Sin tax myths – why smokers reduce health costs

Smokers have been the target of Australia's latest sin tax. Meanwhile, debate continues over using sin taxes to reduce consumption of 'unhealthy' foods such as soft drinks and confectionary.

(The word unhealthy is used quite loosely due to the fact that there is sufficient uncertainty about health – Are eggs good or bad these days? Margarine? – and because it is typically not the food itself, but the quantity consumed of a single food that is unhealthy.  Almost any food item consumed in excess will be unhealthy).

The primary arguments in favour of sin taxes are that

1.      the taxes reduce ‘harmful’ or ‘unhealthy’ consumption, and

2.      the taxes raised offset likely health costs such behaviours incur on others.

Unfortunately neither argument is compelling.

Energy efficiency: A flawed paradigm

The word efficiency carries a meaning immersed in all things positive – you never hear that being more efficient could possibly be detrimental.  In fact, if you can bear the evangelical fervour, you may have read about achieving ‘Factor Four’ or ‘Factor Five’ gains in energy efficiency, as part of a ‘Natural Capital’ revolution comprising a ‘decoupling’ economic growth from a growth in the consumption of exhaustible resources – aka ‘sustainability’.  You may even have heard that I=PAT, where environment impact (I) is a function of population (P), affluence (A) and technology (T), and that becoming more efficient will enable a desired level of affluence will far less environmental cost.

Believe me, this is all nonsense, and indeed counterproductive to the stated aims of curbing resource use and decreasing negative environmental externalities.

When it comes to natural resource use, and the externalities associated with resource extraction and production, efficiency alone is the enabler of greater consumption.  William Stanley Jevons first noted that technological improvement, in terms of greater efficiency and therefore productivity, was the enabler of greater coal consumption in Britain back in 1865 in his book, The Coal Question: an Inquiry Concerning the Progress of the Nation, and the Probable Exhaustion of our Coal-mines. His observation was coined Jevon’s Paradox, even though the argument that technological improvements in resource efficiency (modes of economy) leads to greater resource use was already widely accepted in the labour market:

“As a rule, new modes of economy will lead to an increase in consumption according to a principle recognised in many parallel instances. The economy of labor effected by the introduction of new machinery throws labourers out of employment for the moment. But such is the increased demand for the cheapened products, that eventually the sphere of employment is greatly widened.”

What does it mean for an economy to ‘turn Japanese’ and what determines whether it will?

What few seem to appreciate, either inside or outside of Japan, is just how strong the resulting Japanese recovery from 2002-2008 was. It was the longest unbroken recovery of Japan’s postwar history, and, while not as strong as pre-bubble Japanese performance, was in fact stronger than the growth in comparable economies even when fuelled by their own bubbles.

How on Earth did Japan manage that with their ageing population and zero population growth? Indeed, Japan outperformed Australia in productivity growth since 2000 and very nearly kept pace with real GDP per capita growth.

The RBA’s Ric Battelino seems confused. In a recent speech on the Australian economy he notes that “the slowdown in productivity growth has meant that GDP growth in the latest decade was not as fast as in the previous decade”, while also saying that for the past two decades “part of the growth came, of course, from the fact that the population grew strongly over the period, particularly in recent years.” What? The data he presents shows a negative correlation between economic growth and population growth, yet he continues to promote a positive relationship.

Australia’s average annual real growth in GDP per capita (currently the best measure of economic performance) since 2000 is 1.28%. While I can’t find a direct measure from the Japanese Statistical agency, using the World Bank data collection I can make a comparison of real GDP growth per capita of Australia and Japan using a common methodology. Using these statistics I find that Australia had a mean annual growth in real GDP per person since 2000 of 1.8% while Japan’s was 1.4%.

Helmet law research hits the headlines

Helmet laws hit the headlines with a new Australian study proclaiming their ineffectiveness at providing safety to cyclists, while in Canada the debate is heading the other way (due to this study - sorry I can't get the full text to review the methods).

The Australian study neatly controls for the number of cyclists and distance cycled by comparing the ratio of head to arm and hand injuries resulting from cycling activities from hospital records. A change in this ratio (lower head injuries per arm and hand injury) would be a clear indicator of the success of helmet wearing in preventing head injury.

The figure above shows the ratio (ICD9) from 1988 to 2000. Helmet laws were introduced in 1991, and self-reported compliance for two age groups (<16years and >16years) are plotted from 1991 to 1995.

The essential argument is that the large decline in the ratio of head to arm injuries occurred before the helmet law, and much before compliance with the law. In the two year period where helmet wearing took off following the legislation (1991 to 1993), the ratio dropped from 0.8 to 0.75 – hardly a success. The drop in the two years preceding the helmet law was from 1.15 to 0.8.

The author suggests that other road safety measures contributed to the decline, while the law itself would have contributed to a decline in the number of cyclists (some evidence for the decline is here) which itself made cycling more dangerous and lead to a flattening of the trend -

The reduction in numbers of people cycling may have actually increased the risk to the remaining cyclists because of Smeed’s Law and the safety in numbers hypothesis.

Population problem? It’s called longevity

Population growth advocates often rely on the ‘age dependency ratio’ as their core economic argument.  This ratio is the population aged over 65 divided by the population aged 15-64.  To give this measure meaning there is an assumption that people will not work beyond age 65 and will therefore be need to be financially supported by those at a working age.  Workers will get less of the return on their productive output because it needs to be shared with more non-workers.  Essentially, the percentage of people in the formal economy will decline. 

I have a different opinion on the age dependency ratio. I see it as a shining beacon of success.  People are working for shorter periods of their life.  We as a group are finally taking some of our productivity gains of the past half-century in the form of leisure time. 

Whether or not you agree this a problem, the suggested solution of population growth is, in reality, counterproductive, and will only aggravate the situation.  An increase in the dependency ratio is principally caused by improving longevity. If each generation lives longer than the last we will face this problem even with a growing population. Simply adding more at the bottom of the population pyramid to keep it bigger than the top has the apt label ‘population Ponzi scheme’. Indeed, to counteract this trend would require a significant increase in the natural birth rate, or age biased migration policies, or even the extreme scenario of sending migrants back home when they hit 65.  None of these are desirable.

Effects of dwelling composition in the property market

Much popular property market analysis based on flawed principles.  A secret to identifying rubbish analysis is to note the following meaningless buzzwords and phrases; underlying demand, housing shortage, urbanisation or population growth.

These buzzwords are based on a fallacy.  The problems they have in common is that they are quantity based (thus ignore prices), and they ignore changes in the composition of dwellings.

Commentators calculate underlying demand by dividing the quantity of population growth in a given period by the average occupancy rate.  This is supposed to give a measure of quantity of dwellings that ‘should’ be constructed of the period.  Unfortunately, the occupancy rate itself changes over time.  It has been declining dramatically for three decades.  If the trend continues we may soon be able to calculate a housing shortage even if we build a new home for every new person!

Calculating a ‘housing shortage’ is then a simple matter of subtracting the number of dwellings constructed over a time period from the underlying demand.  The graph below shows the result of this calculation for Australian from 1994 – 2009 using quarterly data (and the occupancy rate at each quarter – not the current occupancy rate).

Spruikers use this measure to justify the likelihood of price gains, yet the price changes observed seem to in fact be inversely correlated to underlying demand.  We had a price boom from 2002-2004 at the same time as a housing surplus!

These measures also fail to acknowledge the heterogeneity of housing.  Counting a studio apartment and a 5-bedroom house as equal in the calculation of a housing supply is a mere fallacy.  Clearly these two different dwellings will house different numbers of people.

Furthermore, the size of existing homes changes over time with renovations and extensions.  It has been widely acknowledged that many home owners have chosen to renovate instead of relocate in their search for more spacious accommodation.  It is easy enough to imagine a street of heritage homes, for example, being renovated and extended to allow a large increase in the population of the street.  No new homes, plenty of new people, and no housing shortage.

What we have seen in the latest property boom is a continuation of the trend to build larger homes with more bedrooms, while the occupancy rate continued to decline.  At some point you would expect the occupancy rate to bounce back before we all ended up living alone with three spare bedrooms.  And it did. 

The ABS summarises the long-term change in dwelling composition and occupancy as follows:

The average number of persons per household has declined from 3.1 in 1976 to 2.6 in 2007-08. In the same period, the proportion of dwellings with four or more bedrooms has risen from 17% to 29% and the average number of bedrooms per dwelling has increased from 2.8 to 3.1.
In 2007-08, most households enjoyed relatively spacious accommodation. For example, 86% of lone-person households were living in dwellings with two or more bedrooms; 75% of two-person households had three or more bedrooms; and 35% of three-person households had four or more bedrooms. Over a fifth (21%) of three-bedroom dwellings, and 8% of four-bedroom dwellings, had only one person living in them

Important demographic reasons explain why we should expect the declining occupancy trend to come to an end.  The aging population including baby-boomers downgrading is a key way in which this will occur (others include a rise in share housing by the forever young Gen-Y who are delaying family formation).

For example, the parents of a family whose adult children have moved out with friends or partners might find that the upkeep of a large house conflicts with their ‘grey nomad’ retirement plans.  They can sell their 5-bedroom house and move into a new 2-bedroom unit, pocketing the price difference for their retirement. 

In this scenario, the construction of a 2-bedroom apartment resulted in a 5-bedroom home being available to meet the housing needs of population growth.

The final fallacious buzzwords that provide property bulls justification for their position are urbanisation and population growth.  If we were discussing any other good or service the pattern of habitation would be of little consequence to the expected prices.  Increased urbanisation doesn’t drive up the price of food, petrol or any other goods – nor does population growth.  

Increased urbanisation can lead to increased land prices, but that doesn't necessarily lead to increases in median housing price measures due to compositional change.  Because new dwellings in outer areas are typically inferior locations to existing homes, the prices one would expect for identical dwellings in new estates would be lower.  Since there is more land at the fringes of cities, we would expect that proportionally more cheaper dwellings to be added to the mix of housing.  Prices for existing homes can rise, but due to the greater proportion of housing in outer areas in the mix, a price index can remain flat at the same time.

The table below shows a hypothetical city made up of identical dwellings, where new supply is mostly added at the fringes.  Even though the price of each individual dwelling increases 10% over the period, a city-wide mean price index would remain flat due to the greater proportion of cheaper dwellings.  The same effect can happen with new apartments in traditional detached housing areas.

Also constantly overlooked is the fact that urbanisation can only occur AFTER new urban dwellings are constructed unless driven by an increase in occupancy rates.  Until the end of 2005 prices was rising fast, urbanisation and population growth were occurring, but the occupancy rate continued to decline.  

Analysis of the property market should focus on returns in comparison with other investments, with renting (user cost approach), and historical returns.  Counting dwellings, and implying demand from population growth or urbanisation is problematic due to compositional factors.

Automation and the housework rebound effect

As I have previously argued, innovations that aim to save time, increase safety, decrease energy consumption can be subject to flow-on rebound effects that lead to the opposite result. These counter-intuitive results have lead to ineffective government intervention and bizarre social norms.

A typical challenge to the idea of rebound effects goes like this.

“If a business has to pay each worker more due to government intervention on wages, they are clearly going to employ fewer employers. Are you challenging the Law of Demand? If the price of labour is higher, demand will be lower.”

No, I don’t argue that if we hold everything in the world outside of an individual business constant that the business will employ more people. I argue that to believe the world is held constant robs you of the vision to see flow-on effects to society and the ability to estimate the real net effect of a policy or action.

Today's rebound effect concerns time saving and housework.

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.

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).

Bakfiets – is Australia ready for the cargo bike revolution?

Note: I bought a Bakfiets long cargo bike in September 2010 from Dutch Cargo Bikes and couldn't be happier. A follow-up (3yr) review is here.  I am now a local ambassador for Dutch Cargo Bikes. If you would like to test ride this bike in Brisbane (or a three wheeler) email me at cameron@dutchcargobike.com.au  

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 taking the world buy storm, and have now made their way to Australia, with the market well served by DutchCargoBike.com.au, who offer a variety of models.

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
$3150 for the bike
Over $4000 if you want electric motor assistance
Plenty of hills in Brisbane
Size and manoeuvrability
Extreme summer heat (can buy a shade for the kids though)

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.

Lower bound problems of hedonic indices

Prices are a fundamental feature of modern economies, yet measuring a true price change is exceedingly difficult due to the constantly changing quality of goods and services. I have previously discussed the use of hedonic price indices, where adjustments are made for quality changes using regression techniques, and the potential pitfalls when interpreting the results of this method. I apologise for raising this issue again, but I hope to clarify my message with an example.

While a hedonic index is a useful tool, and when part of a package of price indices can clarify our understanding of price and quality movements, many unresolved issues persist. One issue that attracts little attention is how to interpret and apply results from hedonic price index calculations.

Today I want to further elaborate upon, and demonstrate using the table below, what I call the lower bound problem of hedonic price indices. Quality improvement does not imply that prices faced by consumers have dropped, especially if lower quality goods are no longer available. Buyers of cheaper products will not see the price declines measured by a hedonic index, and may even see price increases.

The above table has been constructed to show how different methods for determining price changes can produce significantly different results. This hypothetical market could be computers, cars, or any other market where quality changes noticeably over time.

The animal names are the models. For car markets, it could be Corolla, Landcruiser and so on, or for computers, Dell Latitude, Apple MacBook or any other model. The reason to include models is that one method for determining price changes is called the model-matching technique. Because models typically have fewer quality changes than the market as a whole, and that they typically represent a segment of the market (budget or premium), compiling prices over time for the same model can give a reasonable measure of price changes for similar quality products. In the table above two models are highlighted, Kangaroo and Echidna, to show how their prices have changed over the period. If we take the average price change of models we can match over the period (the model matching technique), we get a price change in this market of -42% over the eight-year period.

The number beside each model is a measure of quality. I have used a single number in this situation, but typically there would be a number of associated quality measures. You will note that the quality of each model improves over time, thus if we use a hedonic (quality controlled) method for measuring price change, it will show a more substantial price decline. If we were to buy a ‘quality level 9’ product in 2001 it would be $3,000, while in 2009 it would be $1,000 – a 67% decline in price.

Using a median price index, where quality is not considered, the data in this table shows a median price increase of 14% over the period (assuming an equal volume of sales in each price category). In this scenario, this measure more accurately shows the price movement of the market as a whole. If you wanted to stay at the same level in the market, this is the price change you would experience.

Finally, and this is the main pitfall when utilising quality-adjusted prices measures to make policy decisions, the price change for the lower bound market entrant has increased 33%. The cheapest computer/car/shoe/phone/appliance, or whatever good this happens to be, has gone up in price significantly while the quality-adjusted measures show large declines.

Measures such as the CPI (a price index) and the Analytical Cost of Living Indexes do consider quality change, yet we apply these measures as a way to adjust welfare payments, even though most welfare recipients will be lower bound market entrants for much of their consumption bundle.

In an ideal world, a selection of price indexes using different methods would be produced for each major consumption category to show paint a clear picture of the situation being faced by different members of society. Not only would we measure ‘pure price change’, but also changes to the cost of living which can more easily guide policymaking.

Steve Irwin's way: Economics of wildlife conservation

At Australia Zoo (I had a lovely time there on the weekend, thanks for asking) there are numerous signs posted to encourage visitors not to buy native animal products – crocodile, emu, and kangaroo meat for example.  I found this very odd, as crocodile and emu are farmed, and most kangaroo species are not endangered – far from it.  So what kind of conservation message was this I wondered?

Steve Irwin expressed his conservation message more clearly on the website:

"Sustainable Use" of native wildlife in so-called modern nations like Australia and the U.S.A. has inadvertently created a multi-million dollar 'bushmeat' industry, where local people kill native wildlife for meat, skins and products. Please don't blame the local people; it's not their fault! They're simply hunting for much needed money. The greatest wildlife perpetrators of today's world are those behind the driving force of "Sustainable Use." 

How are the Tiger Farms in Taiwan and China helping to save Tigers in India, SE Asia or Siberia? They are perpetuating the market in Tiger products, which is the single greatest reason for the endangerment of Tigers.

…If we can destroy the market, we'll destroy the industry. Historically the only reason spotted cats, like Leopards and Cheetahs are still found in the wild, is because of peer pressure. It became 'uncool' and controversial to wear spotted cat fur coats, so the market was destroyed and the industry suffered. Slowly, less and less Leopards and Cheetahs were being shot for their skins, and just as well or they would've been extinct 20 years ago.

The principle behind this message is that if we eliminate demand for wildlife products, we will preserve species.  But there are alternative ways to protect wildlife and biodiversity (a side note: do we really care about an individual species, or do we use iconic mammals as the canary in the coal mine of biodiversity protection?)

In addition to the ‘demand destruction’ technique, economists propose other ways to preserve threatened species – promote domesticated supply (farm threatened species), the Coase solution (give rights to the species to a group who can profit from non-consumptive use of the animals such as eco-tourism and research), and simple land conservation.

Which of these measures work?  Should we try them all, or are they mutually exclusive?

CityCycle scheme, bicycle helmet laws, and a better alternative

In my bio I promise to turn ideas on their heads to gain a better understanding. In this spirit I ask the following question of Brisbane City Council’s proposed CityCycle bicycle hire scheme – is it better for council to subsidise a bicycle hire scheme to stimulate bicycle use, or is it better for council to subsidise a car hire scheme to encourage bicycle use?

(And yes council will have to subsidise the scheme through the donation of public space, and possible contributions to ongoing costs, as has happened with such schemes in Europe, even though hire costs and advertising on bikes provide the main sources of revenue for the operator).

I suggest the latter may be preferable. Here is my logic.

Economic arguments against population growth

While Population Minister Tony Burke may be new to the debate, the population debate itself is certainly not new to politics. In 1994 the Commonwealth commissioned an inquiry (the Jones inquiry) into Australia’s population and carrying capacity, yet the inquiry failed to make firm recommendations. One of the inquiry’s authors then wrote a book in protest of the ‘government’s timidity’ and concluded that

... a sensible population policy for Australia would be to aim at stabilising the population within a generation or so and that this was quite feasible if net immigration of something below about 50 000 a year (say 100 000 migrants in gross terms) could be maintained. Population would then more-or-less stabilise somewhere between 19 and 23 million (depending on actual immigration) sometime before 2050.

Now, Tony Burke is faced with twin challenges of developing a policy position on population that keeps enough people happy to keep him in government.

We can easily run through some of the options available to Minister Burke – stimulate or dampen population growth. I suspect he would also like to encourage migration away from capital cities due to the ‘obvious housing shortage’, but as far as I can tell the Federal Government has little power to influence such regional migration (maybe an income tax relaxation depending on how remote your residence?)

To stimulate growth we could increase migration intake, and encourage higher birth rates – maybe $15,000 per child would do it? Or Burke could moderate population growth by reducing immigration quotas and discouraging high birth rates (by removing the baby bonus or even having a ‘child tax’).

But which option is best for Australia? Are there strong economic arguments in favour of either higher or lower population growth? I would argue that on balance, economic principles strongly favour a declining rate of population growth (even a negative rate of population growth not a problem).

For a start, we need to discredit some of the nonsense economics floating around. Bigger is not better. China and India both have plenty of people, while countries with the highest per capita incomes and standards of living generally have fewer people. China has greatly reduced population growth with its one child policy and seen vast economic growth – shouldn’t China have failed to grow because its population stabilised? The map above shows a pretty clear inverse relationship between population growth rates and standards of living.

Nor is a comparison of population density meaningful in this debate, or we could argue that any region with a low population density is ‘underpopulated’ (like Antarctica or the Simpson desert) because we have compared the region to Hong Kong or the Netherlands.

One core economic argument in favour of a greater population is that utility theory suggests that a trillion people living in poverty and slavery are better that one million happy and fulfilled people, leading lives directed by their own desires. It is known as the repugnant conclusion. I doubt anyone believes this is a good outcome, nor is claimed to be a good reason for greater population – it just happens to be at the heart of economic theory and can spawn unusual conclusions.

A second argument appeals to economies of scale and suggests that with greater domestic consumption industries can expand to a point where they have economies of scale that make them internationally competitive. Why domestic population is currently a barrier to industry development is beyond me. If there are no artificial constraints on trade, shouldn’t the world be the marketplace of any industry even in its infancy? This argument only works if you couple high population with protectionism (the infant industry argument, which itself is often challenged).

A third argument, that may be the focus of this debate, is that the demographic shift towards a flat population pyramid means that the proportion of people in the workforce will be much lower, and that public welfare support for the elderly will become a burden on a smaller workforce. However, one does not need to think too hard to realise that stimulating population growth simply delays this inevitable demographic shift. We have known this shift was coming for decades yet have failed to act. But it is not too late to implement solutions more practical than stimulation population growth.

Another argument is that of national security. Unless we have enough people, we won’t be able to defend our borders. To truly defend Australia from all others, how many people would we really need? 150million? More? This is a ridiculous argument and a reason we have strong allegiances with countries with large defence capabilities.

Apart from these arguments for high population growth over low growth or declining populations, Chris Joye cites the following reasons for a population minister, all of which have confusing and possibly contradictory implications

1. Australia’s long-term human capital requirements
2. The ramifications of those population projections for real GDP per capita and public finances;
3. The infrastructure that will be required to support the population base;
4. How that infrastructure will be funded by the public and private sectors;
5. The consequences of the population expectations for the nation’s housing needs;
6. Where we expect to locate this new housing (i.e. in which cities), and hence our long-term urban plans; and
7. The inextricable linkages between new housing supply and infrastructure investment, where the latter is a condition precedent to ‘enabling’ new shelter.

My response would include such lines of questioning as:

• Why would our human capital requirements ever be greater than our human capital?
• Why would population change have ramifications on per capita measures of GDP?
• Would not points 3), 4), 5), 6) and 7) suggest a slower rate of growth is preferable?

My last challenge leads to the heart of the arguments against high rates of population growth. My (and many others) argument is that providing basic services for these new people diverts investment from new technologies that improve per capita productivity. Population growth inflated by policy wonks is a burden many of us would choose to live without.

Like my argument that housing investment does not improve productivity, simply expanding the scale of capital infrastructure (such as roads, water supply, electricity supply etc) to match the scale of the population does not improve our per capita productivity. This investment diverts labour and resources away from actual productive capital investments such as new manufacturing technologies.

A second economic argument against stimulating population growth is that a high fertility rate will keep women (and some men) out of the workforce for longer. If we are worried about the welfare burden on a smaller workforce, we should also be worried about so many parents out of the workforce, and the increased welfare burden from the children (their education and health costs).

My final argument against high rates of population growth is that environmental impacts of new land developments are difficult to assess. The faster our rate of population growth, the lower we will be our standards of environmental controls. New mines, new housing, new industrial areas and ports will all have environmental impacts. To preserve environmental amenity for the current population, we should be careful about these impacts and adopt a cautious approach.

And what of a declining population? Traditionally a population decline was the result of war or famine, but, as suggested here, that doesn’t mean population decline should always be in the disaster basket.

But if the causes are benign, what about the consequences? If the decline in the number of people is slower than the natural growth in productivity (or output per person), then the economy will still grow. For example, a modest population decline of 0.25% a year would reduce Britain's economic growth rate of 2.25% to just 2% a year. That's hardly a recession. The number of consumers may decline, but the growth in incomes-and export markets-will ensure that demand stays buoyant. Nor will there be a demographic crisis, with huge numbers of old people overburdening those of working age. Population decline also leaves fewer children to support, train and educate for the first 20 economically unproductive years of their lives. The dependency ratio of workers to non-workers is virtually unaffected whether the population is growing 0.255 a year or falling 0.25%. Adjustments to an ageing society-discouraging early retirement, moving from pay-as-you-go to funded pensions-will be necessary in any case.

A high rate of population growth, stimulated by policy wonks on the back of fallacious economic reasoning, is a social burden I am sure we can do without.

Drought is not exceptional

The front page of yesterday's Australian newspaper reports Agricultural Minister Tony Burke's recent speech outlining his intention to reform Australian drought policy. The specific part of the Exceptional Circumstances subsidies targeted by the Minister's speech was the interest rate subsidy. Under this scheme farmers in drought declared areas can have 80% of the interest on their farm debts paid for by Australian taxpayers.  Farmers were provided $61 million per month in drought assistance at the end December 2009 - or about $730 million per year.

As a side note, it makes me wonder how substantial agricultural subsidies must be in Europe. Australian direct agricultural subsidies amount to approximately 8% of farm income, while in most European nations subsidies account for greater than 60% of farm income.

What I find particularly interesting about drought policy is the logical dilemma encountered when determining what are in fact 'exceptional circumstances'.

The leisure dilemma: Rebound effects from productivity improvements

A recent report from UK think-tank New Economics Foundation generated plenty of publicity recently by suggesting that a 21hour standard workweek would significantly improve well being by giving people more time for family, friends, neighbours, and leisure activities. My own experience is that reducing work time has surprisingly large positive impacts on well-being.

Interestingly, economist John Maynard Keynes envisaged in a 1930 essay on the Economic Possibilities for our Grandchildren the following situation

Thus for the first time since his creation, man
 will be faced with his real, his permanent problem--
how to use his freedom from pressing
 economic cares, how to occupy the leisure,
which science and compound interest
 will have won for him, to 
live wisely and agreeably and well.

The productivity gains imagined by Keynes did eventuate. Everywhere we look we can see far greater output per hour of labour, from agricultural production all the way through the production processes in our complex 21st-century economy.

However recent research suggests that leisure time has been relatively constant since 1900, and time spent on home production activities (cooking, cleaning etc) has actually slightly increased. Additionally, while time spent at work over a lifetime has decreased since 1900, most of this is the result of more time spent studying.

How is it that we continue to fill our time not with leisure, but with work, study, and household chores?

There is a rebound effect at play.

To properly explain how this rebound effect occurs at a national (and sometimes international level), we need an analogy closer to home. Instead of businesses and industries improving productivity across the economy, imagine yourself improving your productivity during your working life. You start on low pay as a youngster and edge your way up the ladder to better paying jobs over time.

Immediately we can see the analogy is sound. Most people don’t take their gains in productivity (as reflected by increases in their salary) as leisure time. Rather, they continue to work the same hours (or more) and receive a higher income.

Why?

The problem is one of cooperation and it has striking similarities to the classic prisoner's dilemma. You see, if you take your productivity gains as leisure time, and the next person doesn’t, they can bid up prices for things you might like to buy (such as land). However, if you both cooperate and each take more leisure time, you will both face accessible prices.

In our analogy, if everyone took their gains as leisure time, incomes would be relativity even, but each person’s work/leisure ratio would be different. The most productive people would work the fewest hours and vice-versa. Because each person’s income is the same, there would be little opportunity for people to outbid each other on prices, or out consume each other in status displays.

Furthermore, as our productivity increases (or our hourly rate of pay in this analogy) the gains at the margin from working just one more hour are far greater. Compared to when you were the local barista making $15 an hour if you worked longer, you might now make $60 per hour and find that you can make in a couple of hours in the evening what you used to make in a day.

How do we overcome this cooperation problem?

There is a simple answer at an individual level, and that is to decrease your consumption expectations and take your productivity gains as leisure (as I have done). There is also a more difficult answer at a society-wide level. Yes, we can regulate maximum working hours and penalty rates for overtime. However, penalty rates increase marginal benefits from overtime hours. Maybe instead we could have anti-penalty rates. After a certain number of hours by law your pay decreases per hour, until after say 30 hours, there are zero benefits from working any longer.

But, as I have discussed before, regulating working hours is a tricky game. Such a law would encourage a cash economy for labour in order to avoid the laws (and avoid taxes), allowing individual workers to get ahead.

In fact, in the spirit of free choice, I would discourage further regulation of hours. Instead, I would opt for solutions such as more public holidays (which also allow a coincidence of leisure for more workers), and labour laws that encourage flexibility and part-time work.

Maybe my grandchildren will be so lucky as to face Keynes’ leisure dilemma.

Housing investment is not productive

Property spruikers are currently having a field day proclaiming the productivity of housing investment. These claims are fallacious. Housing investment does NOT improve productivity.

To clearly explain why this is the case we first need to define productivity. Productivity is a measure of output from a production process, per unit of input. A productive capital investment therefore enables more future goods and services to be produced per unit of input (such as labour, materials etc).

An example of a productive investment may be a machine that enables a new design of metal fasteners to be produced from less metal, and with less labour time, but is equally as strong. In this case we have a productivity gain in terms of materials and human labour time for the same output. This investment allows use to produce more fasteners in future periods even with no more inputs.

Housing does nothing of the sort. It simply houses more people and does nothing to improve the per capita productivity.

Let's use a little thought experiment to prove the point.

GI Joe and the Market for Lemons

GI Joe is possibly the worst movie ever (see the number of goofs and plot holes here). But I still spent 2 hours watching it, even though there were plenty of better things to do with my time. Am I simply a fool?

The answer is, well, maybe. The reason I sat all the way through is that I thought the movie might redeem itself by having a nice twist at the end, or even a few cheesy lines that I could laugh at. But no.

Considering the number of terrible films made this type of situation is relatively rare. It is easy to get a number of honest reviews to narrow down the quality before watching a film.

In any case, it got me thinking that movie markets are similar to lemon markets because the quality of the good cannot be known in advance. In a true lemon market the quality cannot generally even be known after the good is consumed.

Economics of work and leisure

Recently, I cut back work to 4 days a week with a surprising result. Rather than feeling like I am enduring marginally less of a bad thing, I am actually finding work more challenging and interesting – even though I am surrounded by the same public sector circus.

I feel like a 20% cut in work has resulted in an 80% improvement in my work satisfaction, rather than merely a 20% boost.

As an economist I really shouldn’t be surprised. Economic theory suggests an optimal work time – there are decreasing marginal benefits to work (in terms of pay), and increasing marginal costs (in terms of time, level of stress, level of frustration etc).

But this experience (and the popularity of this television show) has got me thinking about how the wellbeing of society at large can be improved by working less.

The Christmas gift arms race

I do like Christmas. Maybe it’s the memories of childhood where a simple water pistol was enough to keep the anticipation high for weeks, and then become an object of desire (and destruction) for months.

But these days I feel like Christmas has become more of a burden then a blessing. My experience suggests that the last decade has seen the demise of delayed gratification. Maybe it’s just because as a child you are subject to parental decisions, and so you learn about delayed gratification. Then in adulthood, you realise there is little need for that anymore and are happy to splurge whenever it suits you. But maybe it is a more widespread cultural phenomenon.

The cause of this burden I feel is what I call the Christmas arms race.