Other economics


The headline on the CoreLogic October report on housing values reads Housing values 1.5% higher in October as growth trends ease and downside risk builds.

Littl house
Prices are rising even faster in the country

That’s right – only 1.5 per cent in one month. That equates to a doubling of price every 4 years.  If we dig further into their detailed report Hedonic home index we find examples of even faster growth – 2.5 percent monthly growth in Brisbane (doubling in just over 2 years) and 1.9 percent in what they call “regional” areas (other than capital cities).

The economic purist may point out that these are nominal price rises; they should be adjusted for inflation. But when CPI inflation is running at 3.0 percent and housing prices are rising at 25 to 30 percent a year, there’s not much point in such finesse.

When we see such a high rate of price inflation as an “easing” we are in serious trouble. If that were our CPI inflation we would be going cap-in-hand to the IMF for a bail-out, but for reasons to do with the quaint conventions of economics, we measure inflation only of goods we consume, and theoretically we don’t “consume” the land on which housing sits.

The obvious consequence of these dizzying prices is the lack of affordable housing.  As Oliver Frankel points out in his monthly report on housing affordability and homelessness in Pearls and Irritations, home ownership for people under 40 is now lower than it was in 1947. He outlines many government policies contributing to housing price inflation, including taxation breaks for “investors” (more properly called speculators).

We can recall that Labor went to the 2019 election proposing to abolish the most distortionary tax concessions relating to capital gains and so-called “negative gearing”. Morrison deceitfully misrepresented Labor’s policies, running a scare campaign claiming that Labor’s changes would wipe out the value of people’s houses. In fact Labor’s proposals were remarkably modest, with grandfathering provisions for existing property speculators: if anything Labor’s proposals wouldn’t have gone far enough in dampening speculative price rises. But neither the truth nor considerations of the national interest were to stand in the way of Morrison’s political opportunism. Hence these concessions remain, and Labor, fearful of Morrison’s opportunism, doesn’t dare propose doing anything about them.

It is useful to explain how these tax concessions came about because few people realise how much enduring damage the Howard government did to our tax system when it scuttled the 1985 Hawke-Keating tax reforms. Those reforms achieved neutrality between capital gains and other forms of income, through applying a simple mechanism of indexation to account for inflation. But in 1999, under pressure from the finance sector who were lobbying for “financial dynamism” (i.e. to make speculation easier), the Howard government abolished the 1985 reforms and introduced a discount system that not only privileged capital gains but also, in abolishing indexation, ensured that the faster an asset was turned over the greater was the benefit to the investor. If someone had wanted to deliberately design an economy-wrecking policy they couldn’t have done better than the Howard-Costello changes, which privileged short-term fast-turnover speculation while discouraging long-term patient real investment. Unaffordable housing is one consequence of that economic irresponsibility.

The other concession relates to “negative gearing”, which allows speculators who borrow to buy houses to claim interest on their housing loans, even to the extent of people being able to claim a tax loss to offset tax liabilities from other income. With the help of a whiteboard and a patient class motivated by an end-of-semester exam, I could explain that this allows for speculators to claim a double tax deduction – for the cost of the property itself and for the cost of financing it.      

It is ironic that the New South Wales government, a Coalition government, is now calling on the Commonwealth to abolish the capital gains tax concessions.  See Peter Martin’s article in The ConversationNow it’s Liberals telling us we are going to have to cut the capital gains tax concession if we want to get Australians into homes.

Getting rid of those concessions would help bring sanity back to the housing market, but the worst driver of housing price inflation has been the extraordinarily low interest rates of the last few years. They were low before the pandemic, and during the pandemic the Reserve Bank lowered interest rates even further. That easing in itself made sense as a stimulatory measure, but in order to give some surety to the market, and in anticipation of a slump in housing and other asset values (that never occurred), the Reserve Bank promised to maintain the cash rate at 0.1 percent until 2024.

In its Melbourne Cup Day report on its decision to hold the cash rate at 0.1 percent, the bank acknowledges that housing prices are rising, but it hopes lending standards will stop house buyers becoming over-committed. It is dropping only the gentlest of hints that it may raise interest rates earlier than 2024. Those who operate in the financial markets, however, know that something has to give, and in just the last three months the yield on government three-year bonds has risen from 0.12 percent to 1.17 percent (RBA statistics, Table fo2D). Isaac Gross of Monash University, writing in The Conversation, explains how the RBA and the market have parted company: Australia’s Reserve Bank signals the end of ultra-cheap money. Here’s what it will mean. It means that variable mortgage interest rates which link to the RBA’s cash rate, are low for now and are falling, while fixed interest rates, which are more responsive to the market, are rising.

If borrowers were rational they would read the market and hold off on getting over-committed, knowing that those low variable rates cannot hold, and that when they rise the effect on over-committed borrowers will be tough. Consider, for example the effect of a 1.0 percent rise, from 2.7 percent (today’s indicative variable rate) to 3.7 per cent on a new loan of $800 000. That’s an $8000 annual rise in repayments. Historically, rises in rates have been off reasonably high base rates, but a rise off a small base rate can be much more painful to the borrower who has been enticed by low rates to take out a large loan.

The trouble is that borrowers are not rational (if we were all economically rational we would never have elected Morrison). Behavioural economists know that immediate outlays are far more influential in decision-making than the prospect of higher outlays one or two years down the track. We are headed to an ugly reckoning, and Morrison’s strategists will be hoping that that does not occur before the election. The ABC’s Ian Verrender explains the political economy of this situation, and the risk to our financial system, in his article How the RBA allowed Australia to become a servant to property prices in a $9 trillion market.

Some people may point out that housing unaffordability, unsustainable personal debt and a boom-bust housing market are problems in all “developed” societies, as explained in a 16- minute Deutsche Welle Business Beyond program. Sydney house prices may be unaffordable, but so too are prices in Berlin, Dublin, Hong Kong, Tokyo, Vancouver and New York.  But our problem is that we have a government politically committed to allowing speculation to continue, and a central bank that made a rash commitment, and over-estimates the rationality of the average borrower. 

Calls for tax fairness

In an article by the ABC’s Daniel Ziffer – Taxes that reward asset-owners and punish wage-earners leading society into crisis, say experts – Rob Pallin, chair of backcountry clothing and equipment firm Paddy Pallin, points out that there are many well-off people, including himself, who would like to see a fairer tax system. Pallin lists a number of tax breaks enjoyed by people who live off inherited or accumulated capital – breaks that are not available to those who actually earn their income through hard work. Ziffer goes on to report on the opinions of tax experts, and introduces us to Millionaires for Humanity, a club of well-heeled people around the world who support a wealth tax.

Even though well-off people such as Rob Pallin are making the case for fairer taxes, Ziffer’s article is likely to attract the accusation that he’s exploiting “the politics of envy”.  But that’s a misrepresentation. Ziffer quotes Mark Zirnsak of Tax Justice Network Australia:

The justification for higher taxes on the rich, is not about “soak the rich”: it's actually about how people who are doing well are generally benefiting from the system that's been set up.

So it's not unreasonable to say if you're benefiting enormously from a system that's skewed to your interests, you should have a more vested stake in actually funding that system.

On a related topic Peter Browne, writing in Inside Story, describes how Australia last century became an early mover in the abolition of inheritance taxes. It’s a story written around the efforts of one person, Syd Negus, the forgotten tax-slayer, who brought some unlikely allies to his cause, such as the Women’s Electoral Lobby, and who was helped by rogue Queensland Premier Joh Bjelke-Petersen, who led an interstate race to the bottom to abolish inheritance taxes.  While acknowledging the inherent difficulties in collecting inheritance and gift taxes – they are very easy to avoid – he makes a convincing case for their reintroduction.

The systems behind your light switches and power plugs

Thank the ESB

We reasonably expect our electricity to be delivered at 50 cycles, 240 volts, and at a high power factor. This was all straightforward when we had huge coal-fired power stations, running 24/7, with the inertial stability of big spinning rotors. There was generally enough dispatchable electricity because those power stations were rarely fully loaded. It was reliable, wasteful, expensive, and it was cooking the planet.

On last week’s Saturday Extra Geraldine Doogue interviewed Kerry Schott, who is stepping down as chair of the Energy Security Board, the body responsible for re-designing markets to ensure stability in electricity supply as we make a transition from coal and gas to renewable sources of electricity. We all know that the output of solar and wind generators can change quickly, and that we need short-term and medium-term energy storage and backup systems. There are established technical means to cope with these problems, but they need to be supported by appropriate market mechanisms. Schott explains how the ESB has gone about that task.

In that 13-minute interview Schott covers a great deal of ground, but doesn’t get on to the Board’s work on connecting Australia’s renewable energy zones which are geographically and time-zone separated. When these are connected up, thanks to geographic diversification, the whole renewable energy system will become even more reliable. The ESB’s recommendations for achieving this integration are in a document Interim framework for renewable energy zones.

Australia’s 21st century capitalists wouldn’t be welcome in the Melbourne Club.

Hamish McDonald, writing in Inside Story, introduces us to Mike Cannon-Brookes in an article aptly titled Atlassian shrugged. It’s partly a biographical story about Cannon-Brookes and his business colleague Scott Farquhar – for example how they financed Atlassian as a startup “with $10,000 drawn on maxed-out credit cards”. It’s also about the contrast between Cannnon-Brookes’ personal presentation and that of the stereotypical Australian businessman – he would find it hard to get past the front door of the Melbourne Club.

It’s a story that would be commonplace in Palo Alto, but that is still quite extraordinary in Australia, and that’s the most telling message from McDonald’s article, because it’s also about Australia’s sclerotic corporate establishment. He notes Andrew Leigh’s observation that apart from CSL, the 5 largest firms on the Australian stock market are the same as they were 35 years ago. Cannon-Brookes and other energetic entrepreneurs see huge opportunities in Australia’s coming industrial transformation necessitated by climate change, while Morrison and the men and women in his circle are struggling to stop that transformation.