bicycle use?

(And yes council will have to subsidise the scheme through the donation of public space, and possible contributions to ongoing costs, as has happened with such schemes in Europe, even though hire costs and advertising on bikes provide the main sources of revenue for the operator).

I suggest the latter may be preferable. Here is my logic.

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.

Affordable housing supply from a market crash

It seems that no matter what the objective market conditions are like, the same lobby groups (the Housing Industry Association and the Property Council of Australia for example) and property spruikers continue to trot out the housing shortage claim in an appeal for government assistance.

If you truly believed there is a housing shortage and hence an affordability crisis, a market crash (price declines >20%) is the best solution. I will outline my reasoning by referring to the appropriate economic models – the same models misused by those who believe that government intervention is causing supply constraints.

Book review: Embracing the Wide Sky

Autistic savant Daniel Tammet wrote this gem, and yes that means he has ‘rainman' like mental skills.  In fact, he learnt Icelandic (his 11^th language) in the week prior to being interviewed for an Icelandic television program. 

Why the next interest rate move is down

Most economists predict another rate hike by the RBA. I am not like most economists and predict the next move will be down. My reasoning is founded on the unfortunate necessity to maintain housing values in order to avoid serious disruption to our financial system. The RBA will move strongly to reduce the interest burden on debt should they see evidence of a fall in house prices (aka values). The following snippets are therefore worrying for the RBA:

Random externalities

A complete reiteration of my arguments against exceptional circumstances provisions for farmers can be found on today on Business Spectator courtesy of David Leyonhjelm.  Simply, we fear a non-existent negative externality of diminished food production should farm businesses fail.   

As a parent I also found this article on the externalities of public advertising quite intriguing.  It seems that movies (private consumption decisions) need to be classified to prepare the viewer for their level of violence and sexuality, yet advertising in public spaces seems to be M rated even when Parental Guidance is not possible.  To avoid this negative externality on children and parents could we not adopt the G rating standard from the film and television industry as the standard for public advertising?

Those who are a fan of the movie Pay it Forward will ba happy to see that acts of kindness can spread through society very easily.  Just another bit of evidence for how culture can change behaviour and how our preferences, expressed through our behaviour, are not fixed at all (as economists would have us believe).  Given this is an example of a positive externality, economic theory would suggest we will face a constant battle to ensure a socially optimal level of kind acts.  Luckily the research suggests that once we adopt a strategy of kindness we don't go back to selfishness very easily.

Newsflash: Property Council of Australia makes a reasonable point

The Property Council of Australia is a powerful lobby group known for ignoring truth and reason in its appeals for support from all levels of government.  The PCA’s latest battle surrounds the proposed amendment to the Valuation of Land Act 1944 (the Act), which will clarify a number of definitions for determining the ‘unimproved’ value of commercial buildings – a value upon which land tax liabilities and local government rates are calculated.

(As a strong proponent of land taxes I should be paying particular attention to the necessary practicality of  valuing unimproved land.)

The property lobby sees this Bill as a tax grab due to the likelihood of higher land valuations, and they have mustered plenty of support from other industry associations to stop it getting passed.

What follows is a brief analysis that suggests the Bill is quite unworkable, that the PCA has actually raised real issues with the practicality of the Bill, and also suggests extreme incompetence by the Queensland government.

Proposed changes to Section 3 of the Valuation of Land Act 1944

Words removed are struck through, and inserted words are in red. 

(1) For the purposes of this Act—

unimproved value of land means—

(a) in relation to unimproved land—the capital sum which the fee simple of the land might be expected to realise if offered for sale on such reasonable terms and conditions as a bona fide seller would require negotiated as a bona fide sale; and

b) in relation to improved land—the capital sum which the fee simple of the land might be expected to realise if offered for sale on such reasonable terms and conditions as a bona fide seller would require, assuming that, at the time as at which the value is required to be ascertained for the purposes of this Act, the improvements did not exist. negotiated as a bona fide sale, assuming the improvements did not exist.