Insights Volume 2 November 2007

INSIGHTS Melbourne Economics and Commerce volume 2 november 2007

Modeling Amazon deforestation for policy purposes

Clive W J Granger Economic policy issues for climate change

John Freebairn The economics of sport

Peter J Sloane A comparative view of unions, involvement and productivity

John S Heywood The world before public affairs

David Merrett Are delays in tariff-reduction programs ever economically rational?

Neville R Norman Occasional Addresses

Jeff Borland and Max Corden

Welcome Insights publishes condensed and edited versions of important public lectures connected with the Faculty of Economics and Commerce. By presenting these lectures in a language and format accessible to the general reader, we hope to share their substance with a wider public and especially with alumni of the Faculty. We also aim to establish archival material for future researchers.

In Volume 2, we delve into diverse topics in economic theory and current affairs, proffered by distinguished academics in their respective fields.

Insights: Melbourne Economics and Commerce ISSN:1834-6154 Editor: Emeritus Professor Joe Isaac, AO Associate Editor: Ms Brooke Young Sub-editor: Ms Rebecca Gleeson Advisory Board: Dr Robert Dixon Professor Bruce D Grundy Associate Professor Bryan Lukas Illustrations: Nicola Page (cover), Matt Clare (internal pages) Design: Sophie Campbell

We often hear from members of business and the community that in a complex world, these voices are welcome additions to the public debate. The illustration on the front cover is from Nicola Page, a graduate student in the Victorian College of the Arts.

We received positive feedback on the first volume, and encourage suggestions and feedback to ensure that we continue to provide a quality publication to our readers.

Joe Isaac, Editor

insights vol 2 Table of contents 03 Modeling Amazon deforestation for policy purposes

By Clive W J Granger An alternative approach to analysing deforestation, to take account of the conservationist and development priorities

09 Economic policy issues for climate change

By John Freebairn The design of appropriate policy interventions faces a number of difficulties – the characteristics of a global pollution externality, uncertainty about both the economic costs of climate change and the costs of mitigation, and the need to make intergenerational comparisons because of the very long time lags between cause and effect

15 The economics of sport

By Peter J Sloane The claim that professional team sports are no different from conventional industries can be challenged; and whether club owners are profit maximisers or utility maximisers remains an area of debate

25 The world before public affairs

By David Merrett Business is under increasing pressure to serve society

31 Are delays in tariff-reduction programs ever economically rational?

By Neville R Norman Can economic theory be used to resolve the tricky issue in trade policy, of whether pre-announced reductions in trade barriers should ever be suspended or reversed?

36 Occasional Addresses 36 The importance of commerce

and commercial principles in determining the well-being of society

By Jeff Borland How graduates in commerce can contribute 39 Guideposts for your future success

Max Corden The importance of taking advice, continued study and communication skills; and more broadly of history, empathy and morality

20 A comparative view of unions, involvement and productivity

By John S Heywood There is room for performance pay, but it does not necessarily succeed in a vast majority of cases

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modeling amazon deforestation for policy purposes An alternative approach to analysing deforestation, to take account of the conservationist and development priorities by clive w j granger A condensed version of a public lecture given at the University of Melbourne in September 2006.

Introduction Despite a significant increase in environmental consciousness in both developed and developing countries, tropical deforestation continues at a worrying pace. According to estimates based on satellite photos, deforestation rates in the Brazilian Legal Amazonia fluctuate at around 20,000 km2/year depending on economic conditions (Figure 1). By 2005, almost 1 million km2, or close to 20 per cent of Legal Amazonia, had been deforested.

While part of the deforested area has turned into highly productive agricultural land, a lot has been wasted with very little social benefit. It is in everybody’s interest to ensure that wasteful deforestation is minimised and that future deforestation is limited to areas where it brings substantial social benefits.

It is now widely agreed that a lot of wasteful deforestation in the past has been induced by special government incentives, such as land concessions based on deforested area, highly

Figure 1: Annual deforestation rates in Legal Amazonia, Brazil.

Source: Official National Institute of Space Research (INPE) figures.

Annual deforestation rate (km2/year)

35000

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0 77/78 88/89 89/90 90/91 91/92 92/94 94/95 95/96 96/97 97/98 98/99 99/00 00/01 01/02 02/03 03/04 04/05

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subsidised credit and tax breaks. These perverse policies brought large private gains irrespective of land productivity, resulting in socially wasteful deforestation. Most of these incentives have been dropped, both because they were expensive for the government, and because the occupation of the Amazon has gained so much momentum that artificial incentives are no longer necessary.

However, one highly controversial policy remains: road building. Many writers are very critical of the construction of roads through the Amazon, as roads invariably attract farmers who deforest along the road. Others suggest that not all kinds of road building are necessarily bad. If existing unpaved roads are paved, for example, this may encourage farmers to settle down close to the road and intensify their agricultural activities on a relatively small plot, instead of deforesting and practicing extensive agriculture further into the forest. Thus, while roads may cause an increase in deforestation close to the road, they may avoid deforestation further away from the road.

In fact, the rural population in Legal Amazonia is growing over time but several farm-level studies suggest that labour is very scarce in the Amazon.

This means that there is likely a negative correlation between the rate of deforestation in different areas, but it is difficult to say how strong it is.

Whether this substitution effect actually occurs, and to what extent, is an empirical question that we have hitherto not been very good at analysing.

While we now have excellent data from constant satellite surveillance of the Amazon, the econometric methods applied so far have been inadequate. The purpose of this paper is to explain why the methods usually applied give misleading results, and to point out some alternatives.

In order to test the impact of a road on overall deforestation, it would be very important to take into account this possible negative correlation whereby, if deforestation goes up in one place, it would have to go down in another. The simple GIS model cannot capture this effect because, while it captures all the additional deforestation along the road well, it does not and cannot capture the avoided deforestation further into the forest.

Geographic Information System (GIS) analysis of roads and deforestation

Municipal level regressions

The raw material used to analyse deforestation consists of satellite pictures of the forest. Analysis of these pictures has shown that almost all deforestation has taken place within 50 kilometres of a main road. Based on this, it is possible to calculate the percentage of vegetation that has been cleared within a 100 kilometre-wide buffer zone around all main roads that are at least, say, 20 years old. Let us call this percentage X. It would then seem logical to expect that if you construct one kilometre of new road, this would cause X% x 1 km x 100 km = X square kilometres of additional deforestation within 20 years.

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While simple and intuitive, this kind of GIS analysis has one major problem: it does not take into account correlation between deforestation in different areas (pixels). Spatial correlation can be either positive or negative. It is probably positive for plots close together, as the clearing of one plot makes it much easier to clear an adjacent plot, both because of easier access and because fragmented forest burns more easily. But correlation may be negative for plots farther away from each other. This would, for example, be the case if labour is a scarce factor. If farmers spend all their time clearing and cultivating one plot, they cannot at the same time clear another plot. Thus, if the number of people dedicated to agriculture is constant, then a rise in deforestation in one place would be matched by a decline in another.

Modeling Amazon deforestation for policy purposes

Another widespread technique used to analyse deforestation in the Amazon is municipal level cross-section regressions with some measure of deforestation as the dependent variable and policy variables, including roads, among the explanatory variables.

Since municipal level regressions use much larger spatial units than GIS analysis, the problems which can arise if we neglect spatial correlation are not as great as in the GIS analysis. This is because at least part of the avoided deforestation will be in the same municipality, but farther away from the road. Thus, part of the avoided deforestation is included in the municipal level data.

Some municipal level regression analyses do attempt to include spatial correlation explicitly, but due to the rudimentary nature of the spatial information, it is necessarily done in a rather crude manner.

The main problem with municipal level regression analyses is that the findings are not at all robust. Deforestation processes have changed dramatically over the last few decades, and a regression made on data from the 1970s is likely to yield completely different results from one made on data from the 1990s. These differences are very likely real, which implies that data from different time periods cannot be pooled to create one large sample. Regressions have to be made individually for each time period, which means that the number of observations is limited by the number of municipalities – 257 to 628 in Legal Amazonia, depending on the time periods included. Since there are hundreds of possible explanatory variables available at the municipal level for Legal Amazonia, and since the dependent variable itself can be expressed in many different ways (for example, levels, logs, shares, changes, changes in shares, based on either

satellite information or on agricultural census information), it is possible to get virtually any result you might be looking for, if you try hard enough. This means that the reader should be highly sceptical when presented with a particular regression result. It may easily be the result of conscious or unconscious data mining.

Given that both GIS analyses and municipality level regression analyses have severe limitations, the following section outlines some alternative approaches.

Alternative analytical approaches Deforestation is simultaneously a spatial, dynamic and economic process, and it is important to recognise that limiting deforestation is not the only objective we have to take into account. The impact on the living standards of the local people is an additional objective that even environmentalists must now consider. This means that we have a highly complex and dynamic spatial system with many economic constraints and interactions, and two objective functions. If we ignore any part of this, our analysis may be seriously flawed.

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Given enough time, a well-funded team of experts in Computable General Equilibrium modeling, GIS analysis and deforestation might be able to develop a model that includes all these dimensions satisfactorily using available data. Whether the results of the model will be trusted, depends a lot on the composition of the research team. If it is dominated by environmentalists and funded by conservation institutions, people worried about local development may be concerned that the analysis is biased towards conservation, and vice versa.

Here is an attractive alternative, which is less demanding in terms of modeling and estimation, and which requires less cooperation and trust between environmentalists and developmentalists.

Let environmentalists develop a map of conservation priorities (on a scale of 1 to 10, say) and let developmentalists create a map of development priorities, and then overlay the two maps to create a mosaic of land uses for development and conservation. There will probably be some areas of conflict between the two

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objectives, but in land-abundant countries – all Amazonian countries – it should be possible to accommodate both development and conservation interests in a rational way.

The map of conservation priorities could be constructed based on sub-maps of species diversity, endemism, carbon sequestration capacity, erosion risk, watershed protection services, and other variables judged important by the conservation community. The map of development priorities is likely to take into account soil quality, existing infrastructure, current and expected future population concentrations, and the existence of other natural resources, such as oil and minerals. Combining the information in the two maps should result in a map that indicates areas that should be conserved in their natural state, areas where development can be encouraged without too much environmental damage, and areas of conflict where care has to be taken as to which kind of development is encouraged.

Advantages with the priority approach The big advantage with the priority approach is that the two underlying maps can be done independently. The specialists in conservation sciences can concentrate on counting birds and beetles, estimating biodiversity, measuring carbon density and assessing environmental services. This is by no means an easy task, but at least they do not have to worry about land prices, globalisation and poverty as well. They do have to acknowledge, however, that there are geographical variations in conservation priorities. The approach will not work if they assign top priority to all remaining natural areas.

The specialists in development will clearly have to take into account population growth and the corresponding growth in demand for agricultural products. Their main tasks will be to make spatially explicit population projections and estimate aggregate demand for agricultural land.

They have to analyse soil quality and other agricultural conditions as well as market conditions, in order to pinpoint where agricultural activities should be ideally located.

Once the environmentalists and the developmentalists have made their priorities spatially explicit, an independent third party can overlay the maps and create a mosaic of ‘optimal’ land uses that gives sufficient room for expected agricultural expansion and at the same time protects the areas that are most important for conservation purposes. This third party will undoubtedly encounter certain areas that both conservationists and developmentalists claim to be top priority. These are conflict areas, where specific interventions will be necessary in order to ensure that the pressing development forces do not cause too much environmental damage. Such interventions could include, for example, encouraging eco-tourism, fish farming, high value perennial crops, or other relatively benign activities as alternatives to extensive agriculture.

Further micro-level zoning can also be made within the areas of conflict, in order to reduce the environmental impact of the inevitable human presence in the area.

While it is not always politically feasible to implement the ‘optimal’ land use mosaic, at least policy-makers receive important guidance, and thus have concrete arguments to back up their proposals and decisions.

Conclusions Road building in the Amazon remains a highly controversial subject. Brazil’s determination to develop the region is met with strong opposition from environmentalists, as is the less organised encroachment occurring in other Amazonian countries. While data is now abundantly available, the methods typically used to analyse the impact of roads on natural vegetation cover are methodologically weak and not very helpful to guide public policy.

This paper discussed the respective weaknesses of typical GIS analysis and typical municipality level regression analysis, and showed what would be needed to construct an ideal model of deforestation processes. It also presented an alternative approach that is much less demanding in terms of modeling and estimation, and which requires less cooperation and trust between environmentalists and developmentalists. This approach involves developing maps of conservation priorities and development priorities, and superimposing the two to create a land use mosaic, which takes into account both priorities at the same time. By doing so, the process acknowledges that both conservation and local development are important objectives.

Professor Sir Clive Granger is Emeritus Professor of Economics at the University of California, San Diego and is a Visiting Eminent Scholar to the Department of Economics at the University of Melbourne.

In 2003, Professor Granger was awarded the Nobel Prize in Economics (with Robert Engle) for his discoveries in the field of time series data analysis.

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economic policy issues for climate change The design of appropriate policy interventions faces a number of difficulties – the characteristics of a global pollution externality, uncertainty about both the economic costs of climate change and the costs of mitigation, and the need to make intergenerational comparisons because of the very long time lags between cause and effect. by john freebairn

A simplified version of a paper given at the Melbourne Institute Forum on Climate Change on 17 April 2007. The full paper is available at http://melbourneinstitute.com/forums/ pub_forums.html

This paper canvasses economic policy issues regarding the mitigation of the external costs of human activity that are likely to cause climate change. It begins with a background picture of some physical aspects of climate change. Policy questions and policy options in relation to climate change are discussed in terms of: – External costs and the rationale for government intervention; – Long time lags, intergenerational comparisons, and discount rates; – The international dimension and policy design challenges; – Imperfect knowledge; and – The pros and cons of different policy intervention options, including taxes, tradeable permits, R&D subsidies and regulations.

Background The science base of climate change is a flow-stock process. The flow of greenhouse gases from all over the world, much of it associated with human activities such as the burning of fossil fuels for energy, transport and heating, and deforestation, adds to the stock of global greenhouse gases. A larger stock of greenhouse gases is thought to be a prime determinant of climate change, characterised by a rise in temperatures, and

greater instances of extreme climatic events, such as droughts, floods and tornados. Likely climate change over the coming decades will have direct adverse economic effects, in particular on agriculture, infrastructure, the availability of water, biodiversity and sea levels. There is not unanimous scientific agreement, and there is uncertainty about the details. However, as documented by the International Panel on Climate Change, there is considerable support for both the likelihood of climate change and the belief that human activities are major contributors.

In terms of economic decisions by businesses, households and governments, the prospect of climate change raises two sets of decisions, namely: – Adapting choices to a different set of exogenous climate conditions; and – Developing appropriate policies to mitigate human decisions which contribute to climate change.

Both sets of decisions will involve changes in relative prices and the comparative advantages of different products and production processes.

There will be a general equilibrium process of ‘creative destruction’ with some losses and some

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gains across different production and consumption activities. Particularly in the case of climate change mitigation, market failure and the potential for beneficial government intervention is important. Apart from government provision of information, there are less instances of market failure with climate change adaptation decisions.

The design of appropriate policy interventions is challenged by the characteristics of a global pollution externality, uncertainty about both the economic costs of climate change and the costs of mitigation, and the need to make intergenerational comparisons because of the very long time lags between cause and effect.

Climate change as a market failure Greenhouse gas emissions are a by-product of many human activities, and in most cases they are unrecognised emissions into a global atmosphere that nobody owns. For example, driving cars and burning of fossil fuels to produce electricity in every country, adds to the global stock of greenhouse gases, but the by-product is not included in the transaction costs or prices. In time, the build-up of the global stock of greenhouse gases leads to climate change and external costs in the form of changes in agricultural productivity, severe climatic events with adverse effects on infrastructure, loss of biodiversity and so forth.

The production of greenhouse gases and associated climate change has sometimes been labelled ‘the mother of all externalities’. If left to market forces, ignoring the external costs of greenhouse gases will result in too much production and consumption of products intensive in the use of greenhouse gas, as well as in the choice of production methods that produce too much greenhouse gas.

Where external costs are involved, economics provides clear guidelines for making more efficient production and consumption decisions, and policy interventions. These methodologies are applicable to the climate change debate. Ideally, we would seek to find levels of production and consumption of products which generate external costs due to greenhouse gases where the marginal social costs,

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Economic policy issues for climate change

both private costs and external costs, equal marginal social benefits. Alternatively, this involves equating marginal external costs with marginal abatement costs (which in turn equal marginal private benefits less marginal private costs). This guideline has a number of important messages.

First, the socially efficient outcome almost certainly will not be a case of ‘business as usual’, that is, no government intervention or zero greenhouse gas emissions. In general, some level of pollution matches marginal social benefits and costs. Second, it would be an extraordinary coincidence if one of the current often touted technical measures is the economic optimum, such as the Kyoto target of 1990 emission levels, or the European stated targeted of 60 per cent below current emission levels by 2050. Current economic assessments of the marginal external costs and abatement costs of greenhouse gas emissions, with the Stern Review as an example, will provide a more informed basis for choosing an economically efficient level of global greenhouse gas emissions.

Third, and most important, the task of reducing greenhouse gas emissions below the ‘business as usual’ levels will involve changes in decisions on both demand and supply sides. Higher prices on the demand side to reflect the external costs of products with inputs producing greenhouse gas emissions are needed to shift consumer choices. Further, as illustrated by observed responses of demand to higher oil prices, these demand changes can be large.

Falls in sales, together with a rise in the costs of greenhouse gas intensive production methods, provide incentives and rewards for producers to change production methods. New technology on both the demand and supply sides will be an important component of the adjustment processes.

The international dimension and policy challenges Global cooperation is paramount to reduce greenhouse gas emissions, because of the global nature of the externality and because many greenhouse intensive industries are globally footloose. Yet, unlike local and national

pollution externalities, such as acid rain and traffic congestion, there is no global governance structure with the powers of coercion of a national government.

From an individual country perspective, the mitigation of greenhouse gas emissions is a type of prisoners’ dilemma game. The lower climate change ‘product’ is a global public good with incentives to free-ride. This is true for large economies, including the US and China, and more so for small economies such as Australia. It is costly for a country to embark on a strategy of reducing greenhouse gas emissions, with many current estimates of the cost of stabilising emissions as high as one per cent of GDP. This would result in only a small fall in the global stock of greenhouse gas and, consequently, in a small reduction in adverse climate change effects for the country. Alternatively, to embark on a strategy of ‘business as usual’ involves no costs, but the country benefits from the decisions of other countries that have reduced their emissions. That is, the selfish country strategy is to free-ride and stay with ‘business as usual’. The result is a global outcome that is less satisfactory than a cooperative solution involving some reduction in emissions from all players.

Clearly, the major policy challenge is to move towards a global cooperative solution in which all, or most, countries participate. Progress so far is not promising, with the Kyoto Protocol negotiated in 1997 as a prime example. Yet, many individual countries, and individual states in the US and Australia, unilaterally have introduced policy initiatives and targets to reduce greenhouse gas emissions. A top-down approach driven by the United Nations at this stage seems less likely to succeed than smaller groupings of nations such as the European Union, and the Asia Pacific ‘six’.

A particularly challenging equity issue relates to sharing the cost of reducing the stock of global greenhouse gas emissions between different countries, and particularly between the developed and developing countries. In the last 200 years, industrialisation has provided both much of the comparative wealth in developed countries and the increased stock of greenhouse gases.

Understandably, developing countries who aspire to comparable living standards and industrialisation in the future – but so far have contributed relatively little to the stock of global greenhouse gases – reject a model of allocating greenhouse gas tradeable permits on a grandfathering arrangement (that is, based on current pollution levels). Developing countries would be more willing to sign up to a model that, for example, allocates tradeable permits on a per capita basis. A system based on a carbon tax, with the revenue going to the country, may have greater potential to win global support than the current policy-push for tradeable permits.

One avenue to support cooperation across countries involves the sharing of knowledge, and especially its transfer at low cost from the developed to the developing countries.

Unfortunately, this strategy is not without some difficulties, particularly since much of the R&D to reduce the dependence on greenhouse gases is likely to be patentable. While this is important to provide the incentives and rewards for investment in such R&D in the developed countries, it raises the cost of the required information. Therefore, governments may have to subsidise the royalty fees for the use of patents in developing countries.

Long time lags, intergenerational equity and discount rates Long time lags are important to the economic policy debate on climate change for at least two sets of reasons: intergenerational comparisons of well-being; and decisions on long-life and large lumpy investments.

The costs of reducing greenhouse gas emissions by the current generation will provide benefits several decades ahead for future generations in the form of less climate change and lower future adaptation costs. The appropriate benefit-cost assessment to find the appropriate level of mitigation (where marginal external costs and marginal abatement costs are roughly equal) involves making inter-temporal or intergenerational comparisons via a discount rate.

Issues to consider include the time value of money as represented in inter-temporal consumption preferences and returns to investment, the relative

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utility of the current and future generations, and the expectation that future generations will be wealthier than the current generation. Further, the current generation faces a choice between a number of investment options, such as education and physical infrastructure as well as climate change, which affect the opportunities available to future generations. The Stern Review chose a low discount rate of 1.4 per cent based primarily on one generation having the same weight as another generation and that the marginal utility of wealth declines with wealth. Such a low discount rate favours early and significant emissions abatement. Critics argue for a higher rate, such as is used in choosing investments in education and infrastructure. Clearly, the discount rate is very important, and remains a subject of controversy.

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Many investments affecting the levels of greenhouse gas emissions have long lives, are large and lumpy, and once committed become sunk costs. Examples include electricity generation plants of all energy sources, motor vehicles and aeroplanes, buildings, and R&D. To change these investment decisions, policy interventions to correct for the pollution externality need to have a long-term focus, be credible and be sustained over many decades. At the same time, longer adjustment periods lower the costs of responding to policy and climate change.

Uncertainty and more information It is important to recognise that there is much uncertainty about the marginal external cost and marginal abatement cost functions, both from science and from economics.

Many see mitigation of greenhouse gas emissions as a risk-management exercise. More is known about the costs of mitigation over the next few decades than about the costs of climate change and adaptation in future decades. Indicative numbers provided in the Stern Review point to a strategy of taking some insurance by investing in the relatively low costs of mitigation now to avoid potentially much larger costs of climate change in the future. Further, current policy should note that as more information and more technology becomes available, it may be both desirable and necessary to modify the details of policy interventions in the future in response to the forthcoming information.

Policy instrument choice Economists favour market-based instruments – taxes or tradeable permits – to deal with the external costs of greenhouse gas emissions.

Regulations such as targets on renewable energy and fluorescent light bulbs, and subsidies for selected lower carbon production technologies such as solar power and carbon sequestration, provide signals for reducing emissions on only a fraction of the possible set of demand and supply change options.

effectively provides the recipient businesses with a windfall wealth transfer, with most of the cost then past forward to consumers.

Given the uncertainty about the marginal abatement cost function discussed above, the tax and tradeable permit options have different market realisation implications. The permit system provides certainty on the pollution reduction quantity, but the market price of the permit and the magnitude of business and household adjustment costs is uncertain. By contrast, the tax system provides certainty of the price, that is the tax rate, but it has an uncertain effect on the quantity of emissions reduced. In practice, both options are unlikely to hit the economic efficient production and consumption levels precisely.

Professor John Freebairn is Professor of Economics in the Department of Economics, University of Melbourne.

There are important similarities and differences between taxes on carbon or on greenhouse gas emissions versus tradeable permits on carbon or emissions. Both place a cost wedge between the producer returns and consumer prices of products that involve the external costs of carbon or emissions. The share of this tax passed forward to the buyer or back to the seller depends on the relative elasticities of supply and demand. Since its seems that the long run elasticities of supply of most manufactured products that generate greenhouse gas emissions are highly elastic, consumers will bear most of the economic incidence of the tax or permit.

If the permits are auctioned, government revenue will be about the same with both the tax and tradeable permit options. However, many current proposals, including those in Australia, are to gift some to all of the tradeable permits to current polluters, a grandfathering system. This system

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the economics of sport The claim that professional team sports are no different from conventional industries can be challenged; and whether club owners are profit maximisers or utility maximisers remains an area of debate by peter sloane A condensed version of a public lecture jointly organised by the Department of Economics and the Melbourne Institute of Economic and Social Research delivered at the University of Melbourne on 17 May 2007. The full paper appeared in Rodriguez, P., Kesenne, S. and Garcia, J. (eds), Sports Economics After 50 Years: Essays in Honour of Simon Rottenberg, University of Oviedo Press, 2006.

The economics of sport is some 50 years old.

Simon Rottenberg’s paper on the baseball players’ labour market in the Journal of Political Economy (1956) is generally recognised as the first academic paper to conduct a formal economic analysis of the industry.

There are, in fact, three distinct areas of study: first, professional team sports such as football, cricket, rugby, baseball, hockey and basketball; second, non-team sports such as athletics, tennis, boxing, golf, horse-racing and motor sports; and third, amateur or participation sports. Economists have tended to focus most attention on professional team sports where the allocation of players among different clubs competing in leagues has led to various forms of anti-competitive behaviour designed to achieve some degree of competitive balance. The peculiar economics of such arrangements derive from the fact that a single team can produce no output on its own.

However, economists have also observed cartel behaviour in action with sports leagues, which is rarely possible in more conventional industries because of their illegality under competition laws.

Further, one can also measure productivity of players much more easily than is the case for workers elsewhere, because of the availability of detailed statistics on athletic performance. Non-team sports have been analysed much less, presumably because their allocation problems are less severe.

However, undue dominance may be a problem too, as was the case in Formula One motor racing when Michael Schumacher was winning most races.

Amateur sports involve different issues, being regarded as merit goods because of positive externalities in relation to health and, therefore, subject to government subsidies. Yet, professional sports, more debatably, have also benefited from government assistance. All these activities, however, amount to less than two per cent of GDP in most countries – clearly, the sector is not particularly large in relation to gross national product.

This paper follows Rottenberg in focusing on professional team sports, but also notes the distinction in the ensuing literature between what is referred to as the North American and European models of professional team sports. This literature is extensive as reflected in the fact that there is now an International Association of Sports Economists, the Journal of Sports Economics and several textbooks on the economics of sport.

The North American profit-maximising approach What, then, is Rottenberg’s legacy? The defining feature of his 1956 paper was a belief that the economics of professional sports leagues could be analysed using the same economic framework as for any other industry. But he did note that there were two unusual features. First, monopsony power Insights Melbourne Economics and Commerce

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(which refers to buyer monopoly or control over the player through contracts restricting the ability to move to other clubs) takes an extreme form. Second, competitors must be of approximately equal size if any of them are to be successful. That is, in order to produce a successful product, differences in the quality of rivals should not be ‘too great’. Fans value uncertainty of outcome.

Rottenberg believed that baseball team owners were rational profit maximisers. If one team became too strong it would be in its own interests to allow players to move to other clubs where their output would be more valuable. Hence, he claimed that the free market would be just as efficient as the reserve clause, which limited player mobility, in terms of resource allocation, through what has been referred to as the ‘invariance principle’. Whether clubs do, indeed, attempt to maximise profits, the extent to which uncertainty of outcome matters and whether the invariance principle holds have been much debated in the ensuing literature.

The invariance principle is a version of the Coase theorem, which states that in competitive markets and given that resources are freely exchangeable, the distribution of their ownership is irrelevant in ensuring that they are used efficiently. However, the assumptions of this model are quite restrictive – perfect competition, perfect information, the absence of transactions costs and the absence of wealth and income effects. It is doubtful whether these assumptions hold in the context of a professional sports league in which clubs are local monopolies and particularly so where clubs are of different sizes.

The European utility-maximising approach I challenged the Rottenberg thesis in two papers written in 1969 and 1971. Based on the experience of English professional football, I noted that lossmaking was endemic and clubs seemed to pursue sporting success to the detriment of profits. I suggested a utility maximising model which assumed that sportsmen-owners were more driven by the urge for power or the desire for prestige than in making money, thus treating a sports club as a consumption activity by putting particular 16

The economics of sport

emphasis on playing success. By and large, European sports economists have followed such a model by assuming that clubs attempt to maximise playing success subject to a break-even constraint, whereas in North America, where there is also some recognition that sportsmen-owners do exist, the profit maximisation assumption has prevailed.

Whether clubs follow one or the other objective has implications for the impact of revenue sharing. Since clubs attempting to maximise playing success subject to a break-even constraint will always spend additional income on improving playing performance, more equal revenue sharing will always improve competitive balance. If, however, clubs follow profit maximising behaviour, this outcome is less certain, though more equal revenue sharing is likely to increase the profitability of poorer clubs.

The pursuit of playing success may well result in reduced competitive balance compared to the pursuit of profit maximisation, since if some clubs are successful in winning more games the zero-sum nature of competition means that other clubs will lose more games and likely incur losses.

The pursuit of playing success at the expense of profits may then tend to destabilise the league from an economic perspective and increase the importance of revenue sharing or other forms of cross-subsidisation as a mechanism for attaining competitive balance.

The importance of uncertainty of outcomes The question of whether uncertainty of outcome is important in maintaining fan interest has been the subject of much investigation. Rottenberg suggested that attendances would be a function of the general level of income in a team’s locality, the price of admission, the goodness of leisure substitutes, population size, the location of the stadium, average league standing of the team (i.e. team quality) and the dispersion of the percentage of games won in the league by different teams (i.e. uncertainty of outcome). By and large, subsequent studies have included such variables in regression models designed to estimate and forecast attendances, in a range of team sports, though with variable success, particularly in relation to the uncertainty of outcome variable.

However, uncertainty of outcome can be measured in different ways and may refer to short-run uncertainty of match outcome, seasonal uncertainty in terms of how many teams remain in contention for the title or long-run domination in terms of whether the same team (or teams) wins the title in successive seasons. Few studies include all these measures or interact them. Uncertainty of match outcome also needs to allow for home advantage, so the most even match will occur when the away team is somewhat stronger than the home team. Also, season ticket holders make their decision prior to the start of a season and this must be based on the performance in the previous season and expectations prior to the start of the current season, whereas those who purchase on the day will be influenced by recent performances. A further problem relates to stadium capacity. If there is a full house then one is not able to observe the true demand curve. For such reasons it is perhaps not surprising that the uncertainty of outcome variables used in attendance models have not always been significant and where they are significant the effects are often small.

Improving the measurement of such variables is an important area for future research.

Revenue sharing arrangements The actual arrangements for revenue-sharing differ across the various sports. In North America, the National Football League (NFL) is the most equal with gate revenue divided 60 per cent to the home team and 40 per cent to the away team. In baseball, the division is 80:20, and in the National Basketball Association (NBA) it is 100:0.

Accordingly, it has been found that competitive balance is higher in the NFL than in the NBA. In Europe, 100:0 is the norm and it is interesting to speculate why gate revenue sharing should be less pronounced in Europe than in North America.

The major source of revenue in most sports today is television. In North America, collective selling of television rights was sanctioned through the passing of the 1961 Sports Broadcasting Act, which enables the major leagues to divide national television income equally among the clubs. The current NFL contract is the richest in the world, amounting to US$3 billion per annum.

In Europe, the collective selling of television

contracts is a more contentious issue. In Spain and Italy, such arrangements are outlawed, whereas political intervention in France and Germany has permitted them. In England, the English Premier League was successful in defending collective selling before the Restrictive Trade Practices Court, but subsequently the European Union has insisted that the product must be offered for sale in a number of bundles to allow more than one broadcaster to obtain the rights. The English Premier League shares 50 per cent of its television income equally among member clubs – 25 per cent on the basis of league position (positively) and 25 per cent on the basis of a facilities fee related to the number of times a given club’s games are televised. While this is claimed to be relatively equalising, the growth in the relative importance of this source of income means that it has become less equal over time. Thus, according to Deloitte (Annual Review of Football Finance, 2004, London), sources of revenue of English Premier League clubs in 1992 were £82 million from gate receipts, £15 million from broadcasting and £73 million from commercial activities. By 2003, these figures had risen to £363 million, £543 million and £340 million respectively, representing growth ratio of 342 per cent for gate income, 3520 per cent for broadcasting income and 365 per cent for commercial income. Television income now dominates other sources of income.

This has impacted strongly on the amounts shared amongst the clubs. While the ratio of television income of the top club to the bottom club rose from 2.2 times in 1992/3 to only 2.4 times in 2003/4, the absolute difference increased from £1.3 million at the start of the period to £19.4 million at the end of it. The gap will be even greater under the most recent three-year contract in operation from 2007–2010, which totals £2.7 billion. This guarantees a Premier League team at least £40 million per annum and increases the gap between clubs in the Premier League and those in the Football League from which promotion and relegation operates for the three bottom and top teams respectively. Further, the top three or four Premier League Teams gain entry into the Union of European Football Association (UEFA) Champions League (and the teams just below to the UEFA Competition), substantially increasing the income Insights Melbourne Economics and Commerce

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of the top clubs relative to the rest. Thus in 2004 the top three clubs – Manchester United, Arsenal and Chelsea – obtained a total of £56 million from European Champions League Broadcasting revenue.

Salary caps This has caused UEFA to consider the introduction of salary caps, even though these would be difficult to administer in a European context, given the differences in the sizes of clubs across participating countries. These are commonplace in North America and amount to a form of revenue-sharing between teams and players. They are not to be confused with maximum wages for individual players as existed in the English Football League up to 1961 and which have been applied in the NBA for certain players. In the case of salary caps, the parties agree upon defined gross revenues for sharing purposes and what share will go to the players.

In some cases there are ‘hard’ caps, which means equal wage bills without exceptions, and in other cases ‘soft’ caps, which may allow exceptions (e.g. free agents who re-sign for the same club do not count against the cap). A minimum of spending close to the cap may also be required to prevent owners from simply pocketing the wealth transfer, though this would seem to be less necessary if clubs are win maximisers subject to a break-even constraint. Regardless of the objective function of the club, there is a strong probability of cheating, since clubs are prevented from being at their preferred position in terms of winning percentages.

There are examples of this in all sports that have implemented such arrangements.

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Summarising the differences We have already pointed to certain similarities and differences between North American and European leagues, often referred to as the North American and European Models. These may be summarised as follows.

– In relation to objectives in the North American Model, profit maximisation is regarded as the norm, while in the European Model the norm is utility maximisation subject to a profit constraint.

– In North America there are closed leagues with each club given a franchise, whilst in Europe there are open leagues with promotion and relegation.

Each has its advantages and disadvantages.

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Open leagues are likely to raise team quality as the fear of relegation with its consequent financial costs will force lower teams to strengthen their squads, whilst the possibility of promotion will encourage the better teams in the lower league to do likewise.

Promotion and relegation will also raise fan interest as a higher proportion of games will matter in terms of teams being in contention for either league championship or relegation. However, open leagues make it more difficult for clubs to choose their preferred win-loss ratio and force a departure from an optimal distribution of teams, as teams of higher quality than those promoted may be relegated. Comparison of the relative merits of the two types of league is, however, difficult as there is a relative over-provision of clubs in Europe relative to North America.

This leads to a third difference, namely size, as there are a restricted number of clubs per head of population in North America compared to Europe.

A fourth difference relates to the geographical pattern of clubs. In North America, clubs have exclusive territories, but franchise mobility, whilst in Europe there is restricted geographical movement of clubs. This enables clubs in North America to move to other locations where potential attendances are perceived to be greater, though they may have to compensate other franchises in order to do this.

A fifth difference is the role of international competition, which is important at both club and national level in Europe, but absent in North America. This has led to conflicts in Europe between club and country, as players may get injured playing for their national team without compensation to the club. Participation in international club competitions also means that it may be necessary for clubs to be ‘too strong’ for their domestic competitions in order to challenge for international competitions, a possibility ignored by Rottenberg in his analysis of baseball.

In North America, player drafts are commonplace whereby clubs are entitled to pick the most promising young players in reverse order of team finish in the previous season in order to improve competitive balance. Such arrangements are absent in Europe.

The sale of players for cash is commonplace in Europe, whereas restrictions on sales of players for cash apply in North America.

– Roster limits on the number of players contracted to an individual club are extensively used in North America, but are absent in Europe.

– As mentioned earlier, a ninth difference is the more extensive use of revenue sharing in North America than in Europe.

– Salary capping is also more extensive in North America than in Europe, though here the gap appears to be narrowing.

– Finally, in Europe there has recently been a trend for clubs to float on the stock market, while in North America this possibility is restricted.

Interestingly, there is no evidence that this has changed objectives more towards profit maximising behaviour and the payment of dividends to shareholders has been infrequent.

Further, a number of clubs have been taken over and subsequently delisted. This has not prevented some economists from suggesting that the two models are converging, a process that may be accelerated by the takeover of several English Premier League clubs by American entrepreneurs.

Where does Australia fit in?

It is interesting to speculate whether there is a distinctive Australian model. Australian sports economists have tended to favour the utility maximisation model preferred in Europe over profit maximisation, but in other respects Australia seems closer to the North American model with closed leagues, player drafts, extensive revenue sharing and soft salary caps.

What is clear, however, is that in all three cases there has been a conflict, particularly in the labour market, concerning restrictions on the freedom of the players to move from one club to another, both in relation to the law and competition policy. In North America, baseball escaped from the rigours of the anti-trust legislation though a 1992 Supreme Court decision, widely criticised, that Major League Baseball was exempt from such policy as it was not engaged in interstate commerce. A negative court case in relation to the collective selling of broadcasting rights was overturned by the passing of the 1961 Sports Broadcasting Act and the reserve clause was only weakened substantially as a result of collective bargaining in the 1970s. In Europe, the Advocate General in the 1995 Bosman case before the European Court of Justice found that the existing retain and transfer system was unlawful as

the Treaty of Rome required free mobility of labour, and following discussions between EUFA and the European Union a modified form of player contract was introduced.

The European Union stance is based on these general principles: to take account of the special characteristics of sport, to apply the competition rules in a manner that does not question the regulatory authority of sporting organisations with respect to genuine sporting rules, and to preserve the social and cultural functions of sport.

It is true to say, however, that European Union policy has been much more interventionist than anti-trust policy in North America. In Australia, a number of court case decisions have found restrictions on player mobility to be in restraint of trade, illustrating the common problems facing sporting organisations in attempting to restrict competition in order to assist competitive balance.

Assessing Rottenberg In conclusion, Rottenberg’s analysis has had a major impact on the ensuing literature on the economics of sport, but it is based on the assumption that competitors are of approximately equal size, which is less true in Europe than it is in North America. His claim that professional team sports are inherently no different from conventional industries can certainly be challenged and whether club owners act as rational profit maximisers remains an area of considerable debate.

The highly visible nature of professional sports leagues is likely to keep them in the spotlight as far as public policy is concerned.

Perhaps, however, there is scope for more economic analysis of non-team sports and participatory sports, which have been relatively neglected by economists in the past.

Professor Peter Sloane FRSE is Research Professor and Director of WELMERC, a centre for labour market research at the University of Wales, Swansea. He is VicePresident of the International Association of Sports Economics and member of the editorial board of the Journal of Sports Economics.

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a comparative view of unions, involvement and productivity There is room for performance pay, but it does not necessarily succeed in a vast majority of cases by john s heywood

A condensed version of the Miegunyah Public Lecture delivered at the University on 1 August 2007.

Introduction Recent years have witnessed the individualisation of employment relations in many countries, and an integral part of this process has been the increased use of performance pay. Unions in many countries have historically objected to performance pay for theoretical, moral and practical reasons.

Yet the transformation to high performance workplaces and increased market competition have ‘demanded’ performance pay as a response. While substantial variation exists across countries, it is clear that unions are increasingly accepting performance pay as a reality, and participate in its creation, design and enforcement. The employment relations systems that allow for this participation will reap the benefits.

The thesis of this paper is not that performance pay is a panacea or even that it necessarily succeeds in the vast majority of cases. Instead, it proposes: that room exists for more performance pay in most industrial democracies; that on average there are net benefits to such schemes; and that those benefits tend to be larger and more likely when workers are involved in the process. As a consequence, unions in several countries have begun to work towards performance pay that makes sense for workers and provides value to firms.

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There is room for more performance pay The suggestion that additional performance pay might be welcomed by workers is based on two sets of empirical findings. First, in the abstract, workers would like to have their pay based on performance to a greater extent than prevails currently. Second, the job satisfaction of those workers actually receiving performance pay is typically greater than those who do not receive performance pay. Let me turn to each of these findings.

In an international survey, workers from a wide variety of countries are asked to describe the setting of their earnings in two ways: one, the determinant of their earnings that they think should be the most important; and two, the determinant of their earnings that they think is actually the most important in practice. The extent to which performance is identified as the most important desired determinant varies substantially across countries (with the US at the highest) but a general pattern emerges. Within most countries, more workers identify that performance should be the most important determinant than they identify that it is the most important determinant. This is one indicator of the room for greater emphasis on performance.

This international survey evidence is matched by detailed within-firm studies and by matched employer-employee surveys. Korea presents a particularly dramatic example. Korean workers were asked to identify the variation in earnings they thought would be appropriate for the best and worst performing worker doing the same type of work within their firm. The resulting figure of more than 25 per cent was then compared with the actual differences within the workers’ firms as reported by the relevant human resource managers.

That figure was only about 7 per cent for nonmanagerial workers.

In a slightly different approach, a representative sample of Korean workers were asked to allocate 100 points across a series of potential earnings determinants as a method of expressing their preferences on how pay should be set. They allocated around 30 points to performance with others to education, tenure and so on. The human resource managers were asked to allocate 100 point across the same series of earnings determinants to describe how pay is actually set in the workers firms. Only a handful of points (less than 10) were allocated to performance.

The Korean case is interesting because the use of performance pay has typically been fairly low, but has been increasing as employment relations are becoming more individualised. Also important is that more than two-thirds of Korean workers want more say in how earnings are set, even if the overall level of compensation remained the same.

The second body of research suggests that those who work under performance pay tend to have increased job satisfaction. A series of studies in Australia, the UK, Korea, Germany and the US broadly indicate that in cross-sectional studies, holding other determinants constant, those workers with performance pay have higher job satisfaction. In the US data, people who were paid tips, commissions, stock options or bonuses reported higher job satisfaction, even controlling for total pay. Women paid piece rates report no difference after controlling for pay. For men, piece rates are associated with lower satisfaction, after controlling for pay but not before. Controlling for pay is important, as it suggests that the higher

earnings associated with performance pay is not the only source of increased satisfaction.

Longitudinal studies of job satisfaction have been done in the US and UK. These studies control for the characteristics unique to each worker in the sample. In essence, they examine the change in job satisfaction as specific workers move between jobs with and without performance pay. In these studies, performance pay continues to be associated with greater job satisfaction.

The point of reviewing these studies is not to suggest that workers will always be pleased with performance pay. Surely, bad performance pay schemes are worse than none at all. The point is to suggest that, on average, workers tend to accept the idea that pay and performance should be linked. Moreover, the extent to which they would like to see this linkage often exceeds the extent to which it actually happens. Even after encountering performance pay with all of its potential pitfalls, the typical worker is not dispirited and, if anything, is motivated and reports greater job satisfaction. Thus, I take as a starting point that there will often be scope for more well-structured performance pay.

The promises and pitfalls of performance pay Performance pay is associated with higher earnings. This is apparent in both cross-sectional and longitudinal data. Moreover, other elements of compensation such as fringe benefits are not substantially reduced. Thus, overall compensation increases in response to performance pay. Behind this increased compensation is the increase in productivity that is usually associated with performance pay. The nature and cause of increased productivity varies by type of performance pay, but I will suggest some of the variations that exist.

In a well-known study of a windscreen installation company, the increased productivity from a new piece-rate scheme came from two sources. First, the scheme attracted more productive workers.

Second, retained workers responded to the incentives and increased their productivity. It is

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important to note that just because productivity may increase, profit need not always increase and it is not suggested that piece rates work everywhere. In some cases, more sophisticated performance pay – emphasising teams or multiple objectives – may be needed.

Indeed, these alternative pay schemes have been associated with internal flexibility. Researchers have found an association between performance pay (especially team-oriented pay) and flatter hierarchies, shorter decision times, fewer rules, greater worker responsibility and greater ease in reallocating resources within the firm.

A merit pay system that attempts to recognise these problems has advantages but brings its own problems. Managers may concentrate on only recent performance. They may also be strategic in their rewards and use of the system. For example, rewarding only those who support the manager, or attempting to signal to the manager’s superiors that all workers are above average or that none deserve promotion, and so on. Finally, there is US evidence that racial and ethnic characteristics may play an independent role in performance appraisal.

Even more generally, performance pay is recognised as part of an overall appraisal system.

The purpose of such appraisal, reinforced by performance pay, is to better allocate workers to jobs, to make promotion and retention decisions, to guide worker development and engage workers in organisational goals.

Group schemes have uncertain consequences but it is well known that workers may free-ride on the efforts of others, causing the direct incentive to be greatly diminished. Even when peer pressure reduces such free-riding, the peer pressure itself can be so substantial that worker utility is reduced by the scheme.

Finally, performance pay (especially profit sharing) is associated with labour costs that vary over the business cycle. This reduces both redundancy and unemployment. Moreover, the reduced probability of separation has been shown to imply longer employment relations and greater investment in worker training.

Again, even such a brief review suggests the ways in which performance pay can malfunction.

Indeed, several commentators suggest that performance pay is an expensive undertaking that only succeeds in making everyone unhappy. Yet the real issue is how to maximise the evident potential from performance pay and minimise the equally evident pitfalls.

As even such a cursory review indicates, the use of performance pay has great potential to benefit both workers through greater earnings and firms through greater productivity and potentially profits. Yet, performance pay comes with the risk of substantial pitfalls as well. Again, the pitfalls vary by the type of scheme but it is worth presenting a short itemisation.

Individual performance pay runs the risk of rewarding only one or a few of the many productive activities that firms want workers to engage in. The resulting ‘adverse specialisation’ means that workers allocate too much effort to those productive activities that are highly rewarded and require the least effort. Thus, workers paid by the piece may ignore product quality, safety, maintenance or customer relations.

Any worker paid performance pay or given promotions based on individual performance may

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also have little or no incentive to help co-workers, such as providing informal training.

A comparative view of unions, involvement and productivity

Worker involvement as an element of success In thinking about the use of performance pay, Germany provides an interesting illustration.

German manufacturing has an extremely high incidence of piece rates and performance pay. It does so in the production of high value products which compete in a world market based largely on their quality. On the face of it, this might seem unlikely. The reason it prospers is, at least in part, due to the institutions of worker involvement. The German works councils are given statutory codetermination over the creation and management of piece rates. The consequence is that German workplaces that have works councils are both more likely to have such performance pay and the schemes last longer than

in workplaces without councils. The performance pay systems can be made transparent to workers and can be independently verified. As such, there is reduced fear of ratchet effects in which the rate is arbitrarily decreased as workers put forth greater effort.

The German experience is not unique. Even within the more decentralised environment of labour relations in North America, there is evidence that performance pay (gain sharing, in particular) is more likely, generates more productivity and is longer lived when a union is present and involved in the creation and administration of the plan. In addition, more information is shared when compared to either a non-union establishment or one in which the union is not involved. In general, workers have valuable information that may help in the creation of effective performance pay. In addition, worker organisations can create confidence in the process of their establishment and the fairness of their administration.

As a consequence of these types of interactions, it is not suggested that every union (or workers’ organisation) will object to performance pay.

Certainly, in examining the empirical evidence on the determinants of using piece rates or individual performance pay, there is simply not a uniform negative relationship with unionisation. Across the US, the UK, Korea, Germany and Australia, the typical estimated coefficient on unionisation as a determinant is insignificantly different from zero.

This does not mean that some unions are not greatly opposed. It simply means that others are more receptive.

Indeed, it may be fair to suggest that in Europe there has been a growing acceptance among unions of the need for performance pay and the need for unions to be involved in them. The Italian Confederation of Workers’ Unions stresses the importance of second-level agreements below the sectoral level that deal with performance pay as an important issue related to competitiveness.

Danish, Swedish and Norwegian unions are credited with ‘essentially accepting variable pay’ as a norm, on the condition that it is transparent and regulated. Irish unions are ‘strongly in favour

of variable pay’ provided that similar conditions are met. They see performance pay as a way of securing a fairer share of gains and an effective way of making ‘workers as stakeholders.’

Even in Korea, there have been calls for reinvigoration of the labor-management committees to deal with issues of performance pay. The point is that worker institutions need to be sufficiently strong to become meaningfully involved. A routine and secure way for workers to be involved in the creation of how they are paid is needed. This involvement has the best chance of increasing the potential and decreasing the pitfalls associated with performance pay.

Conclusions There exists room for additional use of performance pay from the perspective of workers.

Performance pay has the potential to increase the earnings of workers and the surplus for firms. Yet, poorly designed or implemented performance pay can have severe and negative unanticipated consequences. The earnest involvement of workers can help reduce the chance of these consequences.

For such involvement to take place, labour market institutions must be allowed meaningful involvement in the creation, administration and alteration of performance pay schemes.

It seems apparent that the use of performance pay around the industrialised world will increase, and the issue is the extent to which such pay will be top-down or, instead, be collaborative. It is the latter that has a greater chance of long-term success in a wider variety of workplaces.

Professor John Heywood is Professor in Economics and Director of the Graduate Program in Human Resources and Labor Relations at the University of WisconsinMilwaukee. The author thanks Michelle Brown and Uwe Jirjahn for their friendship and recognises the debt owed to his joint work with each in developing this paper.

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the world before public affairs Business is under increasing pressure to serve society by david merrett A condensed version of the Centre for Corporate Public Affairs Oration, 29 June 2006.

A fuller version is published in The Melbourne Review, 2, 2, 2006.

Victims of ‘corporate criticism’ and ‘regulatory activism’?

My views are those of an ‘outsider’, as someone looking into the world of corporate public affairs.

However, I have spent the greater part of my professional life studying Australian business, particularly big business. In preparing for this talk I was struck by the defensive language used in the Corporate Public Affairs publications. While the public may see the ‘big end of town’ as enormously powerful, I get the sense that many businesses see themselves as innocent victims of ‘corporate criticism’ and ‘regulatory activism’.

Was business always under the sorts of pressures it feels today? Why are so many government agencies and social movements ranged against it? My aim is to give you my interpretation of why Australian business, from a corporate public affairs point of view, was able to lead a charmed life up until the 1960s and 1970s. This raises the question of why business has found itself in a more adversarial role subsequently. Finally, I shall speculate on whether the situation is likely to change.

All of the issues that currently inspire ‘corporate criticism’ and ‘regulatory activism’ have been around for a very long time. Economic development left scars from the first days of European settlement. Trees were cut down, cleared land became subject to wind and water erosion, irrigation resulted in salinity, native grasses were eaten out, introduced fauna and flora replaced some native species, Aboriginal people were displaced, mining activity choked streams and rivers, and

manufacturing processes produced hazardous air and water-borne wastes. Some of the newer chemicals were poisonous, while coal fired power generators and leaded petrol did harm. Uranium was mined. Adulterated food products, flammable children’s clothing and dangerous electrical appliances were sold to the public. The economy became populated by monopolies, and anticompetitive behaviour was rife. Businesses failed and swindlers parted investors from their money.

The circumstances pre-1960s My point is that none of the concerns I mentioned above fuelled any widespread anti-business feeling before the 1960s. Certainly, none generated the ‘traction’ that would be the norm today. There were opposition groups that coalesced around particular issues from the late nineteenth century: the environment and Aboriginal people had their champions; there were calls for banking reform from the 1890s; radical pamphleteers attached monopolies and ‘trusts’ from around the First World War; and in the 1930s country housewives pioneered what became the modern consumer movement.

Business has always been engaged in a dialogue with governments. For the most part, business got what it wanted. Access was not a problem. In the words of Geoff Allen, ‘For most of the past century the unchallenged concentration of political power in the hands of a few top bureaucrats and senior Ministers had made policy advocacy a relatively simple and direct matter.’ Moreover, the flourishing industry-specific regulations – tariffs,

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subsidies to rural producers and manufacturers, occupational licensure, entry restrictions into liquor retailing and so on always favoured the interests of producers over those of consumers. So much so that such arrangements have been roundly criticised as ‘rent seeking’ and explained by ‘regulatory capture’.

Why was business immune to sustained criticism and challenge in the past?

One part of my explanation rests on the slow speed with which big business emerged in this country.

Their coming posed no general threat to the existing order, indeed until after WWII government enterprises were far larger employers.

In the US, by contrast, giants such as Standard Oil, US Steel, AT&T, the railways and so on, burst onto the national stage in the last decades of the nineteenth century. Their size and power prompted government regulation. Australian business continued to be perceived as being ‘partners’ and ‘citizens’ until the 1960s and 1970s.

Unlike their American cousins, local businesses were securely grounded within the myths surrounding national identity.

The unifying story about the Australian experience throughout the nineteenth and much of the twentieth century has been one of ‘progress’, ‘nation building’ or ‘national development’, the latter including notions of modernity and national security. Art, literature and political rhetoric sought to interpret and legitimate this pioneering endeavour. It was a world in which everything had to be built from scratch, literally and figuratively.

The wilderness became a garden, ordered and productive. Towns and cities rose up from rude hamlets to possess all the accoutrements of civilization and culture. A new order emerged.

There was pride in achievement and a sense of confidence in the future. The story was one that fused individual and communal effort and reward.

That optimism was punctured temporarily around the turn of the twentieth century. A combination of labour unrest, bank crashes, a serious depression and calamitous droughts signalled the need for a new social and political compact. Nation building

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required new institutional developments.

Federation united the Australian colonies in 1901.

In the context of a new national parliament, a twoparty system emerged replacing the factional politics of the past. By 1909 an agreement had been hammered out between labor and its conservative opponents that would give direction to Australian politics until the 1970s. Australian turned inward: White Australia and tariff protection excluded unwanted visitors and competing goods. Moreover, the state would determine needs-based wages and provide welfare.

Governments would continue to promote national development through the encouragement of immigration and the building and operation of national infrastructure.

Where does business fit in these national myths?

Business, in the form of the family farm, the stock and station agency, the small engineering firm and the corner shop, was the key instrument in the process of pioneering, building the economy, populating and civilizing. The emergence of large organisations, the big end of town, added weight to the story rather than over-turned it.

Manufacturing came to have a special significance throughout the first half of the twentieth century as the growth of agriculture and mining slowed.

Firstly, it was widely believed that only industry could provide jobs on a scale that would allow for continued population growth. More importantly, manufacturing was science-based and ‘modern’, a symbol of a civilized and powerful society.

Industrial strength also promised the national security that Australians craved.

These ideas about manufacturing were communicated to the Australian people through a wide variety of media. Books such as Roy Bridges’ From Silver to Steel: The Romance of the Broken Hill Proprietary, published in 1920 and Ambrose Pratt’s The National Handbook of Australia’s Industries (1934) celebrated these achievements in word and picture, this was a story about ‘production’ rather than ‘brand’. The marvels of modern engineering such as the transcontinental railway (1912-17), the Sydney Harbour Bridge (1924-32) and the Snowy Mountains Scheme (1949-74) were widely reported in the press,

lionised in books and shown in newsreels in cinemas. It’s a tale of modernity and scale, a story of national pride and reassurance.

The 1960s and 1970s These beliefs about the world were challenged in the 1960s and 1970s. One of the most profound changes was the rejection of the prevailing economic orthodoxy, the Keynesian-consensus, which had legitimated government intervention in the economy. By the 1980s there had been a sea change in the nature of Australia’s political compact. The old order of inward-looking protected business, needs-based wages and a welfare state, was rejected. It could no longer produce full employment, low inflation, or generate a growth of personal income to match that of other OECD countries or Asian dragons. Bureaucrats and politicians were seen to serve their own rather than

the public interest. Business had fought hard alongside the conservative side of politics to achieve the brave new world of small government, deregulated markets and individual freedom.

The decades of the 1960s and 1970s also saw the rise of the issue based movements such as the consumer movement, Aboriginal rights, the environment, the peace movement, the women’s movement, gay rights and so on. As Ian Marsh reminds us in his excellent book, Beyond the Two Party System: Political Representation, Economic Competitiveness and Australia Politics (1995), the ideas that stimulated these movements within Australia were imported from abroad. In many cases, the movement’s ‘formation was stimulated by a seminal book – a kind of secular tract that served to galvanise popular concern about, and understanding of an issue and to suggest a program of political action.’

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The corporate public affairs challenges facing the resources industry provides the starkest example of changing public attitudes. Geoffrey Blainey’s popular histories of mining in an earlier era are located on the mining fields in outback Queensland, Broken Hill and north-western Tasmania rather than in Collins Street. They resonate with the enduring myths of pioneering and a benign technology. Moreover, heroes in these stories are the individuals living and working in distant communities, not the companies. Compare these sympathetic portrayals with the welcome given to resources companies from the mid-1960s onwards. The development of new mines in the remote parts of northern Australia might have struck a chord with the retelling of the old stories. Instead, they have found themselves in battles with peace activists, environmentalists and Aboriginal rights groups.

Business was challenged in new ways. New regulatory agencies sprang up in the 1960s and 1970s giving legislative force to the concerns of the issues groups, the environmental protection agencies, consumer affairs in the trade practices legislation, occupational health and safety and so on. Science, once the hand maiden of progress, now provided ammunition to its enemies.

Cherished notions of development, expansion and growth were challenged by new metaphors such as the ‘limits to growth’ or ‘space ship earth’. Old stories of taming the wilderness to make it productive were countered by allegations of environmental destruction. Environmental impact statements became the order of the day. Tobacco and asbestos manufacturers began a long retreat.

The affairs of companies are subject to a multitude of new regulations.

Did business win a pyrrhic victory in the acceptance of a new social order, the world of individual liberty and small government? Taxes are lower and unions less powerful. However, it is hard to see that the level of government regulation has decreased – one sort of regulations have been swapped for another. On a more fundamental level, it is more difficult for business to make a case about its social worth in the new environment. The point is eloquently made by

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The world before public affairs

the eminent scholar Carl Kaysen in his introduction to The American Corporation Today (1996) when he writes ‘it is not only government as an instrument that is widely seen as inherently flawed; it is the idea of social interests and social goals other than the result of essentially selfreferential individual choices that is widely suspect. This view is … often cast in populist terms: any attempt to define social goals beyond the aggregate of individual desires is termed “elitist” and attacked accordingly.’

In the new world that champions individualistic choice, the overwhelming responsibility of business is to offer ‘value’. But to whom? The shareholders and customers have been the winners. However, the bonds of citizenship and community have been loosened. Australian-based firms may seek competitive advantage by downsizing, outsourcing and moving their operations offshore. Globalisation has meant access to cheaper goods and services, and better quality. Part of this gain has come at the expense of Australian workers and suppliers. Firms are increasingly ‘foot-loose’, their location decisions are driven by the needs of the bottom line rather than to a commitment to a community or neighbourhood. Many of the firms that provide jobs are foreign owned, whose shareholders have little concern about the local consequences of their leaving for greener pastures elsewhere.

How does business demonstrate that it serves society where there is no consensus about social goals? What is our sense of ourselves as Australians?

The pre-1970 myths and stories about business had enormous power because they gave business a privileged place as contributing to universally held national goals, progress, modernity and security at both the individual and national level.

Business was seen to deliver. That it did so muffled criticisms about the ‘costs’ arising from its activities.

Will business continue to operate in a world where it perceives itself to be without friends?

Have the social issues groups won the battle for

the hearts and minds? From my perspective, I do not see business as likely to lose its ‘licence to operate’ in this country. Public affairs professionals have played their part in blunting criticism and negotiating with governments. Moreover, business is indispensable to the community. There is no viable alternative. Socialism was rejected by the Australian electorate in the mid-twentieth century and communism is totally discredited as an alternative to capitalism. Business continues to generate profits, exports and jobs, and buys from local suppliers. Successful companies underpin the high standards of living in this country. Business is too important to be allowed to fail, a point made by the American political scientist, Charles Lindblom, in his influential Politics and Markets: The World’s Political Economic Systems, published more than 30 years ago.

capabilities of domestic firms and industries.

Venture capital and incubators are new version of old stories of start ups. Collaboration between government, scientific research institutions and business building hubs, clusters and networks is another form of community building. The outcome of this engagement with the wider world matters to all Australians. The stories of national development and business are still inter-woven.

You need to find ways of telling them.

Professor David Merrett is in the Department of Management and Marketing at the University of Melbourne.

Can business recapture the position it held for so long as a valued and trusted partner within the community? That it once did so resulted from its inclusion in powerful stories and myths about national identity. The challenge for business today is to tell a story about what it does that fits into a wider national story. However, the ongoing ‘culture wars’ – the clash over the interpretation of the past – signals that here is disagreement about who we are, how we got to where we are now and where we are going.

The way forward is to build bridges with the past.

The old powerful story is about the taming of a continent, albeit with the damage done to it along the way. It is a story of going inland. We need a new story to make sense of Australia’s place in globalising world, a story of going out as exporters, partners in supply chains and as multinationals. Globalisation poses challenges as great as those in the first stage of ‘pioneering’.

Then we faced challenges of understanding a new continent, coping with its distance, heat and lack of water. Now the challenges come from having to find ways to compete in the wider world. All the virtues of the old story are required now: determination, resilience, the ingenuity to make do with little, and an optimism that you will eventually succeed. Immigrants, individuals and multinationals, play their part in developing the

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are delays in tariff-reduction programs ever economically rational?

Can economic theory be used to resolve the tricky issue in trade policy, of whether pre-announced reductions in trade barriers should ever be suspended or reversed? by neville r norman

A shortened version of a paper given at the Conference on Regulation, Governance and Markets in Small, Open Economies organised by the Department of Economics, University of Melbourne and the National University of Singapore on 14-15 December 2006.

The full paper is available at http://www.ecom.unimelb.edu.au/research/publications/ nus_symposium/joint_symposium.html

Trends in world trade policy Two striking features of trends in world trade policy since about 1990 are: 1. Significant, often spectacular, reductions in announced and actual nominal tariff rates; and 2. Delays and reversals in the actual tariff reductions and often the replacement of import-duty protection by other protective measures.

The first trend seems fully in accordance with economist textbook demonstrations that freer trade enhances national and world welfare. The tariff reductions arose from unilateral actions, multi-lateral agreements, such as China’s requirements to attain membership of the World Trade Organisation (WTO), and the succession of bilateral free-trade agreements (FTAs) between pairs of countries and trading blocs. The most spectacular recent example of significant reduction in tariff rates must be China’s nearremoval of very high nominal tariffs. In 1996, import duties applied to foreign motor vehicles entering China were 80 per cent and 100 per cent, depending on engine capacity; while more

recently they sit at 12 to 15 per cent. Australia’s car import duty rates were reduced from 57.5 per cent in the late 1980s to 10 per cent at present.

The second trend appears as a politically driven contradiction of the first trend, with no apparent foundation or support from economic analysis. A clear example of delay in the pre-announced program of tariff reductions occurred in the early life of the Howard Government in Australia. In 1998, substantial delays were applied to textile, clothing and footwear tariff reductions and to those applying to motor vehicles. Much earlier, the Whitlam Government’s 25 per cent acrossthe-board tariff reductions in July 1973 were followed by exchange rate, tariff and quota responses within two years that effectively reversed the tariff reductions.

The gaps in standard economic analysis Standard economic analysis does not accommodate either time delays (or any specific chronology), or adjustment burdens imposed on specific sectors, regions, businesses or individuals. Accordingly, any significant emphasis upon those adversely affected by tariff-reduction programs and policy

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responses designed to address their plight can easily be branded ‘purely political’ responses that delay reaping the consumer benefits of lower tariffs. Press reports from journalists and some economists following the Howard delay decisions in 1998 said exactly this. Somewhat grudgingly, it was said that such delays might be the only political course to attain the goals of eventual free trade. We can call this the ‘adjustment burdens and adjustment costs’ political justification for delays in tariff reduction programs. In a broad sense it is also an economic argument, if one accepts that the political alternative is a return to the starting point before tariff reductions, as in the Whitlam example cited above.

Attempts to fill the gaps Some attempts have been made by economists to incorporate this adjustment burden argument into formal economic models. In many ways, economistsare responding to a huge challenge laid down by the prominent Canadian economist, Harry G. Johnson, whose writings and seminars dominated international economics in the 1960s and early 1970s. Johnson claimed that while politicians accepted the case for delaying tariff reductions, such policy responses were not derivable as policy-optimal from any formal economic models. He issued this challenge at international conferences, such as the 1969 Monash International Trade Conference organised

by Ian MacDougall and Richard Snape, and the 1972 Cambridge World Development and Trade Conference organised by Oxford economist Paul Streeten. Johnson’s challenge does not seem to have appeared so bluntly anywhere in print.

One approach is to ascribe time paths to potential economic activity, with three relevant scenarios: 1. A control state where tariffs are left unchanged.

Overall economic activity (say, real GDP), product prices and measure of welfare stay constant or grow at some pre-determined growth rate; 2. A radical one-off elimination of tariffs, with significant short-term adjustment costs and delays, as immobile and specialised resources are retrenched from import-competing sectors

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Are delays in tariff-reduction programs ever economically rational?

and take time to move to, or be retrained for production in, the efficient/export-competing sectors, if ever. Real national production reaches greater heights, eventually, than under the control scenario, the difference being the long-term gains from trade, which incorporates the main message from standard (static) economic analysis of tariffs in a more realistic dynamic setting; and 3. A staged or sequenced set of partial tariff reductions that takes longer to attain the static gains from trade. However, this strategy cushions the adjustment costs and makes it more ‘politically’ acceptable.

Some writers have explicitly allowed for adjustment costs. However, such factors are not part of the conventional or accepted literature. An important ingredient of any time-based approach to policy analysis is to incorporate present values by applying discount rates to time-specific economic variables. This procedure has the immediate consequence of favouring strategies that delay the bad news (adjustment costs) even though part of the good news (gains from trade) is also delayed.

It also demonstrates how impatient policy propensities (high discount rates) will justify delayed rather than full-throttle tariff reductions.

In formal terms, the delays are economically optimal, at least from the standpoint of individual nations. There are important pointers here for negotiators of free-trade agreements and also for the role and relevance of formal economic analysis.

There is another aspect of tariff reduction sequences that offers a completely different potential economic justification for delaying tariff reduction. It is not based on political responses or adjustment delays, or even significantly on present-value considerations. Rather, it arises from a close treatment of business investment responses to the alternative tariff-reduction scenarios. Once again, it is not easy or not possible to incorporate such aspects into standard trade and tariff theory.

It is important to understand why this is the case.

Assumptions of classical tariff theory Classical tariff theory implicitly supposes that the capital stock is fixed and given in what is

ostensibly a stationary-state economic model driven by comparative static policy experiments.

There is by definition zero business investment activity, other than capital stock replacement and maintenance. Consistently, there is no incentive for the perfectly-competitive firms to embrace profitseeking extraneous activities as free entry negates any potential advantage they might seek. A broader world of multi-national firms operating in oligopoly markets with product differentiation and entry barriers offers richer opportunities. In this setting, there is potential for cost-reducing aggressive business investment and technology strategies to be adopted under the ‘delay’ scenarios to a fuller degree than under the full-throttle scenario. This is exactly what firms like General Motors argued to support the delays in tariff reduction in Australia in 1998. An important further consequence of the business setting we envisage is that costs and prices of (imperfectly-) competing products can be different, both from each other and over time. This feature is not consistent with standard tariff theories that invoke the ‘law of one price’ for all relevant products in every relevant market.

The case for modelling costs Economists and other observers are wise to be circumspect about the arguments advanced by protected interests for delaying tariff reductions.

This is why a return to modelling the full consequences of the tariff delays seems highly desirable. The two main questions that economists should ask are: 1. Would the cited business investment have happened anyway under the more radical reduction scenario?

2. Would the cited business investment detract from other/better uses of the same funds in other parts of the economy?

In the Australian case, companies like General Motors gave clear answers to the Australian Government. Firstly, they argued that the business investment would not otherwise have happened, an assertion supported by confidential board minutes and research papers. Secondly, if the investment had not gone ahead in Australia,

it would not have released funds for any other investment in Australia. This second observation reflects one of many significant consequences of incorporating the activities of multi-national firms into the analysis. Even accepting both these representations, economists have further questions: 3. How extensive and sustained are the cost reductions flowing from the business investment that would not otherwise have occurred?

4. Are the welfare benefits to consumers arising from the cost reductions associated with the induced investment sufficient to offset the detriment to consumers flowing from the delays in the tariff-reduction program?

This is exactly the framework of the analysis set out in the paper to the National University of Singapore-University of Melbourne Symposium.

Clearly, there are some demanding tests to be passed before this investment-based argument turns out to be welfare increasing. In summary, there need to be positive answers to the four questions posed above, and significant quantitative cost reductions associated with the delay-induced investment, if the tariff delays are to be justified. That said, if all the tests are passed, we have established a new argument for potentially optimal delays in tariff reduction programs that has nothing directly to do with adjustment delays and burdens.

The model treats the policy-adjustment phase as one large period. There are three relevant avenues of final expenditure within the home country: 1. Outlays on the protected manufactured products, designated X; 2. Outlays on rival (product-differentiated) foreign-produced goods, denoted Y; and 3. Outlays on other products, called Z. The tariffs applied to Y are either reduced in accordance with a pre-announced timetable, or are frozen for a time and then reduced later. We call these policy alternatives the ‘reduction’ and ‘freeze’ (or ‘delay’) scenarios.

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The essential difference between these two scenarios is that we allow the level of production costs (and product prices in X) to become lower under the delay scenario, through the cost-reducing effects of the induced business investment. That carries consumer benefits associated with higher tariffs than would otherwise be the case. Anyone drilled in conventional tariff analysis would find this result (consumer benefits from higher tariffs than otherwise) difficult to accept, but it has already been established in the literature by economists Helpman and Krugman. The result is also consistent with recent econometric work directly investigating price responses by import-

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Are delays in tariff-reduction programs ever economically rational?

competing firms in the case of cost and global pricing influences. The criterion equation developed is whether this induced investment benefit does or does not compensate for the alternative-policy loss of welfare arising from delaying the benefits to consumers form the earlier reduction in tariffs under the reduction strategy. This criterion can be transformed to ask a more direct question: What degree of investment-induced cost reduction is required to justify delaying the program of tariff reduction?

The model provides the framework for these questions to be answered and for trial or actual numbers to be inserted to gauge quantitative answers.

Conclusion The general conclusion is that, subject to a sufficient induced cost-reduction, the case remains open for delays in pre-announced tariff reduction programs to be policy optimal. Moreover, this case does not depend on adjustment delays and burdens, which supported previous demonstrations that tariff delays may be policy optimal. In many ways, we have developed a more strictly economic, rather than political or reactions-based, set of circumstances that may justify the delay.

The message here is not that delays in tariff reduction programs are justified. It is that a set of questions can be developed that open up this possibility. The questions are specific and demanding. Unless the welfare gains from cost reductions induced by the business investment are sufficient, and unless the business investment would not have arisen without the incentive effects of the tariff delay, the case is not made out.

Indeed, the way in which classical tariff theory is set up, these questions cannot even be asked, let alone be answered.

Associate Professor Neville Norman is a member of the Economics Department of the University of Melbourne.

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occasional addresses by alumni at university of melbourne graduations

the importance of commerce and commercial principles in determining the well-being of society how graduates in commerce can contribute by jeff borland

An edited excerpt of his Occasional Address delivered at the graduation on 15 December 2006.

For those of you who graduate with a Bachelor of Commerce, I feel I am something of a bookend. I was a lecturer in your first semester at the University of Melbourne, and now you are hearing from me again at the very end of your studies. You will be pleased to know that I am not going to engage in a final revision of demand and supply or game theory. Instead, I propose to look in the opposite direction – forward, to where you are heading next.

This is exciting because there is much to look forward to in your professional lives. It is something that always comes home to me when I meet up with our Honours alumni in Economics.

They are a small snapshot of the totality of commerce graduates, but from this group I can tell you that there is currently: one member of the Federal shadow cabinet and one newly elected member of the Victorian Parliament; a former secretary and a deputy secretary of the Department of Prime Minister and Cabinet; heads of Investment Banking and Mergers and Acquisitions at major international investment banks; professors at Oxford, Stanford, and the University of British Columbia; partners in many law firms, and more generally, many working in government departments with responsibility for economic policy and in large economics consulting firms around the world. In fact, I

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counted fourteen different countries where our alumni are currently working.

This list suggests that an education in commerce can be the start of a very diverse range of careers in which many past students from Melbourne have excelled. However, as good as the opportunities have been in the past, I believe that they have never been greater or more exciting. Today’s commerce graduates are in a prime position to make a contribution to society.

This is mainly because commercial activity and the principles generally associated with commerce have never before been so influential in determining the well-being of people in many countries. I will use some Australian examples to illustrate this point but they also apply to other countries.

One example is the finance sector. Today, the wealth and living standards of households in Australia depend more than ever on the quality of decisions on asset management made in the finance sector. In his recent Boyer lectures, the former Governor of the Reserve Bank, Ian Macfarlane, noted how in the period from 1985 to 2005 holdings of financial assets in Australia increased from 100 per cent to 350 per cent of GDP, and that an increasing proportion of these assets have been financed with debt. In his

The importance of commerce and commercial principles in determining the well-being of society

words, if ‘a large fall in asset prices or a recession were to occur, the effect…would be greater than in the past.’

In the government sector, the importance of commercial principles is also evident. Major reforms have taken place in Australia since the mid 1980s, such as privatisation and the application of financial criteria in setting new performance standards for government enterprises and departments. Further, in the exciting field of economic design, governments are trying to apply market mechanisms to deal with such problems as: reducing emission of pollutants; improving biodiversity; providing greater R&D incentives to private drug companies to develop vaccines for third-world diseases such as malaria; and efficiently allocating public resources, such as radio spectrum and marine resources, between potential users.

The importance of commercial principles is also apparent in the not-for-profit sector. This is reflected in the weight that so many of these organisations now attach to them and in their desire to learn from (as well as teach to) the private sector. A good friend from my Economics Honours year, Michael Traill, gave the Occasional Address at a graduation earlier this year. He is the CEO of an organisation called Social Ventures Australia, which has as its mission to deal with some of Australia’s social problems by applying business principles drawn from the commercial sector and working in partnership with outstanding social entrepreneurs. Emphasising the need to build bridges, he explained how important various initiatives had been to improve educational outcomes for indigenous Australians and to increase employment opportunities for school leavers in high unemployment regions.

Thus, the skills that come with a commerce degree are relevant in every corner of society – for running successful private companies, for governments to be able to contribute the greatest good to society, and for socially effective not-forprofit organisations. The exciting prospect about graduating with a commerce degree is that it offers endless opportunities for doing valuable work where you will know that your role has been essential.

Should you feel confident that you will be able to take advantage of the opportunities that are available? The answer is definitely yes. This is partly because you have been able to study a broad range of disciplines that span the world of commerce. By my rough calculation, those doing a BCom will have attended 936 hours of lectures and tutorials, worked outside class for at least 1872 hours (or at least should have!), and completed 50 hours of examinations and 48,000 words of non-examination assessment.

However, I think you should also feel confident because what you have learned goes beyond the subject matter of economics, accounting, management, finance and actuarial studies. As the President of Yale University, Richard Levin put it in an address to a graduating class at Yale a decade ago, ‘What you have learned – the specific knowledge you have worked hard to acquire – matters. What matters more is that you have learned how to learn.’

This was something that I reflected on this year when I to talked to a group of high-achieving high school students about what university education is like. I started out by saying that, in many ways, being at university is a continuation of their present education – accumulating extra knowledge and skills in their chosen fields of study. However, I also suggested that university education offers more than this. It requires a student to engage in a learning process that is very different from what they would have experienced at school.

I hope you will understand what I mean when I say that being at a university is a bit the same and a bit different from being at school. I realised what being at university meant to me and why I enjoyed it so much, when I studied Australian history in the second year of my Arts degree at the University of Melbourne. I had to write an essay on the Petrov conspiracy, an episode in the 1950s when Vladimir Petrov, a member of the Russian Embassy in Canberra, and his wife defected to Australia. At the suggestion of my essay adviser, Lloyd Robson, I wrote to those who had been members of the Commonwealth Parliament at the time of Petrov’s defection, to find out if they could add to the documents I had been consulting.

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This gave me the opportunity to talk to former Senator Justin Byrne, known as the ‘Father of the Senate’. Byrne was fascinating person – a POW in WWII and a member of Australian Senate for more than 30 years, with unique historical and political experience. I was spellbound as he gave a perspective of the historical background of Petrov’s defection – the role of Russia in WWII, the rise of cold war sentiment in Australia and internationally, and to the event of the defection itself. Examining the motives and behaviour of many of those involved made this event come to life for me, while building the interview into my essay made me feel that I was constructing my own view of history.

It is this process of independent discovery that university education facilitates, namely: knowing what are the important questions; using research techniques to find new evidence to answer questions; applying available evidence rigorously and critically to arrive at an answer; and then developing a way of integrating what you have discovered with what you might have concluded earlier. Ultimately, these are the skills – in effect, learning how to learn – that will be most valuable to you. By developing and applying them as you move into what I have called the ‘looking-forward phase’, you will be able to successfully contribute to your chosen field.

There is one final thing that I would like to say about making the most of your talents and contributing to society. However, let me first confess that I am straying from an area where I have some expertise to what is dangerous territory for an economist: prediction. Economists, of course, are experts in giving a perfect explanation of why a prediction they made did not eventuate.

Nevertheless, I will chance my arm and comment on why I believe that following your passion is so significant. For myself, my colleagues in Commerce at Melbourne, my friends and exstudents who I meet from time to time, we are most fulfilled by work we believe to be important.

An example that comes to mind is the career of Charles Darwin. In his early twenties, like you, having just graduated from university, Darwin was offered the opportunity to travel as a gentleman companion on a ship undertaking a voyage to

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complete a survey of the southern part of South America. Initially, he was torn between becoming a country parson as expected by his family, and his passion for biology and collecting specimens. His family was concerned that this trip, to quote Darwin, would be ‘disreputable to my character as a clergyman’ and that he ‘should never settle to a steady life thereafter.’ However, the passion manifested early in his life ultimately triumphed.

Darwin recognised, as the biographer Janet Browne puts it, that ‘this proposal was a dramatic opportunity…to do the things he yearned to do, to see the world, and make something of himself.’

The voyage on the Beagle, which lasted 57 months from December 1831 to October 1836, was indeed to be the making of Charles Darwin and the making of much of modern science. Darwin is a great example of the importance of saying ‘yes’ to challenges that initially may seem out of reach, but ones you know you would love to face.

I know that many of you are already indeed following your passions in this way. Over the years, in the course of writing many references for exchange programs and scholarships, I have always been greatly impressed to see the range of part-time jobs and extra-curricular activities you and your fellow students are undertaking. These have included activities such as starting businesses in software development, importing and retailing; undertaking tutoring programs for refugees; producing websites and radio shows for welfare organisations; leading trips for young business leaders to developing countries; teaching English in places like China, Vietnam and Thailand; and doing volunteer work for human rights organisations.

Let me conclude by congratulating you on your achievements at this University and by expressing the hope that you will continue to inspire those around you with your abilities and your willingness to be involved in promoting the wellbeing of society. I hope you find great satisfaction and fun in doing so.

Professor Jeff Borland is Professor of Economics in the Department of Economics of the University of Melbourne.

The importance of commerce and commercial principles in determining the well-being of society

guideposts for your future success the importance of taking advice, continued study and communication skills; and more broadly of history, empathy and morality by max corden

An edited version of his Occasional Address delivered at the graduation at the University of Melbourne on 25 August 2007.

I graduated here with a Bachelor of Commerce degree 58 years ago. When I was asked to give this address I asked in return, ‘Why me?’ The answer given was, ‘You are old, with a lot of experience.

So you should be able to give the graduands some advice.’

My first reaction was to seek some advice from several of your teachers, and from others. I also sought advice from Confucius: The Master said, If the scholar be not grave, he will not call forth any veneration, and his learning will not be solid.

Book 1, Analects of Confucius

Good advice: I must be serious, otherwise you will not venerate me.

My first piece of advice to you is to be ready to take advice before making important decisions, and take it from qualified people. This applies to decisions in governments, companies and indeed any organisation. One can think of many examples where Prime Ministers and Presidents have not taken adequate advice and thus made bad decisions. Before returning to Australia five years ago I lived and worked in the US for 13 years. Hence I think of American examples.

Whose advice did the President of the United States take before he embarked on a disastrous war in the Middle East? He took advice from the wrong people.

My second piece of advice is to keep studying.

Let me quote Confucius again.

The Master said, Is it not pleasant to learn with a constant perseverance and application?

Book 1, Analects of Confucius

Certainly, you should continue to study economics and any other fields you studied here. But also go beyond them, perhaps to science, philosophy and particularly history. I will come back to that later.

My third piece of advice is to learn to speak and write clearly and simply. If you can do this already, you have a great advantage. Communication is crucial to success in life, especially in the jobs that most of you will be doing. When I was a student like you, I was very shy. I could not imagine myself standing in front of a large audience. But I observed the style of good speakers, and when the time came to lecture to a class or to speak at a formal occasion, I discovered the key: careful preparation, plus a few tricks.

I have now given you three pieces of advice for personal success. Now, I come to three more pieces of advice, involving larger issues.

I have always been interested in public policy and politics. Also, I have wanted to understand why some countries are economically successful and some are not; and why policies and economies go wrong, or how they can be made better. I am sure you will be thinking about these matters in years to come.

I draw here upon some of my reflections, which are contained within three key words: history, empathy and morality.

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History

Morality

We can only understand the present, and form sound views about the future, by knowing the past. I encourage you all to study history. For me, it is a life-long study. I will give three examples which fascinate me: 3. China is going through a fantastic growth period with a massive movement of people out of agriculture and into big cities. This has many problems. Pollution is just one of them.

Study the nineteenth century history of Britain and the US, and you will recognise similarities in the problems faced, which means you may be able to anticipate some of them.

3. US and Iraq. Study the history of Iraq – which shows how the British constructed an artificial country after WWI out of three provinces of the Ottoman Empire – and you will understand its present problems. Clearly, American decision makers did not know that history.

3. Australia. To understand the political system, the legal system, and many attitudes – including a deep commitment to democracy – one needs to know the history of Britain and how Australia was formed as a set of British colonies in the nineteenth century.

To get socially desirable behaviour, economists emphasise incentives. If we want to reduce the amount people smoke, we raise the price of cigarettes and people will have a financial incentive to smoke less. But sometimes the price mechanism cannot do the job, so we turn to the legal system and regulations, which are costly to enforce.

Empathy Empathy is an understanding of how others think and feel. In negotiations – whether commercial, financial or political, or between employers and workers – empathy is crucial. For some of you, negotiations will become an important part of your future work.

In multicultural societies, empathy for people coming from different cultures is particularly important. And it is necessary for international peace, social harmony and personal success in business. If there is to be peace (and hence economic prosperity), empathy is needed between Sunnis and Shias, between Palestinians and Israelis, and between Serbs and Croats.

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Guideposts for your future success

If tax evasion becomes very common, it becomes costly to enforce the tax system. If managers of companies generally behaved like those at the notorious Enron firm in the US – who showed a lack of corporate ethics – there would have to be many more strictly enforced regulations. The same is true when bureaucrats are lazy or corrupt, or when teachers neglect their teaching duties.

Morality – or call it ‘professional ethics’ – is much cheaper for society than the regulations, the enforcement staff and the paperwork that regulations require. In a successful economy (like the Scandinavian ones) there will be a high degree of morality. In any case, behaving ethically should be an end in itself for all of us. Those of you that will practice accountancy must particularly remember the need for corporate ethics.

Be moral yourself, and especially favour others – whether in politics or in organisations, private or public – whose behaviour is moral.

Professor Max Corden is Professorial Fellow in the Department of Economics, University of Melbourne.

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Mailing address: The Faculty of Economics and Commerce The University of Melbourne Victoria 3010 Australia Telephone: +61 3 8344 2166 Email: gsdir-ecom@unimelb.edu.au Internet: www.ecom.unimelb.edu.au/insights Published by the Faculty of Economics and Commerce, November 2007 Š The University of Melbourne

Disclaimer Insights is published by the University of Melbourne for the Faculty of Economics and Commerce. Opinions published are not necessarily those of the publisher, printers or editors. The University of Melbourne does not accept responsibility for the accuracy of information contained in this journal. No part of this journal may be reproduced without the permission of the editors.