End of Financial Year Wrap Up

HOUSING MARKET
All things considered, the Australian housing market looks ready to dive.  My conversations with real estate agents are the only ones they've been having - no buyers are willing to even make a call at the moment.  Home lending is down, prices are taking a u-turn, sales are down, and first home buyers are lost somewhere in the mist of winter mornings.

There has been some interesting analysis from Steve Keen lately, along with the more spruikung from renouned pro-housing, anti-commerical property, anti-shares, anti-all other investments, man on the spot Chris Joye.

My outlook – a surprise drop in home prices leading a significant decline in economic activity in Australia. The Reserve Bank will act promptly to reduce interest rates while pointing fingers to troubles abroad. Bulls will then promptly join the finger pointing, noting how exceptional strong Australia’s housing market has been and the supply shortages still threaten to create future unaffordable housing.

Aspirational home buyers should take a look at a true financial comparison of home ownership and renting before making any major decisions.

AUSSIE DOLLAR
The Australian dollar will not be safe.  Think September 2008 all over again.

BLOGOSPHERE
Two new blogs worthy of mention are Delusional Economics, where you will be enlightened by some straight talking no-nonsense commentary, and a special mention for the Unconventional Economist for some very high quality articles on the Australian property market.

REBOUND EFFECTS
My attitude on helmet law rebound effects has been seen as quite controversial. But for those interested this site articulates my position quite accurately. 

Experience shows helmets give only limited head protection. Studies in Australia show some prevention of superficial injuries (such as scalp lacerations) but only marginal prevention of “mild” head injuries and no effect on severe head injuries or death. When helmets were made compulsory in Australia, admissions from head injury fell by 15-20%, but the level of cycling fell by 35%.

To summarise, helmet laws led to a major decline in cycling.  Fewer cyclist on the road decreased awareness of them by drivers, leading to cycling in general becoming less safe.  Further, helmets themselves offer limited head protection in a limited number of crash circumstances - a helmet doesn't help much if you go over the handle bars and land on your face for example. And if you get hit by a truck (the classic pro-helmet argument) you are stuffed whatever you are wearing on your head.

THE LAST WORD
If the financial and economic circus of 2009/10 has been all too mauch, it might be time for a holoiday.  For those who take this advice but want to optimise their holiday time, have a read of this quality article.

Creating road space without building roads

This unreliable article suggests that each passenger trip on the QR passenger network is subsidised in the order of $9 – probably double the average fare price. How this figure was determined is anyone’s guess, but the issues surrounding such apparently high subsidies are interesting.

While at first the $9/trip figure may seem high, it is important to acknowledge that the benefits of subsidising public transport do not go solely to the users. Each time a person uses the rail network they are not using the road network (either car or bus trips) - thus simultaneously improving traffic conditions for road users. What looks like a rail subsidy could easily be classified as a road subsidy. The reduction in road usage has a similar effect to increasing road capacity.

Most public transport systems around the world are subsidised from the public purse. If you subscribe to the belief that a degree of government support is warranted due to external benefits for road users, the two key questions to consider are:
1. How much of a subsidy is acceptable?
2. How can incentives be provided to improve the efficiency of the whole transport network?

Some guidance on the first question could be gained by looking at a cross-country comparison; however the second question is far more interesting.

We can see examples of the failure to consider multiple types of transport as a single efficient solution to urban (and regional) mobility. The profitability of the Airtrain has been completely undermined by the expansive government subsidy of competing road networks. Had the government instead heavily subsidised the Airtrain link itself (to make ticket prices an attractive alternative to taxis and pickups), the demand for road space would have reduced as train use increased.

Further, the success of the rail network rests on the failure of its competition. We can never reach a situation where there is high public transport patronage while at the same time having cheap uncongested private automotive alternatives. These two networks are in competition and the direction of government assistance can tip the advantage either way it chooses.

The ignorance of this reality and the external benefits from new transport connections may be one reason that the traffic forecasting for Brisbane’s major road projects grossly overstated traffic demand.

Using this case study we can make a couple of pertinent observations:
1. New transport connections provide internal benefits to users, as well as benefits to users of competing transport connections
2. Subsidies to incentivise rail use can provide the net effect of increasing road capacity through road spending.

Is Australia the best place to raise children?

This HSBC report ranks Australia as the best place to raise children for expats. IN fact, the media release suggest that the Expatriate Survey reveals the expats ‘say Australia is the best place in the world to raise children’. What it doesn’t do is justify that claim.

The report is based on a sample of 30 respondents from each country and they are asked to compare the various factors about raising children, such as child care costs, amount of junk food eaten, and time spent playing outdoors, with what occurred in their home country.

This may be interesting, but it is no way to rank a country’s performance. Without knowing the country of origin of the expats it is impossible to make a controlled comparison. For example, if the majority of expats in the sample living in Australia are from the UK, and the majority of expats living in the US are from Australia, we get a nonsense conclusion that Australia is the best country (because the difference between the UK and Australia is highest), even if the US is ranked in preference to Australia.

The rankings are the result of the difference between the country of origin and the new country without knowing the country of origin. The way to be highest ranked is to have the most expats from much poorer countries so that the positive change experienced is greatest.

Don’t misunderstand me. Australia probably is one of the better countries to raise children and could easily be the ‘best’ out of the comparison countries (UK, US, Singapore, UAE, Hong Kong). But this report is a classic example of how conclusions do not match the facts presented.

You don’t have to look far to find other cross-country comparisons of family well-being with utterly unsurprising results.

Negative Gearing Exposed

By far the best analysis of the impact of negative gearing on the residential property market is found here.  The myths that negative gearing increases the supply of rental accommodation and keeps rents down are exposed, and some quality suggestions for improving housing affordability are made.  Highly recommended.

The Proximity and Lateness Rebound Effect

I have a habit of labelling any unintended consequence that works in the opposite way to the intended consequence as a rebound effect. With this in mind, I hereby declare the discovery of the Proximity and Lateness Rebound Effect.

The discovery is not mine of course, but the name is. I learnt of this bizarre social phenomenon here.

The Proximity and Lateness Rebound Effect (I would appreciate any better name suggestions) describes the offsetting behaviour of people to commuting distances. One would initially think that moving closer to their workplace, their relatives, friends or other regular destinations would reduce lateness, but in fact the opposite effect can potentially occur – as your commute decreases your lateness increases (in frequency - you are late more often).

Here’s my proposed theory as to why this may occur.

First, 100% punctuality is surely suboptimal.  Because each trip has a degree of uncertainty, if we budgeted for perfect punctuality we would have to allow for a commuting time under the worst circumstances every time.  We would be far too early most of the time just to ensure that we weren't once a minute late.

Now suppose that being a little late is not a big problem, but being quite late is a serious problem. We might say that we want to be less than 10 minutes late 70% of the time, and less than 20 minutes late 95% of the time.

If your commute is typically 50mins, but traffic congestion and delays mean that the trip takes less than 70mins 95% of the time, less than 60mins 70% of the time, and less than 50mins 50% of the time, you can budget for a 50 minute commute and meet your lateness expectations. You will be on time 50% of the time, more than 10mins late 30% of the time and more than 20mins late a mere 5%.

If instead your commute is a mere 10mins on average, with only a very small variation in time (say less than 2 minutes), and you budget 10mins for your commute you will far exceed your lateness requirement. Therefore you may start allowing less and less commuting time to get to your destination, and soon become accustomed to regularly being a little late, but never very late.

Because of the difference in trip variation, the person with the long commute needs to be more cautious to avoid being exceptionally late. Doing so increases the frequency that they arrive early. On the other hand, those with short commuting distances have very little chance of being extremely late, and therefore need to pay little attention to factoring in their commuting time and may regularly be a little late.

My personal experience of moving closer to work is just this. I almost treat the 10 minute commute as negligible, and am typically a little late to everything. Previously, when the commute was about 30 minutes I would ensure that I had budgeted enough travel time, with a little room for delays.

What is German economic culture?

This interesting post by American economist Tyler Cowen, who I believe now lives in Berlin, delves into some differences in the economic principles embedded in the minds of Germans and German policy makers in contrast to their American counterparts (and Australian I would suggest). He believes there are a number of consistent views held by German policy makers which put Germany in the running for the ‘best country award’:

1. It is the long run which matters and we should be obsessed with the long run consequences of our choices.
2. Economic growth comes from high productivity, most of all in quality manufacturing.
3. Borrowing to finance consumption is a nicht-nicht. Savings is all-important.
4. If we need to make a big change, we'll all grit our teeth and do it. For instance Germany has done a good deal, on the real side, to restore its export competitiveness in the last ten years, not to mention unification and postwar recovery.
5. These strictures should be enforced by rigorous rules, to limit temptation, because indeed you will find cases where it appears to make sense to break the rules.
6. Values matter, as do norms of cooperation.
7. Don't obsess over the creation of too many low-wage jobs, because in the longer run it will be bad for your cultural capital. If need be, pay people to be unemployed, but hold high human capital. In the longer run, try to educate them up to higher productivity and thus employment.
8. Be obsessed with self-improvement, most of all at the personal level.

Regular readers may note that I hold many of these views. Last week I noted that minimum wage laws may not be great in the short run for job creation, but in the long run the may be - showing my belief in points 1 and 7. Also, I have raised the long term focus of German capital gains tax rules on property, which are charged at the highest tax rate unless the property is held for more than ten years.

Point 2, that economic growth comes from high productivity, is another point I have tried to make during discussions of population growth, the productivity of housing investment, and the overstated benefits of the mining boom.

I also agree that values and social norms matter (point 6), as I have suggested when discussing work and leisure, and cycling culture.

In my experience however, German rules and laws can appear overly intrusive for the uninitiated (point 5). But for one to aspire to these principles, rules do need to be made to ensure that individuals’ short term gratification of does not override the long term prospects of the country as a whole. If you believe people are perfectly rational and fully informed, your inner libertarian may have a problem with this – who is to say that I cannot rationally make decisions about the future for myself and why would the government be any better at it than me?

Clearly I believe the points observed by Cowen are key factors to the long run prosperity of any country. But I would appreciate any insights into whether this is truly representative of the German policy machine, and what the application of the principles means for people on a day to day basis

The Big Short: Inside the Doomsday Machine

Lewis's book provides a fascinating insight into the minds and mischief of the characters shorting the sub-prime mortgage market during the US real estate bust and general GFC calamity.

I found the unintentional insights into herd behaviour eye opening. The players shorting the market almost couldn’t believe that the price to insure sub-prime mortgage backed securities was so low when by their analysis, they carried so much risk. They spent an achingly long time trying to figure out if there was some critical piece of information missing from their analysis. If there was, it might explain the apparently irrational behaviour of the counterparty to the bets.  But the more they searched, the more they realised that it was a simple matter of ignorance that kept the sub-prime security holders in the game.

It took a strong will to bet such grand sums against the markets, and for those behavioural economists looking for insights into our predictable irrationality this book offers a thorough exploration of the personality differences amongst the characters in this ill-fated market.

Minimum wage decision and the textbook response

Economists like to promote the idea that increasing the minimum wage results in fewer jobs. The law of demand states that when the price of a good goes up, demand goes down. But a welfare State has a role not just to encourage people to work, but to improve overall welfare.

The job loss textbook response is only fair if we cling to the unreasonable ceteris paribus assumption – that minimum wage increases and all else stays constant. But that is not reality.

For example, offsetting effects of an increase in the minimum wage include

- people choosing to study instead of work
- businesses investing in capital equipment to improve labour productivity

Both of these indirect effects of the minimum wage are good for society’s welfare in the long run via increased productivity.

Apart from being a good long run policy, I see the minimum wage as a tool to control possible market power of employers. Uninformed and low skilled workers are easily vulnerable to manipulation, and are unlikely to access legal guidance or negotiate their wage with vigour. Not all people are fully informed, perfect knowledge homo economicus. Asymmetric information and the resulting market power of employers of low skilled workers are justifiable reasons for government intervention.

One needs to exercise extreme caution when applying economic principles to reality. Most mainstream economic theories are based on completely unreasonable assumptions (an upward sloping supply curve and an ignorance of time for example).

The Noble Lie?

In his book The Noble Lie: When Scientists Give the Right Answers for the Wrong Reasons, Gary Greenberg challenges conventional wisdom to suggest that many social vices have become labelled as diseases, without evidence, but for the betterment of society.  His book delves into the grey areas of science, politics and philosophy, conveying a line of reasoning that presents a picture of positive self-delusion on a grand scale.

This review summarises some of the challenging points in the book.

For instance, Greenberg explains how alcoholism's transition from vice to disease was a welcome one, especially following Prohibition. It was long viewed as an allergy, though the specific allergen persistently failed to appear. Even today, neither its disease-nature nor any possible cures have manifested themselves. Regardless, people are happy to accept the idea that addiction is a medical illness, perhaps, Greenberg suggests, because of our ambivalence towards the role of pleasure and our uncertainties about free will and self-determination. “With the disease model we have an answer,” he writes, “one that has the imprimatur of science; addiction isn't wrong, it's sick.”

In the absence of scientific proof that addiction is a disease, is it wrong for medical professionals to perpetuate the idea? Not necessarily, Greenberg says – there are times when what is scientifically wrong, or at least uncertain, is morally right. “There can be no doubt that the disease model has helped millions of people. If a made-up disease can be of such immense value, then we must consider the possibility that the truth is not what it's cracked up to be. Perhaps, in the republic of medicine, the fiction that addiction is a disease is a noble lie.”

Sometimes the noble lie works the other way round. In a chapter on homosexuality, Greenberg shows how humane concerns first led people to prefer a medical to a criminal definition, but conflict followed concerning the disrespect a medical definition implied toward what should perhaps be viewed as a free life choice. In 1973, following the Stonewall riots and the start of the gay rights movement, the American Psychiatric Association deleted homosexuality from the Diagnostic and Statistical Manual of Mental Disorders (DSM), a move decided not by scientific facts but by political and moral attitudes. “It may be the first time in history that a disease was eliminated by the stroke of a pen,” Greenberg writes.

Mining on a pedestal?

The proposed Resource Super Profits Tax (RSPT) has received both scathing criticism, and reserved admiration. Critics proclaim that the mining industry is almost a fundamental necessity, without which Australia would grind to a halt. Otherwise respected firms are making contradictory claims of social benefits, including increased wages, while also arguing that there is little impact on wage rates in other parts of the economy, and denying that other investments are being 'crowded out', as most capital is raised abroad. They indirectly state that foreigners are reaping the most benefit from Australia’s resources providing an intangibly small flow-on effect to other sectors of the Australian economy.

Such is the confusion about the true social and economic benefits from mining and the likely impact of the RSPT on Australia's welfare.

This type of confusion in the debate over the RSPT and its likely impact is widespread, possibly even within the government itself, which is still to make decisions on exactly how to implement the proposed tax. While I agree with the principle of the tax, which has the same theoretical basis as the Petroleum Resource Rent Tax, certainty of the details is required – particularly the rate at which the RSPT will begin to apply (currently 6%).

But one thing we can examine is the claim from miners that their industry brings great benefits to your average Australian. A recent report by David Richardson from the Australia Institute does just that and makes surprising conclusions:

The mining boom would have had a major stimulatory impact on the Australian economy but for two factors. First, the Gregory effect saw the exchange rate appreciate, which caused a contraction in the rest of the economy. Secondly, the Reserve Bank of Australia increased interest rates in an attempt to offset the stimulatory effects of the boom.

Anyone owning resource stocks would have benefited from the enormous paper gains, which peaked in May 2008 but had largely disappeared by the end of 2008. However, to the extent that the gains persisted, the benefits would have gone to the top 20 per cent of wealthy households where share ownership is concentrated.

Overall, it is hard to identify the benefits to ordinary Australians of the mining boom. The estimated nine per cent increase in real incomes from the terms-of-trade changes do not appear in the figures for wage earners or recipients of government income-support payments. It seems that the benefits of the boom barely went beyond the mining industry itself.

Further, in Ken Henry’s Senate testimony he claims that the mining industry is not a source of economic stability, but a highly speculative and cyclical business that did not contribute to Australia’s economic stability in recent years, having dropped 15% of their workforce in response to the financial crisis.

Just because mining is a large industry when compared in terms of dollars of investment, does not mean that it is more productive than other forms of investment. Only improvements in productivity lead to broad social gains.

We can plod along happily talking about number of people employed in mining, the dollars invested into mine projects, or any such figure, but unfortunately any number is rather meaningless without an alternative with which to compare.

One could be tempted to brag, for example, about the contribution their farm makes to the regional economy by stating how many people they employ, how much the invest in capital works, and how much food they produce. But if their next door neighbour employs more people, invests in more capital works, and produces more food per hectare, the first farmer is performing poorly and is a burden to the nations’ productivity.

The contribution of mining to Australia’s welfare is determined by its productivity gains, and simple investment numbers say nothing of the opportunity costs of labour, land and capital.

All comments/criticism welcome.

Interesting news

Developers using cows to reduce land tax burden.  One of the defining traits of rule makers is that they rarely foresee the extent of gaming likely to occur.  It seems Australian agricultural policies are not immune to the type of manipulation seen in Japan.

History repeats (must see video).  BP's deep water oil spill in the Gulf of Mexico is almost identical to a spill in 1979, where the same inneffective and oddly named 'solutions' were tried.  That spill lasted months and was only brought under control by drilling relief wells to take the pressure from the oil bed.

Melbourne Cycle Scheme up and crawling.
Users will have to bring their own helmets as they won’t be available for hire with the bikes. However, those joining the scheme will be issued with a free helmet, while hotels and other city outlets will have cheap helmets available for hire or purchase. (here)

A cycle by-pass is also proposed in Melbourne - a step in the right direction for urban transport planning.

A lesson on being sceptical about statistics in economics (warning: technical content)

Organic farming – a closer look.

Bakfiets – is Australia ready for the cargo bike revolution?

Recent discussions on cycling culture and the imminent arrival of our second child have resulted in an obsession with cargo bikes or Bakfiets (Dutch for boxbikes). These bikes are making their way to Australia, with various businesses now selling the contraptions (such as Good Concepts in West End, cargocycles.com.au, and more here).

I want one, exactly like in the photo above, but I don’t know why.

Economists generally believe people know how to make decisions that maximise their welfare. But in many cases we can’t know how much we will enjoy our consumption decisions in advance, since we have never experienced them before – such goods are known as experience goods.

Having already test-ridden one and been impressed, I am now attempting to evaluate the bike's worth by first itemising the pros and cons. Any assistance or insight or suggestions are appreciated.

Pros
Can handle a load of groceries plus children for short trips
Can pick up hitchhikers
No parking or fuel costs and only minimal maintenance
Fun

Cons
$1650 for the bike
$2450 if you want electric motor assistance
Plenty of hills in Brisbane
Not many safe streets to take this slow and slightly less manoeuvrable bike
Cannot jump off or up gutters if necessary (probably off but it won’t be pleasant
Extreme summer heat (could make a shade for the kids though)
Summer storms and bad weather in general

More importantly, to determine the value to our family of the bike I have been thinking in terms of marginal utility. Instead of thinking how good or practical the bike could be in isolation, I think in terms of how much better having the bike would be compared to our current situation.  And by this analysis, the cargo bike falls short.

Our family owns a car which this bike will not replace, nor will trips by cargo bike replace trips by car. So cost savings are not a selling point. However, even if car trips were being replaced by trips by cargo bike, the savings would be minimal since the marginal cost of a car trip is quite low.

Most of the cost of car transport is a cost of ownership – depreciation, registration and insurance etc – while only small costs can be attributed to extra kilometres. For example, it would cost our family about $3,000 to drive 4,000kms a year – or 75c/km on average. But if I reduced driving by 1,000km I would not save $750 because the registration, insurance and depreciation are somewhat fixed. I might only save 20c/km or less.

Replace a 5km car trip with cycling might only save $1 – a somewhat negligible amount in hilly terrain in the heat of a Brisbane summer with a family of four, especially given the likely time savings of driving.

Furthermore, our 2 year old can already walk to the grocery store, so it is simply a matter of taking the new baby in a stroller (which is also good for luggage) for that regular trip.

However, while the marginal benefits for our family do not yet warrant the cost, I do believe Australia is ready for the cargo bike revolution.

Drivers for change include urbanisation and young families losing the ‘must have a house to raise a family’ attitude, instead opting for well located apartments. If this group is forgoing a second car (they may not have a parking space anyway), and using a cargo bike for work, school and shopping trips, their may be significant benefits.

I want to leave you with a short story that demonstrates the difference between cycling culture in Australia and the Netherlands.

The two agents in the car look at me as if I have “Cops are Dicks” written in bold letters across my back and motion for me to stop and talk. They don’t get out of their car nor do they want to see my ID or anything official. The driver, obviously angry, leans over and asks some pointed, rhetorical question to the tune of “what the heck was that, asshole?!”. The female agent in the passenger’s seat is giving me that “Yeah, duhhhh!” look… though I was thinking approximately the same in reverse.

I’m no genius but I can put two and two together; It’s pretty obvious he’s referring to my riding through a red light a few meters back. A quick assessment of the situation suggests that admitting guilt and feigning embarrassment is my best approach. But the cop continues before I’ve had a chance to test my acting skills: “How do you think it makes us feel when you ride through red and everybody giggles and looks to see what we’ll do? You show no respect!” They don’t seem to have a problem with a cyclist breaking the law. The problem is that I did it in front of a police car. Oh, now how do I react? I can’t exactly say “Sorry officer, had I seen that you were there I wouldn’t have continued.” Likewise, admitting guilt to jumping a red light is a pointless since he’s already noted that it’s accepted.

A couple moments later they still hadn’t stepped out of their car so I figured they’d no intention of giving me a ticket or fine unless I did something stupid. I played it safe, sticking to “Yes, that was dumb of me.” and “I see your point… Understood.” Then they drove away, apparently satisfied that they’d made their point.