## Tuesday, December 14, 2010

### Health economics –unnecessary treatment and economic costs of illness... and goodbye

This blog has been quiet lately.  The evidence is mounting in support of much of my earlier analysis of Australia’s housing market, while the Government attempts one more manoeuvre to bolster the market.  The supreme risks to the market are no longer a secret, and our chronic supply shortage has been receiving far less airtime.  There is very little for me to add to the current discussions.

One reason for the lack of posts is that I am studying for the GAMSAT test that one needs to pass before commencing a graduate degree in medicine.  Yes, my disillusionment with economics has driven me to seek a more useful profession. And despite my rational nature, I will give up quite a deal of income for it.  At least this economist knows that money doesn’t buy happiness.

In this final sign-off post it may be worthwhile taking a look at economic issues surrounding medicine and health care.  This is a burgeoning field, with demand growing for paper shufflers of this particular specialty, and universities eager to fill the void with a qualification.

My core argument in this field has been that increasing preventative health care, while having the benefits of a healthier and long life, often come at increased total lifetime health costs, rather than decreased costs as is often proposed.  Remember, we all die some day, and any potential cause of death postponed will allow another to take its place, which of course has its own health costs.  Alternatively, a more healthy existence may make us more productive for longer and lead to us contributing more in taxes over our lifetime than the potential increase in health costs which were paid through the tax system for our preventative care.

Governments, and subsequently economists, worry about these things because many health care costs are borne by others though tax revenue, yet the net economic effect is anything but straightforward.

In light of these concerns a cottage industry of economic analysis has developed pandering to the interests of particular interest groups involved in medical research.  Each disease these days seems to have a lobby group, and to ensure funding for further research it is necessary to argue in terms of economic costs and benefits of a cure or treatment.

Over at Catallaxy Files there is an interesting take on the abuse of economics and shady use of statistics when consulting firms are asked to produce reports on the economic cost and impact of a particular disease. After prodding around the reports from one firm, the author notes that:

Adding up the estimated economic cost of all these conditions begins to exhaust the GDP, which suggests that the estimates of the economic costs are grossly exaggerated for a number of reasons.  This should not come as any surprise of course since the sole purpose of these studies – they have no academic credibility – is to provide RHETORIC  to bolster the case for the RENT SEEKERS who are attempting to prize out additional taxpayer monies to support their particular activities, worthy though they may be.

One of the real problems with these studies is the double/triple/…  counting associated with these studies as many people have multiple pathologies.  Moreover, the projections of the numbers afflicted by these conditions in the future should be treated with a grain of salt (probably box).

These studies also conflict with the findings of the Productivity Commission in their work undertaken in relation to the National Reform Agenda. In large part because most people with chronic conditions manage to continue their working life, the PC’s estimates of the cost of most chronic conditions (including mental illness) are not especially high.

The interesting work of Eric Crampton at the Canterbury University – great paper delivered at the Mont Pelerin Society – also shows that government studies of the economic costs of alcohol use are grossly exaggerated. There are typically  both conceptual and measurement mistakes.

I have a slight problem comparing the sum of a total cost of over time (total economic cost) with a flow of production in a single time period (GDP), but the general practices of double counting, including a potential undiagnosed population, and taking the extreme assumptions of the diseases impact and applying to every candidate, are intentionally misleading.

This is perhaps one reason why proponents of preventative medical treatments overstate the aggregate benefits to the community and subsequently the reduction in health cost borne by the taxpayer. Another reason preventative health care does not always provide net benefits can be explored at an individual level.

Movember have been a huge promotional success, yet at the heart of the charitable event is a desire to raise awareness of prostate cancer and promote early detection and preventative treatment.  However, this particular cancer is possible one case where the cure is worse than the disease at an individual level.

They know that prostate cancer is overwhelmingly a disease that kills men late in life. The average age of death for prostate cancer in Australia is 79.8 years, while the average age for all male cancers combined other than prostate cancer is 71.5.

The average age of death for an Australian man is 76 so on average, men who die from prostate cancer actually live longer. In 2007, just 2.8 per cent (83 men) who died from the disease were under 60, and 10 (0.1 per cent) were in their 40s.

The author notes that the unnecessary treatment undertaken by many men as a result of early testing often leads to impotence and occasionally incontinence, when there was a very high probability that they would have died from another cause before the cancer severely impacted their health.

Medical associations and governments try hard to examine these issues prior to funding and promoting preventive health care.  Where current screening techniques return too many false positives the chances of over treatment are severe. One the other hand, a screening technique returning a high number of false negatives may not be such a concern if the disease develops slowly and screening is recommended periodically.

In all, it seems that the health industry is not immune to manipulative economic analysis and rent seeking behaviour.  I am sure there are positive ways economics have been contributing to debates on public health, yet in the haze of spin it gets very little publicity.

Thanks to all my readers for contributing ideas and thoughts on this blog in the past few years.

Merry Christmas.

Cameron

## Monday, December 6, 2010

### Parkinson's Law

Work expands so as to fill the time available for its completion

Some might know Parkinson’s Law as it has been quoted above, yet the implications of this law are rarely acknowledged.  In bureaucracy this is especially the case. I have witnessed it firsthand.  Ironic, since the ever-expanding British bureaucracy was the focus of Parkinson’s original 1955 article.

Parkinson’s work may have been seen as mere parody, yet his insights appear to be consistently proven over time.  This very blog post was achieved under pressure of time, utilising this Law to my advantage.  Had I allowed myself and hour it would have taken an hour.  Since I allowed myself just 30 minutes, with a 3pm deadline, magically, I expect it to take that long.

Parkinson’s explains the theory behind his law starting at a position best summarised by this passage:

Granted that work (and especially paper work) is thus elastic in its demands on time, it is manifest that there need be little or no relationship between the work to be done and the size of the staff to which it may be assigned.

He finishes with this gem of a formula explaining the continuous growth in numbers of bureaucrats.

(Where k is the number of staff seeking promotion through the appointment of subordinates; p represents the difference between the ages of appointment and retirement; m is the number of man-hours devoted to answering minutes within the department; and n is the number of effective units being administered... and where y represents the total original staff)

Parkinson notes that this figure will invariably prove to be between 5.17 per cent and 6.56 per cent, irrespective of any variation in the amount of work (if any) to be done.

The figure for Australian States in the past decade was a measly 3.1% - still significantly faster than the rate of population growth.  Yes, government is outgrowing the country.

A further development of Parkinson’s ideas is his Law of Triviality, which suggests that organisations give disproportionate weight to trivial issues. Parkinson dramatizes his Law of Triviality with a committee's deliberations on a nuclear power plant, contrasting it to deliberation on a bicycle shed. A nuclear reactor is used because it is so vastly expensive and complicated that an average person cannot understand it, so they assume that those working on it understand it. Even those with strong opinions often withhold them for fear of being shown to be insufficiently informed. On the other hand, everyone understands a bicycle shed (or thinks he or she does), so building one can result in endless discussions because everyone involved wants to add his or her touch and show that they have contributed.

The Law of Triviality can be expanded to apply to the state of public debate surrounding important political decisions.  Debate over where to host the local Christmas carols often trumps the debate surrounding reform of the banking sector or our participation in wars in the Middle East.  Perhaps we simply prefer not to think about these big issues for fear of being overwhelmed.

In all Parkinson's insights seem to be rarely used to our advantage.

## Tuesday, November 30, 2010

### GDP only positive because of rain drenched agriculture

Today’s National Accounts figures were not a huge surprise - except, of course, to many of the mainstream economic commentators, some of whom continue to demonstrate their undying faith by stating that the decline is nothing to worry about.

Neither are the downward revisions to the June quarter figures worth a second look.  The June quarter growth trend down was revised down from 0.9% to 0.7%, and seasonally adjusted down from 1.2% to 1.1%.

And possibly my favourite lines from the ABS release
In seasonally adjusted terms, Agriculture (up 21.5%) contributed 0.4 percentage points to GDP growth driven largely by strong forecasts for grain crops... GDP increased 0.2% in the September quarter, while non-farm GDP fell 0.2%

If it wasn’t for the surge in agriculture driven by last season’s strong rains, GDP growth for the quarter would have been negative, and for the year, just 2.3%.

Perhaps it is time to revisit some forecasts by our favourite economists back in September.

Peter Jolly, NAB - Our year ended GDP forecast has lifted to 3¼% from a little under 3%
Christopher Joye, Rismark - The economy is about to embark on a period of above-trend growth
Warren Hogan, ANZ - Hogan believes we are about to see a period of serious inflationary pressures thanks to the commodities boom's income wave
Michael Blythe, CBA - reckons the income surge will add 3 or 4 per cent to GDP over the next couple of years.

Yet the serious inflationary pressures and above trend growth seem to be a little hard to come by at the moment.

At least I can give myself a plug.  Heck, isn’t that what economists do?  My prediction from early September - Inflation and GDP will surprise on the low side in the September quarter.

Steve Kates explains much better how the data early in the year was deceptive due to the dramatic impact of fiscal stimulus, and that the private sector recovery is yet to appear.

Using the National Accounts to better estimate changes in well being (PPT link) – from the OECD Measuring Progress Agenda.  Aka - Why I don’t feel like I benefit of changes in GDP.

A better comparison of the cost of living in cities around the world?  Numbeo provides a user generated cost of living index for any city in the world, with prices updated continuously as users add price data.

One interesting comparison - Consumer Prices in Munich are 14.65% lower than in Brisbane, and
Consumer Prices Including Rent in Munich are 5.13% lower than in Brisbane.

Who desires a longer commute? Apparently a 7% of people desire an extra 5 minutes commuting time (from here) -

In one of their studies, Mokhtarian and Redmond examined the commute (i.e. the trip to and from work). They conducted a survey in the San Francisco Bay area which asked subjects what duration their ideal commute would be, and whether their current commute is the “right” length or not.

Counterintuitively, very few people expressed a desire for a commute of “zero.” The most frequent response put the ideal commute at 15-19 minutes, and almost a third of the sample actually said their ideal commute was over 20 minutes. Only 1.2 percent answered zero; this surprising result was largely borne out in follow-up focus groups, where subjects were prompted that zero was a permissible answer.

A comparison of respondents’ ideal commutes and their actual commutes revealed that while most (52 percent) wanted their journey to work to be shorter, 42 percent reported their commute was about the right length and seven percent (mostly those with short commutes) actually wished it would take them an additional five minutes or more longer to get to work. On average, people wanted a commute of around 16 minutes.

I suspect there may have been confusion from respondents about what the question was asking – Do you desire to live in a location where the commute is X (longer, shorter, zero etc)? Or, do you want the commute from your existing location to work to be X (longer, shorter, zero etc)? Or, what is the ideal commute time from your current location with current transport systems?

More on the Peltzman Effect - Night clubs are employing emergency medics to monitor the crowd, yet the Australian Medical association has concerns that it gives a false sense of security to revellers. I can just imagine the conversation – “If you want to experiment with new drug X, do it here because they have medical staff!”

Finally, from The Onion, a spoof economics and finance article that might just make it to the front page of an Australian daily newspaper.

WASHINGTON—Some sort of tax cut or earnings or money or something was reported in economic news this week in further evidence that a lot of financial- related things have been going on lately.

According to numerous articles and economics segments from major media outlets, experts on banks and such have become increasingly concerned over a new extension or rates or a proposal or compromise that could signal fewer investments, and dollars, and so on.

The experts confirmed that the stimulus has played a role.

"This is a clear sign of a changing cycle," some top guy at one of the big banks in New York said of purchasing power parity or possibly rate of return during a recent interview on CNN. "Which isn't to say that a sustained drop in wages couldn't still occur, even if the interest paid on reserves is lowered."

"In short, it's possible but not probable that growth could outpace our initial expectations," added the banking guy, who went on to say other money things, too. "It depends on investor sentiment."

The man, who also apparently mentioned the Nasdaq, the Dow, and the Japan one at some point or another, talked for a really long time about credit or reductions or possibly all these figures, which somehow relate to China.

Greece was also involved.

## Monday, November 22, 2010

### Prison, parenting, selection bias, and measuring success

In both parenting and the legal system one must carefully consider the role of punishment.  Recently, the discussion surrounding imprisonment has become focussed on rehabilitation, using recidivism rates inappropriately as a statistical measuring stick of success.  This seems to be the product of confusing success in parenting with success in crime prevention.

## Tuesday, November 16, 2010

### The Australian Housing Fiasco

The Australian housing market has experienced a hiatus at this blog but has been the subject of intense debate elsewhere.  Time for an update on Shocking Tales, Government Intervention, Why we are different, A ridiculous publicity stunt, and Google predictions.

Shocking Tales
Some say the when he catches cold it takes a $40billion bail out to bring him back to health, and that he sneezes deflation, all we know is... that the Stig of Australian banking, insider ‘Deep Throat’, has provided spectacularly shocking insights into the world of banking and housing finance. Consider the following comment about the use of automated valuation models to ratchet up home values on loan books. So with roughly a revaluation of the property of 20% (ask any property spruiker, “That’s nothin’ mate!”) a bank can save itself$3.20 of capital per $100 of mortgage which can be recycled as capital to support another mortgage. Think about how that increase in both return on capital and funds allocated to another mortgagor slave is an absolute incentive for bankers to perpetuate the cycle up of house price valuations. Their reward? Huge bonuses based on what is in essence a positive reinforcement spiral where everyone pats each other on the back for what a great job they’re doing. Well at least, that is, until the money runs out There are more shocking tales over at Delusional Economics, including a prescient story behind the latest intervention being considered by the Australian government to prop up the housing market and the banks. Government Intervention The proposed intervention involves extending a government guarantee to residential mortgage backed securities, ala Canada, essentially shifting risks taken by banks in the housing market to Australian tax payers in a bid to secure the ability of Australian banks to raise capital as asset values stagnate. Welcome to the world of moral hazard that is banking. What makes the whole fiasco so outrageous is that is has proceeded under the guise of increasing competition in banking and under the housing affordability banner more broadly. Eager to spur competition in a banking industry dominated by National Australia Bank, Commonwealth Bank, Westpac and ANZ - now with rates higher than central bank policy - Canberra plans sweeping reforms to open up the mortgage market more widely to smaller lenders, by creating a bigger government-backstop to residential mortgage-backed securities. (here) Regardless of whether we are following Canada into financial a black hole, the degree of continued government intervention is one reason why we are different, for now. Another is variable rate mortgages. Why we are different Australia’s love affair with variable interest rate mortgages has enabled monetary policy to be highly effective, unlike other countries that have suffered at the hands of the financial crisis. This gives government, via the RBA, plenty of ammunition to prop up house prices while appearing to act on affordability. And it also makes our monetary policy far more effective than our counterparts in the US, Asia and Europe. Of course the big dilemma is what is happening elsewhere in the economy. The dramatic drop in interest rates by the RBA in late 2008 failed to stimulate the housing market without the added assistance of the first home buyers boost. Given this situation, and coupled with government’s obvious strong desire to see housing prices stabilise, one must be careful when entering into a bet on house prices. A ridiculous publicity stunt Australian property spruiker Chris Joye has challenged US fund manager Jeremy Grantham to bet on house prices. This comes as a result of Grantham’s scathing analysis of the extent of Australia’s housing bubble. As others have remarked, it is a classic ‘heads I win, tails you lose’ bet. This is the deal. Rismark believes it can facilitate a transaction whereby Mr Grantham will be able to invest$100 million into a short position over the RP Data-Rismark Australian capital cities dwelling price index, which is universally regarded as the most accurate and timely house price benchmark in the market.

Mr Grantham’s investment would be structured as a very simple “delta-one” transaction: for every 1 per cent fall in the index, Mr Grantham would receive $1 million. Conversely, for every 1 per cent rise in the index, Mr Grantham would pay$1 million away. The trade would be settled at the end of three years with monthly margining to manage credit risk.

There are three main reasons why this is all publicity and no substance

1.      The nature of the index
...look at the index Joye wants to use, the RP Data-Rismark Index. You may recall I mentioned above that Joye was the Managing director of Rismark International? Talk about a conflict of interest. Joye wants Grantham to take a bet, the outcome of which is directly reliant on an index which doesn't allow public examination of their methodologies and further to this one that Joye's company is directly involved with? Surely he jests! (here)

Have I mentioned the hazy area of hedonic price indexes before?

2.      Exchange rates
I’m no genius, but if I was an American investor I would want my return in US dollars.  At current exchange rates (which are already dropping from their record highs), the bet in AUD would expose about US$98million to the AUD. He would be paid AUD$1million for any 1% decline in the index.  Unfortunately a decline in the index will be accompanied by speculation of lower interest rates leading to a decline in the Aussie dollar.

Say the price index falls by 15% and as a result of renewed uncertainty about the strength of Australia’s economy the AUD declines to $0.75USD. Grantham would win the bet, but lose financially. He would now have AUD$115million, which is only USD$86.25million – a loss of 12%. Assuming his position does not entail actually having AUD$100million, but is simply a gamble on the move of the index, he would still earn just USD$11.25million for that 15% move. Remember, the greater the decline in the house price index, the greater is the likely impact on the exchange rate, so Grantham effectively faces a limit to his gains. 3. Australian government intervention When the counter-party to your bet has a direct line to many political power brokers (Malcolm Turnbull, the Liberal Party treasurer, had known Joye as a family friend for 15 years), and the Australian government seems hell bent on doing whatever it takes to prop up house prices, I wouldn’t be too keen to put my money on the line. Even after offering this outlandish challenge, Joye disclaims his position by saying that Australian dwelling prices will be placed under modest downward pressure over the next 12-18months. This makes no sense, until you look at the following scenarios. The bet is taken, Joye wins. Now Joye can claim that his index is superior and used by international fund managers and that his analysis is so great he won a bet against Grantham (although his actual prediction was wrong). The bet is taken Joye loses. Again, a claim of the validity of the index and that his prediction of price movements was correct (ignoring that he lost the bet). The bet is not taken. Publicity, and a win whichever way the price index moves. If it increases he would have won the bet. If it decreases it is in line with his forecast. Google Predictions I have mentioned before that the frequency of Google search terms was quite a good indicator of the peak of the US housing bubble (see final graph). What is interesting is that the new more refined Google Insights for Search shows a dramatic upward trend for the term ‘housing bubble’ from Australia. Last week’s auction results from Brisbane confirm the findings from Google – 21 auctions, 2 sales, 8% clearance rate. ## Monday, November 15, 2010 ### Updates and a CityCycle apology Plastic bag banning Well known demographer Bernard Salt had a stoush with Dick Smith in a little documentary a few months ago discussing Australia’s population growth. Now he is back with more nonsense. Brisbane’s CityCycle scheme, from my observations, appears to be well used. I was pessimistic about the potential take-up rate of the scheme, but in the past six weeks of operation I have seen 27 people using these bikes – about 26 more than I expected. I do however live across the road from one station, work in a building adjacent to a station, and cycle past another half dozen twice per day. Interestingly, I have seen one person using the scheme helmetless and smoking while talking on a mobile phone (I don’t have a problem with this if they are not riding dangerously, which they weren’t), and one bloke walk up to the bikes in work attire and promptly retrieve a helmet from his backpack before shooting off on a hire bike. I can only hope that with more (are there more cyclist, or just people deciding to use the scheme to avoid bike theft and wear and tear?) cyclists there will be a strong push for more user-friendly bike lanes. And just for fun, a hilarious rap battle between Keynes and Hayek to entertain the inner economics nerd. ## Wednesday, November 10, 2010 ### Sin tax myths – why smokers reduce health costs Smokers have been the target of Australia's latest sin tax. Meanwhile, debate continues over using sin taxes to reduce consumption of 'unhealthy' foods such as soft drinks and confectionary. (The word unhealthy is used quite loosely due to the fact that there is sufficient uncertainty about health – Are eggs good or bad these days? Margarine? – and because it is typically not the food itself, but the quantity consumed of a single food that is unhealthy. Almost any food item consumed in excess will be unhealthy). The primary arguments in favour of sin taxes are that 1. the taxes reduce ‘harmful’ or ‘unhealthy’ consumption, and 2. the taxes raised offset likely health costs such behaviours incur on others. Unfortunately neither argument is compelling. ## Tuesday, November 9, 2010 ### Public and Private schools – evidence from economics? As an Australian parent in 2010, the public versus private school debate is hard to avoid. In a society where private schooling is becoming the norm, yet literacy and numeracy skills are stagnating, how does one objectively analyse the costs and benefits of school choice? First, let me say that school choie is just one factor determining vocational, personal and emotional skills during adolescence. Genetics, parenting, the home environment, peer groups, sports and other club activities, amongst many factors, all contribute to shaping young minds. Additionally, the composition of students at the school plays a strong role in determining academic outcomes. Many private schools for example, offer academic scholarships. If those students had instead attended the local public school, any difference in average academic results may be greatly reduced. How then does one separate the impact of school choice from these other factors? Without the opportunity to conduct controlled studies, for example, by studying twins who attend different schools while holding all else constant, the best analysis of the measureable benefits of private schooling would be a statistical test of various measures of ‘success’, controlling for external factors such as parental intelligence and education, household income and location, and child’s intelligence prior to arrival at the school. Unfortunately, in this debate one of the most overlooked considerations is what measure of 'success' would potentially make private schools ‘better’ than public schools. Is it simply a matter of final grades and tertiary entrance scores, or do parents (and children) value a broader measure of success? Does a public school with more diverse student cultural backgrounds give a better social experience, or does a private school offer more valuable professional connections? The results of any statistical study will necessarily be narrowly defined to reflect the impact of school choice on a single measure (such as academic test scores), ignoring social benefits and opportunities for extracurricular achievement. So what do economists and social scientists have to say? ## Wednesday, November 3, 2010 ### Talking climate with Warwick McKibbin I met RBA board member Professor Warwick McKibbin yesterday. Alas, his reserved academic demeanour was a successful deterrent to a gruelling discussion on monetary policy and his thoughts on Australian housing. I was, however, enlightened about his academic research and particular area of expertise – macro-economic modelling and climate change. For such a diminutive guy he manages to raise a large public profile and promote intense debates on matters of macro-economic policy. He was intensely critical of the government stimulus package, although many economists see it as very well implemented in hindsight. Some of the critics of the implementation of Australia's fiscal stimulus fail to see the broader political picture. Professor Tony Makin, for example, argued that the fiscal stimulus was not necessary because adjustments in exchange rates and interest rates absorbed most of the impact of the crisis. Yet he gives no credit to domestic impact of fiscal stimulus from abroad, particularly with our main trading partners. His argument was that we should have been free riding on the stimulus of other nations. The broader political picture reveals that there was an explicit agreement by G20 nations in November 2008 to take coordinate fiscal action to avoid this very issue. In an international context our stimulus appears light on – maybe we still did partly free-ride. But McKibbin is clearly most passionate about climate policy, driving hard his ideas for coordinated global action – The McKibbin-Wilcoxen Blueprint for climate policy. ## Monday, November 1, 2010 ### Rates surprise The RBA Board decided to raise official interest rates by 25 basis points today against my, and many other economists, expectations. One wonders if they take pleasure in proving forecasts wrong, or whether they are simply following the cardinal rule of monetary policy - defy expectations. Unfortunately I think it is the destabilising thing to do, and maintain that we may see this decision reversed in the future. With a housing market waiting to crumble, tourism and education exports fading, commodity prices peaking and inflation already moderating, expect some sullen economic data this festive season. ### Australia not an island away from world’s troubles – recession, bank runs, and printing cash The continued media hype around Australia’s economic stability and security can be partly attributed to the fact that, by official figures, we avoided a ‘technical recession’ during 2008/09, and also that ‘the health and strength' of Australia's banking system played a major factor in domestic economic outcomes following the financial crisis (here for example). Griffith University’s Professor Tony Makin, however, has a little more to say about whether Australia actually avoided recession. The answer depends on your definition, and we are unique in that respect. In the aftermath of the GFC in September 2008, Australia's nominal GDP, real GDP measured on an income basis and on a production basis, as well as real GDP per person, all fell over two successive quarters, as did various other national income measures that account for the slump in export commodity prices (or terms of trade) at the time. Of the many national accounts series the Australian Bureau of Statistics publish, the only one indicating there wasn't a recession was the real, or price level adjusted, national expenditure series. In the US, a recession dating committee of the National Bureau of Economic Research uses a battery of macro-economic measures, not just the somewhat arbitrary two successive quarters of negative real GDP. If the behaviour of Australia's business cycle in the aftermath of the GFC had been assessed by an independent committee of economists with reference to a broader range of macroeconomic indicators in this way, a recession, albeit mild, would most likely have been declared for 2008-09. But this would not have been of great concern because, due to greater labour market flexibility, unemployment did not rise anywhere near as much as in the recessions of the early 80s and early 90s.(here) No doubt business people would have wondered how official figures could have been so out of touch with on the ground realities during early 2009, but a mere statistical discrepancy kept the headlines optimistic. And as far as the ‘health and strength’ of our banking system, well, let’s just say a better phrase would be ‘government rescue’ of the banking system, with the deposit guarantee and massive fiscal and monetary stimulus. This extract from the book Shitstorm: Inside Labor’s darkest Days, has far more detail on just how perilously close our own banks were to disaster. All around the country, banks were facing unusual demands for cash. Small businesses in Queensland and Western Australia were switching their deposits from regional banks to accounts with the big four banks. An elderly woman turned up in the branch of one bank in Queensland with a suitcase and asked to withdraw her term deposits of$100,000 or more. Once filled, she took the suitcase down to the other end of the counter and asked that it be kept in the bank's safe.

A story did the rounds of the regulators about a customer who wanted to withdraw his six-figure savings. The branch manager said he did not have that quantity of cash on hand, but offered a bank cheque, which the customer accepted, apparently unaware that the cheque was no safer than the bank writing it.

It was a silent run, unnoticed by the media. Across the country, at least tens and possibly hundreds of thousands of depositors were withdrawing their funds. Left unchecked, there would soon be queues in the street with police managing crowd control, as occurred in London at the Golders Green branch of Northern Rock a year earlier.
...
Households pulled about $5.5bn out of their banks in the 10 weeks between US financial house Lehman Brothers going broke - the onset of the global financial crisis - and the beginning of December. That is roughly 80 tonnes of cash salted away in people's homes. Mattress Bank is doing well, was the view at the Reserve. A year later, only$1.5bn had been put back.

The worst problems were in the second-tier banks, particularly Queensland's Suncorp and, in Western Australia, Bankwest. Deposits at the big four banks were surging as customers sold their shares, pulled money out of cash management trusts and put the proceeds in the bank. But at Suncorp deposits slumped by $1bn. They dropped$2bn at Bankwest.

The regulators and the government were gravely concerned for these two banks. Suncorp had total assets of $75bn and Bankwest$60bn. Bankwest was in double trouble because its British parent, HBOS, was teetering on the edge of bankruptcy.
...

Despite their preparation, the Lehman crash caught local banks by total surprise. NAB chairman Michael Chaney had set off on a 13-day rafting trip down the Grand Canyon on the day Lehman failed. He had taken a satellite phone but by the time he got it to work his share price had collapsed by almost 30 per cent. "I couldn't get a helicopter in there, so it was a five-hour climb out," he says.

Balance of payments figures show that in the immediate aftermath of the crash, Australian banks were called on to repay $50bn in short-term debt to international investors who refused to roll over their exposures. Governments across the world were also being tested. Two weeks after the Lehman crash, Ireland's banking sector was facing an alarming run on larger deposits. The government stepped in and guaranteed all deposits and wholesale fundraising. There was an immediate call for the British government to follow suit. Within a week, Germany, Denmark and Greece had offered unlimited deposit guarantees, while the British and a number of other European governments had increased the size of their insurance schemes. The Reserve Bank, APRA and Treasury were worried as were the chief executives Wayne Swan was talking to. The long-standing concerns of the main banks about depositor protection were cast aside. The fate of small institutions could influence the stability of the system. "One of the lessons of this whole period is you can have an abstract almost clinical discussion in the absence of a crisis about which institutions are systemically important and which are not. But when the crisis hits, is there any financial institution that is not systemically important?" Henry says. "It was my view back in September after the collapse of Lehman, I came to the view there was no financial institution in Australia that could not be regarded as systemically significant." The issue was so delicate that most cabinet ministers knew nothing of what was going on. "Some of this stuff is so sensitive, the bank guarantee could only be agreed between the Prime Minister and myself," says Swan. The government's unlimited guarantee of retail deposits went further than any other country, partly because Treasury was now concerned about capital flight. ## Thursday, October 28, 2010 ### Nothing is so firmly believed as that which least is known - or why changing your mind is evidence of learning For a second, consider of all our major public thinkers today. They do the opposite, constantly telling how sure they are of their beliefs and criticizing their “opponents” for changing their minds. Changing your mind is a good thing, Montaigne would say. It means you’ve resisted the impulse to think you’re infallible. He wrote that as part of his profession of getting to know himself he found such “boundless depths and variety that [his] apprenticeship bears no other fruit than to make me know much there remains to learn.” If only we could internalize that attitude—instead of feeling cocky when we learn something, acknowledge that it really just taught us how much more we need to learn. (here) While I often use this blog to vent frustration, propose new ways of looking at problems and possible unintended consequence of our actions, this does not mean that my ideas and opinions are as fixed once published. Indeed, if I look back at some of the opinions I held some years back I can imagine a heated debate between current me and previous me. For example, for a period of time, I had a fixation about peak oil and what it meant for society. I thought in a linear manner, ascribing a reduction in total economic production possible to a reduction in technically possible rates of oil extraction, without thinking of behavioural responses and adaptations likely to take place including a renewed demand for alternative resources. My last post clearly shows that I have edged away from that view to a more reasoned and 'systems' view of economic behaviour. I used to be passionate about ‘sustainable’ living (whatever that means). If we could only all do our little bit our environment, in the holistic sense rather than just the trees and animals sense, would be a better place to live. However, with more research into the matter it appears that while my own choices are the only ones within my control, there are offsetting effects from the actions of others that may render my personal actions ineffective. While my ideas evolve slowly as I seek evidence one way or another, I can’t help but marvel at how quickly strongly held beliefs can change in a time of crisis, even when evidence for the new idea is as sparse as the one previously held. ## Tuesday, October 26, 2010 ### CPI surprise Today’s Australian CPI data, according to the headlines, was ‘lower than expected”. This was the first part of a forecast I published here back in early September, when I said “Inflation and GDP will surprise on the low side in the September quarter”. GDP figures come out with the National Accounts on the 1st December so we had a little while to wait before assessing my prediction (1st November is the ABS capital city price index which may also show some surprises). But the CPI print really shouldn’t have been a surprise. Maybe most economists have loyal wives and girlfriends (or husbands and boyfriends, although it is a male dominated profession) to do their shopping, so they wouldn’t have noticed the price declines in food, health, communications and transportation in the previous quarter. It is evidently odd that the US can experience no price growth with a collapsing dollar, while Australia’s currency has gained strength yet our favourite media hungry economists forecast high inflation and multiple interest rate rises. The high dollar was always going to dampen any inflationary pressures. On a far more interesting note, Google has been experimenting with a real-time price index compiled, I assume, by experimental software that searches for listed prices of items on the web. Their index has showed a “very clear deflationary trend” for the US, and has the additional benefit of compiling the same (or at least comparable) indexes across countries. By the same measure the UK has shown a slight inflationary trend, attributable to the weak sterling. The automatic nature of the index also provides the possibility of releasing multiple indexes with different scope and purpose, to provide a much richer picture of prices changes across the economy. For example, hedonic price adjustments can be in one index and not in another, and the basket of goods can be quickly changed to suit different social groups. There has been a strong push for the ABS to publish multiple prices indexes to address these very issues, particular with regard to quality adjustments. I have demonstrated the Lower Bound Problem of Hedonic Price Indexes before, although Rob Bray makes the argument more concisely: Revise the approach to quality adjustment to take account of the actual utility consumers achieve from changes in product ‘quality’; and also consider an approach which reflects the extent to which products actually exist in the market place for consumers to purchase Twice the quality is not the same as half the price. The benefits of real-time data available to Google are yet to be fully understood by economists, but there is no doubt the Hal Varian, Google’s chief economist, will change that soon enough. Mr Varian also discussed some of his other work on using Google’s search data for economic forecasting. He said that he is working on “predicting the present” by using real-time search data to forecast official data that are only released with time lags. For example, searches for “unemployment insurance” may be a good tool to predict actual claims for unemployment insurance, or the unemployment rate. This is something I have tested before with the US housing bubble, clearly demonstrating that search volumes can be amazing predictive tools. It won’t be long before these real-time measures become commonplace in mainstream economic publications. ## Monday, October 25, 2010 ### Zombie Economics This Friday, 29th October the Young Economists will host the launch of John Quiggin’s much anticipated, and creatively titled, book, Zombie Economics: How Dead Ideas still Walk among Us. This is an opportunity to meet an interesting bunch of economists and young professionals in a social atmosphere and discuss some of the challenging ideas in Professor Quiggin’s book. All are welcome to this free event, and there are free drinks for Young Economist and ESA members. There are prizes on offer for best dressed living dead economist, and best economic limerick (try here for some inspiration) A PDF flyer is here. ## Wednesday, October 20, 2010 ### No limits to economic growth For an environmental economist these words are blasphemous, but I said them, and I have good reason to. The modern Limits to Growth movement gained prominence with the publication of the Club of Rome’s book of the same name in 1972. This book, by Donella Meadows and colleagues, reports on the results of a computer simulation of the economy under the assumptions of finite resources. The World3 computer model produced scenarios showing that under various assumptions, a decline in non-renewable resources will lead to a decline in global food and industrial production, which will in turn lead to a decline in population and greatly reduced living standards for all. The following image is one example of the results of their simulations where a catastrophic decline in industrial output, food production and population will result form reaching our finite resource limits. While I don’t doubt the finitude of many natural resources, and that the human population cannot grow indefinitely, I doubt that finite limits of resource inputs to the economy necessarily means that economic growth cannot continue indefinitely. To be sure, I am certain that substantial unforeseen changes to the rate of extraction of some resources will lead to short-term disruption of established production chains, such as shocks to oil supply, but in the long run I see no reason that an economy with finite resource inputs cannot increase production through improved technology and efficiency. I need to be clear that when I talk of economic growth I mean our ability to produce more goods and services that we value for a given input. Increasing the size of the economy by simply having more people, each producing the same quantity of goods, will be measured as growth in GDP, but provides no improvement in the material well being of society. A better measure of growth is real GDP per capita. This adjusts for the disconnection between the supply of money and the production of goods, and adjusts for the increase in scale provided by the extra labour inputs. Even then, this may overestimate the rate of real growth occurring, as there has been a trend of formalising much of the informal economy, for example child care, which is now a measured part of GDP rather than existing as individual family arrangements. On these adjusted measures economic growth is a very slow process. In a world where non-renewable resource inputs are fixed or declining, it is the rate of the decline and the speed of adjustment that will determine the overall outcome for our well being. If the rate of decline of non-renewable resource inputs is below the rate of real growth (our ability to produce more with less) and the rate at which we can substitute to renewable alternatives, we can avoid economic calamity in the face of natural limits. Unfortunately there are other factors at play. The rate of population growth will greatly determine the per capita wellbeing in a time of limited growth. While extra labour input will no doubt contribute to production inputs, my suggestion is that this input will be outweighed by a decline in complementary resource inputs. Remember, we care about real economic ‘wealth’ per capita, and with more people there is a smaller share of remaining resources each person can utilise in production, thus reducing wellbeing. Further, we can begin to take productivity gains as leisure time instead of more work time, thus there is a possibility of maintaining a given level of production in the economy with fewer labour inputs over time. There is also the reliance of our financial system on high levels of growth. Many economic growth critics cite the need for exponential growth of financial measures of the economy as being in conflict with any finite system. Yet the ‘system’ itself is a human construction and I seen no reason why a stable money supply cannot operate under various levels of growth (even prolonged negative growth) if used cautiously and with little leverage. Often forgotten is that many resources are currently fixed and yet go unnoticed. There are always 24 hours in a day, but that doesn’t stop us producing more each day. If a shortage of hours was encountered, would a sudden change to 23hrs (a 4% decline) have a dramatic impact? Or would society easily adjust to this new environment of tighter time scarcity? While a smooth transition to prosperity under much greater limits on resource inputs to the economy is theoretically possible, I don’t expect this to be our future reality. Self interested governments, businesses and the general public will react to short term shocks in unexpected ways, potentially promoting conflict, and taking the bumpy road. I have no doubt that there will extended periods of prosperity in the future, but also expect a rough ride to get to them. ## Monday, October 18, 2010 ### Counterintuitive findings? Pool fences Could Queensland’s new tougher pool fence laws offer an opportunity to study the Peltzman Effect? Will we now feel that pools are no longer a safety hazard for toddlers and drop our supervisory guard? One man, who refuses to comply with the laws, has argued this exact point and is strongly supported in his views (if you can trust the newspaper comments). In one case, a pool owner living on a canal has had to fence their pool, yet is not obliged to fence off access to the canal. One does wonder about how far governments can go to protect us from our own behaviour. Pool fences are only there to protect kids from parents who don't. There are no fences around all the lakes in Brisbane, Southbank's lagoons are not fenced, the Brisbane River is not fenced. Why? Because we are responsible enough to ensure our children don't get into danger in these areas. What further astounds me is that lack of evidence in the pool fence debate. In one of the more interesting studies I could find, 52% of pools where toddler drowning events had occurred in Western Australia where compliant with the pool fence legislation (compared to 40% for randomly selected pools). There was no further discussion of this key point – that statistically it appears more likely to drown in a fenced pool that an unfenced one (I would be very interested if anyone can find a more thorough study of the effectiveness of pool fence laws). While this is just a small sample from one State, and I would question whether general conclusions can be drawn, some more rigorous examination of the effectiveness of pool fence laws is seems appropriate before toughening the laws. Is the government really going to do the same thing and expect different results? Cycling by the road rules The Council is inviting CityCycle subscribers to undertake a Cycling Confidence Course to improve their bicycle skills and brush up on their knowledge of road rules. Maybe that's a bad idea. Recent research suggests that people obeying road rules are more likely to be killed by trucks than those who disobey the rules by, for example, running red lights. Women may be overrepresented in [collisions with goods vehicles] because they are less likely than men to disobey red lights. By jumping red lights, men are less likely to be caught in a lorry driver’s blind spot. Cyclists may wait at the lights just in front of a lorry, not realising that they are difficult to see. In more than half the fatal crashes, the lorry was turning left. Cyclists may be deceived by a lorry swinging out to the right to give itself room to make a left turn. I can’t agree more with these findings. Every day I see cyclists waiting in the blindspot of a car or truck at traffic lights, and occasionally see a cyclist sneak up the left side of a bus while it is turning left. I hope Brisbane City Council’s cycling confidence course acknowledges that sometimes it is safer to break the rules. Congestion (queuing) as an efficient allocation mechanism I have raised the idea in the past that road congestion is in fact an efficient allocation mechanism provided that there is prior knowledge of expected travel times. Now, from The Australian we have this: Sure, if we invested enough in roads, all cars could travel at the speed limit. But the costs of thus expanding road capacity would greatly outweigh the value motorists place on the savings in time and discomfort. Exactly the same applies to road charging. With charges set sufficiently high, remaining drivers could go at speeds rivalling the Melbourne grand prix. But even Mrs Moneybags, rocketing in her Ferrari, would not value the benefits enough to offset the welfare loss to the peons forced by the high charges to walk to work. Add to their loss the costs of implementing the road charging scheme and the efficiency loss is all the greater. ## Wednesday, October 13, 2010 ### Murray-Darling Basin Plan: Despite extreme lobbying, you can’t take water that does not exist The release of a guide to the Murray-Darling Basin Plan is receiving very poor media coverage. This headline – “Basin Authority holds its first public meeting” - is entirely misleading. The Authority had numerous meeting with stakeholders including water users, irrigation groups, farmers groups, local councils, and anyone else who could claim and interest for the past two years. There should be no surprises. Another here – “As many as 130,000 jobs could be lost because of reduced water allocations in Victoria's fruit bowl region under the Murray-Darling Basin plan, a farmer says” That’s right. A farmer says so, therefore it must be true. This is a week the farming lobby has spent years preparing for, and they are basking the attention. The further problem which is completely overlooked by the media, is that while the reductions in rights to take water are ‘up to 37%’ that means that most reduction in most rivers are ‘between zero and 37%’. Let’s not also forget the fact that these are reductions of paper rights, not volume taken. There would be very few water users whose volume taken matches the volume of their rights due to variability and recent dry conditions. The graph below shows that recent rainfall conditions are below historical averages, although this is not uncommon in the long term. What is missing from this mainstream media nonsense is any actual thought about the reason the plan was developed in the first place. Simply put, there are more rights to take water ‘on paper’ than there is water in the system. This leads to both downstream water users suffering at the expense of upstream users, and environmental areas suffering due to upstream water users. When downstream environmental assets, such as wetlands, receive water, the water also flows through to downstream users. There is even the possibility that the next five years more water will be used by irrigators than the past five years, even with the Basin Plan, simply because of rainfall variability. The percentage figures are based on long run averages, which are a distant memory for many people in the Basin. Imagine I give you a piece of paper that allows you to take 100ML/annum of water from a particular reach of a river. The river flow is highly variable and because of this you get 60ML one year, zero the next three, 100ML the next, then 25ML. You average 31ML. Then, you get told the stream is overallocated and you are getting cut 37%, so that your allocation is now 63ML. If we had the previous six years again the impact would have only occurred in one year - the cut would take your five year average from 31ML to 25ML – a 20% decline in average use, and a once in five year impact. If over the next 5 years you can take 63ML, zero, 25ML, 50ML, 5ML and 60ML, you might end up with even more water on average – 34ML/a instead of 31ML/a – despite the theoretical cut to you water right. In South Australia for example, irrigators have only been able to access 10% or less of their water rights over the past 5 years or so. If the Basin as a whole shares the water more equitably, these irrigators may be able to use 63% of their previous water allocation – a 37% cut on paper, but a 600% increase in real water use compared to the past 5 years. Even the MDBA itself showed just how low actual water use is compared to these theoretical baseline figures from which reductions are calculated. The graph below is from page 130 of the Guide and shows that the average water use since 2002-03 is equal to their most ambitious reduction scenario. My point is, people are taking the cuts as real water then multiplying impacts to flow on industries then getting bigger and bigger impacts that border on ridiculous. These complementary agricultural industries are clearly already adjusted to any proposed cutbacks. The only person to present any figures on the media circus is economist Quentin Grafton. He makes his case that farmers are exaggerating losses as follows: "In 2000-2001, the gross value of irrigated agricultural production was just over$5 billion, and they used surface water of about 10,500 gigalitres in that particular year," he says.

"Fast forward to 2007-08, 70 per cent reduction in surface water use, guess what happened to the gross value of irrigated agricultural production? It changed by less than 1 per cent."

Not only are impacts greatly overstated but water users will generally be compensated for their theoretical water loss at market prices for water – whether the water exists or not.

Historically most water rights are a gift from the State to landholders. They have generally earned a good living from these gifts, and now that the government has realised that too many were granted, they are going to pay to buy them back.

While I’m on the water bandwagon, some people are taking the chance to have a dig at cotton and rice growers for their water consumption. What they need to understand is that while Australia is a dry continent, we are characterised by variability of rainfall. Some years it floods and to make use of the water you need a thirsty annual crop. That’s why the virtual desert regions south of St George are cotton areas, even though this intuitively seems bizarre.