Wednesday, July 18, 2007

Ozonomics by Andrew Charlton

Andrew Charlton is 28 years old and has one of those CVs that makes you jealous. He was a Rhodes Scholar, has worked at the OECD and United Nations, and has spent the last couple of years at the London School of Economics. He has co-written several academic papers and a book with Nobel laureate Joseph Stiglitz, and his second book Oznomics was launched in Sydney last night by Labor leader Kevin Rudd. Clearly he’s an intelligent, ambitious young man, and judging by the thrust of Oznomics he has a well developed sense of social justice.

Oznomics is one of a series of recent books about economics written for non-economists. Charlton approaches the questions that people have about economics with one very particular goal: to show that the prosperity that Australia has enjoyed over the past decade is not solely due to the economic management of the Howard/Costello ‘dream team’.

On the way, Charlton skewers a number of myths about economics and the economy. First off, he tells us what economics isn’t. Economics isn’t very concerned with daily fluctuations in gold prices, share prices, and the value of the Australian dollar. In fact, Charlton argues, there are really only three issues that matter in economics: productivity, jobs and equality.

On productivity, Oznomics is uncontroversial. Charlton echoes Paul Krugman’s sentiment that productivity isn’t the only thing matters, but in the long run it is just about the only thing that matters. He is of the opinion that in Australia’s national debate, productivity doesn’t get enough attention.

On jobs, Charlton does a good job of de-bunking the myths perpetuated by ‘sandbaggers’ – people who would erect trade barriers to try to keep out the rising tide of the global economy. At the same time, he clearly opposes the ‘market fundamentalism’ of the Howard government’s WorkChoices policies.

On equality, Oznomics cites the growth of the gap between the lowest paid and the super-rich CEOs and sports stars, and argues that ‘conspicuous consumption’ for status is a zero-sum game that makes us all worse off (if everyone buys their fiancés a big diamond ring, big diamond rings are no longer a sign of status).

Oznomics then sets out the benefits of free markets – chiefly their ability to respond quickly to what people want. However Charlton challenges what he sees as dogmatic ‘market fundamentalism’ that considers that markets are always superior to government at providing services. He gives a couple of Mike Moore-esque examples of private companies doing a poor job of what he seems to think should be done by governments (contractors in Iraq and the failings of the US health system), and states that:

‘In Australia there are many examples of “deregulatory overreach”, where economic reform has ended up causing more inefficiencies than it has eliminated’ (p. 98)

Charlton cites the privatisation of the Commonwealth Employment Service and the subsequent poor outcomes for the long-term unemployed as an example of ‘deregulatory overreach’.

Ozonomics then moves on to the substantive matter of the book: the myth of Howard and Costello as ‘economic superheroes’. First Charlton outlines some of the major economic reforms of the Hawke/Keating era (floating the currency, the prices and wages Accord, the first microeconomic reform). Charlton correctly argues that these reforms have contributed to Australia’s economic performance of recent years.

The rest of the book is devoted to debunking six economic ‘myths’ perpetuated by Howard, Costello and their supporters. These myths (and Charlton’s rejoinders) are:

Myth 1: Budget deficits lead to higher interest rates.
Charlton: The market for funds is so large, and budget deficits relatively so small that the effect of budget deficits on interest rates is miniscule.

Myth 2: Government debt is irresponsible. Howard and Costello have done us a great service by paying down ‘Labor’s $96 billion debt’.
Charlton: The debt has been paid off by selling off public assets. Essentially public debt has been replaced by private debt.

Myth 3: Reforms to workplace relations have boosted employment and economic growth.
Charlton: The effects of getting rid of unfair dismissal laws are miniscule. WorkChoices was really an exercise in diminishing the power of unions.

Myth 4: Interest rates will always be lower under the Coalition.
Charlton: Interest rates have been low since 1996 due to low inflation and the actions of the Reserve Bank. Besides, it’s not interest rates that matter, it’s the total interest bill that people pay. People are now borrowing more (e.g. for more expensive houses), so are paying more in total to service their debts than in the late 1980s. He also takes the predictable shot at Howard’s performance as treasurer.

Myth 5: Something about house prices (this chapter is a garbled mess, not sure what it’s really saying).
Charlton: The housing boom is really just a great ‘intergenerational scam’ played out by Baby Boomers on the next generation.

Myth 6: The GST was a significant change to Australia’s tax system.
Charlton: Howard and Costello have been timid on tax reform. And anyway, we don’t need to worry about tax too much, as it’s part of a ‘social contract’ and people don’t mind paying tax.

So, there’s a run-down of the contents of Ozonomics. The question is, is it any good? Well, sadly it’s not, really. And I say ‘sadly’ because clearly Charlton’s ideas have gained some currency in the Labor party. Events of the last few weeks (Kevin Rudd’s mangled attempts to use productivity statistics; Kim Carr’s promise to ‘review’ tariff cuts; Rudd’s populist attacks on petrol and grocery price ‘gouging’) suggest that Rudd is a bit naïve when it comes to economic matters. On the surface, an Oxford educated Rhodes scholar should have been able to inject a little sense into Labor’s economic policy.

The problem is that while he debunks some persistent myths about the economy, Charlton falls for a few others that are just as bad. One myth that pervades Ozonomics is the ‘mercantalist myth’. Basically, this is the myth that Australia is like a big corporation, and ‘we’ are competing against the rest of the world. This myth shines through in phrases like ‘our national competitiveness’ (p. 114), and in references to Australia’s ‘ranking’ against the rest of the world.

The mercantilist myth is dangerous because it misses the point. Australia’s economic fortunes don’t depend on how successful Australian firms are in world markets. Australia’s economic fortunes (in the long run) depend on productivity. Instead of worrying about how we stack up against the rest of the world, Australian governments should be doing what they can to remove barriers to productivity growth. (For those wanting more, Paul Krugman does a good job of debunking the mercantilist myth in his 1994 article Competitiveness — A Dangerous Obsession, available at

So what can governments do to increase productivity? Unfortunately Ozonomics has little to say. Charlton murmurs about education, innovation and infrastructure, but it’s motherhood stuff. Two possible areas of reform that could increase productivity in Australia are rejected: labour market deregulation and tax reform. According to Charlton, deregulating the labour will not do much to add to productivity (WRONG), and tax is an issue for crazy right-wingers to obsess over (nobody has ever explained to me exactly how it is ‘progressive’ for the government to waste vast sums of taxpayers money through welfare churning).

It seems that Charlton favours just pumping public money (our money) into education, innovation and infrastructure, and hoping for the best. He implicitly assumes that the government will get good results from its investments. That sounds nice in theory, but in practice governments waste money. They pork-barrel. They try to pick ‘winners’ that inevitably run a poor second to the private sector. And they soak up vast sums of money that could have gone to more efficient private investment.

As well as taking a mercantilist view of the economy and not offering anything much on the big question (productivity), Charlton is selective in the evidence he cites, and ignores vital counter-factuals. For example, he opposes cutting the conditions of employed people (WorkChoices), but doesn’t discuss the effects that this has on the unemployed (it keeps them out of the labour market). Nor does he mention that the best way to guarantee yourself a well-paid, secure job is not to get the government to protect you from evil employers: it is to get a set of skills that make you so valuable to your employer that they would not dream of treating you badly.

In rejecting privatisation, Charlton cites one example of a privatisation that did poorly by some people. The privatisation of the Commonwealth Employment Service may have reduced the support given to the long term unemployed, but there are far more examples of regulation and government intervention making us worse off than there are examples of deregulation making us worse off. Moreover, the fact that some groups lose out from privatisation and deregulation does not mean that the regulations should have been kept in place. All policies produce winners and losers. On average, the benefits of deregulation normally outweigh the costs. Isolated examples of ‘deregulatory overreach’ are not a convincing argument against deregulation.

On top of that, Charlton wastes time worrying about the biggest non-issue in economics: inequality. Sure, we may all find it offensive that there are kids starving in Africa while Posh Spice starves in a Malibu mansion, but the problem is not inequality – it’s poverty. Take Posh Spice out of the picture, and the fact that kids are starving in Africa is still offensive. Trying to ‘fix’ inequality through punitive taxation and income redistribution will achieve nothing. What we need to focus on is getting people out of poverty by equipping them with the skills to participate in a modern economy.

There are a lot more things I could say about Ozonomics, but this is getting too long (it is my first effort at a book review since high school). Suffice it to say that Andrew Charlton has his heart in the right place. I believe that he really does want higher productivity, more employment, better wages and all that good stuff. But I don’t think he knows how to get there.


Unknown said...

Hi there.

It was interesting to see your take on the book.

Might I suggest to you that at least some of your criticisms are philosophical in nature, not strictly economic?

For instance, your assertion that inequality is the "biggest non-issue in economics" is really your own personal view, and not strictly an economic question.

As to empirical evidence on this score, the social psychology literature (and, from what I've read on the economic blogs, the behavioural economics literature) has heaps of studies demonstrating that it is the relative outcomes in a group, rather than the absolute outcomes, that seems to motivate people most strongly.

As to whether deregulation of the labor market will improve productivity or not, perhaps the best way you could add to this debate is pointing to research on the issue to demonstrate that he's wrong, not just assert it. Yes, I understand the economics 101 version of the argument, but economics 101 doesn't quantify the benefits of particular changes.

One more thing to think about - there are things about workplace regulation that are not measured by its impact on GDP. Repealing environmental laws might improve GDP too (at least in the short run), but do you really want to go down that road?

Anyway, good to read your input, and look forward to seeing more of your stuff in the future.

Robert Merkel.

Hippocratic Economist said...

Thanks for the comment, Robert.

You are of course correct to say that the root of a lot of my disagreements with Ozonomics is philosophical (although I wouldn’t say that they are ‘not strictly economic’ – economics isn’t accounting, and economic questions always come down to how you view the world). I am more libertarian in my outlook than Andrew Charlton, and less trusting of government, and I think his outlook leads him to some bad economics (like mercantilism).

On inequality: My starting point as a policy economist is to identify the problem. The next step is to figure out if government can improve on market outcomes. So what’s the problem with inequality? Basically it’s one of perception – I feel worse off because somebody else has more than me. As far as I’m concerned the role of government is to correct market failures and to guarantee people some basic material comfort and the opportunity for self-improvement. Provided I have enough for a reasonably comfortable life, it’s not the government’s job to make me feel better about myself. So I say that rather than being distracted by inequality, government should focus on the real issue: poverty. Poverty is awful. It’s a real, substantive problem that severely damages people’s chances in life. Inequality might make people feel bad, but it doesn’t have many real effects on people’s lives or opportunities.

You mention the behavioural economics literature. One strong conclusion from behavioural economics is that people are loss-averse. That is, the pain caused by losing a dollar is greater than the pleasure of gaining a dollar (particularly when the people gaining the dollar are already materially comfortable). This result suggests that income redistribution from rich to poor will lead to a net reduction in social welfare. On top of that, Okun’s ‘leaky bucket’ effect means that every dollar you take from the rich costs them more than a dollar (because their work effort falls). These results taken together suggest that trying to reduce inequality through income redistribution will be extremely welfare-reducing.

Now I should make it clear that I’m not making an argument in favour of inequality. Just that in my opinion, the only way to reduce inequality without drastic negative consequences is to raise the incomes of the poorest. And the only sustainable way to do that is to make them more productive.

As for the labour market, you are right, it is difficult to quantify the productivity benefits of deregulation, but that doesn’t mean they aren’t there. Nor is the lack of empirical evidence any kind of argument for supporting the status quo. It is difficult to quantify the benefits of floating the dollar and cutting tariffs too, but we know from first principles (and twenty years of experience) that those policies have delivered significant benefits.

I’ll be clear that I don’t favour a complete free-for-all in the labour market, but I think that Labor’s policy of getting rid of AWAs will have a damaging effect in some sectors where it will reduce flexibility. Moreover, I think it should be the right of anybody to trade off entitlements like leave, holiday pay etc. if they want to. And as I said in my post, the way to protect vulnerable people from rapacious employers is not through regulation: it’s through enhancing their bargaining position by equipping them with skills. Low unemployment helps a lot there, too.

defworld said...

Basically what you're implying is that we are all equal and have equal imput and will therefore be equally protected. We aint. We are generally indispensible - except for the few that you are concerned with. Further you want to make everyone indispesible but at the same time not investing in does that work exactly? That's the problem. No amount of window dressing or wishful thinking will change that.

Further we cant compete with cheaper labor markets, no amount of tweaking AWAs will make us competative ('fairness tests' run counter to the point of having AWAs) - it'll just make society more depsperate and less happy and continue the shift (stampede) from government to personal debt.

What we have to sell is prestige, in education, tourism and perhaps other fields. And 'quality' no matter how creatively defined. And ofcourse resources. The rest is conservative wishful thinking.

Unknown said...

I can certain understand not having government investing in 'innovation' but I do think investing in education is essential to increasing productivity; skilled people are more productive and investing in education increases the average skill level of the population. I also think investing in infrastructure is essential. If people can't get to their workplace or have to spend long hours commuting, for instance, it makes it harder for business to employ properly skilled and productive people and wastes extra time in traveling instead of working (or consuming). Providing communications infrastructure can boost productivity by improving efficiency in many tasks.

One point that always made sense to me was that government should be investing in areas where the return is not, or mostly not, a direct financial one. When looked at this way, it becomes obvious what areas government should stay out of as well. If the return is indirect (the legal system, for instance), governments have a role to play.

SPR said...

"Australia’s economic fortunes don’t depend on how successful Australian firms are in world markets. Australia’s economic fortunes (in the long run) depend on productivity. "

Actually its both. You can be as productive as you like, but if you dont then make a trade it is a waste of time.

Beijing Cultural Heritage Protection Center (CHP) said...

"biggest non-issue in economics: inequality."

Inequality a non-issue?

It is a fundamental economic issue that affects the majority of people in this world.
"A principal player on the front line is senior adviser Andrew Charlton. Charlton — with a sharp intellect and an impressive CV — is one of Rudd's intellectual young guns who has been helping to direct the debate on economic management away from the "hands-off" approach to government of the Howard years."

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Iain said...

You mentioned that the best way for a worker to retain employment would be to gain as many specialised skills as possible rather than run to the government.

I strongly believe that this principle should apply to most of the population, but I was watching a documentary some time ago that made me think about this stance.

It was one of those programs about how 'spectacular' British industry is/was and at the end of it, the presenter stood in a British ship yard and said something along the lines of "pretty soon all the shipmaking work will soon be outsourced to Poland. Think about all the years of apprenticship and experience amongst these workers that will be made obsolete because of this."

That made me think. We can't really say that this was the fault of the workers for not gaining the proper skills; they've spent years learning how to properly weld, paint and machine, which are all very valuable skills. In turn, it comes down to a matter of cost. Do you think that the workers should accept a considerable drop in wages just to hold on to their jobs? Or should the government step in a subsidise the ship yard for a few years to let them down gradually?

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