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Category Archive: Economics

In support of Judith Sloan’s critique of the Commonwealth Treasury’s policy mettle

When I came to Australia in late 2000, I received an interview call from the Commonwealth Treasury (CT). They were about to send me the air ticket for an interview in Canberra. But by then my son had been given a scholarship by Melbourne Grammar School (supposedly one of the best private schools in Melbourne), so I decided to stick to Melbourne and declined the interview offer. I was to join, soon after, the Victorian Government's largest regulator, and later, the Victorian Treasury. In retrospect, this was a good decision.

I've had occasion to interact with the CT on a few matters. I won't go into details since doing so will breach the public service code of conduct. But from my vantage point as close observer of numerous economic debates and based on published papers and policies of the CT, I am able to write in support Judith Sloan's critique of the CT

Let me detail Judith's concerns.

1) The CT does not focus on the prosperity of all Australians

To understand this point, we fist need to understand Amartya Sen's deplorable confusions. The disastrous Human Development Index adopted by the even more confused UNDP was his "contribution". Mixing up social and economic variables using subjective weights can never be justified. This is mumbo-jumbo; pure nonsense. The Victorian Treasury's vision is uni-dimensional: a prosperous future for all Victorians. Period. Per capita real GSP is the key measure in such an approach. People can buy wellbeing IF they have money. The government's job is to enable and support the ability of the people to earn money.

But from Judith's analysis, it appears that the CT uses a mushy way of thinking (perhaps in the Sen tradition?):

It is quite difficult to pinpoint the exact start of the decline. My feeling is that the adoption of the mushy, confusing and unhelpful wellbeing framework in the late 1990s marked the beginning of the Treasury's loss of prestige. "The wellbeing of the Australian people" remains one of the core elements of Treasury's strategic framework. Where, once upon a time, Treasury essentially focused on maximising per capita gross domestic product, there are now five elements of wellbeing, some contradicting each other. These elements are: opportunities, distribution, sustainability, the level and allocation of risk, and the complexity of choices. [Sanjeev: What do these terms mean!! ] The real problem with using five ill-defined criteria to judge policy is that without some explicit weighting of the five factors, virtually any decision can be justified. [Sanjeev: No, Judith, these non-economic terms are pure nonsense, in the same category as the meaningless term 'social justice'. Multiplying nonsense with 'weights' can never create sense.] Sure, a policy will reduce per capita incomes, but just look at the improvements to sustainability. It is heaven on earth for the Greens.

As economics professor Jonathan Pincus notes, "any decision made by Treasury can be justified by (the wellbeing framework) unless it can be shown to worsen wellbeing in all five dimensions". The framework relies on the subjective (and political) value judgments of Treasury officials to weight the five dimensions of wellbeing. Of itself, this politicises decision-making within Treasury. [Source: Treasury's fall from grace started with wellbeing, Judith Sloan, 13 November 2012, The Australian]

This serious muddle-headedness apparently started in around the mid-1990s (HDI was created in the early 1990s and soon became a joke among real economists). It is possible that had I joined the CT in 2000 I'd have been a misfit and left it, long ago. 

2) The CT recruits Keynesians and lefties:

This is news for me: a shocking disclosure from Judith, today:

The Treasury has leaned left for some time. Potential graduate recruits, for example, have been asked for their views on the pricing of carbon dioxide emissions and the value of stimulus spending to deal with economic downturns. The “correct” answers have been pretty obvious. This bias and the perceived politicisation of the Treasury, more generally, have to be eliminated." [Source: John Fraser will face challenges to restore Treasury’s reputation, Judith Sloan, 15 November 2014, The Australian].

If what Judith is saying about Treasury recruits is true, this is a sure way to ruin any prospect of objective, sensible economic policy advice

3) The CT's approach prevents it from looking objectively at data

Then there is this third critique – that the CT uses subjective, rosy glasses while looking at data:

Another example of Treasury's loss of status and respect is reflected by comparing the first edition of the Intergenerational Report released in 2003 and the one released in 2010. Originally commissioned by Peter Costello when he was treasurer to highlight the fiscal implications of the ageing of society, the first edition was a solid piece of work. The 2010 edition, which was brought forward by Wayne Swan, is a complete embarrassment.

It is an overly long, verbose document that spends most of its time praising the government for its current policy stance, even though the focus of the report is 40 years out. It even includes a ridiculous chapter on climate change and the environment, a topic that quite rightly was not included in the previous editions. What the reports also demonstrate is that Treasury is completely incapable of forecasting basic variables such as labour force participation, even a few years out. (This point could be applied more generally to the credibility of Treasury's modelling.)

If you read the first report, you would conclude that we will all be "rooned". The second one (2007) was a bit more upbeat about our prospects, but the last gave the impression that, because of the outstanding and far-sighted policies of this government, everything will be fine. [Source: Treasury's fall from grace started with wellbeing, Judith Sloan, 13 November 2012, The Australian]

EXAMPLES OF BAD POLICY ADVICE

I have been frequently disappointed with the macro-economic (and even micro-economic) policies advocated/ supported by the CT. Judith points out a few examples:

  • The CT's approach to taxation of ­employee share ­options
  • The CT's design/ advocacy of the mining tax
  • The CT's approach to changes to the fringe benefits tax
  • The CT's modelling of the impact of pricing carbon
  • The CT's "contrived modelling of the impact of the government’s stimulus spending spree in response to the global ­financial crisis that, according to Treasury, “saved” 200,000 jobs. The Treasury also tried to argue that the countries that had boosted government spending the most were least affected by the GFC. It turned out that the Treasury had cherry-picked the countries for inclusion in its analysis. When a comprehensive list of countries was included, the relationship fell away."

In my view, the CT's advice has badly damaged Australia's prospects in the coming decades. The Rudd 'stimulus' was a disaster. Any attempt to justify it should rank in the category of NONSENSE/ quackery of the sort that Keynes spouted, e.g.

"If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. [Keynes, “General” Theory (and other crap)]

[Indeed, combining Keynes and Sen would be the surest way to destroy any society’s future prospects, almost as certainly as using Marx’s ideas] 

Stephen Anthony wrote last year about the shortage of brain power in the CT [Source: Treasury needs more brainpower and less of the touchy-feely, Stephen Anthony, AFR, 29 April 2013]. I don't think this is a brain power issue. Brain power (IQ) is of no use without the right way to think. That's why high IQ people throughout mankind's history (till around 1700) achieved nothing, while ordinary people with the right thinking since 1700 have achieved wonders.

The CT's problems seem to stem from a fundamental failure to understand economics.  Let me I quote (genuine Nobel Prize winner) Ronald Coase and hope that the CT will pay heed to one of the greatest economists of all time:

Economics thus becomes a convenient instrument the state uses to manage the economy, rather than a tool the public turns to for enlightenment about how the economy operates.  [SourceRonald Coase, Saving Economics from Economists, Harvard Business Review, December 2012]

My advice to the CT, for whatever it is worth, is this:

1) Try to understand the process of the price system and how this process balances the self-interest and local information (including budget constraints) of all people on this planet, simultaneously. 

2) Try to understand, therefore, how your interventions will invariably distort the price system and reward rent-seekers and frauds at the expense (very often) of hard-working savers and workers. 

3) Finally, try to understand that governments necessarily play the game of politics, marginal seats and lobby groups. Their game, while essential to a liberal democracy, also imposes costs and damages society in many ways. Democracy is not costless. But we are not in this game. Our job is to limit the damage caused by government interventions, not exacerbate it.

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Without liberalising and radically reforming education IMMEDIATELY, India’s future is DOOMED.

Vishal Singh drew attention to this article in The Economist: Arrested development: The model of development through industrialisation is on its way out.

It notes "The falling cost of automation makes the use of robots attractive even in India, where cities are swarming with underemployed young workers."

Those of you who follow this blog know that I've raised this issue on NUMEROUS occasions on this blog. There are MILLIONS of unemployable people in India, and people are moving to robotics.

I am currently reading Race Aganst the Machine – which is one of the best books on this topic. I've also been making detailed notes for a future manuscript The Glorious Abundance and Creativity of the Robotic Age.

India has almost entirely missed the bus on manufacturing. We need to focus on training people for services and domestic construction (which has become a boom sector as people want bigger and better houses across the world, as they grow richer).

And as I've already said many times on this blog – the developed world is NOT going to leave the best brains of India/ China in those countries. Such people are being attracted to the West in large numbers, and will abandon India/China. Australia, too, is engaged in such active attraction of top talent from the developing nations. 

Without liberalising education, India is DOOMED. That is not in doubt.

With people like BJP/Modi/Smriti Irani, bid goodbye to India's future.

ADDENDUM:

The third great wave

Wealth without workers, workers without wealth

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PV Indiresan was firmly against Keynesian ‘pump-priming’

I’ve been reading a number of books simultaneously, including PV Indiresan’s Vision 2020. Indiresan, although not trained in economics, seems to have broadly understood a number of economic concepts. He does make a few errors here and there, but he is definitely not socialist, nor Keynesian. Not entirely classical liberal, his views are broadly consistent with classical liberalism.

In particular, he has some harsh words for Keynesians:

For four decades, the government went on a spree creating jobs whether they were needed or not. The prevailing view was that employing people was a good in itself – even if there was no work to do, or the work done was not commensurate with the wages paid.

Keynesians consider themselves expert in this area. Stung by the disastrous loss of competitiveness that resulted from their policies, they have been lying low for nearly ten years. Now, they are back at the centre-stage insisting that pumping money into the economy, and increasing fiscal deficit, is the only remedy for unemployment. Fiscal deficit puts all that money and patronage into the hands of politicians and officials. Neither of them is always wise or even honest.

Applied across the board, as Keynesians would do; pump-priming is like rain, it falls both where it is needed and where it is not, even where it may do much harm. So, the consequences of classical Keynesianism are problematic at best and disastrous at worst. [Vision 2020, p.93]

I’ll summarise his key points separately, but this section was good enough for me to scan, OCR and publish.

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V.Kumaraswamy’s book on India: Some brilliant gems interspersed with forgettable bits

I’ve finished reading most of V.Kumaraswamy’s brand new book, Making Growth Happen in India: A Road Map for Policy Success [I bought the book from Flipkart]. The Kindle version should be out in a few weeks.

Overall, I’d rate the book as among the better books on Indian public policy that I've read. I'd give it 6 out of 10 (in comparison, Gurcharan Das’s books might rate around 8 out of 10, Nandan Nilakni's around 8.5 out of 10).

I have struggled to determine Kumaraswamy's worldview (i.e. his theory of the state or of the individual). He does not examine why we have a government in the first place. There is not one word I could find regarding individual freedom nor any discussion on basic governance reforms. He seems to prefer operating as a technician, not as an architect. 

This mode of operation can lead to fundamental contradictions. In some places Kumaraswamy comes out strongly against subsidies for the rich; in other places he seems to support them. In places he seems to follow Keynes (multipliers, see p.148), while elsewhere he believes markets work best. In some places he supports alternative technology (p.151: while forgetting that if jobs are to be an objective of building infrastructure, we should build roads with spoons). Although Kumaraswamy talks a lot about the need for price discovery, he seems comfortable with the continuation of many administered prices (there is no serious questioning of MSP for agricultural produce or the PDS system from first principles).

This absence of a coherent worldview flows through into the weak sequencing of topics. This is also perhaps because Kumaraswamy has strung together a number of themes from articles he published over 15 years in Business Line and Business Standard.

Despite these limitations, this book should form part of the toolkit or library of every Indian interested in public policy. It is bubbling with ideas (ranging from the bizzare to the really good). It adds value to policy debates in India.

Illustrative good bits and not-so-good bits, listed below:

EXCELLENT
1.  Suggestions regarding cost recovery (p.105 onwards, 113, 115). These are part of standard good governance toolkit across most of the developed world, but in India the rich are HEAVILY subsidised. That needs to go.
2. The need for proper analysis of infrastructure projects (p.200).
3. Some good ideas re: employment (e.g. forestry p.155, landscaping p.181)
4. Parking requirements in urban areas (p.158)
5. Good commentary re: incentives of the government as a regulator (p.180) [despite that he promotes continuous involvement of the government in a vast set of areas where it can perform better as a regulator than doer].
6. Hypocrisy of socialists (p.105)
7. Build private cities (p.104)
8. Free up interest rates and credit (p.84). On this he positively shines. Brilliant.

GOOD
1. Discussion re: incentives (p.207, etc.)
2. Position re: urbanisation – both good and poor.
3. Land acquisition (p.6)

QUESTIONABLE
1. Opposes state funding of elections without understanding alternative models (p.15, 123).
2. Suggestion to increase the bureaucracy (p. 159)
3. Thinks of the government as an entrepreneur (p.188).
4. Misplaced objection to gold (p.190-91).
5. Confusion re: the role of real estate (p.194-96)
6. Some ideas on employment are bizzare (p.146)
7. Solution re: PDS (p.179)
8. Recommendations against agricultural productivity (p.56)
9. Grossly underestimates returns to education (p.60)
10. Likes to use the stick against citizens (p.63) and brings a “planning” mindset to many discussions.
11. Poor analysis of corruption (p.12).

Overall, I plan to re-read some of the sections while I'm revising the SKC agenda. The book was money (and time) well spent.

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The microeconomics of governance: the principal-agent-subagent problem

Most (perhaps 98 per cent) of the economists across the world have a blind spot: the economics of governance. And 100 per cent of Indian economists have that blind spot.

Have you ever seen someone who keeps their home clean and beautiful but makes a mess outside? This is the key to understanding the microeconomics of governance.​ 

Collective decisions regarding which public goods constitutes part of public choice theory. This discusses the design of the institutions of democracy and their many limitations. 

But there is an under-developed branch of public choice theory which assesses whether the individual actors in specific institutions of governance can deliver the goods we want, and why most such institutions in the developing world perform so poorly. Essentially, this is about understanding the incentives of individual players at the microscopic level. There is a huge difference between managing something in the private sector (which the discipline of management looks at) and managing public goods, which is the subject of public administration. 

Chapters 4 and 5 of Breaking Free of Nehru contain an elementary discussion on the microeconomics of the main governance institutions of India. The analysis involves examining the principal-agent-subagent problem and consideration of the costs and benefits for the parties involved (politicians/ bureaucrats). In these chapters I pick up key variables in the electoral system and bureaucratic system and analyse why these are poorly designed, and will lead to perverse outcomes.

My slides prepared for the 2013 governance reforms conference  should be seen as forming part of this branch of microeconomics. My talk at that conference summarises key aspects of the microeconomics of governance:

Much of Arthashastra by Chanakya contains the microeconomics of governance (although he tends to present the conclusions of his analysis, not the underlying argument).

There is also a considerable analysis of microeconomics of governance in the new public management literature, followed in countries like Australia and New Zealand. My article on the Victorian bureaucratic system highlights part of this analysis. The aim of this branch of microeconomics is to ensure that there are sufficient incentives to perform and deliver results. 

In brief, this branch of economics is about understanding how the citizen (principal) can get the bureaucrat (his sub-agent) to do what he wants through his agent (politician).

This involves similar principles to the standard principal-agent problem, but because of the vastly greater information gaps, uncertainty, measurability issues, etc. involved, this is a more difficult problem to resolve than the more simple principal-agent problem typically considered in the field of management. There is far more gaming, far greater moral hazard, far more costs of monitoring and enforcement, than in a simple private sector principal-agent problem.

There are also issues regarding the social contract (which I've addressed in Discovery of Freedom). – on which far more work has been done by economists in the recent past.

I must say that practitioners of public administration in the West have largely understood the basics of this branch of economics, as a result of which they have designed largely functional institutions. But perhaps Singapore outdoes all of them in the depth of understanding displayed. 

Time permitting, one day I'll write a text book on the microeconomics of governance. Without understanding it, no one can deliver public goods at an efficient cost.

ADDENDUM

My comment here:

I believe the key issue is never ownership per se, but the incentives at the micro level. Government owned organisations can perform wonderfully well, as demonstrated by Singapore (see section on Tamasek in my blog post, linked below):
http://www.sabhlokcity.com/2014/07/singapore-model-authoritarian-economic-liberalism-an-alternative-to-classical-liberalism/
I've been investigating the microeconomics of governance – a subject deeply neglected by economists – over the past 15 years. Many useful insights are obtained from operating at the micro-incentives level. http://www.sabhlokcity.com/2014/08/the-microeconomics-of-governance-the-principal-agent-subagent-problem/
If the incentives are right, then government ownership should NOT present a problem for then the citizen (principal) is directly able to achieve his/her goals at the lowest possible cost.
In most cases, however, the incentives are not right – mainly because politicians are ignorant and economists don't care about details. In those cases Friedman and Rothbard are right (even if they may exaggerate in a few cases). Those are the more common cases.
Economists are generally unwilling to examine real institutions (their incentives to publish are stacked against such detailed analysis). If they do so they'll need to examine employee contracts, funding models, etc. That's a lot of hard work. Much easier for lazy mathematicians to make wild assumptions and preach "ideology". That's an unscientific approach, however. It is time for economists to study real institutions in great detail.

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