Home ownership remains strong in Australia but it masks other problems: Census data

From The Conversation.

The great Australia dream of owning your own home is still alive despite the various problems plaguing housing affordability, new Census data shows. Even though the overall home ownership trend remains strong, it’s masking other issues.

The latest 2016 Census data assesses what the national home ownership and rental rates are and how these vary location. It also gives us a picture of mortgage and rental costs.

Comparing home ownership rates since the 2011 Census, there’s a slow but steady decline in home ownership rates overall – down by 2.9% from 64.9% of all Australian households in 2006, to 62.0% in 2016. However, 7.4% of households did not state their housing tenure in the 2016 Census. This accounts for some of the variation in reported rates of home ownership decline.

This contraction is nowhere of the scale of equivalent falls in home ownership in the US and UK and New Zealand over the same period.

What’s more interesting than the overall trend, is the greater decline in outright home ownership, involving no mortgage debt, from 31.0% to 29.6% between 2011 and 2016. There’s also a lesser decline in home owners who are purchasing with mortgage debt 33.3% in 2011 compared with 32.4% in 2016.

The opportunity households now have to borrow against their mortgage loans for spending undoubtedly accounts for some of this change. Also contributing to this is home purchasers are less likely to reach retirement age with no remaining mortgage debt, in the same numbers as previous eras.

Another aspect of housing affordability is masked by these numbers – the wide variation in being able to purchase a home according to age and income. Recent evidence indicates would-be-home-owners try various means including very high mortgage debt and moving to outer urban locations away from employment and into smaller dwellings, to be able to buy a house. Some even delay having kids.

Census figures show that for people wanting to purchase a home, a change in state or city location may be an option. According to the data Darwin was the most expensive city to buy in, whereas Hobart was the cheapest for home purchasers.

For households across the income spectrum, 7.2% of purchasers are paying more than 30% of their income on mortgage costs, the data shows. This figure is likely to be far higher among the lowest income (40% of households) for whom such costs place them in housing poverty.

Given the national obsession with investment in private rental, it’s no surprise that the proportion of all Australian households now renting has also increased. Census 2016 results show the private rental sector grew in size, from 20.2% in 2006, to 22.0% in 2011 and to 23.6% in 2016.

In 2016 a total of 2,089,633 Australian households rented privately, either from real estate agents or private landlords.

The growth of the private rental sector largely reflects the high costs of home purchase. Many households who rent have a relative lack of security and control over rental increases.

For those unable to pay rent in the private market, social housing is likely to provide little relief. Census data shows overall rates of social housing declining from 4.7% in 2006 to 4.0% in 2016. In this context, the growth in rates of homelessness in the last decade is perhaps not surprising.

For Indigenous Australians, the housing picture is different. Census 2016 data show among households in which at least one resident is Aboriginal and/or Torres Strait Islander, 12.2% are outright owners, 25.9% are purchaser owners, 32.4% are renting privately. Around a fifth of households, 21.5%, live in social housing, reflecting targeted social housing programs in metropolitan, rural and regional areas.

Overall, home ownership has not changed as dramatically in the last decade, as some would have anticipated. However, it’s likely with the labour market being what it is and the adaptations people are making to try and buy a home, there may be longer-term problems to be seen in future.

Excessive household debt, polarisation of cities into low and high income earning areas and deepening family housing constraints indicate these Census figures likely mask bigger problems. This may translate over time into a more costly social problem, as increasing proportions of households require housing assistance of some form. Australian society could become even more divided on the basis of housing wealth and opportunity, if these trends continue, as we expect they will.

Authors: Wendy Stone, Associate Professor, Centre for Urban Transitions, Swinburne University of Technology; Kath Hulse, Research Professor, Centre for Urban Transitions, Swinburne University of Technology; Margaret Reynolds, Researcher, Centre for Urban Transitions, Swinburne University of Technology; Terry Burke, Professor of Housing Studies, Centre for Urban Transitions, Swinburne University of Technology

Who’s responsible? Housing policy mismatched to our $6 trillion asset

From The Conversation.

Does the Australian government have the policy, organisational and conceptual capacity to handle the country’s A$6 trillion housing stock? We ask this question in a newly released research report. The answer is critically important to both household opportunity and prosperity, and to the management of our largest national asset.

Australians’ wealth is overwhelmingly in our housing. As of late 2016, our housing stock was valued at $6 trillion. That’s nearly double the combined value of ASX capitalisation and superannuation funds.

Clearly, the way the housing sector is managed has huge implications for household prosperity and opportunity. The public debate about high house prices, for example, reveals a gnawing anxiety that the distribution of housing as an asset has shifted too far in favour of a growing class of rentiers rather than households.

Housing also has clear national economic implications. This relates both to its scale as an asset, and to the way it provides shelter for those most in need where that need is clear.

Any misallocation of housing to low-productivity uses is potentially a major drag on the economy. This necessarily requires a wide understanding of productivity.

How is Australian housing policy framed?

We asked whether there is a clear systematic policy framework through which the Australian government understands the dynamics of the housing system and its contribution to productivity. We might expect such a framework to be clear and prominent given recent public and policy attention to housing questions.

To better understand the Commonwealth’s approach, we surveyed recent major housing policy reviews by the government. We assessed how housing was conceived in terms of its economic and social dynamics, its influence on productivity, and the role of policy in shaping these effects.

There is no shortage of documentation to appraise. Our sample included the Henry Review of Taxation (2010), the National Housing Supply Council report series (2009-2013), the Productivity Commission inquiry into planning (2011), the COAG Report on Housing Supply and Affordability Reform (2012), the Financial System Inquiry (2014), the Federation Report on housing and homelessness (2014), and (albeit not a government report) the Senate Inquiry into housing affordability (2015).

We also prepared an inventory of housing policy instruments operated by governments in Australia to understand how these were conceived within the policy reviews. We found 13 policy instruments that influence housing systems. These operate across housing, economic and fiscal policy and at multiple tiers of government.

A picture of incoherent policymaking

We were surprised to discover that few of the major policy reviews provided a systematic framework for understanding the economic role of housing.

There is thin evidence, at best, that these inquiries constructed or articulated a systematic conceptual understanding of the links between the housing system and economic productivity.

Even the Productivity Commission’s inquiry into planning and zoning, which focused on housing affordability, did not offer a conceptual framework for understanding the influence of planning regulaton on urban or national productivity.

Our review of these documents further shows there is no coherent framework articulating how policy objectives link to instruments and their effects. Housing policy, despite the $6 trillion value of housing, seems strangely incoherent. Australia doesn’t currently have a minister for housing.

The debate over negative gearing during 2015 and 2016 partly demonstrates our contention. During this period we counted at least six reports by non-government organisations articulating a view on the purpose and effect of negative gearing. Nowhere could we identify a government policy document articulating a clear, extended and analytically based position on this policy explaining its purpose and effects.

Our search for an explanation of these gaps in policy was not exhaustive. But we did assess the current administrative orders for housing within the Australian government.

Responsibility for understanding housing issues is divided. The Department of Social Services is responsible for social housing, rent assistance and home ownership. The Treasury has responsibility for housing supply policy.

Elsewhere, the Reserve Bank deals with monetary policy and financial stability. The Australian Prudential Regulation Authority APRA manages macroprudential policy. And the Tax Office (ATO) administers tax concessions. The Productivity Commission offers occasional advice on housing.

Yet there appears to be no obvious co-ordinating point in government that oversees housing. No one authority is responsible for formulating a coherent systematic understanding of housing and its effects on productivity and Australia’s economy or society generally. The National Housing Supply Council established in 2009 partly filled this role, but was abolished in 2013.

Further dispersion appears via COAG, which is convened by the Commonwealth government. COAG periodically marks out a housing issue, such as land supply, for discussion with state governments and to formulate policy recommendations. But COAG communiques are typically short political statements and not analytically founded.

Within state governments, responsibilities for different aspects of housing are typically spread across several agencies.

What needs to be done?

Our report demonstrates weaknesses in Australia’s approach to housing and housing policymaking. There is evidence this is deliberate. For example, the Coalition members’ minority response to the 2015 Senate inquiry into affordable housing rejected almost all of its policy recommendations. Many of these would rectify some of the deficits we have identified.

The weak formal coordination in housing policy contrasts with other sectors such as energy, defence, biosecurity, disability, heritage, drugs and road safety, among others. Each has a dedicated national strategy articulating policy objectives, problem conceptualisation and coordination of policy instruments.

It is doubtful that housing is less significant to the nation, economically or socially, than these sectors.

We recommend that the Australian government reflects on the position of housing within the architecture of government. The $6 trillion national asset that housing represents deserves much better understanding of its dynamics and effects on the national economy, including productivity.

We argue that Australia needs a federal minister for housing, a dedicated housing portfolio, and an agency responsible for conceptualising and co-ordinating policy. The current fragmented, ad-hoc approach to housing policy seems poorly matched to the scale of the housing sector and its importance to Australia.

Authors: Jago Dodson, Professor of Urban Policy and Director, Centre for Urban Research, RMIT University; Sarah Sinclair, Lecturer in Economics, RMIT University; Tony Dalton, Emeritus Professor, Centre for Urban Research, RMIT University

Price hikes in Ether and Bitcoin aren’t the signs of a bubble

From The Conversation.

When there is a rapid growth in any of the crypto-currencies and assets such as Bitcoin, Ether, Zcash and others, many will call it out as a bubble. Indeed, on a relatively short time scale it clearly looks like a bubble.

The entire crypto-currency market capitalisation currently stands at around US$100 billion; it was US$60 billion one month ago. But Bitcoin was worth 1/100 of a US cent in June of 2009, 7 cents in June 2010, and US$7 in June of 2012.

Recently all eyes were on Ether. Over a 90 day period, Ether appreciated twice as quickly as Bitcoin did in late 2013, when Bitcoin crashed to around 35% of it’s highest value. Aside from the 2013 crash, Bitcoin has experienced smaller crashes many times since, but is now worth double its 2013 high.

In the longer term, these are fluctuations around a strong growth trend. Crashes will cause some to abandon the field. But signals of longer term growth in these crypto-currencies and assets point to a possible emergence of a new type of market, through the building of a new economic infrastructure.

Ether is the token of the Ethereumblockchain, a platform that runs “smart contracts” through a distributed online ledger that records transactions. It’s second only to the crypto-currency Bitcoin in price. Some believe it will one day overtake Bitcoin (a process dubbed “The Flippening”).

Price hikes not the sign of a bubble

Fundamental aspects of the technology that underpins crypto-currencies and assets are causing people to re-imagine, and then enact, new ways of creating and exchanging value online.

The key difference between Bitcoin and Ethereum is that you can use Bitcoin for payments, but you can use Ether to automate any number of processes using smart contracts.

While many use cases for Ethereum are still at the proof-of-concept stage, it is now attracting the attention of major banks, businesses and governments, all interested in the potential of the technology to provide greater efficiency and transparency in transactions. That normalisation has collapsed the implicit risk premium attached to this technology.

Venture capitalist Albert Wenger describes the current activity in crypto-currencies and assets as “fat protocol investing”. To explain what this is, take the example of the underlying internet and web protocols (TCPI/IP and HTTP), used to build and run websites. These are not able to store value – therefore they are “thin protocols” in Wenger’s terminology. So instead, people invest in companies that make software (applications) and hardware that rely on these protocols.

Companies such as Google and Facebook made a fortune by collecting and storing data generated by users through their online interactions. Meanwhile, users, and the developers who created internet and web protocol, received nothing in return. Blockchain is a “fat protocol” because it can be monetised, including incentives for developers but also for users. For example, the creator of JavaScript and co-founder of Mozilla Brendan Eich, recently released an Ethereum-based web browser through which users can be paid for the attention they give to advertisements.

What is making crypto-assets and currencies appear bubbly is the way in which many of these new platforms and applications have raised money through what are called initial coin offerings. An initial coin offering (a word play on ‘initial public offering’) is a mechanism by which developers sell the tokens associated with their platform to the public. Depending on the structure of the offering, buyers can usually then trade the tokens, creating secondary markets. As the founder of Ethereum, Vitalik Buterin, has noted, no-one has figured out the right model for these offerings.

This could be due to the immaturity of the Ethereum platform and ecosystem (which started development in 2013 and went live only in 2015). What we’re observing here is a new economic infrastructure being built and coming online. In tweets on Tuesday, Buterin distanced himself from initial coin offerings, stating he would no longer agree to be an advisor.

So while the current speculation in crypto-assets should make us pause, this is not speculative like tulips, or gold mining stocks. It is speculative like building a new city, in that infrastructure needs to be developed first before you get to see who moves there.

A further point to note is that investment bubbles are actually useful and important mechanisms for building new technologies because of the way they concentrate speculative resources on a new technology to facilitate exploration.

There is an enormous effort proceeding to building new crypto businesses and infrastructure on the Ethereum platform. If this platform does indeed begin to carry large parts of the global economy as predicted by Deloitte, a business consultancy, then it’s still massively undervalued.

These comments should not be construed as offering personal financial advice.

Authors: Jason Potts, Professor of Economics, RMIT University; Ellie Rennie, Principal Research Fellow, RMIT University

Australia is facing an interest rates dilemma

From The Conversation.

This week the US Federal Reserve, as expected, raised its benchmark interest rate by 25 basis points, to a range of 1-1.25%. This was the third such hike in the last six months.

Fed Chair Janet Yellen said:

Our decision reflects the progress the economy has made and is expected to make.

Yet not everyone was so jazzed about the decision. In a terrific piece former US Treasury Secretary Larry Summers articulated “5 reasons why the Fed may be making a mistake”.

And whether the Fed view or the Summers view is the better one has tremendously important implications for what the Reserve Bank should do here in Australia.

The nub of Summers’s concern revolves around the implicit model of the economy that the Fed is using – and whether it still works in the economic world in which we find ourselves.

The general worry with keeping rates too low, for too long, is that inflation will take off. In the past, policymakers have worried – with good reason – that waiting to raise rates until inflation starts rising much is dangerous because it can get out of control.

If one is not going to wait to see what happens to inflation, then one needs a way to predict the path of it. The traditional approach that policymakers have taken is to look at the relationship between unemployment and inflation – the so-called Phillips Curve – and predict future inflation based on unemployment.

Summers prefers what he calls the “shoot only when you see the whites of the eyes of inflation” paradigm. This – as the imagery suggests – involves waiting until the last possible point before raising rates. In other words, be really sure that the inflation is happening.

This makes sense if the old model is broken, and Summers makes a persuasive case that it is.

First, he points out that the Phillips Curve (the allegedly stable relationship) may not even exist. And even if it did, scholars have pointed out that it would be very hard to estimate statistically the Goldilocks point where unemployment is such that the rate of inflation is stable (the so-called Non-Accelerating Inflation Rate of Unemployment or NAIRU).

Second, Summers offers a different model of the world – at least in part. That model is one where advanced economies – like the US and Australia – are suffering from “secular stagnation”.

According to Summers, the implication for monetary policy of this are as follows:

there is good reason to believe that a given level of rates is much less expansionary than it used to be given the structural forces operating to raise saving propensities and reduce investment propensities.

I am not sure that a 2 percent funds rate is especially expansionary in the current environment.

Moreover, he sees asymmetric risk with getting it wrong, going on to say:

And I am confident that if the Fed errs and tips the economy into recession the consequences will be very serious given that the zero lower bound on interest rates or perhaps a slightly negative rate will not allow the normal countercyclical response.

Maybe the combination of a fire hose of global savings chasing too few productive investment opportunities has changed what level of interest rate can provide a serious boost to economic activity.

Which bring us to Australia. We, too, have relatively low unemployment by historical standards (the ABS just announced a drop in May to 5.5%), yet wage growth is remarkably low. Those two things happening together suggests that our old understanding of the labour market is off the mark. That low wage growth is a major driver of the low inflation we are also experiencing.

If Summers is right, and there isn’t some big point of difference between Australia and the US in this regard, then the unmistakable implication is that the RBA should probably cut rates – perhaps twice – later this year.

But there is that whole housing price thing in Australia. A rate cut could fuel further price rises which, as bad as that is for affordability, is also deeply problematic for financial stability.

Yet, if the Australian economy really does need a rate cut, and governor Philip Lowe holds steady because of housing price fears, then that could trigger a further slowing of GDP growth, put wages under even more pressure, and trigger a recession itself. And that would be bad news for financial stability, too.

Let’s see how the RBA handles that Gordian Knot.

The problems with asking banks to police financial abuse

From The Conversation.

The Australian Law Reform Commission wants to give banks the responsibility to protect vulnerable customers from financial abuse. But there are a number of issues with this approach. Its success depends on the good faith of the banks, and could leave some customers uncovered and the banks with no one to report abuse to.

In a new report on elder abuse, the commission recommends that the Code of Banking Practice be amended so that banks take “reasonable steps” to prevent financial abuse.

But the code is voluntary and some banks have been lax in the past, meaning some customers won’t be covered. “Reasonable steps” still needs to be defined, to ensure all banks meet a standard. And we need transparency to know what financial abuse banks are dealing with, how and when.

Around 9% of older people living in the community are financially abused. It is likely the number is even higher among those with cognitive impairment or who live in institutions. Financial exploitation of older people is increasing and mostly perpetrated by those close to the victim, including family members.

The amendments to the code will include measures such as enhanced staff training to recognise elder financial abuse, an obligation to report suspected abuse, and recommendations to tackle the problem of forced guarantees for mortgages and other loans to relatives.

Can the banks protect vulnerable people?

Elder financial abuse is difficult to detect. However, banks and financial institutions are in a unique position to see it. Banks have face-to-face contact with customers, play a role in providing third-party authorisations, monitor electronic transactions and oversee lending.

But the Code of Banking Practice is voluntary, and many in the industry are not signed on. This could lead to troubling gaps in coverage. Institutions that do not sign up to the code will be under no obligation at all.

Although some have imposed protocols to address elder financial abuse, a recent interview with Kirsty Mackie, chairwoman of the Elder Abuse Committee of the Queensland Law Society, noted that training of front-line banking staff, collaboration between institutions, understanding of the bank’s legal position, and preparedness to act in the customer’s best interest were all lacking.

The commission also settled on a standard that requires banks to take “reasonable steps” to prevent financial abuse, despite Legal Aid NSW recommending that a higher standard be adopted. The proposed alternative was to require banks to “take all steps” to prevent financial abuse.

A standard based on what is “reasonable” is problematic as context matters; what one bank may regard as a reasonable response to suspicions of elder abuse may differ from what a court or the general public thinks.

In the United States, some states impose mandatory reporting of elder financial abuse, but Australia looks set to make reporting voluntary. This leads on to the issue of transparency.

We need to know under what circumstances banks will keep matters “in house”, to decide if these are appropriate. Criteria for reporting suspected financial abuse need to be established, as well as a body to report to. The commission has recommended the implementation of an adult guardian to which complaints could be referred. All these issues remain unclear and will require more discussion.

A related concern is the potential ramifications for people who make reports. In Australia, whistle-blower protection remains inadequate. Indeed, the Australian Banking Association submission to the Australian Law Reform Commission suggested that immunity be granted to banks that report instances of elder financial abuse.

Finally, given that banks will deal internally with most instances of elder financial abuse, it is important that we ensure the bank’s response balances the autonomy of older people while addressing elder financial abuse.

Where to from here?

The commission recommendation is welcome and will bolster the safeguards already in place. More discussion will be needed in the aftermath of the inquiry to ensure the recommendations are implemented and their potential realised.

The reality is that success will rest largely on the good faith of the banks. There must be willingness to build a collaborative and consistent approach to acting on elder financial abuse and to ensure rigorous internal procedures are put in place and followed. Employees who make reports of elder abuse must also have adequate protection.

This, in turn, must feed into an appropriately resourced entity where the most serious matters can be directed.

Author: Eileen Webb, Associate Professor, Curtin Law School, Curtin University

A better alternative to levying the bank tax

From The Conversation.

In all the noise and fury surrounding the bank tax, a more effective alternative proposal to implementing it has apparently been forgotten. In 2015 South Australian Premier Jay Weatherill proposed that banking should be subject to the GST.

This idea had much sounder economic underpinnings than the current levy, would have raised much more revenue (maybe three to four times), and would have applied to all banks rather than just the big banks. Of course, that last feature would have united the banks in opposition, in contrast to the current divide and (hopefully) conquer approach of Treasurer Morrison.

Unlike other industries, the traditional business of bank deposit taking and lending is exempt from GST. This creates economic distortions and omits a large part of the economy from being taxed.

The omission of banking from the GST is a product of history, because applying it to the banks was seen as too complicated. The reason lies in the nature of the GST as a “value added” tax.

Essentially the 10% tax is added to the sales price of an output good or service, but the seller obtains a GST credit for the tax component of the price of input goods they have bought. The historical view was that it is difficult to identify what are banking sector inputs and outputs, and thus value added.

Is providing a deposit account an input (in making loans) or an output in its own right? And there is generally no explicit fee charged for the service of intermediation between depositors and borrowers, with bank costs and profits covered by the interest rate spread.

The argument that its too complicated is no longer a sufficient justification. At one level the aggregate “value added” by a bank is easy to estimate. It’s the sum of profits and wages. The size of the profits and wage bills of the banks by itself indicates the potential tax revenue foregone and potential economic distortions caused by favourable tax treatment of banking services.

At the product level, while banks receive input tax credits on purchased inputs they do not add a GST cost to the price of deposit or loan products and services. Introducing GST would mean that banks would need to add the tax on their value added to prices charged (directly or implicitly via changes to interest rates) but would be able to utilise the GST credits they currently get on purchased inputs.

The historical complication was determining how much of aggregate value added and various input costs to allocate to each product. How should the cost of bank premises or teller time be allocated between individual deposit and loan customers?
That is a difficult problem. But banking systems of activity based costing, product and divisional profitability have evolved to enable an application of the GST. It might be an imperfect application, but that is arguably a lot better than none at all.

Exempting traditional banking services from GST is a significant cost to tax revenue. But it also creates economic distortions.

One, at an aggregate level, is that banking services get a tax advantage over other forms of economic activity – perhaps helping to partially explain why the financial sector has grown as a share of total GDP.

Another distortion lies in effects on different types of customers. Yes, application of GST to banks would raise the cost of banking services to all customers – since it is unrealistic to expect that this tax, even though effectively levied on bank profits plus wages and salaries, would not be passed on.

But it would mean that business customers would get GST input tax credits on their purchases of banking services to offset against the GST bill on their sales. Households, as consumers would not get that benefit, reducing tax induced distortions to their use of banking services relative to alternative expenditures.

The detail of the GST (including federal – state revenue sharing implications) is a mystery to most people, so it’s easy for counter-arguments to be produced to obfuscate and obstruct the proposal to apply it to banking. But it has merit and warrants serious consideration.

It’s highly unlikely that Treasurer Morrison will want to deal with the fall-out from adding a bank GST impost on top of the “big bank tax”. But perhaps, placing a sunset clause on that and using the lead time to develop a coherent plan for applying GST to banks is worth considering.

Author: Kevin Davis, Research Director of Australian Centre for FInancial Studies and Professor of Finance at Melbourne and Monash Universities, Australian Centre for Financial Studies

Growth Slowed in the March Quarter to 0.3 per cent

Data from the Australian Bureau of Statistics (ABS) shows the pace of growth of the Australian economy slowed in the March quarter to 0.3 per cent in seasonally adjusted chain volume terms. Through the year, GDP grew 1.7 per cent.

Investment in new housing fell by 4.4 per cent in the March Quarter 2017 which brings the sector down from record high investment in December 2016 and back to levels similar to those experienced at the start of 2016.

As Saul Estlake noted in The Conversation today:

It’s now been 103 quarters (25 years and 9 months) since Australia last had consecutive quarters of negative growth in real gross domestic product (GDP), in the March and June quarters of 1991.

Contrary to much-repeated claims, the Netherlands didn’t experience more than a quarter-century of economic growth without consecutive quarters of negative real GDP growth between the early 1980s and the global financial crisis.

The Netherlands’ real GDP declined by 0.3% in the June quarter of 2003, and by 0.01% in the September quarter of that year, according to data published by Statistics Netherlands and, separately, by the OECD. So, at best, the Netherlands went for only 22 years without experiencing a recession. Australia surpassed that benchmark in 2013.

Yes, that second quarterly decline in 2003 was almost imperceptible. But sporting records are delineated by margins as small as one one-hundredth of a second, so we can’t blithely discount a -0.01% fall in real GDP as “not relevant”.

Even if you blinked and missed that tiny second successive decline in real GDP in the September quarter of 2003, the Netherlands still wouldn’t hold the record for the longest run of continuous economic growth. That belongs to Japan – which, according to OECD data, went from the March quarter of 1960 to the March quarter of 1993 without ever registering two or more consecutive quarters of negative growth in real GDP. That’s 133 quarters, or more than 33 years.

Indeed, if Japanese GDP data were available on a quarterly basis earlier than 1960 it’s likely that this run of continuous economic growth would have been even longer, perhaps as long as 38 years, inferring from annual data available back to 1955. So Australia would need to avoid consecutive quarters of negative real GDP growth until at least 2024 if it is truly to be able to claim this “world record” as its own.

Even more importantly, the definition of a technical recession as (two or more consecutive quarters of negative growth in real GDP) is, as former RBA Governor Glenn Stevens said, “not very useful”. It was originally proposed in December 1974 by Julius Shishkin, who at that time was the head of the Economic Research and Analysis Division of the US Census Bureau (now the Bureau of Economic Analysis, which publishes the US national accounts).

It’s not used to identify recessions in the US. It takes no account of differences over time, or as between countries, in the rates of growth of either population or productivity – which are the key determinants of whether a given rate of economic growth is sufficient to prevent a sharp rise in unemployment. This is something which most people (other than economists) would use to delineate a recession.

While Australia has avoided consecutive quarterly contractions in real GDP since the first half of 1991, we’ve had two periods of consecutive quarterly declines in real per capita GDP (in 2000 and 2006). We’ve also had two periods of consecutive quarterly declines in real gross domestic income or GDI, which takes account of income gains or losses accruing from movements in Australia’s terms of trade (in 2008-09, and in 2014). Perhaps most meaningfully of all, Australia has had two episodes where the unemployment rate has risen by one percentage point or more in 12 months or less (in 2001 and 2009).

That’s still a better track record than almost any other advanced economy during the past quarter-century or so – and it reflects well on the quality of economic management (and the nature of our luck) over this period. Nonetheless, we shouldn’t be in the business of awarding ourselves prizes to which we’re not entitled.

And the long term trend also highlights a slowing, so we need new growth engines if we are to keep the growth ball in the air!

Growth was recorded across the economy with 17 out of 20 industries growing during the quarter. Strong growth was observed within the service industries including Finance and Insurance Services, Wholesale Trade, and Health Care and Social Assistance.

Agriculture, Forestry and Fishing decreased after strong growth in the previous two quarters, while Manufacturing decreased for the tenth time in eleven quarters.

Chief Economist for the ABS, Bruce Hockman said; “This broad-based growth was tempered by falls in exports and dwelling investment. Dwelling investment declined in all states, except Victoria, and overall is the largest decline for Australia since June 2009.”

Compensation of employees (COE) increased 1.0 per cent in the March quarter, a pick up from the negative growth recorded in the December quarter, and is consistent with other labour market data. COE is still only 1.5 per cent higher through the year, continuing to contribute to the reduction in the household saving rate. The household saving ratio fell to 4.7 in the March quarter, half the rate it was in March quarter 2013.

Mr Hockman said; “Even though there was a fall in dwelling investment this quarter, levels are still historically high. There was also positive growth in household consumption, albeit in non-discretionary items such as electricity and fuel purchases. The softer growth in household consumption is broadly in line with modest income growth.”

Does Labors $22 Billion Gonski Add Up?

From The Conversation.

School education funding is once again front and centre of Australian politics. Despite historic bipartisan agreement on the concept of needs-based funding, Labor is throwing Gonski 2.0 back in the Coalition’s face.

Labor, backed up by the Australian Education Union, insists that nothing less than “the full Gonski” is worth contemplating. Further, they claim that this requires an extra A$22 billion over the next decade.

Surely more money is a good thing?

Not so fast. Money can’t be spent twice, so funds must be directed where they will have the most impact. Thus, we must analyse why Labor’s plan is so much more expensive than the Coalition’s. Each component can then be considered on its merits.

To save you the trouble, I crunched the numbers. My estimates are necessarily rough, given that the different components cannot always be cleanly separated. But the overall picture is clear. Most of Labor’s extra $22 billion is not directed according to student need, and would have little impact on outcomes.

Over-funded schools – $2 billion wasted

Every school has a target level of government funding, called its Schooling Resource Standard (SRS). Under Labor’s plan, the combined Commonwealth and state funding for nearly all schools would reach at least 95% of target by 2019. (A side deal means that Victorian government schools would get there in 2021).

But about 1% of schools already receive well more than their target, costing about $200 million each year. Under Labor’s model, these schools would get funding increases of 3%, per student, per year.

Separately, Australian Capital Territory (ACT) Catholic schools are over-funded to the tune of about $45 million a year, courtesy of a special deal that treats them as comparable to Catholic schools across the nation, despite the fact that they are considerably more advantaged.

Added together, over-funding schools wastes roughly $2-2.5 billion over a decade.

Indexation is too high – another $2 billion

Every year, per-student costs go up, largely driven by teacher wages. To account for this, both Labor’s plan and Gonski 2.0 include annual indexation of the SRS target.

The problem with Labor’s plan is that the indexation rate was fixed at 3.6% in the 2013 Education Act. As Grattan Institute’s Circuit Breaker report shows, this rate is now too high given historically low wages growth.

Gonski 2.0 removes the fixed indexation rate in 2021, replacing it with a floating indexation rate that is more in line with school costs.

Compared to this, Labor’s plan costs $2-2.5 billion more over a decade. This is enough to hurt government budgets, but the extra money is spread so thinly that it would have minimal impact on student outcomes.

Better than both parties’ approaches is to apply the floating indexation rate from 2018 or 2019. This would save billions, which could be used to fully fund schools more quickly.

Sweetheart deals waste at least $2 billion

Parents who send their kids to non-government schools are expected to pay school fees. Parental capacity to contribute is estimated based on where they live.

Under the current legislation, however, all schools within an education system (for example, Catholic, Anglican or Lutheran schools) are rated as having the same capacity to contribute. This means – for the purposes of calculation – that the parents are treated equally, whether they live in Toorak or Toowoomba.

This “system-weighted average” costs the Commonwealth about $300 million per year. A related quirk in the calculation of capacity to contribute for primary schools adds another $200 million per year.

The main beneficiaries are Catholic primary schools in affluent neighbourhoods, which use the funds to keep their fees artificially low.

Gonski 2.0 removes these sweetheart deals; Labor, which put them in there in the first place, would keep them.

Catholic school leaders say these features are needed to compensate for flaws in the SES score, and the formula does need to be reviewed. But even if they are half right, Labor is wasting about $2 billion over a decade.

Labor’s cash splash puts about $2 billion at risk

Labor back-ended its Gonski funding so heavily that some disadvantaged schools would get huge funding increases in 2018 and 2019.

But much of this money will be wasted if schools chase the same limited pool of resources – speech therapists, instructional leaders etc – without the market having time to adjust.

Delaying by just two years, to 2021, would save about $2 billion, and give schools time to plan how to get the most out of the extra cash.

By contrast, however, the Coalition’s 2027 target is too far away. If Labor wants to invest the extra $7 billion needed to deliver Gonski 2.0 in four years rather than ten, that would be a solid policy argument. Even then, nearly half of this amount could be funded by moving to a floating indexation rate two years sooner.

Commonwealth generosity is a two-edged sword

The last component of Labor’s high-cost model is more subtle. Back in 2013, federal Labor offered to pick up the lion’s share of whatever money was needed to get schools to their target.

This generous approach has perverse impacts. Western Australia, which funds its government schools well, gets nothing extra from the Commonwealth. Victoria, which does not, gets rewarded.

By 2027, these differences are stark. Victoria would get a two-thirds boost in its Commonwealth funding (on top of enrolments and indexation), such that its students get 28% of their SRS target from Canberra. WA students are left languishing at a paltry 13%. These huge differences are not driven by student need, but by discrepancies in state funding.

Commonwealth government funding as a proportion of SRS, by state, government schools, if Commonwealth picks up 65% of the needs-based funding gap in each state. Source: Grattan school funding model, based on analysis of data from the Commonwealth Department of Education and Training

Removing this inequity is a central element of Gonski 2.0: once fully implemented, all government schools will get 20% of their target from the Commonwealth, and all non-government schools 80%.

Labor’s model adds about $8 billion to the Commonwealth’s tab over a decade, money that should be stumped up by states.

Where to from here?

If Labor believes Australian schools need $22 billion more than the Coalition is offering, ambit claims won’t cut it. It must explain how its additional funding will benefit students. And soon.

Author: Peter Goss, School Education Program Director, Grattan Institute

The government will likely get more from the bank levy

From The Conversation.

In this year’s budget papers, Treasury estimated that the bank levy will collect about A$1.5 billion in each of the next four years for the government. But this is actually a conservative estimate.

Labor has argued there will be a A$2 billion dollar hole in the bank tax revenue. This is based on the disclosure to the ASX of four of the five affected banks, on what they will likely pay government.

But the banks’ numbers assume there won’t be change to any decisions in response to the bank levy. Research shows this is highly unlikely, as bank customers have worn the cost for bank taxes like this, imposed after the global financial crisis in the UK.

In fact, if the economy keeps growing as many have predicted, and banks grow too, then the amount of revenue the government collects from the levy may even be bigger than Treasury estimates.

What we know about the bank levy

When it comes to what revenue the government can get from the bank levy, both the taxable sum, and the tax rate applied, determine what gets collected.

The budget papers specify the taxable sum as including “items such as corporate bonds, commercial paper, certificates of deposit, and Tier 2 capital instruments” but not “Tier 1 capital and deposits of individuals, businesses and other entities protected by the Financial Claims Scheme”. The bank levy will be an annualised rate of 0.06%, applicable for all licensed entity liabilities of at least A$100 billion from July 1, 2017. Small banks and foreign banks are exempt.

Although it is possible the bank levy would not be a deductible expense in calculating corporate income, precedent and statements by government indicate the levy will be deductible. Special taxes on the mining industry (including royalties and the petroleum resource rent tax), state payroll, land taxes, stamp duties and indirect taxes such as petroleum excise are all deductions in the calculation of taxable corporate income.

Errors in the assumptions about banks

Labor and banks also assume that the bank levy is a deduction in assessing corporate income. The preliminary data made public by four of the five affected banks indicates the gross revenue gain of the bank levy, less the reduction in corporate tax, will be less than the budget numbers.

That is, the net revenue reflects a 0.042% levy rather than the 0.06% rate. This also assumes shareholders will bear all of the net additional taxation.

But it also assumes the banks will not change any decisions. This is both a simplistic and an unlikely scenario.

In essence, the bank levy is a selective indirect tax on one of the inputs used by the large banks to provide financial services to their customers.

A more likely scenario is that the banks will seek to, and succeed in, passing forward most of the new indirect tax to their customers as a combination of higher interest rates and fees. From past experience, banks pass forward higher Reserve Bank of Australia (RBA) interest rates, just as they pass forward lower rates.

Given that the affected five banks account for over 80% of the market, together with the reluctance of most Australian business and household customers to switch banks, there is a high probability that most of the levy will be passed forward as higher bank interest rates and fees.

Should the banks pass forward most of the levy to their customers, the increase in bank revenue will match the increase of bank costs caused by the levy. That is, taxable corporate income will remain about the same. Then, the overall government revenue gain is given by the gross 0.06% bank levy.

The bank levy could even collect more

If the output and incomes of the five banks to pay the levy expand over the next four years, then we would expect additional revenue to be collected by government to increase over time. The budget papers, the RBA, international agencies and private sector economists all forecast economic growth. It’s unlikely that the big five banks would not also experience economic growth.

So the budget paper forecast that the bank levy revenue collection of about A$1.5 billion a year for each of the next four years, has to be on the conservative side.

The revenue estimates for the levy are forecasts or projections compiled in a world of uncertainty. So a lot is still up for debate, including not only the design of the levy but the future path of the economy in general and for the large banks in particular.

Details and assumptions underlying government estimates of the revenue from the bank levy are unclear. It would be an unusual precedent not to allow the levy to be a deduction in calculating corporate income tax, and so reducing the net revenue gain. But the implicit assumption of the bank released numbers of no decision changes by the banks is unrealistic.

If banks, as businesses in general, pass forward to customers much of an input tax, a large part of the first-round fall in corporate income, is offset by higher revenue. Government forward estimates of additional government tax revenue collected by the levy likely are on the conservative side.

Author: John Freebairn, Professor, Department of Economics, University of Melbourne

Investors are exploiting returns on debt financing to muscle out home buyers

From The Conversation.

Investors have played an increasingly important role in the Australian housing market in recent years. Our new research shows the actual return rate for housing investors almost doubled a layman’s expectation. Experienced investors are taking advantage of the knowledge gap and might continue to price out other housing buyers.

The sharp increase in investor credit in recent years could be partly attributed to the strong growth of housing prices, particularly in Sydney and Melbourne. However, the reported capital gains might not have fully reflected investors’ actual returns as the impact of debt financing in property investment has been neglected.

Since housing investors typically use large amounts of debt to fund their investment, using the return on equity (after adjusting for debt financing) more accurately reflects their actual return.

In recent years, regulators such as the Australian Prudential Regulation Authority and lenders have implemented measures to moderate the growth of investor lending. Despite these efforts, investors have come back into the housing market since the second half of 2016.

Proportion of housing investment loans

ABS, Housing Finance, Australia: February 2017

Higher returns come with greater risk

Our research sampled properties in 14 suburbs across Sydney, using the Property Investors Alliance database. The results provide some empirical evidence to demonstrate the housing return on equity with debt financing is significantly higher, at an annual return of nearly 14% per year, than the housing return on property without debt financing of about 7% per year.

This could explain the increasing proportion of investment loans in the housing market. The knowledge of investors’ advantage should also be used to inform the ongoing debate about regulating investment housing loans to enhance housing affordability for first home buyers in particular.

It is important to highlight the effect of debt financing on decisions to invest in housing. The results clearly show the enhanced returns are likely to have an acute impact.

At the same time, a higher risk level as a result of the use of debt financing has also been documented. This highlights that housing investors should closely manage their exposure to financial risk from using debt financing by using a prudential risk-management tool.

Returns and risk on housing portfolios: 2009-2015

Author provided

Explaining the increased rate of return

We used an assumption of 20% equity to demonstrate the impact of debt financing, which is in line with the current deposit requirement from major banks. Here’s an example to demonstrate the effect of debt financing.

Say an investor buys a house for A$1 million. The investor provides a 20% deposit ($200,000); therefore $800,000 was borrowed. The investor took an “interest-only” loan with an interest rate of 5% per year – so the interest cost is $40,000 per year. The investor also receives a net rental income of $30,000 in Year 1.

A year later, the investor decides to sell the property for $1.1 million (its value having increased by 10% over the year). The traditional performance analysis of property (without debt financing) would show the return on this housing investment is 13%: ($1,100,000-1,000,000+$30,000)/$1,000,000 = 13%.

Given the housing investor used debt financing, 13% is not the actual return for the investor. The investor’s actual return on equity for the investor is 45%: ($300,000-$200,000)+($30,000-$40,000)/$200,000 = 45%.

Property returns vs equity returns

Author provided

Experienced investors exploit their advantage

Overall, the results suggest the actual return rate for housing investors is significantly higher than the layman might expect from the major housing index providers.

The documented returns may not be applicable, however, to owner occupiers who are also using debt financing, via mortgages, to buy their property. There are two main reasons for this:

  • owner occupiers mainly use their houses for their own residency purposes, so no rental income will be generated to offset the mortgage repayment; and
  • housing investors are able to sell their properties whenever they want to realise gains in value, while owner occupiers do not have that flexibility.

Importantly, experienced housing investors, in the current low interest rate environment, have realised the benefits of debt financing and taken advantage of the knowledge gap to exploit the higher returns available to them.

These findings also highlight the need for an innovative product to assist home buyers to enter the housing market.

Author: Chyi Lin Lee , Associate Professor of Property, Western Sydney University