The taxi problem in Western Australia is no secret. If you have ever been out after 6pm, you will have encountered the all too common scenario of calling the State's taxi company (the monopoly known as Swan Taxis), requesting a taxi, being informed that there should be one there within 15 minutes only for nothing to show up. Follow-up calls are usually made in vein; the company informs you that the taxi who picked up your request simply decided he had a better offer elsewhere, says you were not there and then your booking is effectively lost (it never goes back to the call centre to be picked up again). Then there is the problem in the so-called social hubs of Fremantle and Northbridge where you wait at a designated taxi stand for hours on end wondering where on earth all the taxis have gone.

But not for any longer! Believe it or not, our wise and benevolent politicians have noticed this too. They claim it is simply a problem of incentives: the taxi drivers just do not want to go to these places because the patrons are drunk or, in the case of a phone call, there is a chance that the patron will have found a better option by the time they get there. So the latest idea to "solve" Perth's taxi problem is to offer drivers an extra $10 on top of their regular fare to pick up passengers from Fremantle nightspots on weekends, paid for with a new $80,000 tax on nightclubs.

While yet another subsidy for taxi drivers may well help alleviate the problem, the real question we should be asking is why is the taxi market not clearing in the first place? Is this really a market failure -- as this response would indicate -- or is it government failure?

We are inclined to believe the latter. The politicians who are proposing this solution are the same ones who flat out refuse to remove the artificial limits they have placed on the supply of taxi plates. It is the combination of both a fixed supply - according to the Department of Transport, the 2007 average market price to buy an existing full-time taxi plate was $217,871 - and a rigid price (it is heavily regulated) which results not only in taxis being unable to raise prices thereby attracting new entrants into the industry to service the less desirable locations and drive prices down (no pun intended) but also a shortage as the taxi drivers, being unable to use the price system to meet demand, simply pick and choose the best fares.

A real solution would be to deregulate the market for license plates. This is of course easier said than done: Gordon Tullock long ago pointed out that once an industry becomes regulated there is a "transitional gains trap", where one outcome is that people who may have initially opposed the regulation support it once it is enacted so as to preserve their sunk costs. The people who gained the most from the regulation are those who got the first license plates and "capitalised" (extracted) the initial gains from society. These people have most likely left the industry already. Thus, we are left with an interest group who has paid the current market price to enter the regulated industry - the current plate holders - and have to be paid off to give up this power, an amount usually equal to the present value of their future income stream derived from their position of power. Unfortunately simply abolishing the licenses altogether would result in large losses for the current entrenched interests, something that is almost always politically and socially unacceptable.

Nationally in Australia we had two announcements from Canberra which won public support from the mainstream media. The first was the go ahead of the Mining tax and the second was the rise in compulsory superannuation contributions from 9% to 12%. 

We have talked about the Mining tax and the concept of profits here and here, so we won’t cover old territory other than to say ‘goodnight and good luck’ to the mining industry.

What about the rise in compulsory contributions to superannuation? We’ve talked about this before. Yet still, isn’t this a win for working families?

Well it’s a win for someone of course, but it isn’t necessarily for working families who may or may not see their retirement money - if it isn’t wiped-out (as it was for many in the wake of the GFC) or if they ever reach the inflating ‘retirement age’.

There appears to be some added confusion as Wayne Swan made the extraordinary claim that the rise in super contributions will be covered by revenue from the Mining tax. But as some have aptly noted, the government doesn’t make compulsory super contributions, employers do...  so Mr Swan’s claim appears to be a fairly poor attempt at political spin, which is also known as a bad lie misleading.

Perhaps he meant to say that company tax breaks of 1%, to those businesses eligible, will offset the increased cost in labor from the rise in super contributions. This again appears to be a thin claim as according to one source, most businesses will be ineligible for the tax cut - and will it be enough to offset the significant rise in wage rates? I guess we’ll see.

Let’s breakdown the increase in compulsory contributions to see who wins and who loses:

  1. Employers will be forced to increase the proportion of a worker’s wage into their superannuation fund by 0.25% (initially, then 0.5% towards the latter end of the transition) each year until it reaches 12% by 2019-2012, according to the government.

2. Increased super contributions add up to significant savings in super for workers... when and if they retire, and if there’s any money left (as discussed above).

To understand the implications of this legislation, imagine that: 1) wage rates are frozen, 2) inflation is 0%, and 3) income taxes are 0%:

So a worker earning $60,000/year will lose $1,800/year of take-home income after 2012. In the real world, we see an economy-wide increase in wage rates every year due to other economic forces. Let’s factor in these real-world forces one-by-one to see how the increase in compulsory superannuation contributions will affect the average worker. 

FACTOR #1: Demand for labor and wage bargaining

Increases in wage rates can occur through the following forces: 

1. Increased demand for labor

2. Decrease in overall productivity within the economy

3. Monetary inflation

4. Individual or collective (union) wage bargaining 

Wage rates, a factor of production, will largely be set by supply and demand for a good or service that a firm will be selling. Therefore, a rise or fall of wage rates based on supply and demand is more sector specific and difficult to predict. However, the demand of labor can be modulated by other economic factors such as inflation, which will be discussed below. Similarly, the supply of labor can be affected by immigration, regulatory and minimum wage laws. Individual or collective bargaining can also clearly raise wage rates, yet this is predominantly within individual companies or industries.

So what contribution does: 1) the demand for labor, and 2) wage bargaining, have on increasing wage rates across the economy each year? The answer is 'reasonably low' as these particular forces are largely case/industry specific. This means that one factory may encounter a situation where there is a higher demand for the goods they make while bearing union pressure to raise wage rates. In this case, the chance for an increase in the wage rate in that factory is very high. Conversely, not all industries experience the same increase in demand for goods/services and wage bargaining pressure. Therefore, other factors to explain the economy-wide trend for increasing wage rates need to be examined.

FACTOR #2: Inflation 

We understand that within an unfettered free market, there is a tendency for deflation and increase in productivity within the economy, which leads to: 1) lower prices, 2) lower ‘nominal’ wage rates, and 3) higher ‘real’ wage rates (i.e. your money buys more per monetary unit). Without a doubt, wage rates in Australia (probably all countries) are rising each year without fail. This isn’t surprising as Australia doesn’t have a free market. It is more free than other countries, but it’s still highly regulated and taxed.

Most importantly, there is a monopoly fiat monetary system in place - through the Reserve Bank of Australia - that artificially expands (i.e. ‘inflates’) each year. The artificial expansion of the fiat monetary supply, monetary inflation, is responsible for a number of deleterious economic effects. Aside from forming business cycles, but relevant to our discussion here, monetary inflation can cause a rise of nominal prices corresponding with a decrease in real wage rates. Anyone on a fixed income is familiar with the concept of ‘indexing’, where gross income rises by roughly 1-5% each year to keep up with inflation (increased nominal prices, higher cost of living, higher wage required).

As discussed above, an increase in compulsory superannuation contributions by employers reduces the take-home wage of workers. On top of this, inflation and income indexing may offset the nominal decrease in wages, but at the end of the day each worker is still taking home less.

FACTOR #3: Tax 

Referring back to the table above, after 2020 a worker on a fixed income of $60,000 (again not factoring inflation, tax and wage bargaining) will lose $1,800/year. This individual, according to current income tax brackets, would remain comfortably within $37,001-$80,000 tax bracket with an effective tax rate of 30%. This means that this worker has to pay the same tax burden with less take-home income each year... on top of an erroding purchasing power. Depending on the strength of inflation, bracket creep may become a serious threat.

FACTOR #4: Employers 

Employers and employees will see and, more importantly, feel the changes listed above. Employers will need to raise wage rates to offset the decrease in real wages caused by greater superannuation contributions. Increasing the cost of labor is increasing a factor of production. And just like raising the minimum wage, if the new cost of labor threatens the entrepreneur’s acceptable profit margin then the inevitable result will be unemployment for some workers. Not exactly what the government was aiming for. Also bigger business are more likely to cope with these changes far better than their smaller competitors.   

The government has stated that the rise in superannuation contributions will be absorbed wage rises each year (remember indexing). Therefore, in their eyes, the effects of setting super contributions to 12%, slowly over 7 years, will be harmless. In reality, the rise in super contributions has cut into offsetting inflation and what workers take home each year. This means workers will have less money to save, pay down debt or consume... all of which will have ripple effects within the economy.

Conclusion 

So who WINS out of all of this. The workers? Not likely. But if I was a CEO of a superannuation fund manager, I would be thanking the PM Julia Gillard and her government for increasing my projected income and commissions for the next several decades. Perhaps this is why if you look at a list of campaign contributions for both parties (http://www.democracywatch.com.au/donations.html), you'll find the big banks and financial institutions (that incidentally manage superannuation funds) in the top 20 polical donors. Maybe, just maybe, this is a subtle and deceptive way of recapitalising superannuation funds that have been grossly mismanaged and underperforming.

God bless,

Washo

A recent post over at ThinkMarkets about the negatives of having big banks in an economy got me thinking about banking in Australia. Unlike the U.S., Australia has a four-pillars banking policy which prevents any of the ‘big four’ banks from merging, something that would supposedly reduce competition in the sector. While that may well be the case, a more important effect it has on the sector is to virtually ensure an oligopoly equilibrium, with the big four able to use this ‘too big to fail’ position to extract rents from the rest of society.

People in the banking sector are quick to point out that the Return on Assets (ROA) of the big four is only about 1%, a very low return which, as Haldane (2009) states, means banks must resort “…instead to leveraging their balance sheets” to meet Return on Equity (ROE) targets, currently between 16 and 20% in Australia.

Bankers would argue that this is perfectly fine; after all, “…the social benefits of successful banks” are profound, as “…profitable and well capitalised banks provide finance for businesses and, therefore, keep people employed”.

But this is simply a rehashing of an age-old fallacy. Just because people are employed doing a certain thing does not mean that that employment is socially beneficial (which I will assume here to mean productive, i.e., wealth-creating, pie-expanding jobs). Likewise, just because a bank makes a profit is no sign of efficiency since its oligopolistic position allows it to achieve, within reason, a desired ROE that will appease shareholders and keep the government off their backs. To find out whether banks are actually socially beneficial we must look at profitability after subsidies. These subsidies include but are by no means limited to restrictions on entry and exit as well as implicit (government) and explicit (RBA) guarantees. The benefits the Australian banks receive from these policies are no doubt the reason for their individual success.

Standard efficiency indicators used by the banks to highlight their social benefits fail to factor this in and are at most useful for analysing changes through time at a given bank but not for cross-sectional comparisons with other Banks which operate under different circumstances. Therefore, given the institutional situation of the Banking industry in Australia, it is more likely than not that the big Australian banks are inefficient rather than efficient when compared with international banks. Progress – that is, true dynamic efficiency – has been stifled and replaced with stagnation, where we have substituted “…uniform mediocrity for the variety essential for that experimentation which can bring tomorrow’s laggards above today's mean”.

While the big Australian banks will have you believe that they are performing a socially beneficial function, in reality they are trading rents extracted from the rest of society owing to a state-mandated lack of competition in their industry. The solution is not to levy new taxes or forcefully break the banks up, all of which are likely to be unsuccessful, futile or actively harmful but instead to appreciate the institutional factors involved where unless there is true competition between banks, a policy of profit maximisation by the big four is likely to be socially harmful.

No matter where you go or who you talk to these days, you are bound to run into a planner. Whether they are a private developer, private consultant (read: government consultant), a state officer or a local council worker, they are everywhere. Each and every one of them is armed with a seemingly endless list of buzzwords and hollow rhetoric such as the inappropriate use of words like “sustainability”, something David Friedman aptly described as “…an argument against whatever policies one disapproves of, in favour of whatever policies one approves of, and adds nothing beyond a rhetorical club with which partisans can beat on those who disagree with them”.

Planners are not bad people; in fact, I count many amongst my friends and generally feel that their views on “planning issues” are the result largely of an unfortunate monopoly that the government holds both on education and the career prospects of anyone who wants to get into development of any kind, especially urban and transport development.

This unfortunate fact means that we are almost certain to keep repeating the mistakes of the past. Decades of relying on government central planning for infrastructure provision – while I cannot speak for other States, Western Australia has operated with centrally directed, top-down detailed land-use and transport plans (the latest of which is Directions 2031) for decades, all of which bear a striking similarity to the 5, 10, 20 and 40 year plans once envisioned by the 20th century socialists – has created countless dilemmas that are being resolved with yet more intervention and top-down planning.

The favourite way to achieve these “smart growth” plans is through zoning. The Economist recently reminded its readers of one of the most fundamental of economic laws in response to a typical ‘planner’ comment expressing concerns about “allowing unlimited rapid development”:

…no one disputes that there is a value to preservation. Yet when private firms and individuals transact voluntarily, we understand that there is value creation, too. This value creation plays an important role in economic growth, and our presumption should be in favour of allowing such transactions to take place…The burden of proof should be on those who would intervene to prevent voluntary, mutually beneficial transactions and disrupt private spillovers. Otherwise—and empirical evidence supports this view—society will tend to get too few value-creating transactions and positive spillovers.

I know by now I may sound like a broken record, but the “problems” that are everywhere and will continue to be everywhere cannot be solved with more of the same “planning”. Today it is encouraging density or so-called ‘smart growth’, yesterday it was all about keeping business and residential districts apart. The only thing in common is that it is the same organisation – government – calling the shots. The “problems” are then institutional; people are acting within the rules to which they must abide (today’s planners) and are repeatedly producing poor outcomes because the payoffs for good outcomes are simply not there.

My theory is that it is because (primarily) the institution of private property has been eroded by decades of zoning and other restrictions on land use. The price system in most scenarios has been either completely distorted or is not existent (e.g., transport). People are no longer allowed to cooperate with each other to achieve efficient outcomes and instead must resort to constant bickering and political lobbying as they try to force their own subjective values onto others’ – something that, aside from their time, they do not have to PAY for. The result is that the local government, planning commission or politician is used to enforce subjective views at no cost to the individual or group lobbying for change but at massive cost to unseen people (e.g., people who want to move into an area but cannot afford to because of onerous zoning regulations driving up land prices).

My thoughts are that a lot of the “problems” that need to be “solved” would be taken care of spontaneously if prices were allowed to convey the knowledge needed to make ever-changing trade-offs. If we get the institutions right, a lot of work that today’s planners do – they are generally smart, articulate people – could be better used adding value in the private sector creating things that people actually want. A continuation of the policy of solving government-created problems with government regulation will simply further restrict important market coordinative information and will result in decisions that will always appear to be poor in any ex-post analysis.

As someone once said, it is always easier to believe narratives about heroic leaders than about complex self-reinforcing political and economic systems. Instead of repeatedly calling for someone with the right “vision” or “leadership” and consequently a further erosion of property rights and the coordinating function of the market (“leaders” will always need more power to enact their “vision”), the focus should be on getting the institutions right. Until that happens, any ad-hoc attempts to “solve” society’s “problems” with new commissions, new powers, better plans or bigger budgets will be like “groping in the dark”.

If you have been unfortunate enough to catch the daily news on one of the mainstream media networks you will no doubt at some point have seen a snippet of our country’s parliamentary proceedings. Parliament is currently preoccupied with the issue of the Medicare rebate – a 30% discount on the price of private health insurance. The government wants to – and, now that they have bribed the Greens and independents with a sufficiently large amount of your money, will – remove the rebate for so-called¹ high income earners.

The justification is one we must suffer every day from those on the left (and those on the right seem almost afraid to challenge the notion): removing the discount for so-called high income earners will create a “fairer” distribution of income. For example, Health Minister Tanya Plibersek went to pains in one session to remind MPs that their health insurance is subsidised by lowly-paid workers like those who clean the parliamentary chamber at night².

First of all: is it? Are lowly-paid workers, such as the chamber cleaners, actually subsidising highly-paid workers? Given that the entire public health system is financed through tax dollars and that the rebate is also financed with tax dollars, then clearly the people subsidising it are, you guessed it, the so-called high income earners. These people pay significantly more tax than so-called low income earners and when government transfer payments are factored in then the so-called lowly-paid workers actually pay negative taxes (Figure 1; Figure 2).

Figure 1: Estimated taxes as a percentage of gross income, by quintile of household-weighted weekly gross household income, 1996-97 (Source)

Figure 2: % Share of Australian Taxes Paid (Source)

Transfer payments are one of the worst kinds of economic inefficiencies. Arthur Okun noted that “…the money must be carried from the rich to the poor in a leaky bucket. Some of it will simply disappear in transit, so the poor will not receive all the money that is taken from the rich”.

I certainly do not support the rebate in its current form but I would also be reluctant to call for its abolishment. We have a tricky situation created by the government’s guarantee of public health care – a guarantee it clearly cannot back up (unless you think rationing, i.e., queues, are a good way to distribute healthcare) – that, it would seem, has created a very real need for some incentive for people to voluntarily opt out of that Ponzi scheme (even though they still have to pay for it). The rebate therefore goes some way to alleviating a problem caused by the initial regulation by keeping people on the margin out of the public healthcare system.

A better solution than the 30% rebate would be to reverse the trend of more government to solve problems created by government, reduce the tax burden of public healthcare and get the government out of healthcare altogether. Government is the reason why healthcare is so expensive and why the so-called poor cannot afford insurance. It is the reason why there is a need for tax rebates to keep people out of the public system in the first place.  

Unfortunately, if we are being realistic the chance of removing government control of health in a modern social democracy is virtually nil and therefore the rebate should stay less we want longer healthcare queues and poorer service for the chamber cleaners. I leave you with Robert Lucas on the issue of “fairness”³ as defined by the Labor party:

Of the tendencies that are harmful to sound economics, the most seductive, and in my opinion the most poisonous, is to focus on questions of distribution…But of the vast increase in the well-being of hundreds of millions of people that has occurred in the 200-year course of the industrial revolution to date, virtually none of it can be attributed to the direct redistribution of resources from rich to poor. The potential for improving the lives of poor people by finding different ways of distributing current production is nothing compared to the apparently limitless potential of increasing production.

[1] I use the term ‘so-called’ because I disapprove of segregating society into two arbitrary classes of people.

[2] I believe the logic behind this apparent ‘subsidy’ is that because the chamber cleaners likely do not have private health insurance, they are missing out on, ahem, “subsidising” the 30% rebate that the ‘rich’ enjoy. Let us just conveniently forget that the subsidy is paid for by taxes anyway (of which the ‘poor’ pay very little if any) and that the entire public health system – that the ‘rich’ do no use much of – is paid for out of the same taxes.

[3] I would of course opt for a different definition of what is ‘fair’: equality of opportunity (equality before the law) rather than the current definition of equality of outcomes.