Thursday, May 27, 2010

On the QT: High School Economics and the Solution with no Name

This morning at the bright and early time of 7:50am, the Secretary of the Treasury Ken Henry, fronted Senate Estimates (the pdf Hansard file is here). In the two hours he answered questions he handed out some pretty big (but subtle) smacks to the critics of the RSPT. When asked about various responses to the RSPT he used wonderfully understated phrases like: “I don't want to say the miners are wrong...”, and when Barnaby Joyce said to him that oil drilling was different to mining for minerals he deadpanned: “It's amazing what one learns”. He also had to do a few “If by that you mean …” to try and give the Senators’ questions some sort of logic. ken2

He was at his best when he was talking about two topics – the first that the mining industry kept Australia out of the recession, and the second that the RSPT will increase prices.

He knocked the first one on the head pretty easily saying:

“I've heard it said on a number of occasions, in fact I have lost count, that the mining industry saved Australia from recession. These statements are not supported by the facts”.

He pointed out that employment in the mining industry during the Global Financial Crisis went down 15 percent. And made this rather scary pronouncement:

“Had every industry in Australia behaved in the same way our unemployment would have increased from 4.6 per cent to 19 per cent in six months.”

Sam Maiden noted in her excellent summary of Henry’s appearance that both Julie Bishop and Tony Abbott – ie our prospective PM and Deputy PM (don’t worry, you weren't the only one who just felt a chill run down your spine at that thought) – have recently made claims concerning the brilliance of the mining industry in saving Australia from recession. Here was Bishop on Sky News on May 4:

“Kevin Rudd likes to say that he saved Australia from the global financial crisis. In fact it wasn't his pink batt scheme or his scandalous school building program that saved us from the recession. It was the mining sector that continued to export our resources to booming economies like China.

Then Abbott at a May 6 press conference said:

"It is China’s demand for Australia’s raw materials which has kept us going through the global financial crisis and, more than anything else, prevented us from falling into the recession."

Henry’s response might be worth remembering the next time you hear a friend say Rudd is trying to kill the golden goose.

Henry also dealt with the issue of the RSPT increasing prices. This was something I wrote about yesterday – and I have to say it was rather gratifying to hear Ken Henry point out that my economic knowledge had not led me astray. He said in a very cutting remark:

"I learnt in high school, from the study of economics, that profits-based taxes can't affect prices."

This is because taxes on production – like royalties – increase prices because they shift the supply curve (what this means is the cost of “supplying” or producing a thing – in this case minerals – becomes more expense no matter how much you produce), whereas a tax on profits does not.

The Commonwealth Bank’s economist Michael Blythe put out a report straight after the Budget which showed this nicely. Here’s what the royalty regime does to the industry:scan0008 

Sorry to bore you with economics’ graphs (but I gotta admit I still kinda find it interesting – yes, I know, I need help).

The red line is the supply curve of mining without a royalty regime. The blue line is with it (ie how things are now). As you can see the royalty regime DECREASES supply (ie decreases mining). It doesn't increase prices in this example because the world price of minerals is taken as being flat – that is what people pay for iron ore is the same regardless of whether the iron comes out of Australia or Brazil or wherever.

This isn’t technically true for all minerals as BHP and Rio for eg will negotiate prices fro iron ore with China, but when it comes to minerals such as gold, well there is a gold price (they usually mention it each night) and every gold mine in the world is beholden to it. In other industries such as those which sell minerals to local business it would. Eg if there was a royalty on granite mines.

I won’t show you the graph of the RSPT because it is pretty eco-unfriendly – ie makes sense to economists but is a bit bewildering to those with a life. However what the RSPT will do is get rid of the blue line. The red line will be the only supply curve. So what the RSPT actually does (and I know this is counterintuitive – it’s why Tony Abbott really gets lost when he tries to argue against it) but because the RSPT refunds the royalty regime (ie renders it nul) it will actually be cheaper for miners to mine, and thus this “tax” will increase produciton – that’s because it is not really a tax, but is a rent.

Why then don’t the mining companies want the RSPT I hear you ask? Well the next graph will explain all – because it is the one that shows why the miners love the current arrangements:


The red line is the world the miners operate in now. As you can see the more profit they make the lower the percentage of tax they pay.

Under the RSPT the more profit they make, the higher their percentage of effective tax – pretty much just like income tax – a person who earns $150,000 pays a higher level of income tax than does someone on $40,000. The current arrangement would be like someone on $40,000 paying 45% income tax, but someone on $150,000 only paying 35%. Does that sound fair to you?

Me neither.

And if you follow the blue line right up to its end point you see the mining company would be paying over 5o% effective tax – which is the figure that the Mining Executives like to bandy about (actually they cite 56.8 percent). But have  alook at the bottom axis – to pay that much tax would mean they are making well over a 50 percent return on their investment. Yes well over 50 percent! (Kinda makes your bank account interest seem a bit shabby, doesn’t it!)

In fact Ken Henry pointed out today that You only get a rate of tax of 56.8 if the rate of return is infinitely large. (This is because the blue line actually flattens out – notice the jump in the bottom axis from 25 to 50). Last year BHP made around a 31 percent return. So you can see why they don’t like the RSPT. But does it increase prices of anything? No.


After Henry’s appearance  finished, Tony Abbott and Scott Morrison strode into a press conference to announce the Liberal Party's new asylum seeker policy. It essentially was a return to the John Howard Pacific Solution, except they wouldn't call it that. Hugh Rimington on twitter said:

Asked a Senior Lib how the new Abbott asylum seeker policy differs from the "Pacific Solution."  "It doesn't. But we're not using the name."

Just like WorkChoices I guess…

The new policy keeps the Temporary Protection Visas that Malcolm Turnbull had said he would bring back in his dog whistle moment in 2008. This is despite the fact that in the two years after they were introduced in 1999 the numbers of asylum seekers sky-rocketed. Scott Morrison on PM Agenda pointed out that the number of boats didn’t increase – as though that was a good thing, ignoring that this meant more people were cramming on to the same number of boats (I guess he thinks that is a positive). They also stated:

In government, we will commence discussions to establish an off shore processing detention facility in another country.

When asked if this nation would be in the “Pacific”, neither Abbott nor Morrison would answer – so desperate are they to avoid giving the media the “Pacific Solution” headline. Geez, how gutless. It’s not like they’re going to commence discussions with Latvia…

They also said:

We will turn back boats where circumstances allow.

This is of course meaningless bullshit. They won’t turn them back. They only did that on the very quiet back in 2001 and the Indonesian Government was furious. They won’t be able to do it this time, because they won’t be able to do it on the quiet – the media will be watching closely. And also they won’t do it because the Navy won’t do it if there is any likelihood that the asylum seekers will scuttle the boat to stop it happening – which they most certainly would.

It also has this nice little nugget:

The Coalition will also reintroduce temporary protection visas and require those on these visas who receive benefits to make a contribution through a ‘work for benefits’ scheme, as is required of Australian citizens.

Get out in the fields their boy! All we need is some plantations and a “masser” and we’ll be all set for Gone with the Wind Part Two… 

So all in all a stupid policy.

And so to Question Time which was a pretty rowdy Thursday affair. Chris Pyne, Julie Bishop and Bronwyn Bishop all got kicked out (bringing on the obvious chess jokes that Abbott had lost both his Bishops – and I’ll let you decide what piece Pyne represents).

The first up question from Abbott (he was actually allowed two today) was on asylum seekers. It was a long rant of a question that eventually got to some sort of point. Rudd had lots of fun with it, as he read out the transcript of the interview this morning between Morrison and Neil Mitchell. It was obvious that the policy had not gone through the Liberal Party-room and Rudd enjoyed reading out all the umm and ahhs as Morrison dodged the question. And he then tore into Abbott on whether or not this policy was the “Gospel Tony”.

There was not one other question on the issue – perhaps because in his answer Rudd had lambasted them for not asking about the RSPT. Maybe this did not have any influence, but it was odd that Morrison didn’t get a question.

Next up was Greg Hunt on insulation, but once again he had a looooooooooooooooong preamble that meant Rudd could talk about whatever he wanted to talk about. And he did. For a loooooong time.

After that the opposition went back to the RSPT, but their questions were very poor. Hockey kept quoting an Economic Note put out by Swan on 9 May and suggested the pie charts on the note showed that the effective tax rate paid by mining companies in Australia was around 27 percent. The only problem is the Economic Note he kept referring to is one of the best explanations of why the RSPT should be put in place. With any luck his metnion of it will get more people (and media) reading it.

Julia Gillard got two Dorothy Dixers in a row on trades training in schools. Before the second one there was a great hubbub in the Parliament. I distinctly heard Julie Bishop yell out “gutless wonder” to someone, whereupon Albanese called back: “Ask a question Julie, you’ve gone missing!”

Bishop (Julie) was booted just in time to avoid Stephen Smith have another go at her utter incompetence as shadow Foreign Affairs Minsiter, as he pointed out that in negotiations with other countries you are not going to get very far if you are making it known that you will engage in illegal acts.

Sussan Lay came up near the end to ask Swan about reports that the Government is going to change parts of the RSPT. The Australian of course called it a “backflip” except the mining industry view was different:

… all the major mining companies have rejected the new proposals as "tinkering at the edges" and not addressing the main risk to mining investment in Australia.

So it’s either a major backflip or it’s tinkering at the edges – it can’t be both (but The Australian will try).

The “backflip” supposedly involves raising the kick-in price of the RSPT from 6% to 11% and getting rid of the losses rebate. Effectively this would make the RSPT like the PRRT (Petroleum Resources Rent Tax). Now to be honest I have no idea which is a more effective tax, but to suggest it is a backflip is to I think massively over-estimate the attention and understanding the Australian public have of the tax.

In my mind all the public will want to know after any “backflip” are four things:

  • Will the tax still be 40 percent?
  • Will I still get my superannuation increase?
  • Will company tax still go down to 28 percent?
  • Will the Budget still be projected to be in Surplus in three years?

If those four questions still get “yes” then I can’t see the whole “backflip” thing flying. But as I say, the opposition with the support of some in the media, will give it a try – even thought he miners will still squeal like stuck pigs, which will hardly suggest the Government has caved in. And given the Liberals are against any resource rent tax, they are left advocating the royalty regime which no one thinks is any good (including all the mining companies). 

At the end, Tony Abbott got up to ask his second question for the day (and only fifth for the week) and he prefaced it by stating that he knew absolute bugger all about economics, the currency market and he stock market. Ok he didn’t actually say that, but it was implicit in his question where he blamed the RSPT for the decline of the Australian stock exchange, and the Australian dollar and for the evaporation of jobs around the country, global warming, his losing his keys that morning, and also for causing women worldwide to ask their boyfriends if their jeans make them look fat (ok maybe he didn’t suggest those last three).

But yes, he did suggest the stock market has gone down all because of an RSPT that doesn't come into effect for 2 years. You see in Tony’s brain it has absolutely nothing to do with the debt crisis in Greece, the poor job figures in America which led to falls in the Dow Jones and the news from China that they are trying to slow growth, which also led to falls in America, Europe, Japan, Australia….. No Tony, it was all to do with the RSPT.

What a fool. Rudd absolutely “pwned” him.

He pointed out the Australian exchange had fallen by less than the other major exchanges, he pointed out the dollar has fallen because there was a flight to the American Dollar due to the debt crisis throughout Europe and concerns over the Euro, and he pointed out that Australia's unemployment level was the envy of the OECD.

He held up his fingers and counted off Abbott’s three assertions and said “wrong, wrong, wrong”. And any one who thinks Abbott is right really needs to open a high school economics text book and have a read – maybe you could ask Barnaby Joyce to borrow his – because I think you’ll find it is in mint condition…


HillbillySkeleton said...

Would you believe it, Tony Abbott is in 'illustrious' company with his 'the RSPT ate the stockmarket' line. Last night on ABC 7PM News, Alan Kohler, in his Finance roundup of the day, stated brazenly that the uptick in Mining Stocks yesterday was a result, purely and simply, of The Australian's headline suggesting a backflip over the RSPT was on the cards. He said that the % rise in that one day, "Showed exactly how much effect the RSPT has had on BHP, ERA and Rio Tinto shares." No mention at all of any of the other factors which contributed to the rise in commodity prices, and hence shares in commodity miners' companies. I know Kohler has an undeclared interest in talking down the RSPT, but that was scandalous. It really has become 'Their ABC', hasn't it?

Greg Jericho said...

Hillbilly, as Ken Henry said yesterday:

"I would simply observe that a lot of people have been prepared to say things about what will and will not happen to share prices as a consequence of the tax.

There is a lot of share price volatility out there. People who really believe that that share price volatility is due to the tax stand to lose some money, I would suggest."

Ropehana said...

Love your posts just found your site read with great enjoyment.
My humble opinion;-
It's very disturbing the ferocity of the media and the oposition's attack on the Government, frightning to say the least. I am 70 years old and have lived long enough to have witnessed some pretty heated battles in politics in our Country - apart - or even - the Whitlam Government this one has to be the worst. Is there something I'm missing. Is this Government realy very bad? or have we been taken over by Aliens....

Greg Jericho said...


This Govt has it's faults for sure, but you are right - the ferocity of the media campaign against it is pretty well the worst since the Whitlam years.

Senexx said...

I put a link to this up on Catallaxy and last time I looked no one had refuted your supply and demand curve (straight lines) graphic.
And they're the ones you would expect to do so.