Insights Volume 7 April 2010 by The Faculty of Business and Economics, The University of Melbourne

insights Melbourne business and Economics volume 7 april 2010

Celebrating Business and Economics at the University of Melbourne

By Margaret Abernethy Meaningful work in the 21st century: Terms, conditions and contexts

By Barbara Pocock The Sex Discrimination Act after 25 years: What is its role in eliminating gender inequality and discrimination in Australia?

By Beth Gaze The strange case of the missing worker: Human resource management, employees and organisational performance

By Bill Harley The road to recovery: Restoring prosperity after the crisis

By Mark Wooden, Hielke Buddelmeyer, Paul Jensen, Guyonne Kalb, Guay Lim, Anthony Scott, Rosanna Scutella, Elizabeth Webster and Roger Wilkins Spaghetti unravelled: How income varies with age

By Stephen P Jenkins Research that informs the standard setting process

By Mary E Barth Strengthening global economic governance

By John Langmore and Shaun Fitzgerald Learning from Australiaâ&#x20AC;&#x2122;s economic history

By Jeff Borland Price discovery and regulation in energy derivatives markets

By Paul Kofman, David Michayluk and James T Moser Occasional Address

By Chris Leptos AM

Welcome Insights publishes condensed and edited versions of important public lectures connected with the Faculty of Business and Economics. Its object is to share these lectures with the wider public, especially Alumni. The issues presented and developed generally relate to research findings on public economic and social policy. Insights also constitutes an archival source of an important part of Faculty life. Suggestions and comments from readers on any feature of the journal are welcome. This volume celebrates the opening of The Spot, the new headquarters of the Faculty; and the Faculty’s new name. The opening article by the Dean, Professor Margaret Abernethy, elaborates on these matters while the images throughout the volume provide visual evidence of the new building. Workplace problems form the substance of papers by Barbara Pocock, Beth Gaze and Bill Harley. Mark Wooden and his colleagues give an account of the highlights of the Melbourne Institute–The Australian conference, which examined the challenges facing our economic recovery. Stephen Jenkins’ paper, with its intriguing title, deals with the complex issue of how personal incomes vary with age. Issues related to the setting of global financial reporting standards are discussed by Mary Barth, a world authority on the subject. John Langmore and

Insights: Melbourne Economics and Commerce ISSN:1834-6154 Editor: Emeritus Professor Joe Isaac, AO Associate Editor: Ms Brooke Young Sub-editor: Ms Rebecca Gleeson

Shaun Fitzgerald advance ways of improving the effectiveness of international economic, financial and social institutions. This volume contains two Alumni Refresher Lectures. The first, by Jeff Borland, deals with the lessons of economic history, and the second, by Paul Kofman et al, analyses issues related to the discovery of natural gas future prices and the role of regulators in this process. The volume concludes with Chris Leptos’ Occasional Address to graduates on the significant happenings in the world in 2009, and the great importance of China for Australia’s economic future. Joe Isaac Editor jei@unimelb.edu.au

Advisory Board: Professor Robert Dixon Professor Bruce Grundy Professor Bryan Lukas Design: Ms Sophie Campbell Photography by Joe Vittorio and Gollings Photography

insights vol 7 Table of contents 03 Celebrating Business and Economics

31 Spaghetti unravelled: How income

By Margaret Abernethy

By Stephen P Jenkins

We must underpin our programs and the culture of the Faculty with certain values – creating social good, embracing diversity and cultural awareness, and commitment to equity

Average income-age trajectories derived from longitudinal data look different from those derived from cross-sectional data

at the University of Melbourne

09 Meaningful work in the 21st century: Terms, conditions and contexts

By Barbara Pocock

Work is not all bad – and we have not paid enough attention to what makes it good and how to get more of the good

13 The Sex Discrimination Act after

25 years: What is its role in eliminating gender inequality and discrimination in Australia?

By Beth Gaze

Despite the Sex Discrimination Act’s undeniable achievements, there is cause for concern about its current and future role, and that more than cosmetic reform is necessary

19 The strange case of the missing

worker: Human resource management, employees and organisational performance

By Bill Harley

It would be fair to say that the conventional wisdom concerning HRM, employees and performance rests on a rather thin body of evidence

25 The road to recovery: Restoring prosperity after the crisis

By Mark Wooden, Hielke Buddelmeyer, Paul Jensen, Guyonne Kalb, Guay Lim, Anthony Scott, Rosanna Scutella, Elizabeth Webster and Roger Wilkins Managing the recovery, the productivity challenge, economic responses to climate change, the housing market, health care reform, the disadvantaged, and the Indigenous gap

varies with age

37 Research that informs the standard setting process

By Mary E Barth

Academic research can help resolve many of the nettlesome issues that standard setters face, and plays a central role in shaping global financial reporting

45 Strengthening global economic governance

By John Langmore and Shaun Fitzgerald

A gap continues to exist in the structure of international economic institutions through the absence of a representative, accountable, politically legitimate forum for discussion of the principal issues of global political economy

Alumni refresher lecture series 49 Learning from Australia’s economic history

By Jeff Borland

Examples on the theme of learning from history for the practical purpose of improving economic policy-making

54 Price discovery and regulation in energy derivatives markets

By Paul Kofman, David Michayluk and James T Moser

Highlighting the interplay between the floortrading exchange and its on-line trading satellite in the discovery of natural gas futures prices

Occasional Address 58 2009 – A tipping point By Chris Leptos AM

Virtually every aspect of life in Australia will be affected by decisions made in China over the next two decades

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Article heading here

celebrating business and economics at the university of melbourne We must underpin our programs and the culture of the Faculty with certain values – creating social good, embracing diversity and cultural awareness, and commitment to equity by margaret abernethy An edited version of her address on the occasion of the opening of ‘The Spot’ by the GovernorGeneral of Australia, Her Excellency Quentin Bryce AC at the University of Melbourne on 23 February 2010. This is indeed a special night for the Faculty, the University and representatives from business and government, as we celebrate the opening of our new building, the launch of our Graduate School, our new name – Business and Economics – and our new directions. It is also a celebration of teaching and research in business and economics since the Faculty of Commerce was established at this University in October 1924 with the appointment of Douglas Copland as Dean of the Faculty.

Our new building Let me first focus on the building and what it means for us. This building, affectionately called ‘The Spot’, will be the home of our Graduate School of Business and Economics. It symbolises the University’s confidence in our ability to build the leading school of business and economics in the region. We have the people, facilities and commitment to do just that. We have come a long way since the 1930s. Then, we had only one lecture theatre with a capacity for 80 people, and two classrooms sharing space in the old Law School. We had four full-time staff and our students were mostly part-time. Copland’s plea for space was heard by The Myer Emporium Educational and Charitable Fund, which donated more than a quarter of the cost of a new building, completed in 1940, now known as

‘Old Commerce’. At that time, it was considered luxurious by the standards of other faculties – the lecture theatre had upholstered seats instead of bare wooden seats; it was commodious and furnished in contemporary art deco style; it had a lift; and it was airy and bright. Before long, however, the Faculty was caught up in post-war exponential student growth – staff and students were accommodated in temporary huts and some were even located on the first floor of the King and Godfree building in Lygon Street So here we are in 2010, in a building that has already become a landmark in a number of ways: – Its distinctive appearance has created an instant orientation point. – The design is functional – it is unique. The large over-sized blades provide structural support, contain air conditioning services and offer shade to the glass. – The external design or frit itself has been finetuned to produce a balance between providing views and daylight, limiting solar (heat) gain and taming glare. – Great attention has been given to ensuring that the building remains flexible and adaptable into the future. – It is a landmark in the University’s commitment to sustainable development. This is the first Victorian university building given a 5-Star

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rating under the Green Building Council of Australia’s Green Star Education (Pilot) tool, denoting Australian Excellence. Already we are seeing the impact on its environment performance – a 50 per cent reduction in energy use compared to other recently completed university buildings. – The building provides world-class facilities for our graduate school – the lecture theatre, interactive classrooms, state-of-the-art technology, and spaces scattered among our academic floors for the brightest of the bright wanting to complete a PhD and work closely with their academic supervisors. Moreover, this building is symbolic of where we are going as a business and economics school. It provides a strong connection to industry – our offices and classrooms look towards the city, symbolising our connection with what our founders envisaged for business education. Just as Copland’s appointment signalled that the Faculty was ‘in business’, this building signals that we are ‘in the business’ of providing graduate education. It manifests our shift to life-long learning. Our new generation undergraduate degree students will be able to go on to graduate school – a feature of the Melbourne Model – while the experienced executives who wish to update their skills or change careers, can complete a graduate degree or participate in leadership forums to deal with important issues facing business and the economy.

The Faculty’s ‘New Direction’ Let me now develop this point further and share with you some ideas I have for the ‘New Direction’ the Faculty will be taking in the future. We have five generations represented here tonight: – Those born before 1925, often referred to as the ‘greatest generation’ – the war heroes and those who endured the depression with resourcefulness and resilience. – Those born between 1925 and 1942 – the ‘silent generation’, who benefited from enormous economic growth in their working lives and were responsible for creating much national wealth. They were particularly important to the University as they were part of the era when 04

Celebrating Business and Economics at the University of Melbourne

professions gained in importance and demand for university education grew rapidly. – Those born between 1943 and 1960 – the ‘baby boomers’, who fought in and protested against the Vietnam War. They redefined our culture, embracing diverse social, religious, cultural and personal attitudes. They can be seen as revolutionaries. – Those born between 1961 and 1981 – Generation X, the latchkey kids, who are savvy and entrepreneurial, and have shown themselves to be thought-leaders and free agents. – Those born between 1982 and 2000 – the ‘millennials’, who are the wanted and protected, connected 24/7 to a diverse world, socially active and destiny-bound, determined to create a better world. This generation is represented by Daniel Norman, our most recent Rhodes Scholar, who spoke so eloquently about how student life has affected him. All five generations are part of our journey.

Our founder Let me say something more about our founder, Douglas Copland, and those of his generation who established the foundation on which we stand today. Copland was a pioneer in business education and recognised the importance of industry to the development of the Faculty. In his Inaugural Lecture, he thanked ‘…the men of commerce whose interests in higher commercial education paved the way for the work of the School of Commerce.’ He recognised that business education is likely to be much more successful if it springs from the needs of industry and is supported by businessmen [and women],’ and he saw a commerce education as a ‘source of intellectual development and a service to business and government.’ Copland was supported by the Chamber of Commerce and Industry, which lobbied for his appointment. The economic environment at the time raised many question, calling for professional analysis. Funds were raised from government and private sources to support Copland’s appointment. And in 1926 Sidney Myer, who established the Myer Emporium, demonstrated in a practical way the importance of the link between education and

business through a generous gift to the University, which saw the creation of the Sidney Myer Chair of Commerce. Copland was the incumbent of this Chair until 1944 and, with the exception of the War years when he was located in Canberra as Prices Commissioner, was also the Dean of the Faculty. This Chair moved with Professor John Rose to the Melbourne Business School (formerly the Graduate School of Management) when it was established in 1989. I am pleased that the Myer Family has supported the return of the Chair to the Faculty. Copland focused on the professional needs of business and a number of the academic staff were appointed from ‘down town’. One of the very early appointments was Alex Fitzgerald to teach accounting on a part-time basis. He was to become the first Professor of Accounting in 1954. I am delighted that one of his daughters and his niece are here with us tonight. From its very beginnings, the Faculty offered programs that were designed to meet the needs of business at the time. Those who came after Copland also held his vision of business education. We took advantage of the boom in demand for university education, particularly in economics

and accounting, in the 1950s. In this period, we also began to forge strong links with the region – Indonesia, Malaysia, Singapore and, more recently, China – to support the demand for quality and modern business education. The first wave of students came under the Colombo Plan and we have many alumni in senior leadership positions in the region who studied with us under that plan. James Riady, who has just endowed a Chair in Asian Business and Economics, reflects the strong relationship we have developed in the region. Like Sidney Myer back in 1926, he knows the importance of the intellectual development of the nation for its economic and social wellbeing. We now have some 38,000 alumni spread around the globe. While our focus in the first few decades was on developing undergraduate education, we did not lose sight of the importance of our contribution to knowledge. This was part of Copland’s vision, as he said back in 1924: ‘economic decisions are made by governments and business alike based on imperfect knowledge, and it is the role of the University to fill this gap and improve this knowledge.’ He saw it as our duty to add knowledge to the wider community. Today, our mission remains the same. The object of

Pictured left to right: Governor-General Her Excellency Ms Quentin Bryce AC, Vice-Chancellor, Professor Glyn Davis AC, Chancellor, The Hon Alex Chernov AO QC and Dean, Professor Margaret Abernethy.

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our research is to improve the functioning of business, the markets and the economy. In this connection, a major turning point in our history was the establishment in 1962 of the Melbourne Institute of Social and Economic Research and the appointment of Ronald Henderson as Director.

in Business and Economics. Our three academic divisions reflect this:

Graduate education

– The Undergraduate School – under the leadership of a Deputy Dean, focussed on maintaining and building the very best BCom and BCom (Hons) programs.

Our early focus was on the BCom and building its reputation. This sometimes overshadows our innovations in graduate education – both researchbased and professional degrees. In the mid-50s, Donald Cochrane fulfilled one of Copland’s aims by developing a summer school for executives. It was managed by a Board consisting of representatives from the Faculty, University, government and business – very similar to our current board. Alex Fitzgerald was a member of the Board and, as Dean in 1957, proposed that a graduate school of business administration should be established to award MBAs. This finally happened in 1963 following the renaming of the Commerce Chair as ‘Commerce and Business Administration’. Our Faculty was the first to offer MBAs in Australia. The development of the MBA reflected a shift to graduate business education. It came from the increased complexity of business and Australia’s increased engagement with the world economy. We began to design programs for the ‘silent generation’ – those building national wealth. Demand came from those with industry experience, and over the years businesses, both here and in the region, began asking for more specialised training. We responded accordingly. The Masters of Applied Finance was developed when industry was lacking well qualified practitioners; our Masters of International Business came from those in Australia wanting to do business outside Australia; and as technology developed, we established the Masters of Business and Technology for those in industry who sought these combined skills.

Our ‘new school thinking’ – life-long learning We are now poised to strengthen our position as the leading provider of business and economics education. We are undertaking a restructure and a refocus of our Faculty, to support life-long learning

Celebrating Business and Economics at the University of Melbourne

– The Graduate School of Business and Economics – led by a Deputy Dean and Director, this will be the home of all of our graduate programs including our research degrees.

– Executive Education Programs – this division will work with the University to ensure that we optimise the opportunities in this important area of life-long learning. To deliver life-long learning, we need to rethink the way we do business – what I am calling ‘new school thinking’. We need to meet the needs of not just those of the millennial generation but also deliver to Generation X and the Baby Boomers. Demand comes from the constant change we face – in business, in government and in the community generally. New skills must be learned; leaders want to be ahead of the curve so that they can identify the next set of problems and the solutions that will help them deliver value to their organisations and the nation. For us as educators, this means we have to be even further ahead of the curve. As Copland and others have observed for many years, ‘The function of the University is to be ahead of best practice, not to be tracking a few steps behind’ (G.L. Bach Management Science July 1958). The source for ‘new school thinking’ is ourselves – we must be honest when we ask ourselves whether we are meeting the challenges of today’s leaders, as well as the needs of the Millenials, who will be tomorrow’s leaders. And then do something about it. Two consequences follow. One relates to our curriculum design. We have known for some time that what we do to – and with – our students is very much related to our curriculum. We need to ensure that our curricula – whether it is for our undergraduates or for our experienced executives – provide the basis that allows participants to redefine how to do business, to rethink their role in society. To do this we need our graduate and executive education programs to have integrated curricula. Of course, we need

high-level skills in each of the disciplines, but problems facing industry do not come neatly packaged up in discipline silos. To quote from a recent edition of the Financial Times : ‘…if business schools were to teach their students to examine problems as part of complex messy systems – to tolerate and appreciate messes – the better off we would be…We need leaders who can cope with messes as a whole.’ They use the Global Financial Crisis as an example: ‘…to understand something as big and complicated as the financial system it must be understood and managed as a mess.’ Leadership is about coping with messes. Moreover, the change in our curricula does not have to be divorced from our research, which will always be a defining characteristic of a great business and economics faculty. Such change can be an integral part of a wider change in the research agenda of the University and the Faculty – tackling big messes related to sustainability, climate change, poverty and more from a multiple-discipline perspective and deriving an integrated solution, or at least an integrated way of coping with the messes.

Establishing a set of values for graduates Committing to a life-long learning model means more than changing the content and the way we teach. It also means embedding life-long values in our teaching. Remember millenials want to create a better world. We must underpin our programs and the culture of the Faculty with a set of values, namely: – Creating social good; – Embracing diversity and cultural awareness; and – Commitment to equity.

Creating social good I want the defining attribute of each graduate from this Faculty to be the recognition of the importance of contributing to the wider community. I want our curriculum to draw attention to how we do business, to recognise that business practices have a social impact and to redefine business to maximise the positive impact of those practices. This should underpin how we teach accounting,

finance, management, marketing and economics. We must also provide opportunities for students to experience first hand what satisfaction and learning comes from working on projects with industry, government or the general community, and being committed to making a difference. Many of our students are already involved in amazing projects working with those less fortunate than ourselves.

Diversity I want us to continue to reinforce in our programs – inside and outside of the classroom – the importance of diversity. We live and work in a global community – embedding this in our curricula and what we do is no longer optional. As Daniel Norman said this evening, he fully embraced diversity in the classroom. It allowed him to create a network of colleagues with whom he will work in the future. It also opened his eyes to what else he could do in his career.

Equity We must direct our resources to ensuring that the very best students can study with us regardless of their means. This is a hallmark of a great business school. Tonight we celebrate an anonymous gift from a Generation X alumnus who wanted to do just that – to create opportunity for others to study with us, so they could benefit as he did from his education. I thank him for what is a very generous gift. We have an ambitious agenda and one for which we need the help of all generations. I know of your commitment to our agenda. I will need advice and support not only from our academics but also from the community we serve. Our vision reflects that of our founders. Now, as in the past, our charter is to improve the economic and social well-being of those around us. I look forward to working with you in achieving our vision in the years to come.

Professor Margaret Abernethy is Dean of the Faculty of Business and Economics and Professor of Managerial Accounting at The University of Melbourne. She was winner of the 2008 Telstra IBM Community and Government Business Woman of the Year.

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Article heading here

meaningful work in the 21st century: terms, conditions and contexts Work is not all bad – and we have not paid enough attention to what makes it good and how to get more of the good by barbara pocock A condensed version of the 24th Foenander Lecture delivered at the University of Melbourne on 21 October 2009. The full text is available at: http://www.unisa.edu.au/hawkeinstitute/ cwl/documents/FoenanderPocock.pdf The concept of work This lecture explores what work is to us as workers and as a society, when we love it, and what that means. What are its positive aspects, and does it have a dark side? How can such love and meaningfulness thrive – even in the midst of the conflicting interests that exist in a workplace – and at the same time be controlled so that it does not lead us to act against our interests, for example, by working ourselves to death? The concept of work as something we want to avoid needs revisiting because its positive side has not been adequately examined in our analytical research work and in the practical activities of unionism and management. Work is not all bad – and we have not paid enough attention to what makes it good and how to get more of the good. However, what makes work good can also make it bad, as it can trap us in extreme jobs and for too much of our lives. Academics, unions and employers generally have tended to view work as ‘a bad’: that is, something most people would like less of or avoid. However, the meaning and practice of work has changed a great deal in the past three decades. The classical worker in the Australian social imagination was, and sometimes still is, a particular kind of waged worker who laboured physically and sweated away in a manufacturing plant, on wharves, ships, or down a mine, and who was in a union. Australia still has many such workers and they are far from immune to injury and death. However, we have seen very rapid growth in the share of service-sector jobs and

in professional and managerial employment. Hard physical labour is still with us, but nothing like the extent prevailing only 30 years ago. And the future will see more of this trend. Growth in services sector jobs is set to continue to outpace other industries over the next five years – except for construction, which is expected to continue to grow strongly. Of course, much of this growth is in part-time and casual jobs, and changes in the form of employment contract and in the quality of work also accompany these compositional shifts. Between youth and old age, we spend a lot of time at work and both governments and employers are keen on more of this.

What do we get from work? What do we get from work? Money, most obviously. But robust surveys tell us that 60 per cent of Australians would go to work even if they did not need the money. Not surprisingly, professional and managerial workers are more likely to hold this view. However, the pleasures of work are not confined to white-collar workers. Over half of cleaners, labourers, and elementary clerical, sales and service workers agree that they would enjoy having a job even if they did not need the money. I suggest that workers gain several valuable things from work – a sense of efficacy, identity, contribution and/or vocation; social connection; the opportunity to learn; and a positive spill-over from work into the home. A great number of workers draw a sense of contribution and enjoyment from paid work. For Insights Melbourne Business and Economics

some, this is a feeling of realised ‘vocation’: a deep feeling of response to a ‘calling’, accompanied by a commitment to what they are doing. For others, it is a sense of feeling good about making a contribution or doing what they do well – whether it is painting a wall, pleasing a customer or caring for a child. Others enjoy just parts of their jobs or its social life. Psychologists define these kinds of motivations as intrinsic, the rewards from which are not associated with any external recognition or payment.

Some cases For example, Portia is a midwife in a birthing centre. Her husband is a caretaker. They immigrated to Australia from the UK a few years ago, have two young children and recently took on a mortgage for their first home. Portia has been working shift work for 27 years – a condition that is generally associated with significantly worse job satisfaction and health outcomes. She would like to have more time at home but works fulltime and is the main breadwinner. She loves her job. She has job security and is paid well. Portia has a true vocation, a calling. She home-schools her children and is religious. She meets Catherine Hakim’s definition of a ‘home-centred’ woman but like so many women, categorisation like this is not so simple. Portia firmly sees herself as a worker as well as a devoted mother. She sometimes feels torn, but she would not give up her job – though she might go permanent part-time if they can get the mortgage under control. She wants to work in a job that she loves and which extends her. Like so many other workers, Portia loves learning, like Sandy (in her late 30s and a sole parent) and Kelly (18) who work in a hardware store. Sandy does special orders, which require a lot of product knowledge, and she loves learning: ‘I need to be constantly learning because once I stop, I get bored.’ Being in a workplace with formal inhouse training makes work very attractive to these workers. Kelly has done all the online courses in the firm and her knowledge makes her feel powerful at work. Many workers value what they learn at work. They prize learning and, whether high or low paid, ‘good jobs’ allow them to keep learning – from each other, from experts, from experience and from formal training. 10

Meaningful work in the 21st century: Terms, conditions and contexts

As in so many other workplaces, these workers also enjoy the social aspects of their working lives. As Kelly puts it: ‘If you don’t feel that you’re part of a group, even though it is only work, you will not want to go to work. It’s a huge part of it.’ Similarly, Wendy has worked for 11 years as an assistant in a school for children with disabilities. Her social relationships are firmly rooted in her working life. She says: ‘The people I work with are my family. I got married two and a half weeks ago, and most of my work came to my wedding over my family.’ Many workers value highly the social relations they make in workplaces. Given that we spend so much of our lives at work, it is not surprising that many of our social relations and deep human connections – both our friends and our enemies – are made at work. For many, the workplace supplants or at least complements the nuclear family, or extended family, the neighbourhood, the church or club. Time is a critical element of this relationshipbuilding and human exchange with patients, school children, customers, or co-workers. Time is also critical to learning, and it strongly shapes workers’ overall views of their jobs. This is very evident for those workers whose numbers are likely to grow strongly in coming decades, namely, community-based aged-care workers. While there is much enjoyment in caring jobs, they are not without significant downsides – low pay, time pressure and low autonomy. Aged-care workers talk of having a clock ‘ticking inside’, one that is wound ‘tighter and tighter’ as every minute is accounted for on detailed time sheets. However, enjoyment of a job is not enough to establish it as a desirable occupation: its terms of employment also matter. This is illustrated by the case of Geoff, who has worked as a para-legal for many years. He is a plumber by trade because his father felt he should have a trade ‘to fall back on’. He is now 63 and a few years off retirement. He ‘loves the law’, but he had to go back to plumbing a few years ago because loving the law meant he had to work long hours: ‘It’s a 100-hour a week job’. This led to life-threatening health problems and a triple bypass. He ‘wouldn’t have survived’ if he had stuck to the job he loved. So he is back to plumbing and, while he is working 60-65 hours a week, there is less stress. Geoff is one of many workers who are caught in a vice where love of

their job conspires with its greedy terms to result in long hours, poor health and in the end ‘no life’ – perhaps literally. The contest between enjoyment of the job and the struggle for time is obvious. Beyond identity and enjoyment of their jobs, education and social relations, workers also report the positive things they take home from their jobs – the positive spill-over. Those who enjoy these sources of satisfaction from work are happier people than those who do not enjoy work. Positive spillover is associated with enough resources to get the job done, flexible working conditions, enough hours to support a living, reasonable working hours, supportive management and leadership, opportunity for personal development and skill acquisition and use, time to transfer knowledge, decent pay and job security.

The dark side of work I have so far considered the nature of work from which many draw positive satisfaction, so much so that we tend not to give sufficient weight and to build on it. However, I also want to consider the darker side of this love for work. More of us give greater weight to paid work and see good things in this work. In the comments of these workers, it is evident that they are realising themselves through their work, their skills and their relationships. However, what does this imply for the social state of ‘not working’? Are we depriving ourselves from that side of work when we are not working? Some workers agree that we are overdoing work. The results of our survey of workers in July 2009 showed that despite the fact that 44 per cent of Australian women work part-time –

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much more than in most comparable countries – a third of all full-time women would like to work less, taking into account what this would do their incomes (Pocock et al 2009). When we released the research, Stephen Lunn of The Australian talked to a professional worker – a single mother of two boys, nine and seven – to illustrate the point (Lunn, 2009). He wrote how she admitted she was ‘seduced by the fast-paced, highlevel work in her large professional services firm’. However, she decided to ‘regain control of her life and reset her priorities, not least of which was to be able to meet her two sons at the school gate’. With her health suffering, she decided to quit her job. When the story appeared one of her ex-colleagues rang to say how ‘brave’ she was in telling her story publicly and ‘admitting that she had failed’. In this ‘masters of the universe’ world, one fails if one steps away from paid work to care. Loving your job is one thing; but it is a jealous love that admits no other, not even the love of your boys.

Conclusion Is the increasing construction of ourselves through work in a regulatory environment where the constraints on working time are weak – ‘porous’ at best – and the alignment of the pleasures of work with its hungry demands, eating away at our social well-being? The implications of this question are especially important for carers – and thus for women. If the best way to ‘be someone’ is through paid work – and this form of identity-making is growing stronger – is it becoming harder to be a carer, to be retired, or to be out of the workforce on parental leave? What do we do about the rigidity in redesigning jobs to meet the requirements of ‘different’ workers – carers, women, someone who wants time away from work? To ‘not work’ should not require full engagement as a carer. There should be an opportunity for other honourable human activities: rest, recuperation, contemplation, art, companionship, gardening and the making of community. To enable more of these to be enjoyed, we may need to reconsider the love we have for paid work, and make sure that we do not stop loving other social aspects of life, while making it possible for people to come 12

Meaningful work in the 21st century: Terms, conditions and contexts

and go from paid work. This issue is especially important for women, as they increasingly enter a men’s world of paid work, on terms men created in their care-less, if historically brief, bread-winner stage. While the feminist project always contested the male terms of paid work and the reallocation of unpaid work, the failure to achieve either of these makes liberation through paid work a wicked result, guaranteeing merely the right to perpetual exhaustion and a diminished sense of self – unless one is a care-less, be-suited professional or a full-time worker who joins the ‘masters of the universe’. There is much to be done to improve the term of work, to manage time well at work, and to harness the meaningfulness of work to the making of a meaningful life – both at work and beyond – in our larger lives.

References Hakim, C. (2004), (2nd ed) Key issues in women’s work: female diversity and the polarisation of women’s employment. London, Glasshouse Press. Lunn, Stephen (2009), ‘The struggle to juggle’, The Australian, July 25th 2009, p3. http://www. theaustralian.news.com.au/story/0,,258301707583,00.html?from=public_rss (Accessed 20th October 2009) Pocock, B, N. Skinner and R Ichii (2009), Work, life and flexibility: the Australian Work and Life Index 2009, Centre for Work + Life, Adelaide. http://www.unisa.edu.au/hawkeinstitute/cwl/ documents/AWALI-%2009-full.pdf Professor Barbara Pocock is Director of the Centre for Work + Life, part of the Hawke Research Institute of Sustainable Societies, University of South Australia.

the sex discrimination act after 25 years: what is its role in eliminating gender inequality and discrimination in australia? Despite the Sex Discrimination Act’s undeniable achievements, there is cause for concern about its current and future role, and that more than cosmetic reform is necessary by beth gaze A lecture delivered to the Social Justice Initiative at the University of Melbourne on 4 November 2009. Introduction The Commonwealth Sex Discrimination Act 1984 (SDA) turned 25 in August 2009. Has it really come of age as a full grown and effective piece of legislative regulation? Or is it instead a case of arrested development? Answering this question requires an evaluation of the effects of the SDA against a background of extensive social change over 25 years and persistent sex differentiation in our society. Analysing changes in large-scale social phenomena such as gender relations and workplace practices is fraught with difficulty, and identifying operative causes of change from among the multitude of factors that affect these social institutions is near impossible. As a result, conclusive and comprehensive answers about the effects of such legislation are elusive. Instead, most of us tend to favour hypotheses consistent with our own beliefs or ideologies. If we regard society as a neutral but benign environment where it just happened that, historically, women suffered disadvantage, or that women’s and men’s roles are simply different, then the SDA could be expected to solve the problem. However, if we believe that society is based on gendered distinctions that structurally disadvantage women, we might be more sceptical about the Act’s ability to bring about the social change required to provide full equality for women. This paper assesses the Act’s influence, and argues that despite its undeniable achievements, there is

cause for concern about its current and future role, and that more than cosmetic reform is necessary.

The Sex Discrimination Act There is no doubt that the SDA was a vitally important legislative milestone in Australia. It was a national proclamation that sex discrimination was unacceptable in this country. Although South Australia (in 1975) and Victoria and NSW (both in 1977) had already prohibited sex discrimination – and Western Australia did so in 1984 – the SDA first prohibited sex discrimination in the other states and territories. Formal distinctions based on sex became unlawful. Jobs could no longer be advertised for ‘men and boys’ or ‘women and girls’, with the better jobs in the former category.1 Women could no longer be paid two thirds of men’s rates for the same work, excluded from jobs or from promotion simply because they were female, or dismissed from their jobs simply because they married. This change was a crowning achievement of the hard work of second wave feminist activists. Compared to what preceded it, the Act’s practical and symbolic effects were enormously significant and produced major advances in women’s position. From today’s perspective, however, where formal equality has been established for three decades, it is easier to see the Act’s limitations, its disappointing record in the courts, and the need for further changes. Insights Melbourne Business and Economics

The basic provisions of the SDA prohibit discrimination on the basis of sex, marital status and pregnancy, not merely discrimination against women – to which potential pregnancy and breastfeeding, and a prohibition on sexual harassment, were later added. It covers the areas of employment (including selection), education, provision of goods and services, accommodation, clubs and government administration. One of its most important achievements was the creation of the office of the Sex Discrimination Commissioner, which has been occupied by a series of courageous, articulate women (including the current GovernorGeneral, Quentin Bryce) who have been prepared to enter sometimes hostile public debate to raise issues that need attention and to press for reform. They have kept issues of importance to women on the agenda – including sexual harassment, pregnancy discrimination, work and family conflict, and the need for paid maternity leave – only some of which have had adequate legislative responses.

The Courts and the SDA The Act prohibits two types of discrimination. Direct discrimination occurs where a person is treated less favourably – on the grounds of sex, marital status, pregnancy or potential pregnancy – than a person of a different sex (etc.) in circumstances that are not materially different. Indirect discrimination occurs where a group of people of a particular sex or marital status are disadvantaged by the effect of an apparently neutral condition, requirement or practice, where that practice is not reasonable. The High Court of Australia has never decided a case on the SDA, but has heard several cases involving equivalent provisions in state sex discrimination laws, on which these comments are based. The early impact of sex discrimination law was illustrated by the 1980 decision in Ansett Transport Industries v Wardley2, in which the High Court upheld the law’s prohibition on excluding a woman from recruitment as a trainee pilot simply because she was female. This case illustrates both the achievements of sex discrimination law in ending formal exclusion of women on the basis of sex, and two of the major barriers to women’s equality at work that are still in operation: managerial prerogative (where courts may be reluctant to find that a respondent acted on a discriminatory basis) 14

The Sex Discrimination Act after 25 years

and the ‘market’ defence (where a respondent argues that they are only acting to provide what the market, that is, the customer, demands). However, it also illustrates the difference between a legal victory and a broad social change – what proportion of flights that you have taken have been captained by female pilots, and what does their absence say about actual equality of opportunity nearly 30 years after Wardley’s case? This absence of women is reflected in innumerable positions of power and influence throughout our society despite the SDA’s 25 years. The law’s initial approach to dealing with discrimination was relatively unsophisticated, just as social understanding of discrimination was. It was not until explicit formal discrimination was largely eliminated that it became clear that the problem had not been solved: traditional attitudes and practices had not gone away but found other avenues of expression. The social structures of gender, race, sexuality and ability all continued to affect opportunities and expectations, while the target became less overt and hence more difficult to identify. Discrimination turned out to be a stronger and more subtle phenomenon than the law had anticipated. The lesson from Wardley was that you could not overtly exclude women, but if the same thing was done covertly, it was very difficult to challenge, because the complainant bears the onus of proving that the basis of the employer’s decision was the prohibited attribute. Since formal exclusion of women was prohibited, workforce practices moved from exclusion of women to treating them as if they were men. This has not provided equality for women, as data on women’s progress in a number of areas indicates. Refusing to take account of responsibilities for care of dependents such as children, people with disabilities and the elderly tends to reinforce the disadvantages experienced by the group that tends to be allocated these responsibilities, disproportionately women. The most recent High Court sex discrimination decision illustrates that indirect discrimination law has not proved to be an effective method for challenging gendered social practices. In Amery v NSW3, a group of female long-term casual teachers complained of sex discrimination because their

pay scale stopped at the equivalent of level 9 of the 13-point pay scale available to permanent teachers. Women were disproportionately represented in the long-term casual category, because permanent teachers could be posted anywhere in the state. To avoid such a posting for reasons of childcare or their husband’s job, many women who were permanent teachers had to revert to casual status when they had children. Their indirect sex discrimination claim was upheld by the NSW Court of Appeal, but the High Court rejected it, saying that permanent and casual teacher categories could not be regarded as one job category to which a condition – of being able to move within the state – was applied. Instead, they were completely different job categories.4 The Amery decision confirms that neither direct nor indirect discrimination law is sufficient to bring about the changes to the deeply embedded social and employment practices necessary for greater equality at work. The law has not limited workforce practices, conditions and expectations that are based on an assumption that the worker is free of care responsibilities. This is not equality for women, and it is not surprising that the data on women’s position in Australia today indicate that equality has not been achieved, and there is still a long way to go.

Women in Australia today Statistics collated by the Sex Discrimination Commissioner show that, compared with other developed countries, progress towards equality for women in Australia has been disappointing.5 Women represent more than 50 per cent of the Australian population, but hold only 29 per cent of elected positions in the 2007 Australian Parliament. They chair only two per cent of ASX200 companies (four Boards), hold only 8.3 per cent of Board directorships; only four chief executive officer positions and only 10.7 per cent of Executive Management positions. Although Australia is in a group of countries ranked number one for women’s educational attainment, it ranks 41 for women’s participation in the workforce, 17 overall in the Global Gender Gap Index, and 28 in the world for women’s representation in Parliament. Although women are 45.1 per cent of the Australian workforce, and 58.9 per cent of women participate in the workforce compared with 72.1 per cent of men, many women work part-time and casual jobs to fit in family responsibilities. Women earn 84.3 cents in the male dollar (for full-time adult ordinary time earnings), but only 66 per cent of what men earn overall. This is because of their part-time status

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and the slight widening of the gender pay gap over the last three years. While factors such as the move to neo-liberalism have clearly contributed to the lack of progress (and even regression) for women, some problems in the Act are also significant. The Act’s definitions of discrimination were weaker than those of comparable overseas laws when it was adopted, and its enforcement depended solely on litigation by the victims of discrimination – no small matter for someone who had lost their job or endured sexual harassment at work, especially given that legal aid in this area is very limited. When cases have been litigated, narrow and technical interpretations have often been adopted, especially by the higher courts as in Amery, that have further weakened the law as a weapon against discrimination. In successful cases, damages have been quite low. This means there is limited incentive to enforce the law, and hence limited pressure for change in social and workforce practices to avoid discrimination.

The need for change Sex discrimination law needs better tools to tackle systemic practices that continue to disadvantage women. Employment practices that disadvantage women because they do not meet stereotypical expectations, or because they may have care responsibilities that might restrict their mobility or ability to work long hours or evenings, have not changed. It is hard to see how women can be equal in the workforce unless such practices are challenged. Commentators no longer believe that the ‘pipeline effect’ (women have not yet come through the system in sufficient numbers) is the reason for these disparities, which have persisted despite women’s presence in the workforce and professions in substantial numbers for decades. Finally, and perhaps most tellingly, our social and economic arrangements ensure that women are poorer throughout their lives than comparable men and face poverty in much higher proportions in retirement6, as documented by the Australian Human Rights Commission. Despite apparent advances for women in the workforce, this data confirms that many women are only a relationship breakdown away from poverty – a situation that has changed very little in past centuries. 16

The Sex Discrimination Act after 25 years

Workplaces still operate on the assumption that the employee is a full-time worker with no domestic caring responsibilities or that they have someone to fulfil those responsibilities for them. This model fits men’s but not women’s lives, and the male norm at work is maintained through women’s exposure to sexual harassment, gender pay inequity, and working conditions that do not make allowances for caring responsibilities that are assumed to be women’s obligations. This virtually ensures that a majority of women will ‘choose’ to take the available casual and part-time, usually poorly paid, jobs in retail, clerical and community services, enabling them both to carry out the care responsibilities that are regarded as theirs and remain in the workforce. Recent moves to allow employees to request flexible work hours to manage their care responsibilities7 have come through the industrial law system rather than sex discrimination law. However, there have been no initiatives to encourage men to share care responsibilities or to solve the underlying problems of gender pay inequity, sexual harassment and the male norm of the ideal worker. Paid parental leave will arrive (eventually) in 2011, but unless the underlying problems are addressed, paid parental leave without encouragement for men to take their share of responsibility for childcare will simply reinforce women’s responsibility for infant care and subsequent childcare. Our neo-liberal political environment does not question these practices, at least not if it would increase the budget deficit.

Conclusion – what reforms are needed? What does all this say about the effect of the Sex Discrimination Act at 25? What could we expect from sex discrimination law outflanked by social and economic ideologies, where media and public debate tends to assume that women ‘are equal’? Sex discrimination law based on private enforcement has not been up to task. While individuals need an avenue to seek compensation for harms they suffer, relying solely upon private enforcement suggests a weak commitment to stopping discrimination. Sex discrimination needs to be recognised as a broad social and structural problem, not merely a complaint for the few individuals who recognise it

and are prepared to fight for their rights. It must be tackled at a systemic level in order to change practices on a society-wide basis. The burden of enforcement has to be undertaken publicly, and be directed towards changing systemic practices rather than solely to redressing individual cases. Although the need for some reform has been recognised in recent reviews of anti-discrimination law8, there is no sign yet of any legislative change. Comparable countries have placed much more emphasis on enforcement by public authorities, such as equality agencies, and on developing proactive requirements. For example, the UK has an equality duty that requires public sector bodies to consider women’s (and other) equality issues in all policy development and service provision. The US requires companies seeking government contracts to comply with affirmative action requirements (relating to minorities as well as gender) and ensure their subcontractors do so as well. Some Australian governments have used this approach in very limited areas – such as equal opportunity in briefing barristers – yet there is scope for much broader application.9 However, these approaches require substantial sums of public money and risk becoming bureaucratic exercises or burdensome and difficult to monitor and enforce on a broad basis. There is another possible alternative. Norway has imposed quotas on women’s board representation since the mid 2000s with success, and France is currently considering doing so. Closer to home, the ALP has had an affirmative action quota for women in winnable seats that has been highly effective in increasing women’s representation in the current Government. Even the ASX has recently adopted a policy that requires changes to be demonstrated in women’s participation on boards to avert the imposition of a quota. Despite media hysteria about quotas, after 25 years, a stronger alternative may be necessary to keep faith with the generations of women who have been promised equality but found the promise to be empty. In conclusion, although the SDA has been vital to progress, it has not been enough, and thorough legislative reform will be needed for greater progress.

Dr Beth Gaze is Associate Professor in the Law School at The University of Melbourne. 1 S. Magarey, “‘To Demand Equality is to Lack Ambition’. Sex discrimination legislation: Contexts & contradictions,” Paper presented at the Sex Discrimination Act Silver Anniversary Conference, Canberra, 1-2 Oct 2009. 2 Ansett Transport Industries (Operations) Pty Ltd v Wardley (1980) HCA 8. The case was brought under the equivalent provisions of the Victorian Equal Opportunity Act 1977. Ansett refused to recruit Deborah Wardley as a pilot, even though her test scores on the intake testing were higher than those of some men who were recruited, because Reginald Ansett did not want women flying his planes, asserting that passengers would not feel safe. 3 New South Wales v Amery (2006) HCA 14. This case was brought under the Anti-Discrimination Act 1977 (NSW). 4 In addition, the distinction was found in the NSW Education Act, which authorised, but did not require different pay scales. 5 Australian Human Rights Commission (AHRC), Sex Discrimination Commissioner: 25th Anniversary of the Sex Discrimination Act (1984), http://www.hreoc.gov. au/sex_discrimination/sda_25/index.html 6 AHRC, Accumulating Poverty: Women’s experiences of inequality over the lifecycle (2009). The statistics referred to in n. v show that in 2007, 2.8 million women and 1.6 million men aged 15 years and over reported not being covered by superannuation; half of all women aged between 45 and 59 have $8,000 or less in superannuation; and current superannuation payouts for women are one third of men’s – $37,000 compared with $110,000. At the same time government policies direct support through superannuation subsidies to those with the highest salaries and greatest workforce connection, rather than individuals whose need is greatest (for example through social security pensions). 7 This is one of the rights in the National Employment Standards for all employees under the Fair Work Act 2009, Part 2-2, Division 4 (ss.65 -66). The ‘right to request’ is only a procedural, not a substantive, right: to request flexible conditions of work, and to receive an answer that addresses the substance of the employer’s workforce needs, not simply a blank refusal. 8 See for example Senate Legal and Constitutional Committee, Report on the Effectiveness of the Commonwealth Sex Discrimination Act 1984 in eliminating discrimination and promoting gender equality (2008); Victoria, Department of Justice, An Equality Act for a Fairer Victoria: Report of the Equal Opportunity Review (2008). 9 See eg. C. McCrudden (2007), Buying Social Justice: Equality, Government Procurement, & Legal Change:, Oxford University Press.

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the strange case of the missing worker: human resource management, employees and organisational performance It would be fair to say that the conventional wisdom concerning HRM, employees and performance rests on a rather thin body of evidence by bill harley A condensed version of his Inaugural Lecture given at the University of Melbourne on 6 October 2009.

HRM and performance

The quest for the Holy Grail

Since the 1980s, it has become increasingly common to hear business leaders say ‘our people are our most valuable asset’. Corporate mission statements are replete with references to the importance of employees in driving business success. Indeed, it would be fair to say that the view that employees are fundamental to organisational success has become more-or-less a given in the contemporary business world. This view has been used by many to argue for the importance of sound human resource management (HRM), on the assumption that if employees are managed well organisations will perform well.

Although the management of people has existed as long as there have been organisations, the profession of HRM as we now know it is a creature of the 1980s. There are different accounts of its emergence, but one compelling version is that it came out of work done by business academics in the US in the early 1980s. These scholars, concerned with the question of why US industry performed poorly during the 1970s in comparison to many newly industrialised economies, looked to Japanese management practices. While critics have claimed that these researchers, seeing Japan through American eyes, completely misunderstood Japanese management, the fact remains that they built an influential account of the link between people and performance on the basis of their observation. Their central argument was that Japanese companies performed well in part because they treated employees as valued members of the company who needed to be nurtured, developed and rewarded in return for which they gave commitment, loyalty and effort. This view of people management, which might be termed ‘developmental humanism’, formed the basis for the emergence of HRM, with its emphasis on treating employees as valuable resources.

There is now a large and growing body of empirical research which demonstrates positive associations between HRM and performance, and which has further bolstered the view that good HRM drives performance. There is, however, a problem. In spite of frequent claims that the effective management of employees is the key to business success, an examination of the empirical research shows that there is rather less evidence than one might suppose that HRM causes performance gains. Perhaps even more surprising, given the apparent centrality of employees to organisational success, there is a dearth of research which actually examines the role of employees as the link between management and performance. Indeed, it would be fair to say that the conventional wisdom concerning HRM, employees and performance rests on a rather thin body of evidence.

As the discipline of HRM grew, both among practitioners and academics, it spread from its birthplace in the US across the Anglophone world and then into Europe and Asia. A discourse Insights Melbourne Business and Economics

of ‘strategic HRM’ – the linking of employee management to corporate strategy – gained currency and advocates of this approach began to argue that HRM was so important that it should have a board-level role in companies rather than just being an operational function. Of course, the best way to get a seat at the board table is to demonstrate that one is crucial to business performance. As practitioners sought an increasingly central role in organisations, and HRM academics sought to show their relevance, a demonstrated link between HRM and business success became what Karen Legge memorably called the ‘Holy Grail’. If only it were possible to demonstrate that HRM was a key driver of business success, this would validate both practitioners and academics. This imperative led to a flurry of research activities in the 1990s seeking to demonstrate the HRM-performance link.

What do we know about HRM and performance? Much of the research on HRM and performance has been based on the concept of ‘high performance work systems’ (HPWS). HPWS involve sets of mutually-reinforcing HRM practices, which are said to drive improvements in performance. Conventionally, HPWS are regarded as having three key elements. First, participative forms of work organisation in the form of self-managing teams and high-discretion jobs encourage employees to work creatively and productively. Second, to work effectively in such forms of work organisation, employees must have the necessary skills, which can be achieved by rigorous recruitment and selection, and the provision of training. Finally, if skilled employees are to work effectively, they must be motivated, which is pursued via reward systems which encourage good performance, notably through performancebased pay systems. Advocates of the HPWS approach argue that organisations which put in place participative forms of work and ensure that employees are skilled and motivated, will reap rewards in terms of better business performance as a result. Since the mid-1990s, research on HRM and performance has largely focused on testing associations between HPWS practices on one hand and indicators of organisational performance on the other. 20

The strange case of the missing worker

As a result of the growing body of empirical research, a consensus has emerged among many scholars and practitioners – that ‘good’ HRM in the form of HPWS causes improvements in business performance. This view has provided a justification for the proliferation of university courses in, and departments of, HRM as well as for a great deal of advice provided to organisations by consultants. At the risk of oversimplification, the bulk of this research has consisted of studies which have collected organisational-level data on the presence of HPWS practices and various indicators of business performance, for example labour productivity, turnover and product or service quality. Statistical analyses have been conducted to measure associations between HPWS on one hand and performance on the other. In many cases, the research has shown positive associations between the practices and performance. On the face of it, this would seem to provide the proof that practitioners and scholars have sought – that HRM improves performance. To put it another way, the seekers of the Grail would appear finally to have found it. There are, however, problems with much of the research. I certainly am not suggesting that the research is in some way substandard or that results have been manipulated. To the contrary, the research published in high-quality international journals has been rigorous and well executed. Nonetheless, it has important limitations which are often overlooked by those who use the results to argue the case for the legitimacy of HRM. First, most studies are cross-sectional – that is, they involve data collected at a single point in time – and they measure associations between variables. However, it is not safe to claim a causal relationship on the basis of positive associations. Second, the measures of HPWS and performance are often limited and problematic. Third, the associations shown in the studies are often very weak indeed. If we take into account these limitations, it becomes clear that we should be very cautious about accepting as a ‘fact’ that HRM causes performance gains. Indeed, the strongest claim we can make is that most studies are not inconsistent with this apparent fact. If, however, we push our scepticism to one side for a moment and accept the claims of advocates of HPWS, an obvious question is: how do HPWS

practices cause performance gains? It is at this point that the paradox of the ‘missing worker’ starts to become apparent.

Where are the workers? Mainstream and critical accounts It is possible to discern at least two very different theoretical explanations of the apparent causal mechanisms which link HPWS and performance. While the two theoretical models are more-orless diametrically opposed, what unites them is the assumption that HPWS practices influence performance precisely because of the effect that they have on employees and the way that employees experience their work. The dominant theoretical model, which I call here the ‘mainstream’ model, suggests that HPWS practices deliver performance gains precisely because they deliver positive outcomes to employees. That is, they deliver ‘win-win’ outcomes, in which both employees and organisations benefit. Very simply and

briefly, advocates of this model argue that HPWS practices deliver increased discretion, satisfaction and commitment, as a result of which employees not only stay with organisations and increase their work effort, but also have the opportunity, skills and motivation to work effectively. To put it another way, the theory tells us that HPWS lead to autonomous, skilled and motivated employees, working ‘smarter not harder’ in pursuit of organisational goals. This is a very appealing explanation, in the sense that it suggests that everyone can benefit from good HRM, but it has not been without its critics. The alternative ‘critical’ model presents a rather less appealing explanation for the impact of HPWS on performance. Often informed by Marxian understandings of the dynamics of management-worker relations, in particular the view that the defining feature of management is the drive to squeeze more effort from workers in pursuit of increased profit, critics have argued

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that HPWS is just a new way of extracting employee effort. The focus of critics is primarily on work organisation and motivation mechanisms. Participative work organisation, they argue, actually represents a shifting from management to workers of responsibility for decisions. Motivation mechanisms, notably performance-based pay, represent a way to put pressure on employees to increase output. From this perspective, HPWS can be seen as a way of squeezing effort from employees, so any performance gains arise at the expense of workers. The two models provide starkly contrasting accounts of how HRM contributes to performance. Advocates of the mainstream model argue that performance gains arise through positive effects on employees, leading to a win-win situation. Critics on the other hand argue that performance gains reflect a win-lose situation in which gains to management come at the expense of employees. The views are united, however, by their common

The strange case of the missing worker

assumption that performance gains arise due to the effect of HPWS on employees. Crucially, they rely on assumption about the role of employees, with little reliable empirical evidence to support their claims.

What do we know about the role of employees in the HRM-performance chain? When I first began to research in this area in the late 1990s I was very forcefully struck by the gaps in our knowledge. While advocates of the two opposing theoretical models argued long and hard for their positions, there was a remarkable lack of evidence which would allow any adjudication of their claims. This seemed quite remarkable given the centrality of employees to the main theoretical models. There were three specific gaps. First, there appeared to be no research which sought to test the competing claims of the models. Second, and even more remarkable, there was virtually no

research on the HRM-performance link which analysed employee data. Third, there was not even any research which tested the impact of HPWS on employees, a central part of the models. It seemed extraordinary to me that a discipline called human resource management appeared to be leaving the human experience out. Since that time, I have sought to fill some of these gaps, using survey-based data. My concern has been twofold. First, I have taken the impact of HRM on employees as a topic worthy of attention in its own right, regardless of its implications for performance. Work remains one of the fundamental human activities – the way we experience it is a critical determinant of our life experience. Hence, an understanding of the impact of managerial practice on employees’ experience of work is an important facet of social scientific research. Second, I have done some work on the links between HRM and performance which has involved employee data. My research on the apparent impact of HPWS on employees has called into question much of the conventional wisdom. Employing secondary analysis of large, cross-industry surveys in Australia and the UK, it has shown that some HPWS practices appear to have no effect on employees, some to have positive effects and some to have negative effects. My research, exploring employee responses as the link between HPWS and performance, shows different practices having different impacts – some positive, some negative – on employees. It provides little evidence, however, that these employee responses influence organisational performance. These results, which rely on rigorous analysis of reliable data, provide little comfort to advocates of mainstream or critical models and suggest that theoretical accounts which present HPWS as ‘good’ or ‘bad’ for employees in a general sense are overly simplistic. Further, the results suggest that causal paths from HRM to performance are likely to be much more complex than the existing theoretical accounts argue.

our knowledge. No doubt incremental gains will continue to be made. For the moment, however, we must recognise that we know much less than is commonly assumed. First, the ‘fact’ that good HRM causes performance gains continues to rest on rather limited evidence. Secondly, the ‘fact’ that HRM leads to such gains because of its effects on employees is even more questionable. The lack of conclusive evidence about the impact of HPWS on employees suggests that we need to move beyond the prior debates between mainstream and critical theorists and ask new questions. If, as the data suggest, some HPWS practices sometimes appear to have positive impacts on employees, some negative impacts and some no apparent impact, we need to refocus inquiry. Specifically, we need to ask: in what circumstances do particular practices have particular outcomes for employees? In what circumstances might these outcomes have an impact on organisational performance? What are the apparent causal paths from HPWS to employees to performance? To answer these questions requires detailed research focusing on specific groups of employees, in different parts of different industries, which can tease out these complexities. Much more work is required before we can feel confident that we understand the HRM-employee-performance link. Professor Bill Harley is Professor of Management in the Department of Management and Marketing at the University of Melbourne.

Where to from here? In the time that I have been researching this area, there has been important work done by others which has also begun to fill in some of the gaps in Insights Melbourne Business and Economics

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the road to recovery: restoring prosperity after the crisis Managing the recovery, the productivity challenge, economic responses to climate change, the housing market, health care reform, the disadvantaged, and the Indigenous gap by mark wooden, hielke buddelmeyer, paul jensen, guyonne kalb, guay lim, anthony scott, rosanna scutella, elizabeth webster and roger wilkins A short selective summary of the proceedings of the 6th Economic and Social Outlook Conference, held by the Melbourne Institute and The Australian newspaper on 5-6 November 2009.1 Copies of many of the presentations together with a recording of each speech are available from the conference website: http://www.melbourneinstitute.com/conf2009 Background In April 2002, the Melbourne Institute of Applied Economic and Social Research and The Australian newspaper joined forces to hold its first national conference designed to bring leading thinkers together to discuss the priorities for Australia’s future economic and social reform agenda. That conference spawned a series of successors, with subsequent conferences being held every 18 months or so. The first five of these conferences were held against a background of strong economic growth and declining unemployment. Indeed, at the time of the previous conference, held in March 2008, ‘the overriding domestic economic policy concern was to contain inflation by restraining the growth of demand to a pace more in line with the economy’s capacity to supply the necessary resources.’2 That said, it is also true that conference participants were very much aware of the possibility that growth would stall or even decline in the US – as actually transpired – and that financial contagion and global illiquidity could undermine prosperity in Australia. Nevertheless, the consensus was that our growing dependence on the developing world economies, especially China, would ensure that any slowdown in Australia would be temporary.3 It is now history that problems in the US market for housing loans ultimately precipitated a Global

Financial Crisis that saw the world economy shrink in 2009. In Australia, the policy response was both large and rapid. Most notable has been the large fiscal response, including two rounds of cash handouts, and expenditure equal to about 5.5 per cent of GDP. The effectiveness of these policy responses was the subject of some debate at the 2009 conference, but what does appear beyond dispute is that the duration and magnitude of the economic downturn in Australia, both relative to most other OECD economies and to past recessions in this country, were relatively mild. There was no Great Recession in 2008/09 in Australia and, as Productivity Commission Chairman Gary Banks observed, within the short space between conferences – just 18 months – the Australian economy went ‘from boom to bust to incipient recovery’. It was thus against this background that the 6th Economic and Social Outlook Conference was held.

Managing the recovery It was widely accepted by the participants that the crisis is behind us; and that the central objective for policy-makers now is how best to negotiate the bumps along the road to the next peak in the business cycle. As Reserve Bank Governor Glenn Stevens put it, the policy debate now needs to focus on how the road to recovery connects to Insights Melbourne Business and Economics

the road to prosperity – an allusion to a previous conference theme. Despite this consensus, it was just as clear that views about how best to manage the recovery were divided. Access Economics’ Chris Richardson highlighted the impact of the fiscal stimulus on the budget deficit and the political difficulties involved in eliminating this deficit any time soon. Banks went further, suggesting that the infrastructure spending phases of the stimulus need to be rethought. His remarks were seized upon by the then Opposition leader, Malcolm Turnbull, who was scathing in his assessment of both the size and composition of the stimulus package. Similarly, ANU Professor Warwick McKibbin was critical of the package, arguing that the magnitude and speed of the response panicked markets and actually made outcomes worse, at least in the short-term. In contrast, Ross Garnaut, Vice-Chancellor’s Fellow and Professorial Research Fellow at the Melbourne Institute, was highly commendatory of policy responses, including not just the expansion of government spending, but also the Commonwealth guarantee provided to the banks and the interest rate policies pursued by the Reserve Bank. However, probably more than any other speaker at the conference, Garnaut was quite pessimistic about the future, urging for ‘prudence’ in future macro-policy making. He made a strong case for the need to restrain real per capita domestic expenditure. Indeed, he argued that Australia needs to ‘go through a period with no real per capita expenditure growth at all’. At the other end of the spectrum, Brian Fisher, of BAEconomics and a former Director of the Australian Bureau of Agricultural and Resource Economics, argued that Australia was still the lucky country and that long-term trends would continue to favour our terms of trade. For Fisher, the main policy message was the need to avoid impediments to foreign trade and investment.

The productivity challenge: competition, skills and innovation There were differences in views about the extent to which policy settings need to curtail spending, but it was widely agreed that the macro-policy task would 26

The road to recovery: Restoring prosperity after the crisis

be considerably easier if productivity growth were higher. The importance of reviving productivity growth – which has been zero or negative in recent years – was a theme that was highlighted in a number of presentations, but especially those by Banks, Stevens, Victorian Premier John Brumby (who delivered the Conference’s opening address) and Deputy Prime Minister Julia Gillard. Banks, for example, identified three priorities for aiding productivity. First, further reducing the levels of ‘unproductive’ industry assistance; second, removing the anti-competitive regulatory burden and avoiding adding new ones; and third, rethinking investment in infrastructure, particularly with a view to ensuring maximum returns from our investments. Interestingly, Banks had little to say about innovation or education, skills and training, despite the fact that these are probably the two major drivers of productivity growth in the longer term. Gillard, on the other hand, emphasised the need for further reforms to the enablers of productivity growth, and she specifically mentioned not only anti-competitive regulation, but also education and broadband technology – a specific type of innovation. Similarly, Brumby acknowledged the importance of easing regulatory barriers and the benefits of improved information and communication technology – and especially high-speed Internet connections. He also stressed the importance of skills and training reforms. The importance of the skills agenda was pursued in greater depth later in the conference. Philip Bullock, Chair of Skills Australia, highlighted the likely persistence of skills shortages, despite the economic downturn. He believed the shortages are unlikely to be alleviated through market mechanisms, at least not in the medium term. Very differently, Australian Industry Group Chief Executive Heather Ridout referred to the ineffectiveness of ‘training on infertile ground’ and specifically the failings of our education system in delivering basic literacy and numeracy skills. Collette Tayler, Chair of Early Childhood Education and Care at the University of Melbourne, spoke on the importance of investment in early childhood education, warning that current investment levels are dangerously inadequate. Tom Karmel, Director of the National Centre

for Vocational Education Research, argued that a growing number of Australians are overskilled, in the sense that their skills are not being adequately used, although Andrew Leigh, from ANU, took a contrary view. The broader issue of innovation was also pursued in a dedicated session. However, the speakers here were critical of our past performance, arguing that – outside of the mining and agricultural sectors – Australia has patchy and poorly developed social, educational and financial infrastructure for sustaining an innovative economy. Realising this deficiency, the Labor Government has made an explicit commitment to improving Australia’s innovation record, especially in manufacturing. The Minister for Innovation, Senator Kim Carr, spoke about how the Government had used the counter-cyclical Global Financial Crisis policies to enhance and broaden public innovation programs. The Melbourne Institute’s Beth Webster summarised the main factors present in the most successful industries over the last two centuries. These included a society that is adaptable, able to cope with change, with a high level of intergroup trust; specialist education and training institutions that are aligned with industry’s needs; dedicated government-industry research institutes; and a well-developed informal network structure among members.

Economic responses to climate change Another major economic policy issue on the agenda, both in Australia and elsewhere in the world, is climate change mitigation. It was inevitable that this issue, and especially the Government’s proposed carbon pollution reduction scheme, would be the subject of considerable debate at the conference. Senator Penny Wong re-affirmed the Government’s commitment to an emissions trading scheme. She emphasised that it is not simply a matter of there being costs of acting – there are (larger) costs from not acting. She also noted that establishing a system soon was important for business investment certainty, something Brumby also stressed in his address.

McKibbin, on the other hand, while supportive of the Government’s general approach to climate change, was critical of the proposed ETS, arguing that it does not allow for smoothing the cost of emissions abatement over time. He proposed an alternative model based on long-term emission permits with prices fixed for a number of years (say five), with a central bank maintaining price stability through permit trading. Ross Garnaut made the point that the costs of Australia playing its part do not have to be large, though that will depend on the extent to which rent-seeking behaviours dominate outcomes.

The housing market Another recurring theme at the conference was the impact of the growing imbalance between supply and demand in the housing market. Unlike many other industrial nations, and contrary to some predictions, the GFC did not result in a collapse in housing prices in Australia. Indeed, as noted by Bill Evans, Chief Economist at Westpac, housing prices have grown at an annualised rate of 20 per cent over much of 2009, and have been a major factor behind the recent interest rate hikes. The Grattan Institute’s Saul Eslake attributed part of the reason for this to the Government’s own policies, and especially the more generous First Home Owner Grant Scheme. Other speakers emphasised restrictions on land supply, while still others, and notably Stevens, spoke of the role of continued strong population growth. On somewhat of a dissenting note, Rismark International’s Christopher Joye presented data on trends in real house prices, revealing that by international standards Australian house prices have not been rising particularly fast, especially if a longer perspective is taken. However, housing affordability was an issue prerecession, and it will remain prominent postrecession. Indeed, Eslake noted that the greater difficulties faced by developers in securing finance in the post-GFC world will only exacerbate future housing shortages. Housing affordability thus appears set to continue to deteriorate, something on which both Kieran Davies, Chief Economist of RBS Group, and Judith Yates from the University of Sydney, presented convincing evidence. Davies, Insights Melbourne Business and Economics

however, argued that most households are meeting mortgage repayment obligations and will continue to do so in the face of modest interest rate rises. For him, the key factor for servicing debt is not changes in interest rates but changes in employment, and on this front the indicators are extremely positive. Yates, on the other hand, focused on the housing problems facing the most disadvantaged. These are low-income households who are in the rental market at the low price end, where shortages are most acute. Government policies to support home ownership do little to help these people; indeed they make the problems worse by placing upward pressure on rents. Recent Government initiatives in social and community housing will help, but as Australian Council of Social Services CEO Claire Martin observed, the additional 20,000 dwellings this initiative is expected to create is still a long way short of what is needed. Judith Yates produced estimates suggesting that there is an immediate shortfall of 90,000 units of social housing and, given current trends and policies, this figure could be expected to reach 150,000 within the next two decades. Ultimately, there seemed to be near universal support for the need to expand housing supply, with the focus not so much on expanding the urban fringe, but on policies designed to increase medium density housing in inner city areas. There was also widespread support for the withdrawal of demand-side subsidies for home ownership.

Health care reform One issue that is always on the conference agenda is health care. This is to be expected given health is so important for both worker productivity and individual well-being. Health reform, however, has always been something of a ‘political hot potato’4 – the fear was that calls for reform made at previous conferences were falling on deaf ears. Such fears appear to have been unfounded, with the health care system set to enter a period of potentially wide-ranging reform – the first since Medicare was introduced in 1984 – thanks to a suite of major reform reports that the Government will respond to in 2010. Tony Scott, from the Melbourne Institute, spoke on some of the challenges in the reform agenda, 28

The road to recovery: Restoring prosperity after the crisis

including the federal-state funding relationship. He argued that the proposal for ‘Medicare Select’, which involves consumer choice between competing health plans, ignores much of the international evidence which suggests that competition and social insurance systems lead to higher costs and poorer outcomes. In his view, focusing on improving performance through strong incentives and performance management for health care providers should be a key way forward. Mary Anne O’Loughlin, of the Council of Australian Governments Reform Council, argued that closer co-operation between the Commonwealth and state governments was already happening through streamlined financial arrangements, providing a solid basis for cooperative reform. In contrast, John Deeble, one of the architects of the current Medicare system when he was employed at the Melbourne Institute in the late 1960s, questioned the view that public hospitals are performing badly compared to private hospitals. Public hospitals treat more complex patients yet productivity seems to have improved more quickly than in private hospitals – while costs remained about the same.

The disadvantaged Yet another recurring theme throughout the Conference was that, regardless of how serious the economic downturn was or how rapid our recovery, particular groups in society continue to require targeted assistance. This was at the heart of Claire Martin’s presentation, but could also be detected in many of the other sessions dealing with unemployment, the Indigenous gap, social exclusion, the tax-transfer system and, as we have just seen, housing. The extent of the broad problem was examined in a session on social inclusion. Rosanna Scutella, who holds joint appointments with the Melbourne Institute and the Brotherhood of St Laurence, for example, presented new data drawn from the Household, Income and Labour Dynamics in Australia (HILDA) Survey, documenting the extent of social exclusion in Australia. The central feature of her analysis was how many Australians, while assessed as disadvantaged on one measure, were not disadvantaged on others. Overall, it was concluded that around

four to six per cent of Australians are still ‘deeply excluded’. One group of particular interest, given recent events, was the unemployed, and in particular the long-term unemployed and those at risk of becoming long-term unemployed. Chief Executive of Jobs Australia David Thompson spoke on the prospects for the long-term unemployed, presenting a fairly gloomy assessment. While the recession is now past, the effects of the recession are likely to be felt by some for a very long time, and in his view, there is simply insufficient investment in active labour market policies to deal with this issue. In this connection, Jan van Ours, Professor of Economics at the University of Melbourne, urged caution, arguing that the international evidence indicates that active labour market policies can only have modest effects. However, he agreed that active labour market programmes, especially of the mutual obligation variety, should be an integral feature of a job creation policy.

The Indigenous gap Like health care, a perennial issue at these conferences – one that has long vexed successive Australian governments – is the gap in economic and social outcomes between Indigenous and nonIndigenous Australians. Nevertheless, perhaps for the first time, there seemed to be a feeling that real progress was being made. Tony Abbott, who was Opposition spokesman for Indigenous Affairs at the time, observed that critics can no longer claim that poor outcomes are predominantly due to inadequate provision of health services. He argues that almost all locations with large Indigenous populations have dedicated Aboriginal health services, and that continuing poor health outcomes are more a function of low education, welfare dependency and lack of employment, which in turn are a function of failure of policy implementation at the community level. He advocated a new governance model, based on the Cape York experience, with far greater decisionmaking power for community issues placed in the hands of a network of lone administrators, perhaps advised by local elders.

that most Indigenous Australians lived in urban areas and hence the greatest potential for closing the gap lay in getting these people into work. On this front, Boyd Hunter, Senior Fellow at the Centre for Aboriginal Economic Policy Research at ANU, presented evidence indicating that the recent period of strong economic growth had been reflected in relatively strong employment outcomes for Indigenous Australians. Most strikingly, unemployment had more than halved over the last 15 years, and on current trends, the gap in unemployment might even be eliminated within three decades. However, this would occur in part because of continuing low labour force participation rates – hidden unemployment is a far more serious issue in the Indigenous population compared to conventionally measured unemployment. Hunter was also much more circumspect about the urban/rural distinction that Aird highlighted, arguing that the issues of a lack of access to jobs and the consequent high rates of welfare dependency are most serious in remote communities. The authors are all staff members of the Melbourne Institute of Applied Economic and Social Research. Prof. Mark Wooden is Professorial Research Fellow and Acting Director of the Melbourne Institute. 1 The Conference was sponsored by The Productivity Commission, the University of Melbourne, and the Faculty of Economics and Commerce (now Faculty of Business and Economics) at the University of Melbourne. 2 Stephen Sedgwick (2008), ‘New Agenda for Prosperity’, Insights Vol 4 November 2008, p.42. 3 A short summary of the March 2008 Economic and Social Outlook Conference is provided in Sedgwick (2008). 4 Dawkins, P. and Kelly. P. (eds) (2003), Hard Heads, Soft Hearts: A New Reform Agenda for Australia, Allen & Unwin, Sydney, p135.

Wesley Aird, Coordinator of the Australian Employment Covenant, on the other hand, noted Insights Melbourne Business and Economics

Article heading here

spaghetti unravelled: how income varies with age Average income-age trajectories derived from longitudinal data look different from those derived from cross-sectional data by stephen p jenkins An edited version of the 2009 Downing Lecture presented on 22 October 2009 at the University of Melbourne. The report on which the lecture is based, ‘Spaghetti unravelled: a model-based description of differences in income-age trajectories’, is available from http://www.iser.essex.ac.uk/publications/working-papers/iser/2009-30. A video of the lecture is available at http://live.unimelb.edu.au/episode/downing-lecture-spaghettiunravelled-how-income-varies-age.1

Introduction My research provides new evidence about the shape of people’s income-age trajectories – how income varies with age – and how these trajectories differ between individuals. I argue that income-age trajectories collectively look like cooked spaghetti – they are a complex mix of wiggly lines. My analysis is based on 17 years of data from the British Household Panel Survey (BHPS) – a survey which has reinterviewed the same set of individuals year after year. The BHPS is similar to the Australian panel survey run by the Melbourne Institute (HILDA). Figure 1 provides some evidence of trajectory ‘spaghetti’: each line in the chart shows the evolution of hourly wages for men born in 1966 who have educational qualifications to at least A-level standard (the qualification for university entrance). There is one line for each of the 517 men in the sample. Similar spaghetti pictures arise for other groups too, including women, and for other definitions of income, including household income from all sources. It appears that, on average, wages rise with age but, even within this relatively homogenous group, there is substantial variation in wages at the start of the working life, and in wage growth thereafter.

Figure 1. How hourly wages (log scale) vary with age (men born 1966 with at least A-level educational qualification) 50 40 30 20 10

Age (years) Source: British Household Panel Survey, waves 1–17.

I argue that statistical models can be used to isolate some key patterns from this spaghetti – this is the unravelling of the title. I propose a framework that provides summary descriptions of not only the way in which incomes among groups of similar individuals change with age on average, but also the way in which trajectories for individuals diverge from the average trajectory of their group. Most of the evidence currently available about the relationship between income and age is derived from Insights Melbourne Business and Economics

Relevance for social policymaking Knowledge of how income varies with age on average, and the extent to which individual trajectories differ from an average profile, is relevant to many aspects of social policymaking. For example, how your income varies over your life is an important determinant of your spending possibilities – and hence consumption and economic well-being – at different ages, and your ability to save for old age, whether privately or through company, occupational, or state pension schemes. It is important to identify the characteristics of not only the groups who, on average, have persistently low incomes and hence low abilities to save, but also whether a ‘group average’ is potentially deceptive. Even if income increases with age on average, this is consistent with considerable yearon-year fluctuation in the incomes of a minority, or a mixture of subgroups with rising income and subgroups whose income is falling. These features complicate the design of effective policies for fostering saving by all.

Unravelling the spaghetti The key ideas underpinning my approach are as follows. First, I differentiate twelve ‘social groups’, with group membership defined in terms of similarity of birth year, educational qualifications and sex. Second, within each group, I summarise income-age trajectories in terms of an average group profile combined with individual-specific 32

Spaghetti unravelled: How income varies with age

divergences from the group average. Figure 2 helps explain the idea. Figure 2. Stylised income-age trajectories for two individuals and the average trajectory

Income

cross-sectional data. The pictures of income-age trajectories are derived from survey data for a given year about a large sample of individuals of different ages. By contrast, my research uses longitudinal data that tracks the same people over time and accumulates information about the income-age trajectory for each person in the sample as each person ages. Data about how income varies between the age of 30 and 40 years (say) is derived by following 30 year olds over a decade until they are 40 rather than comparing today’s 30 year olds with today’s 40 year olds. If one is interested in documenting the nature of individual’s income-age trajectories, including how income varies between one year and the next for each person, while also describing the heterogeneity across individuals in income-age trajectories, then a longitudinal approach is essential.

Age (years)

Note. Chart shows stylised income-age trajectories for two individuals (dashed lines) and an average trajectory (solid line): see text for further explanation.

The dashed lines show stylised income-age trajectories for two individuals from the same social group (men born in the same year who both left school with GSCEs but without any A-levels, say). John’s profile is summarised by a relatively low income at the beginning of the working-life (taken to be 25 here) combined with a relatively large growth rate in income with age (long dashed line). The other profile (short dashed line) combines a relatively high initial income but a relatively low growth rate in income with age – the slope of the trajectory is less steep than in the first case. Think of the first situation as characterising someone who qualified as plumber. The starting salary is relatively low but increases over the working life, reflecting the return to the investment in training. The second situation represents Mike who instead trained as a motor mechanic. Initial earnings are higher than for John and remain so until both individuals are nearly 50 at which point, John’s earnings are overtaken by Mike’s. The solid line represents the average of the two individual profiles. The key differences between John’s and Mike’s trajectories are, first, the difference in the initial incomes (one is below the average trajectory initially; the other is above the average initially) and, second, the difference in income growth with

age (again one rate is above the average and the other is below it). A third important feature is that initial incomes and income growth rates are negatively correlated: John has a lower income than Mike to start with but experiences greater income growth. Their trajectories cross. Now suppose that we wish to summarise the trajectories for all of the many individuals in this group, not only those for John and Mike. Given the average trajectory for the group as a whole, we can think of there being a distribution of initial incomes around the average and also a distribution of income growth rates, and some correlation between initial incomes and growth rates. Although most individuals within the group are located relatively close to the average, there are a few outliers either with relatively low or high initial incomes or growth rates. The relative frequencies of high and low deviations from the average initial income are illustrated in Figure 2 using the curvy solid line. Most people are located close to the average value at age 25 (the curve is ‘higher’), with relatively small numbers with extreme values (where the curve is ‘lower’). In my analysis, the joint distribution of initial incomes and growth rates with age is characterised using only three numbers – the standard deviation of initial incomes around the average, the standard deviation of growth rates around the average, and the correlation between initial income and growth rate – and these parameters can be estimated from longitudinal survey data along with the parameters that describe the group average income trajectory. This characterisation is consistent with both the trajectories increasing with age for a majority within the group, and declining with age for a minority. The model implies that not only is there withingroup inequality in income at each age, but also that this inequality varies with age. Intuitively, the less dispersion there is in initial incomes, or in income growth rates, the lower the within-group inequality at any age. Substantial dispersion in the income growth rate will tend to increase agespecific within-group inequality levels as the group members age. The cumulative effect of persistent differential income growth is to magnify initial income differences, providing an impetus for profiles to fan out with age.

There are additional features introduced into the model to make it more realistic. First, the group average trajectory is allowed to have more ‘wiggles’ than the stylised trajectory shown in Figure 2. Second, an additional year-by-year source of idiosyncratic variation in an individual’s income from the group average is introduced to account for the substantial longitudinal variability in incomes that arises in real life. This variation might conceivably arise from several sources, including genuine transitory variation, measurement errors in income, or reflect the impact on income of major life events such as the birth of a child or divorce.

Estimates of income-age trajectories: group averages and individual divergences The average trajectories for wages for employees of working age are shown for the twelve groups in Figure 3. The groups are characterised using information about individuals’ sex, educational qualifications and year of birth. The trajectories are plotted using logarithmic scales, so that the slope of the trajectory shows how the proportionate growth rate of wages changes with age. (If wages increased at the same percentage rate each year, the profile would be a straight line.) The trajectories are shown only for the age ranges covered by the various estimation samples, so the pictures for the 1955+ birth cohort cover the age range 25–52 and those for the pre-1955 birth cohort cover ages ranging from 37 to 64 (men) or 59 (women). Some clear patterns emerge. First, hourly wages increase with age from the beginning of the working life, but at a decreasing rate (with some anomalies that I return to shortly). On average, and regardless of group, men’s wages grow continuously from the start of the working life but at a decreasing rate, peak in the late 40s and fall thereafter. In contrast, women’s profiles do not have such a distinct peak – wage growth declines up until the late 30s but then appears to rise again. The growth slowdown for women is consistent with their greater prevalence of part-time work, which is less well paid, particularly over the ages when many have children. Second, for both men and women, and for both birth cohorts, having higher educational Insights Melbourne Business and Economics

qualifications is associated with higher wages, with the return to additional qualifications greater for women than for men up until middle age (women’s trajectories appear more parallel than divergent). But, third, among persons with similar educational qualifications and birth cohort, men are paid more on average than women at every age. Fourth, individuals from the later-born birth cohort are on higher trajectories than those from the earlier-born cohort, other things equal. The returns to different levels of education and between the sexes are substantial. For example, for men aged 40 from the 1955+ birth cohort, the difference on average between those with no qualifications and qualifications of at least A-level standard is around 50 per cent (just over £12 per hour compared with just under £8). For women, the corresponding difference is around 55 per cent. But the difference between the hourly wage of a 40 year old man and a 40 year old woman, both from the younger cohort, is more than one third in his favour on average (around 35 per cent). The average trajectory for women with A-level qualifications lies below that for men with some qualifications. The average trajectories for men with no qualifications lie almost everywhere above the average trajectories for women with some qualifications.

Potential anomalous aspects There are some potentially anomalous aspects to some profiles at the beginnings and ends of

the working life, notably for the pre-1955 birth cohort: observe the upward twists in these cases. My explanation for these is that they reflect the impact of the selection effects cited earlier. For instance, arguably the women most likely to remain in the workforce as the state retirement age (60) approaches, are those for whom the pay rates are relatively high; those with relatively low pay rates retire. So, the pay rates used to estimate average trajectories over that age range are an over-estimate relative to the average that would be calculated were all women to have remained in work. Similar arguments can be made concerning older men, but it is a puzzle why the increase in the average is so pronounced for men with some qualifications but not for those with no qualifications. There is also a slight decline in average wages for men and women just prior to age among the pre-1955 birth cohort. Arguably this reflects a period effect. For this group, these years correspond to the recession years of 1991–1993 and, again, men with relatively low earnings propensities were less likely to work, thereby raising the average calculated from those who were in employment.

Within-and between-group differences The nature of the within- and between-group differences in wage levels at different ages is illustrated by Figure 4, which focuses on the middle of the working life (age 40). The chart shows that there is substantial dispersion of wages within each group, and this implies substantial overlapping in

Figure 3: Estimated average wage-age trajectories, by group, for employees of working age Men

4 25

Age (years)

Women

Hourly wage (log scale)

Pre-1955 birth, no quals.

Pre-1955 birth, some quals.

Pre-1955 birth, A-level+

1955+ birth, no quals.

1955+ birth, some quals.

1955+ birth, A-level+

Spaghetti unravelled: How income varies with age

Age (years)

the wage distributions of different groups. Among those born in or after 1955, the man at the 75th percentile of the group with no qualifications earns slightly more than the man at the middle of the group with some qualification. But the man at the middle of the no qualifications group earns more than the woman at the 75th percentile of the group with no qualifications. In additional analysis, I show how these patterns of inequality at each age exist right across the working life.

Conclusions Most descriptions of the income-age relationship are based on comparisons of income across age groups in a particular year and are based on cross-sectional data. In contrast, my research takes a longitudinal approach. Average income-age trajectories derived from longitudinal data look different from those Figure 4: The distribution of log (hourly wage) at age 40, by group Men

Born 1955+, A-level+ Pre-1955 birth, A-level+ Born 1955+, some quals. Pre-1955 birth, some quals. Born 1955+, no quals. Pre-1955 birth, no quals. 0.0

1.0

2.0

3.0

4.0

5.0

log (hourly wage)

Women

Born 1955+, A-level+ Pre-1955 birth, A-level+ Born 1955+, some quals. Pre-1955 birth, some quals. Born 1955+, no quals. Pre-1955 birth, no quals. 0.0

1.0

2.0

3.0

4.0

5.0

log (hourly wage)

Note: The line for each group shows the group-specific interquartile range (distance between the 25th and 75th percentiles). The filled circles show the group medians (50th percentile), which is the same as the mean.

derived from cross-sectional data. For hourly wages for instance, trajectories at the beginning of the working life are steeper â&#x20AC;&#x201C; wage growth is greater â&#x20AC;&#x201C; according to longitudinal data. My analysis draws attention to the cooked spaghetti nature of income-age trajectories. I have argued that this pattern can usefully be summarised in terms of a number of factors. Looking at groups of individuals with similar observed characteristics, one can distinguish an average income-age trajectory for each group. Within groups, one can summarise differences across individuals in terms of: differences in incomes at the start of the working life; differences in income growth rates; and the association between initial incomes and income growth rates (they are negatively correlated). In addition, income-age trajectories differ because of substantial individual-specific transitory income changes from one year to the next. My report argues that it is the transitory error component of income that cooks the spaghetti. These transitory changes may represent genuinely transitory effects on income, measurement error or, for broader measures of income, the effects of lifecourse events such as having children, and family formation or dissolution. A task for future research is to incorporate more sophisticated assumptions about its nature and persistence over time. This is likely to be facilitated by access to even longer panels than used in this study (perhaps from administrative record data, which may also have less measurement error than survey data). Long panels are necessary to help study the nature of income persistence in all its complex detail, including the extent to which observed short-run income changes for individuals are genuine. Stephen P. Jenkins is a professor at the Institute for Social and Economic Research, University of Essex, Colchester, CO4 3SQ, United Kingdom. He was the 2009 Downing Fellow, and visited the Melbourne Institute for Applied Economic and Social Research from October to December 2009. Email: stephenj@essex.ac.uk 1 The report was commissioned by the UKâ&#x20AC;&#x2122;s National Equality Panel (http://www.equalities.gov.uk/national_ equality_panel.aspx).

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Article heading here

research that informs the standard setting process Academic research can help resolve many of the nettlesome issues that standard setters face, and play a central role in shaping global financial reporting by mary e barth A condensed version1 of the 70th Annual CPA Australia/University of Melbourne Lecture presented on 12 October 2009. A recorded version of the full Lecture can be found at http://live. unimelb.edu.au/episode/cpa-congress-2009-70th-annual-research-lecture Research and standard setting Research can inform standard setting issues for a variety of reasons. First, accounting research helps standard setters identify the issues with which they should be grappling. Second, academic research can help structure standard setters’ thinking about the issues. Third, research can provide evidence on standard setting issues. Research also provides unbiased analysis to standard setters. Academics are one of the few groups who have no stake in the outcome of any standard setting decision. Companies care about standard setting decisions because they must follow the standards. Auditors care about the standards because they have to audit the required information. Analysts want the standards to require information that they use in their own analysis. Further, academics are trained in economics and understand the role of information in capital markets. It is information economics that underlies standard setting. In 1974, Gonedes and Dopuch published a very influential paper that maintains that accounting standards are public goods and involve externalities. Thus, it is not possible to determine the desirability of any particular accounting standard simply by looking at the relation between share prices, or equity returns, and accounting amounts – even if markets are fully efficient. Determining the desirability of

any particular standard requires specifying social preferences and the inevitable trade-offs between the winners and the losers. Standard setters develop the framework and specify in it what is important in making standard setting decisions. Academic researchers then take those criteria, operationalise them in their research design, and indicate to the standard setters how particular aspects of various accounting treatments embody those criteria. Research informs standard setting, but cannot answer the question, ‘What should the standard be?’

The many research questions The good news for researchers is that there is no end to the questions to which we do not know the answers. This applies to technical agenda topics as well as cross-cutting issues (the term used by standard setters for issues that apply to many topics) that include: fair value, recognition versus disclosure, the role of uncertainty and risk, relevance and faithful representation, the role of incentives and judgement in financial reporting, the distinction between liabilities and equity, user needs, and cost and benefits. Another important research topic is the globalisation of financial reporting. Countries such as Australia have adopted International Financial Reporting Standards (IFRS) to achieve, hopefully, some benefits; and academic research is trying to identify those benefits.

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Fair value Fair value is one of the cross-cutting issues that arises in almost every International Accounting Standards Board (IASB) agenda – it is currently the focus of the Financial Accounting Standards Board (FASB) and the IASB in several joint projects. The growing academic literature on fair value considers almost every topic in financial reporting. Whenever the issue of measurement arises, fair value is considered. The IASB’s current conceptual framework does not include much guidance relating to making measurement decisions, but a framework chapter on measurement is being developed. Fair value also arises in financial instruments, non-financial liabilities, and pensions. It is also relevant for revenue, insurance, and leases – again, just about every topic on the agenda. Standard setters often look to fair value as a possible measurement basis, mainly because fair value provides information that assists in making economic decisions. Fair values are nothing more than the present value of expected future cash flows. The discount rate reflects the uncertainties inherent in those cash flows. Although fair value is not always the right measurement basis, it should be on the list to be considered. Fair value is also consistent with the definitions of assets and liabilities. The definitions focus on the future – inflows in the case of assets and outflows in the case of liabilities. Fair value is relevant because it reflects expectations of the future adjusted for the time value of money and risk. Fair value requires taking an unbiased, market participant view rather than a management view of a favourable picture of the company. Moreover, fair value possesses many of the qualitative characteristics of accounting information specified in the framework – relevance and faithful representation. The current measure of something will be more relevant to users making decisions than a twenty-year old, modified historical cost number. Comparability means that like things should look alike and different things should look different. Fair value would accomplish this. The mixed attribute model that we have today masks some economic mismatches 38

Research that informs the standard setting process

and creates accounting mismatches, which is why we are then forced to use hedge accounting. Not everyone believes fair value is the best measurement basis. An important concern is the scope for error in estimating fair value, particularly for non-traded instruments, and therefore scope for management to exercise discretion. The response of the advocates of fair value is that almost every number in the financial statements requires the exercise of judgement. Fair value puts a market discipline on the exercise of that judgement. Some are concerned about recognising holding gains and losses in earnings. They view this as an opportunity cost approach to financial reporting, which they regard as inappropriate, arguing that if users’ models are designed to cope with the measures we currently report, a different view on financial reporting will be confusing to users. Others consider there is too much earnings volatility. But when does earnings volatility become ‘too much’? In the current financial crisis, the concern about fair value also includes concerns about liquidity effects, pro-cyclicality, and the effects of financial reporting on bank capital. The outcome of the IASB project would not require any greater use of fair value than applies currently. It would only clarify the meaning of ‘fair value’. Let me explain some of the common sources of confusion. Fair value is an exit price from the perspective of the company. It is the price in the sale of an asset or the transfer of a liability. Fair value assumes either a sale or use in a business, both based on a market-participant perspective. It is not a liquidation notion. Differences are sometimes made between exit price and entry price, but these are the same for a given asset or liability when they relate to the same item, on the same date, and in the same market, and when buyers and sellers have the same information. While the two prices can be different in different markets, the fair value measurement definition applies to the most advantageous market.

My own research on fair value I will describe some of my own research on fair value. One study2 addresses fair value accounting

for liabilities and own credit risk. The motivating question is, ‘Do changes in credit risk affect the fair value of a liability?’ Many do not think that credit risk changes should be reflected in fair value. The secondary question is, ‘If we were to recognise the effects of own credit risk on liabilities, would net income be misleading?’ The concern here is that when a company’s financial condition deteriorates, its credit risk increases and the value of its liabilities decreases. The first research question is whether the effect of credit risk changes on equity returns are mitigated by leverage. That is, when the company is in trouble, equity returns are negative. But is that negative return smaller when the company has more debt because the debt holders share in the fall in equity value? If so, then the presence of debt reduces the decline in equity value. The second research question is, ‘How would net income, or profit or loss, differ if fair values of debt were recognised?’ On the first question, we estimate the relation between equity returns and the change in credit risk interacted with leverage to see how leverage affects the relation. We also estimate the change in debt value by looking at the financial statement disclosures of the maturities of debt – the cash payments due in each of the next five years, the following five years, and the next five years. We discount these amounts using the interest rate that is commensurate with the company’s credit risk at the beginning of the year, we discount them again using the interest rate commensurate with the credit risk at the end of the year, and then we see how the amounts differ. We find that equity returns are less negative when credit risk increases, when the company has more debt. Interestingly, we find this result for most credit risk levels, not just the highest. We know from theory that the credit risk effect is greatest when the company is in severe financial distress. However, the question arises whether one can even detect this effect when the company is not in financial distress. Our findings reveal that the answer is ‘yes’, and confirm that equity holders gain when credit risk increases. Thus, the seemingly counterintuitive effect is not counterintuitive at all – it is an economic fact.

Regarding the second question as to how net income would differ if fair value of debt were recognised, we obtain asset and liability value estimates by inverting the Merton model. We then restate net income first to reflect all changes in fair values and then to reflect only changes in debt fair values. We find that when we consider all changes in value, as one would expect, income is lower for companies that have credit downgrades – whose credit risk has increased – and the opposite for companies with reduced risk. These findings tell us that the model is working. Also consistent with what we would expect when we only recognise debt value changes, we find that income is higher for downgrade firms and lower for upgrade firms. This anomalous effect is of concern to some. But when the company is in financial trouble, accountants write down assets. The question then becomes, ‘Are those write-downs big enough to absorb this credit?’ Importantly, we find that the answer is ‘yes’ – recognised asset write-downs exceed debt value gains for most firms. This finding tells us that the concerns about anomalous income effects are warranted because we do not recognise all assets. Since we do not write up all assets, we cannot write them down when things go bad. The second example of my research is an examination of the relation between fixed asset revaluations and future company performance.3 The motivating questions here are: ‘Are asset revaluation amounts reliable estimates of asset fair values?’ and ‘Do managers exercise their discretion, so as to render the fair value estimates unreliable?’ Lack of reliability of fair value estimates is one concern some have about fair value. The research question we address in the study is, ‘Do upward asset revaluations explain changes in future operating performance, where we define operating performance as future operating cash flows and future operating income?’ The notion behind this research question is that if asset revaluations explain future operating performance, then the revaluations must be reflecting part of the value of the asset. If the revaluation amounts were totally unreliable, or if managers were managing the revaluation numbers, we would not detect a relation. In this study, we look at UK firms with upward asset revaluations and look for Insights Melbourne Business and Economics

incremental explanatory power in a regression of changes in realised future performance.4 We find that revaluation amounts are significantly associated with changes in future operating performance; both future operating income and operating cash flows, one, two, and three years ahead. Revaluation balances are associated with share prices and revaluation increments are associated with returns. We find that the relation is less positive for higher debt to equity firms. The interpretation from this study is that fair values of fixed assets are reliable as reflected in future operating performance, and changes in fair values are relevant to investors and reflect timely changes in asset values. We do find evidence of management discretion, but the effects of discretion do not eliminate the relevance and reliability of the revaluations.

The lessons and questions from fair value research What have we learned from fair value research taken as a whole? The studies I have described are just two examples in a very large literature. Just about everywhere academics look, fair values are relevant and reliable enough to be reflected in investors’ valuations. This finding applies to financial instruments, tangible assets, and intangible assets such as brands. We also find evidence of managers exercising discretion in estimating fair values. Nevertheless, the discretion never seems to be enough to eliminate the overall relevance of fair value amounts. Despite the large literature that exists, there are many open questions. Perhaps the biggest question is whether we can measure fair values reliably. Can we do it well enough, to justify putting the estimates in financial statements? Is fair value the right measurement basis? If it is, is fair value the right measurement basis for all assets and all liabilities, or only some? If only some, which ones? If not fair value, then what? This is a huge open question. What information do investors need about fair values? Do they need information about the distribution of fair value estimates? Does recognition or disclosure matter? Often, companies seem to be happy disclosing numbers in financial statement notes, but not so happy about recognising those numbers. Are concerns about earnings volatility 40

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legitimate? What is ‘too much’ earnings volatility? What are the effects of management discretion in determining fair values? We know discretion is there, we find evidence of it, but what are the implications of it? How will the use of more fair values affect investor or management behaviour? What are the implications of incorporating more expectations about the future into financial statements today? In particular, what does profit or loss mean in such a world?

Globalisation of financial reporting I turn now to issues related to the globalisation of financial reporting. The IASB’s vision is for a single set of high-quality global standards that are used in the world’s capital markets. Why is this the vision? The most important reason is that we accountants want to improve the functioning of global capital markets. ‘Improve’ means increased comparability across firms, thereby reducing information processing costs. For many countries, ‘improve’ also means increasing the quality of accounting information; and decreasing the cost of preparing financial statements, particularly for large multinational firms currently using different standards. A single set of standards reduces information risk arising from users not understanding financial statements and so imposing a risk premium and increasing the cost of capital. The worldwide International Financial Reporting Standards (IFRS) adoption experiment has generated considerable interest among researchers. To give two examples of research studies, consider first the stock market reaction to the adoption of IFRS in Europe.5 The first motivating question here is, ‘Did investors perceive net benefits to the IFRS adoption in Europe?’ The second motivating question is, ‘If there were benefits, did the benefits come from convergence of standards or from perceived improvement in the quality of information?’ The main research question addressed is, ‘Did the European stock market react positively to events that increased the likelihood of IFRS adoption and negatively to events that decreased this likelihood?’ We find a significant positive overall market reaction to events that increased the likelihood

of IFRS adoption. We find that the reaction was incrementally negative for firms in code law countries. Prior research tells us that investors in code law countries in Europe are concerned about enforcement and implementation, so this is consistent with investors in those countries being less excited about the change. We find that the market reaction was incrementally positive for firms that had lower quality information – more pronounced for banks and firms with greater information asymmetry. These findings are consistent with investors responding more positively when they assess the change as increasing the quality of the information they would be receiving under IFRS. However, we also find an incremental positive market reaction from firms with high-quality preadoption information, suggesting that investors perceive benefits from convergence. Thus, investors perceive net benefits to the adoption of IFRS in

Europe; they are concerned about enforcement of the standards; and they expect net benefits associated with both increased information quality and increased convergence. The second example relates to the possible adoption of IFRS by the US. One of the questions raised in the US is whether US Generally Accepted Accounting Principles (GAAP)-based financial information is comparable to IFRS-based financial information.6 The motivating questions here are straightforward. The first is in the study’s title: ‘Are international accounting standards (IAS)-based accounting amounts comparable to US GAAP-based accounting amounts?’7 The second is, regardless of whether they are or are not comparable, ‘Is there evidence that comparability has increased?’8 The findings of this study indicate that the US GAAP-based accounting amounts and IAS-based

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accounting amounts are not fully comparable. However, comparability with IAS is higher than it was with non-US domestic standards and comparability has increased over time; in other words, the widespread application of IAS by non-US firms and convergence efforts have increased comparability with US firms, but differences still remain. The study just referred to is one of several that conclude that investors viewed the adoption of IFRS in Europe positively, and the extensive literature finds that IAS-based accounting amounts are of higher quality than non-US GAAP-based amounts. This literature also finds that IAS-based accounting amounts are of comparable quality to US GAAP-based amounts reported by firms in many countries, although not to amounts reported by US firms. Again, comparability with US GAAP is increasing over time. We also know that having a single set of accounting standards is a necessary but not sufficient condition for comparable financial reporting around the world. The IASB can write standards, and those standards may be identical to those of any other country. However, many accountants are involved in turning those standards into financial statements. The quality of the information in the resulting financial statements depends on the incentives of managers and auditors. We also know that cultures change slowly, not by fiat. It takes time for people to understand what is expected. Finally, there is a study that I really like because it reveals my bias. This study derives equilibria from models of an economy. Sometimes such models have more than one equilibrium and there is no reason to prefer one to another. This study shows how countries that have very similar economies can end up with very different financial reporting standards. I like this study because it shows that it is possible that we did not end up with different standards around the world because we are fundamentally different. It could just be that we were not talking to each other. Thus, maybe it will be easier to bring the financial reporting world together than many people think. A key question is whether globalisation of financial reporting reduces the cost of capital, which is unobservable and hence 42

Research that informs the standard setting process

it is very difficult to provide conclusive evidence on this question. Thus, we need several studies so that we can triangulate the findings. We would also like to know whether globalisation facilitates the allocation of capital and cross-border trading. This is part of the objective of having globalised financial reporting. Does it reduce home bias in investing? Is part of the reason for the current home bias in investing that people understand financial statements from their home country and not other countries? Another question: Can we remove the impediments to global standards? The literature does not explain how these impediments can be removed or which impediments are the most important. Overall, the question of whether application of IFRS results in higher quality financial reporting is still open. And we also do not fully understand the costs and benefits of globalisation. Change involves costs but do the benefits outweigh the costs?

The Global Financial Crisis I do not believe that accountants should take the blame for the current financial crisis. The crisis is not the result of fair value accounting. We accountants are just the messengers and are simply stating the facts. However, there has been tremendous pressure to reduce the transparency of financial reporting and the independence of standard setting as a result of the financial crisis. Bank regulators have tried to convince others that we should not permit accounting to ‘tell it like it is’ – they argue that when the financial statements ‘told it like it was’, we ended up in a financial crisis. The G20 statement on the financial crisis supports high-quality transparent global standards set by independent standard setters. This statement was extremely important. Hopefully, the statement will help offset some of the political pressure being placed on the accounting standard setters. Also, I believe that the financial crisis has increased the focus on convergence around the world, particularly between US GAAP and IFRS. We live in a global world and we need the same financial reporting. Without global standard setters, financial reporting will end up at the

lowest common denominator. It is a challenging time for all involved in financial reporting.

Concluding thoughts Many open questions remain. This is great news for academics, not so for standard setters and other accountants. For example, it is embarrassing to tell non-accountants that accountants still do not know what revenue is when, for 500 years, we have been putting revenue at the top of the income statement. Yet, the FASB and the IASB have been debating revenue for the past five years.

Lang at University of North Carolina, Chapel Hill and Christopher Williams at the University of Michigan. 7 We refer to the amounts as being based on IAS, rather than IFRS, because part of our sample period predates IFRS and IAS is a more generic term. 8 The technical details of this study are recorded in the full paper at: http://live.unimelb.edu.au/episode/cpacongress-2009-70th-annual-research-lecture

There are many possible research designs that can make research relevant to standard setting. I described four research designs, and I believe each provides relevant input to a standard setting issue. The researcherâ&#x20AC;&#x2122;s task is to design research that links the research question to the motivating question, so that standard setters and others can see the contribution of the research to the issues of the motivating question. Standard setters need all the help they can get. Conducting research that contributes both to the academic literature and to standard setting has a double impact. Academic research can help resolve many of the nettlesome issues standard setters face, and play a central role in shaping global financial reporting. The slate is open and ready for our collective input. Professor Barth is the Joan E. Horngren Professor of Accounting and the Bob and Marilyn Jaedicke Faculty Fellow. 1 I am indebted to Professor Bruce Grundy for assistance in editing this paper. 2 This study is joint work with Leslie Hodder at the University of Indiana and Steve Stubben at the University of North Carolina, Chapel Hill. 3 This study is joint work with David Aboody, at University of California, Los Angeles, and Ron Kasznik, a colleague of mine at Stanford. 4 The technical details of this study are recorded in the full paper at: http://live.unimelb.edu.au/episode/cpa-congress2009-70th-annual-research-lecture 5 A study jointly with Chris Armstrong at the Wharton School, Alan Jagolinzer, a Stanford colleague, and Eddie Riedl at the Harvard Business School. 6 This question is addressed in an unpublished working paper written jointly with Wayne Landsman and Mark

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Article heading here

strengthening global economic governance A gap continues to exist in the structure of international economic institutions through the absence of a representative, accountable, politically legitimate forum for discussion of the principal issues of global political economy by john langmore and shaun fitzgerald This paper was given at a conference entitled Re-Embedding the Market: Crisis and Reinvention. Market Governance after the Financial Crisis, and was hosted by Harvard University, the Max Planck Institute for the Study of Societies, Cologne and the Social Justice Initiative at the University of Melbourne. The conference was held on 3-4 December 2009. Global democratic deficit The evolution of international economic and social institutions lags well behind the deepening of global interdependence. Interest in reducing the global democratic deficit and improving the political effectiveness of international economic, financial and social institutions has not kept pace with globalisation. Global economic forums are still too exclusive, unbalanced, slow, unaccountable or weak to enable formation of policies which facilitate improving the wellbeing of most people with maximum effectiveness. The upgrading of the G20 to be the major international meeting for national leaders of large, economically influential countries on economic and financial issues is a substantial step forward. But the G20 is self-selected, exclusive, has a static membership, and lacks an independent secretariat. It is therefore only a step towards a more equitable and effective body. Other existing forums have even more serious inadequacies, so further reform and innovation is imperative. Just as a rule-based international system is vital for peace, so is it for economic and social development, but a necessary condition is that the rules be equitable. A brief look at existing global economic forums reveals severe imbalances – most developing, some developed and most transitional countries are under-represented in the global economic and financial institutions. The people of the developing countries account for over

85 per cent of the world’s population yet decisionmaking on key global economic issues remains concentrated in the major industrial countries.

The UN Economic and Social Council (ECOSOC) With the establishment of a new world order in 1945, ECOSOC was designed to be the principal international forum dealing, amongst other subjects, with global economic coordination. With every state privy to the Council’s dealings, it is also the existing inter-governmental body with the greatest potential to link the isolating ‘silos’ into which international economic, financial, trade, social and environmental organisations have tended to settle. Yet, no one would claim that it is close to fulfilling its functions adequately. With 54 members, it is too large to be swiftly decisive. Its principal session is held once a year during July and in the past has not adequately addressed global crises. The world’s major economies are only rarely engaged with its activities at senior levels. And it has few powers and no resources with which to implement its decisions. The effectiveness of ECOSOC has been improved in recent years through inaugurating meetings twice a year with the heads of the International Monetary Fund, World Bank, World Trade Organisation Insights Melbourne Business and Economics

and United Nations Conference on Trade and Development; by having more short meetings on high priority issues during the year; and through improvements in procedures and preparation. These reforms could be further strengthened through the establishment of an ECOSOC executive committee with quick response capability, instituting sessions on macroeconomic cooperation, regularly reviewing the provision of finance for development, and by inviting other institutions of economic governance to contribute to sessions.

The International Monetary Fund and World Bank Established contemporaneously with ECOSOC, the problems with the IMF and World Bank – the Bretton Woods Institutions (BWIs) – have been well documented. The governance of both institutions suffers from a lack of inclusiveness – voting power grossly favours Western nations, especially Europe and America. The top 20 nations account for 71.2 per cent of IMF votes, leaving the remaining 166 nations with 28.8 per cent of voting power.1 The lenders are the principal shareholders and the borrowers provide the income. This imbalance marginalises the voices of large and smaller developing nations. This difficulty is further exacerbated by the unfair majority rules effectively requiring the affirmative vote of the US for major decisions. The process of electing CEOs is contrary to modern democratic thought. The Managing Director of the IMF has been appointed by a small group of European countries in consultation with the US, and the President of the World Bank has been an American. Without the participation of the broader global community in an election of these leaders, the BWIs will continue to be viewed as largely transatlantic institutions. Many IMF and World Bank policies and procedures are not disclosed to the wider public. The current system of national representation entrenches inequity: while large developed countries have their own executive directors, other executive directors represent as many as twenty-three diverse nations. Ngaire Woods writes that ‘participants from smaller countries (feel) that there is no role for their authorities in actively contributing to the 46

Strengthening global economic governance

formulation of their constituency position.’ The dominance of developed economies has had three notable results on the implementation of BWI programs in developing nations. BWI policies have been preoccupied with controlling inflation, which has biased policy towards macroeconomic contraction. Policy has sometimes been further undermined by politically motivated loan decisions, whereby donor nations’ foreign policy preferences have been injected into loan decisions. Additionally, intrusive conditions attached to loans infringe unjustly on national sovereignty and subvert national democratic processes. Developing country concerns have been increased by the enhanced role given to the IMF by the G20 in response to the Global Financial Crisis.

The Organisation for Economic Cooperation and Development (OECD) Founded in 1961, the OECD is an exclusive body with a membership of 31 largely European and North American governments, although Turkey, South Korea, Mexico and Chile have recently joined. The organisation has gained a strong reputation for high quality technical work and reports. Yet, its once influential position in international policymaking has been eroded as its membership has failed to take account of international economic changes. Many people see the OECD as little more than a nebulous group of wealthy countries. This legitimacy issue is further complicated by the OECD’s slow progress on key reform issues, such as its incapacity to introduce multilateral foreign investment or tax cooperation regimes. So, despite the OECD’s high quality analytical work, its exclusive membership and policy inertia stymies its ability to lead global economic governance.

From the G8 to the G20 Formed in 1975, the Group of 7 (or G8 following Russia’s 1997 entry), is an informal annual meeting of powerful economies that has broadened in both scope of agenda and attendees in recent years. While the heads of government of these developed nations (Canada, France, Germany, Italy, Japan, Russia, the UK and the US) were able to meet relatively exclusively for much of their

existence, the increasing economic power of large developing countries and the growth of global interdependence has resulted in a decline of G8 nations’ relative prestige and their ability to steer the world economy. Lacking the formal input of developing nations (including China, India and Brazil), the G8 was obsolete. As Lord Mandelson has noted, ‘however long it may persist as a grouping, as a steering committee for the global economy, the era of the G8 is over.’ The Group of 20 was formed in 1999 as a broader forum of powerful economies, with finance ministers and central bank governors from 19 countries. It also includes the CEOs of the BWIs. Its purpose is to promote international financial and economic stability and to address the challenges posed by increasing globalisation. At the September 2009 Pittsburgh Summit, the G20 was accepted as the pre-eminent international economic body, superseding the smaller, more exclusive groupings already mentioned – yet also diminishing the influence of groups with wider constituencies (i.e. the UN system agencies including the BWIs). The G20 includes in its membership emerging economies such as Argentina, Brazil, China, India, Indonesia, Mexico, South Africa, Saudi Arabia, and Turkey, as well as the powerful G8 nations, and Australia and South Korea. An excited Financial Times editorial said that it ‘includes everyone who matters.’ The grouping accounts for 85 per cent of global GDP, 80 per cent of international trade and two thirds of the world’s people. The members encompass a wide range of incomes and approaches to economics. Certainly, when compared to its immediate predecessor (the G8), the G20 has a notable diversity and scope that has been widely applauded by politicians and commentators alike. The elevation of the G20 to the level of heads of government in November 2008 has afforded greater prominence to issues faced by developing country. With the inclusion of nations as diverse as India, Mexico and Saudi Arabia in the international economic dialogue, the G20 is better positioned to take account of the concerns of the global South. This agenda expansion is a legitimising factor for the G20.

The G20 has also made progress on certain economic reforms that had failed to lift-off in the G8 or OECD. Work on tax havens and transparency came through the G20 after a combined German/Australian initiative because the other groups were fundamentally incapable of breaking deadlocks. Recent G20 meetings have resulted in agreements to modestly increase developing country votes in the BWIs. The membership of the G20 remains a problem. Members were apparently selected by the US with some consultation with Canada and Germany, a secretive and undemocratic process. This method of appointment marks the G20 with a democratic deficit. Additionally, there is no open provision for change over time. Indeed, Joe Stiglitz has emphasised that the composition of the G20 ‘does not reflect the voice and priorities of the global community.’ The interests of medium and smaller developing nations, especially low income economies, are not represented in the group’s current make-up. The Heavily Indebted Poor Countries group has ‘deplored’ the fact that no poor country is represented at the G20 and urges this to be ‘remedied’. The exclusion of 172 nations from discussion about critical issues of economic and financial governance corrodes G20 legitimacy. The membership of the G20 may be evolving as a result of national pressure: prime ministers from Spain and the Netherlands attended recent meetings, as have leaders of regional and international organisations as observers. Developing country membership of the G20 has divided the developing countries and is perceived by some as undermining the UN’s work in the area, though the effects are still being assessed. Singapore has convened a group of about 30 developing countries to discuss how to react to the G20 and how to improve cooperative activity between the G20 and the UN. Further questions have been raised regarding G8 dominance within the G20, with the organisation effectively functioning as the G8 + 12. So far, the G20 has served principally as a vehicle for mobilising support for G8 initiatives. Leonardo Martinez-Diaz, an authoritative Brookings Institute researcher, writes that ‘the G8’s position was reflected in G20 communiqués twice as Insights Melbourne Business and Economics

frequently as the Group of 24 developing nations’ [position]. The victories the G8 appear to have won at the G20 are not only more numerous, they have been of much greater consequence than those of the G24.’ Concern has been expressed not only by developing countries but also by certain European nations about the extent of US and UK dictation of the G20 agenda. Unlike many international groupings, the G20 does not have a dedicated secretariat. Responsibility for the agenda and direction of the meeting lies with host nations. These structural weaknesses in the G20 contribute to the questionable nature of some of its decisions. For example, Stiglitz has criticised their decision to give the big banks – those deemed ‘too big to fail’ – carte blanche to continue with the kinds of activities that led to the recent financial crisis. The G20 has so far failed to address the systemic causes of the crisis. The reliance of the grouping on the IMF to carry out its financial decisions is additionally fraught with difficulty, given the Fund’s own issues of representational and intellectual asymmetry. It is clear that the emergence of the G20 as the pre-eminent international economic body is a step forward due to its enhanced membership, and the accompanying potential broader scope. Enthusiasm about this should be tempered, however, as the static, unelected nature of the grouping diminishes its authority, and the lack of legitimacy further negates the potential of the G20 to ease the democratic deficit in global economic governance.

Where to now? A gap continues to exist in the structure of international economic institutions through the absence of a representative, accountable, politically legitimate forum for discussion of the principal issues of global political economy. The Report of the Commission of Experts for the 2009 UN Conference on the World Financial and Economic Crisis called for the creation of a Global Economic Coordination Council to ‘address areas of concern in the functioning of the global economy in a comprehensive and sustainable way.’ Establishment of a permanent global council within the structure of the UN might involve 48

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changing the Charter – a difficult task. A step which is immediately possible would be for the G20 leaders, who normally attend the beginning of the General Assembly’s annual session each September, to hold a summit meeting in New York before the Assembly starts. An obvious further step would be to hold elections for the G20. The size of this summit could be minimised if there were two stage elections, first of regional representatives and then of summit members. Establishment of a secretariat within the UN would further increase effectiveness. The principal value of such a summit could be in its articulation of goals, priorities and policies for the international system, in something of the same way as was achieved in the Millennium Declaration agreed at the UN Millennium Assembly. That Declaration and the Millennium Development Goals derived from it are contributing to greater coherence of action by international agencies and countries. Ultimately, such a meeting could emerge as a more legitimate and politically effective forum for global discussion and strategic decision-making than the static G20. As the world moves toward recovery following the Global Financial Crisis, it is imperative to strengthen institutions of global governance to facilitate the wellbeing of all people, everywhere. Professor John Langmore is a Professorial Fellow in the School of Social and Political Sciences at the University of Melbourne. He has been an economic advisor to the Australian Treasurer, a federal MP and a director in the UN Secretariat.

Shaun Fitzgerald is a graduate scholar at Royal Holloway, University of London. He won the McMahon Ball prize in international relations at the University of Melbourne in 2009. 1 Just over five per cent of votes are basic votes distributed in equal numbers to all IMF member states and the rest are based on quotas which are set through a complicated formula based partly on GDP. Despite the apparent precision of the formula, disagreements continue because of differences over measurement of the factors in the formula and failure to use them comprehensively and to update quotas when factors change.

alumni refresher lecture series

learning from australia’s economic history Examples on the theme of learning from history for the practical purpose of improving economic policy-making by jeff borland A condensed version of an Alumni Refresher Lecture delivered at the University of Melbourne on 16 September 2009.

The history of economic history Teaching of and research in economic history has a proud history at the University of Melbourne. However, the development of other discipline areas in the 1990s led to reduced student numbers for economic history, after which the Department of Economic History was merged into what was to become the Department of Management and Marketing. Teaching in economic history then virtually disappeared. In the past six years, the Department of Economics has been trying to revive the teaching of economic history. Currently, I teach a first year subject in world economic history while Robert Dixon runs a research-based seminar on the history of economic thought; I also teach a second year subject in Australian economic history; Mike Pottenger teaches a second year subject about the history of the international economy and globalisation in the twentieth century; and John Creedy teaches a third year subject in the history of economic thought. We have found there is a strong student demand for economic history. The first year subjects have combined enrolments of almost 300 students, there are about 200 students in the second year subjects, and usually 15 to 20 students at third year level. I have found that this demand grows when we teach on topics that students find not only interesting but also of practical relevance.

One way I have tried to provide this sense is through the idea that we can learn from history. Both subjects I teach have a dedicated section of two to three weeks of lectures that show how lessons can be drawn from historical experience. In The Historian’s Craft, Marc Bloch talks about how having knowledge of events and understanding what caused those events are very different things, and that humankind has rarely been satisfied with just knowledge. This theme – learning from history – is the subject of my lecture.

Learning from history Margaret Macmillan, in her recent book The Uses and Abuses of History, describes the many ways in which we try to draw lessons from history, or in which history is used – for example, by ethnic or national groups in establishing identity, or by political leaders to support their legitimacy or policies. I propose to deal with something more specific. All my examples will be on the theme of learning from history for the practical purpose of improving economic policy-making. I should say at the outset that I’m certainly not claiming the historical episodes I have chosen tell us everything we could or need to know about the lessons I am drawing. Rather, the big lessons in history are likely to come from putting together our understanding of many events and episodes. Nevertheless, the examples I have chosen should Insights Insights Melbourne Melbourne Economics Business and Economics Commerce

give you a flavour of how learning from history can happen.

Early European land policy My first example is quite general – an illustration of the difficulties that government regulation can have in trying to corral and direct people’s self-interest. This relates to the policies the British government and Colonial governors in the nineteenth century used to control the take-up and take-over of land in eastern NSW, from the Indigenous population by British settlers. At that time the desire for land was being driven primarily by the emergence and rapid expansion of the pastoral industry in NSW. There were three main phases of the land policy. First, from the mid 1820s to early 1840s, an attempt was made to control the boundaries of settlement to within a defined area known as the ‘nineteen counties’. This was largely unsuccessful, and hence the period came to be known as the hey-day of squatting. Second, in the mid1840s Governor Gipps sought to impose greater regulation. He proposed that some ownership rights should be provided to squatters while simultaneously winding back the extent of their access to land. This was opposed by the squatters, and the subsequent Waste Lands Occupation Act 1847 was more to the benefit of squatters – albeit while retaining a leasehold system for occupation of land by the squatters. In The Squatting Age in Australia, historian Stephen Roberts comments that: ‘The pioneers had become a monopolistic minority.’ The third phase was the era of free selection that began in the 1860s. Free selection was an attempt to open up access to land then occupied by squatters. Pressure for this policy came from the growth of a working-class population and the broad franchise in early colonial governments. The Alienation and Occupation Land Acts 1861 allowed that, within ‘settled’ and ‘intermediate’ land areas, anyone could select 40 to 320 acres on the condition of paying one-quarter of the purchase price, the balance being paid and freehold secured after three years. Squatters had what were intended to be limited pre-emptive rights to land that they occupied prior to the Acts. A first lesson that comes from studying the outcomes from European land policy is the 50

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difficulty of preventing attempts by individual settlers to capture property rights through discovery and possession. With a strong economic incentive to establish farms on the best available land and little enforcement of government policy on allowable regions for settlement, the take-up of land by squatters in the 1830s raced far beyond the intended 19 counties. Governor Gipps mused: ‘As well might it be attempted to confine the Arabs of the desert within a circle drawn on the sands, as to confine the graziers of New South Wales within any bounds that can possibly be assigned to them.’ A second lesson is the difficulty of designing effective regulation against the creativity of those seeking to avoid the regulation. Nowhere is this more evident than the ways by which squatters sought to overcome free selection, to increase the amount of land which they would themselves retain. Through various practices – such as ‘dummying’, or paying for other family members and workers to claim adjacent land; ‘peacocking’, pre-emptively choosing the highest quality land, for example, with river frontage and access to water; and falsely claiming improvements to land – squatters were largely able to stymie the intent of the free selection legislation. The third lesson is the tendency for ‘inefficient’ regulation to be undone by the market – an idea represented formally in the Coase theorem. It quickly emerged that land allotments allowed to selectors under the Alienation and Occupation Land Acts 1861, were generally too small and too far from cities to make farming on them profitable. Wool production was viable only on more than 640 acres, and the high cost of transporting dairy produce or wheat to Sydney from rural areas limited the returns to those activities. Hence, the most valuable economic use of land taken by the selectors was in most cases to integrate it back into land-holdings of the squatters. This is what happened. By 1881, eight selections out of nine had passed from their original occupants, and 96 individuals in NSW owned eight million acres of land. The need for governments to regulate property rights, in the way that occurred in Eastern Australia in the eighteenth century, has been a recurring theme. As the economist John Kay has

recognised in his book, The Truth About Markets: ‘Every generation must extend the rules of a market economy. In America and Australia, settlement demanded the creation of land rights. Larger-scale production made it necessary to invent corporate organisation. Today new rules are needed for the new technologies of the Internet and the genome.’ Hence it is interesting to ponder on whether there are parallels between the Australian experience with land policies and the more recent race for property rights in the human genome. Very briefly, it seems to me that such parallels do exist. One example has been the difficulty of implementing effective regulation. With an inherent desire for knowledge by researchers, and the potential value of applications of knowledge about the human genome, scientific activity has not always respected established property rights. This is illustrated by the case of Myriad Genetics, owner of a patent on the BRCA1 gene, which found 2,500 research papers on this gene in contravention of its patent.

External shocks in an open economy My second example of learning from history is understanding how ‘external’ shocks affect an open economy. More specifically, I want to consider the effect of a resource boom on an open economy, using the 1850s Gold Rushes in Australia as a case study. Because of the small size and relatively simple structure of the Australian economy at that time, the effects can be easily observed. In the current mining boom in Australia, the share of mining activity in GDP has increased from around five per cent in the late 1990s to seven or eight per cent of GDP at present. This compares with the Gold Rush era where, for example, gold mining increased from 2.8 per cent of GDP in 1850 to 36.4 per cent in 1852. Hence the effects of the gold mining boom of the 1850s were ‘writ large’ on the Australian economy; and through this example we will see how history can allow us to trace out with particular clarity the effects of a major ‘shock’ to an economy. To understand the effects of a resource boom, the following analysis may help. In the 1850s we can think of the Australian economy as consisting of three main sectors – wool, gold and services. Gold and wool were traded on international markets at fixed world prices. Services were traded only

within Australia, with prices being determined in the domestic market. Consider what happens in this economy when, as occurred in the 1850s, there is an increase in the return from gold-mining. Workers will shift to this activity. Hence wages paid in the other sectors will need to increase in order to retain workers. This causes a ‘price-cost squeeze’ in the wool sector. Costs have increased, but the price of wool set in the world market stays fixed. Therefore, profitability of wool production declines and as a consequence the share of wool production in overall economic activity in Australia falls. This process is now commonly referred to as ‘Dutch disease’, the ‘Gregory effect’, or a ‘resource curse’ effect – whereby a booming resource sector crowds out an economy’s other export sectors. What actually happened in Australia? It turns out that the analysis above is a very good guide. The Australian economic historians Ian McLean and Rod Maddock have shown that the Gold Rushes were initially associated with a five-fold increase in the return to gold mining. Wages for shepherds then more than doubled in the early 1850s, and for some other occupations such as carpenters and servants more than tripled. What followed was a significant decline in the share of economic activity accounted for by the wool sector. The annual growth rate of sheep numbers fell from 13 per cent in the 1840s to three per cent in the 1850s. However, soon thereafter, the return from gold mining fell and wage costs decreased, thus restoring the profitability and central role of wool production in the Australian economy. The fall in the return to gold mining is largely explained by rapid growth in the number of gold miners following massive migration to Australia. With fixed exchange rates, higher nominal wages in Australia meant higher real wages in comparison to Britain, and hence an incentive for migration. From 1851 to 1860, Victoria’s population grew from under 100,000 to almost 550,000.

Speculative episodes My third example relates to speculative episodes – periods where there are changes in asset prices that appear ‘excessive’ when judged against new information about their future income flows. Insights Insights Melbourne Melbourne Economics Business and Economics Commerce

Australian experience suggests a common set of factors associated with the onset of speculative episodes. One is the existence of ‘easy money’ – a period of favourable economic conditions with easy access to credit. Second, is the taking on of ‘high risk’ by participants in asset markets. This can be due to a number of influences: the asset being associated with a new or not easily understood economic activity; the existence of ‘wrong’ incentives for lending in the banking sector; psychological factors such as envy that promote speculation; and occasionally ‘corrupt’ practices by market participants. The third factor is the poor prudential regulation of financial markets by government. I’ll consider three Australian examples. The first is from the 1830s and 1840s when the prices of both sheep and land increased spectacularly and then fell just as spectacularly – for example, the price of sheep falling from sixty shillings to sixpence. Each of the factors I mentioned was present in this period. Easy money was available due to the rapid increase in the number of new banks and from the flow of funds to banks from government land sales and British investors. Between 1830 and 1835 loans made by the Bank of NSW increased by 700 per cent. The novelty of sheep farming and wool production made it difficult to estimate their long-run returns, and a lack of supervision of bank lending in Australia by British investors meant that there was a high risk of default with many loans. There was also little regulation of banking practices. The second example is the 1880s property boom in Melbourne. For much of the 1880s, the average annual increase in the value of land for investment was 50 per cent; and when the crash came in the early 1890s, land prices fell in a matter months to less than a third of their previous levels. Here again, easy money came from a rapid growth in bank lending for land buying, new land banks had been created, and there was a high inflow of British capital. Corrupt activity by politicians, bankers and business people added to the risk of borrowing. Further, innovations such as the introduction of the hydraulic lift for high rise buildings and the growth of a public transport network into suburban areas, made it difficult to judge the value of land. There was still little regulatory control of banking and investment practices at this time. 52

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A third example is the ‘double whammy’ episode of speculation in the late 1980s. First, from early 1986 to 1987, the All Ordinaries Index of share prices more than doubled, before losing all those gains in three weeks, commencing on 20 October. Second, from around 1985 to 1990, commercial property prices in Australia grew rapidly – doubling in Sydney and Perth, and almost doubling in Melbourne – but then falling rapidly to below their 1985 levels by 1993. Easy credit was again in the picture. Financial market deregulation in the mid-1980s caused a substantial expansion of bank lending. For example, business credit as a share of GDP increased from 25 per cent to 55 per cent from the early to late 1980s. The unfamiliarity of banks with corporate expansion and takeover activity made it difficult for them to establish appropriate lending standards – for example, the overall extent of leverage of some borrowers who were borrowing from several banks seems not to have been taken into account. Moreover, there was a deliberate emphasis by banks on market share rather than the quality of loans. John Phillips, Deputy Governor of the Reserve Bank, noted at the time: ‘Regrettably… performance supplements, bonuses, commissions etc., were all too prevalent in the 1980s. These were seen as an incentive in the race for market share…These types of practices are legitimate in the sense that they are within the law…However, they are at least ill-conceived and often downright dangerous.’ It also seems that this was a period where the Government’s capacity to effectively regulate financial markets and the banks lagged behind the new environment.1

Does history repeat itself? Each of my examples shows how we can learn from history. Understanding the specific causes of past events, or the role of particular influences, provides historical analogues of the present. This can allow a better appreciation of present circumstances and what may happen in the future, thereby assisting in framing appropriate personal and public policy. There are, however, limits to what we can learn from history. First, learning from history does not mean finding a situation in the past that matches the present followed by events unfolding in exactly the same way. Instead, as the historian E.H. Carr has

put it in his book What is History? ‘…the specific is unique’. The best we can do is to discern patterns in the past that give us a general guide to the forces that are likely to be important in determining what happens in the present. Second, we cannot ever think of the past as holding objective lessons for us about the present. Historians are likely at any time to disagree about which events or episodes in the past are relevant to understanding the present; and even when they agree about where in the past to draw lessons from, they may have quite different interpretations of that past. Third, we always need to be aware of how history can be mis-used in its application to the present.

– Macfarlane, Ian (2006), The Search for Stability (ABC Books)

These ideas – learning from history and the limits on that learning – have been nicely expressed by the historian John Lewis Gaddis in his book The Landscape of History: ‘This gets us close to what historians do…it is to interpret the past for the purposes of the present with a view to managing the future, but to do so without suspending the capacity to assess the particular circumstances in which one might have to act, or the relevance of past actions to them.’

1 See, for example, the report from the early 1990s by the House of Representatives Standing Committee on Finance and Public Administration, A Pocket Full of Change.

About history: – E.H. Carr (1961), What is History? – J.L. Gaddis (2002), The Landscape of History – Margaret MacMillan (2009), The Uses and Abuses of History Professor Borland is Professor of Economics in the Economics Department of the University of Melbourne.

Some suggestions for reading Readings on the historical examples: – Stephen Roberts (1935), The Squatting Age – Maddock, Rod and Ian McLean (1984), ‘SupplySide Shocks: The Case of Australian Gold’, Journal of Economic History, 44, 1047-1067 – Michael Cannon (1966), The Land Boomers – John Simon (2003), ‘Three Australian asset price bubbles’, in A. Richards and T. Robinson (eds) Asset Prices and Monetary Policy (Reserve Bank of Australia) – Charles Calomiris (2008), ‘The Subprime turmoil: What’s new and what’s next’, mimeo, Columbia University General readings on Australian economic history: – Sinclair, William (1976), The Process of Economic Development in Australia – McLean, Ian (2004), ‘Australian economic growth in historical perspective’, Economic Record, 80, 330-45

Insights Melbourne Business and Economics

price discovery and regulation in energy derivative markets Highlighting the interplay between the floor-trading exchange and its on-line trading satellite in the discovery of natural gas futures prices by paul kofman, david michayluk and james t. moser

A condensed version of an Alumni Refresher Lecture delivered at the University of Melbourne on 9 September 2009.

Introduction The Global Financial Crisis has highlighted the fragility of the global financial system and has exposed financial markets, institutions and participants to intense public scrutiny. While much of that scrutiny focused on alleged market abuse, it also became painstakingly clear how fundamentally important efficient and liquid financial markets are to sustain the global economic system. Just to remind you, financial markets provide an efficient, cost-effective means of pooling current and future demand and supply for assets, and an efficient means of disseminating material information to all market participants simultaneously. In fulfilling those two functions, derivatives markets ensure fair and equitable price and a utility optimising risk transfer from hedgers to speculators. For those beneficial market outcomes to occur, you need a transparent trading process. A recent energy derivatives market ‘scandal’ illustrates how a lack of transparency has the potential to jeopardise the integrity of these markets. In the absence of a minimum level of regulation – or in this specific case, a leakage in the regulation – market participants are easily deceived by the partially obscured trading strategy of one major player. What follows is sustained price distortion (a speculative bubble) and the inevitable sharp market correction. Markets trading in energy assets have only recently flourished. Earlier attempts to organise trading in key energy assets failed for a number of reasons, 54

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including a lack of market participants, an excess of regulatory intervention (governments regulating retail and wholesale energy prices), poorly designed contracts, and perhaps even an excess of price volatility due to frequent supply/demand interruptions. So what changed? First and foremost, the ‘weather’ changed. Climate change concerns have put the spotlight on the economic importance of energy assets and the need for their prices to better reflect scarcity. Second, as a consequence, new trading platforms were developed by private enterprise capitalising on perceived profitable market opportunities. Third, the new trading technologies embraced by these private enterprises to reduce trading costs allowed for better designed – more flexible and bespoke – contracts. Finally, the withdrawal of government regulation at wholesale, and increasingly at retail, levels allowed these markets to set prices (and volatility) that properly reflected market conditions. Benchmark wholesale and even retail pricing of key energy assets – including crude oil and natural gas – nowadays occurs on a few key energy derivatives exchanges including traditional trading platforms like the New York Mercantile Exchange (NYMEX) and online trading platforms of which InterContinental Exchange (ICE – formerly known as Enron Online) is a prominent representative. The well-known Platt’s indicative energy prices are derived from exchange based prices, but intense competition for order flow between the traditional and online trading platforms is clearly shifting

in favour of the lower cost online platforms. The traditional derivatives exchanges are aware of this slow erosion in their market share and most are now also adopting automated trading systems to run in parallel with their floor trading system.

A regulation disparity To better understand the market impact of multiple trading platforms competing for market share, we need to consider the issue of regulation. Traditional US derivatives exchanges are partly self-regulated, and partly regulated by the Commodity Futures Trading Commission (CFTC). Self-regulation consists of monitoring compliance with market rules, and monitoring trading to prevent manipulation, price distortion and disruption of delivery/settlement. A traditional exchange has the ability to impose position limits on speculators and has authority to liquidate positions. The CFTC monitors the daily trading reports and positions by individual traders of the exchange, and reviews the often price volatile expiring contracts. The CFTC also has the option to make a special data call, which is occasionally used when markets are excessively volatile. Last but not least, clearing members and exchanges have the obligation to report large trader positions. So-called Exempt Commodity Markets (ECM), which cover most recently developed online trading platforms, face none of these ‘restrictions’. ECMs were originally characterised as Over-TheCounter (OTC) markets predestined for traders ‘who knew what they were doing,’ and therefore could be expected to self-regulate in their best interest. The bespoke nature of their contracts would reflect commercial interests and not be suitable or attractive to speculative interests. While speculators have in fact found their way to these markets, and often provided them with necessary liquidity, regulation has not kept up with these developments. The effective online derivatives lobby has strongly argued that regulation would unduly stymie much needed market development and in any case, these online markets are unlikely to distort the price discovery mechanism. In fact, the settlement prices in online contracts are often designed to ‘converge’ with the traditional exchange contract settlement prices. So what we observe is a

curious situation where a key derivatives exchange is fully regulated to ensure a transparent trading process, yet a satellite online derivatives exchange operates outside this regulator’s scrutiny. The risk to market integrity of such dualism is manifest in natural gas derivatives trading.

The natural gas derivatives market We first take a closer look at the unusual events that shaped natural gas derivatives trading throughout 2006.1 Following the disastrous hurricane Katrina – and the disruptions it caused to natural gas supply from offshore exploration to the onshore Henry Hub storage facility in Louisiana – natural gas prices increased to unprecedented levels. The Henry Hub price is the reference point for retail gas pricing on the Eastern seaboard of the US. Henry Hub price volatility has, therefore, significant public and regulatory implications. Retailers use the Henry Hub NG futures price as a signal and a hedging tool. This extreme price volatility offered new trading opportunities for hedge funds that thrive on the opportunities for complicated trading strategies that this situation provided. The Amaranth hedge fund, in fact, made the NG derivatives trade its core focus of trading activity in early 2006. From January to April 2006, Amaranth established significant futures spread positions – predominantly on the NYMEX platform. These spreads involved long positions in winter months’ maturities, offset by short positions in spring months’ maturities. If, as Amaranth believed, a repeat hurricane season were to hit Louisiana again in August of 2006, the following winter-months contracts would skyrocket in price as they had the year before, while the spring-months contracts would remain relatively unaffected. The resulting widening of the spread between winter and spring would create tremendous profits for Amaranth. Throughout the first half of 2006, this strategy seemed to work as the spread value did indeed increase, although this was entirely due to the demand/supply pressure from Amaranth itself. The fragility of the position became evident in May when Amaranth started to have trouble finding counterparties to trade with, and liquidity virtually disappeared. To avoid the spread value from collapsing and thereby causing cash problems due to the marking-to-market, Insights Melbourne Business and Economics

What were the consequences of this collapse? Customers of Amaranth lost their investments. There were allegations that Amaranth had deceived its customers by changing and concentrating its trading activities. NYMEX and the CFTC suffered from bad public relations and a series of government and regulatory inquiries were set up with the potential to ramp up the level of regulation. Perhaps the most important consequence was public mistrust in the price signals provided by derivatives trading in natural gas futures.

The investigation To investigate the premise that online trading is merely a satellite to floor trading – and therefore could not feasibly distort the price discovery process – a recent paper2 has taken a closer look at price leadership during Amaranth’s trading activities in 2006. Figure 1 neatly summarises its findings. The graph displays the inferred information share (the percentage contribution to price discovery) for the NYMEX exchange trading in the Natural 56

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Figure 1: The NYMEX Information Share 100% 90%

Information Shares

80% 70% 60% 50% 40% 30% 20% 10% 0 20 06 20 010 06 6 20 020 06 2 20 022 06 7 20 030 06 8 20 032 06 0 20 033 06 0 20 040 06 7 20 041 06 9 20 042 06 7 20 050 06 5 20 051 06 5 20 052 06 3 20 060 06 1 0 20 60 06 9 20 061 06 9 20 062 06 7 20 071 06 0 20 071 06 8 20 07 06 26 20 080 06 3 20 081 06 1 20 08 06 21 08 29

Amaranth had to keep extending its positions. By late July NYMEX notified Amaranth of its position limits and indicated that it had to curtail its trading activities. At that stage, Amaranth started to move a significant part of its positions to the ICE platform and further extensions of these positions occurred almost exclusively on ICE. NYMEX (and the CFTC) were unaware of this by now huge concentration in Open Interest by a single trader. They could not be aware, as the ECM-exempt ICE trading platform did not report trader positions to the CFTC. While Amaranth had been mostly successful in sustaining its spread position value, by mid-August it started to unravel. Betting market prices on the prospect of a 2006 Louisiana hurricane indicate that, by then, the likelihood of a repeat hurricane had dropped from even odds throughout the first half of 2006 to below ten per cent and falling. It was clear that winter prices would not reach the previous year heights and Amaranth’s future position precipitously collapsed. Amaranth formally defaulted in the first week of September and, somewhat interestingly, its positions were assumed by a rival hedge fund that subsequently made substantial profits.

Trade dates

Gas futures contract, maturing in September 2006. This contract was first listed for trading in 2001, but any serious liquidity only occurred in January 2006. What we observe from the graph is the dominant NYMEX information share until the end of April 2006, when the ICE information (100 per cent minus the NYMEX information share) rapidly becomes dominant. While this is only a single contract maturity (at any one time up to 72 contract maturities can be traded), Kofman et al call this a signature pattern. It occurs where NYMEX dominates price discovery when a contract is ‘far-from-maturity’, and ICE dominates price discovery when a contract is ‘near-maturity’. The explanation is that liquidity is low in far-from-maturity contracts, and whereas floor platforms have to stand ready to offer liquidity, online platforms do not and effectively withdraw from this low-volume market. For the high-volume near-maturity contracts, liquidity is cheap and speculators will opt for the lower-cost online platform. Using proprietary trading information, Kofman et al also investigate the impact of Amaranth’s trading activity on the ICE platform. They find that Amaranth’s ICE transactions significantly increase the ICE information share. Lastly, when the Amaranth-induced artificial futures prices at last collapsed in early September, there was a dramatic reversal in information shares back to NYMEX. Nonetheless, after a short adjustment period, ICE has retained its dominant information share in the near-maturity contracts – undoubtedly due to the low-cost argument mentioned above. These findings certainly put paid to the notion that ICE is merely a satellite exchange with no real impact on price discovery.

Conclusion The Amaranth affair has exposed the dangerous interplay between regulated and unregulated energy derivatives markets. It is interesting to note that one of the reasons for originally exempting OTC markets from regulation was that their products would cater for a sophisticated clientele. This idea has, of course, been superseded by today’s electronic trading platforms used by many OTC markets. Electronic (online) trading has undoubtedly improved trading efficiency in OTC products and thereby reduced the cost of trading, often making these markets accessible for retail traders and speculators. The no-regulation proponents suggest that this ‘low-cost bespoke’ nature of electronic OTC markets makes them essentially satellites orbiting the central regulated exchange. There is therefore no need to have a fully transparent audit trail that exposes every speculator’s trading positions – potentially driving them and the liquidity they offer from the market. Preserving market-wide liquidity is certainly a powerful argument. Yet, if these satellites have the potential to ‘distort or influence’ prices on the exchange, then a trade-off needs to be made. The 2008 Congress Farm Bill notes that ‘if [exempt commodity] markets… play a significant role in setting energy prices, they will be required to register with the CFTC and comply with several regulatory core principles…’

Paul Kofman is a Professor in the Department of Finance at the University of Melbourne; David Michayluk is a Professor at the University of Technology Sydney; and James Moser is Deputy Chief Economist at the Commodity Futures Trading Commission. 1 A good source is the US Senate Permanent Subcommittee on Investigations Staff Report (2007), Excessive speculation in the natural gas market. 2 Kofman, P., D. Michayluk and J.T. Moser (2009), Reversing the Lead, or a Series of Unfortunate Events: NYMEX, ICE and Amaranth. Journal of Futures Markets 33, 1233-1244.

Our investigation of information shares has highlighted the interplay between the exchange and its satellite in the discovery of natural gas futures prices. To avoid a repeat of the Amaranth ‘blackout’ by the derivatives regulator, two measures are therefore required. First, the regulator should establish and enforce position limits of traders on the exchange – including these traders’ positions on satellite markets. Second, the exchange and satellites should be required to publish an Open Interest (OI) concentration measure. This would give market participants some confidence in the ‘market-reflecting’ nature of the price. Or, if this OI concentration measure is particularly high, it would indicate the possibility that current prices are not truly reflecting the market forces of demand and supply for the underlying asset. Neither of these two measures requires real-time or even public disclosure of trader identity, thereby safeguarding the anonymity so craved by speculators. Insights Melbourne Business and Economics

occasional address

2009 – a tipping point Virtually every aspect of life in Australia will be affected by decisions made in China over the next two decades by chris leptos am

An edited version of his Occasional Address delivered at Wilson Hall, the University of Melbourne, 15 December 2009. What did not happen in 2009? When it comes time to chronicle the big events of the twenty-first century, the year 2009 will be legendary for what did not happen. In my diary, on the final day of this year, I will write that 2009 will be remembered as the year that the Global Financial Crisis did not happen; and the year that we did not get an Emissions Trading Scheme. These are, of course, closely related events. Let me explain. In this ninth year of the third millennium, consumers in China bought more motor vehicles than consumers in the US. Behind this brutally simple statistic lies a story as powerful and significant as what happened 20 years ago – 9 November 1989 to be precise, the day the Berlin Wall came down.

The Global Financial Crisis It has famously, and amusingly, been said that financial markets have predicted 11 of the past four recessions. But this Global Financial Crisis was neither amusing nor predicted. It was a giant wake-up call, so gigantic in fact, that it destroyed trillions of dollars of pension fund investments and brought the world banking system to its knees.

– The demolition of South Africa’s Apartheid regime; and

I was at the Sea World Resort in Queensland on a family holiday in September 2008 when I heard the unbelievable news that Wall Street titan Lehman Brothers had collapsed. And not just collapsed, but was allowed to collapse, perhaps even willed to collapse by the Secretary of the US Treasury Henry Paulson – who perhaps wanted to teach us all a lesson about ‘moral hazards’. I suspect it was because I was not wearing a suit that day that the Lehman news dazzled me, and left me feeling punch-drunk. As I sat by the pool in my shorts and thongs, sipping a Corona, my instincts immediately told me that the portents were very, very bad. And indeed, it was so.

– The year that the Israeli–Palestine peace process came within a whisker of a negotiated settlement.

Today, happily, we can joke that the Global Financial Crisis was the shortest and shallowest

The collapse of the Berlin Wall heralded a memorable – and some would say ‘golden’ – era. Here are a few of the historical markers of this time: – The reunification of Germany; – The fragmentation of the Soviet Union and the end of the Cold War;

The experiences of this past year have been as tumultuous as these historic events, although the inevitable absence of nostalgia perhaps makes it difficult for us to see with clarity and perspective the significance of what is happening around us.

2009 – A tipping point

‘depression’ in recorded history. We laugh, nervously, that it was a ‘near-miss’. But for many months over the past year, the global financial system was in tatters. It was a period when we had to admit we neither understood how the global financial system really worked, nor how to fix it. It was a period when we even doubted our ability to understand, let alone defend, capitalism.

How did we get so close to the precipice? Now that the financial storm has receded, I would like to take just a brief moment to offer a view on how we got so close to the precipice – how the global financial system very nearly ate its progeny. I can see the thought-bubbles above your heads saying that it would have been nice to share these insights before the crisis. For the present, I want to limit my remarks to the work of brilliant academics who you may have heard of and perhaps studied in recent years – renowned scholars like Black, Scholes, Merton, Markowitz and Sharp. Their work on quantifying and valuing risk had a profound impact on financial markets over the past decades. In plain English, their models allowed us to fix a precise price for risk. Indeed, very precisely. And as we all know, once we can price risk precisely, we have ‘certainty’! And because we had ‘certainty’, we took much more risk. This was rational and reasonable behaviour. Or at least it would have been so if the degree of precision was justified. But it was not. The precision was a mirage.

Academic theories To see through the mirage, we need to get a little closer to these academic theories, and when we do that, we discover that many of the economic theories have their genesis in the natural sciences. It is not too much of a stretch to say that these academic theories assumed that human beings (i.e. investors) would act like molecules in a physics lab – neutral, statistically independent, and rational1. In short, the theories were fine. The assumptions were precise. But the application of the theories was utterly unjustified. Millions of column-inches have been written about the Global Financial Crisis, but we still struggle to find the words to explain ‘how’ we got to this point.

This is of course a feature of the human condition – we tend to personalise and trivialise both the good and the bad in our lives. So the next time you hear someone say that the Global Financial Crisis was caused by ‘greedy investment bankers’, remind them that all would have been well, if only humans had acted like molecules in a physics lab.

The Emissions Trading Scheme This talk of physics takes me to my second theme, indeed, the second ‘near miss’ for 2009 – the Emissions Trading Scheme that we did not get. On the Labor side of politics, Caucus unanimously supported the ETS legislation. Surprisingly, there was not a heated and intense debate in the Labor Caucus Room about the Emissions Trading System, one of the most significant and far-reaching pieces of legislation of our generation. Instead, there was unanimity, broad consensus, no cross-factional negotiations. There was agreement ‘on all fours’, as the legal fraternity likes to say. This troubled me. It was too neat. It was too harmonious. The absence of acrimony struck me as being artificial and confected. Call me a sceptic if you must, but the French have a useful expression for this, which loosely translates as ‘through conflict comes the truth’. In my view, there was not enough ‘conflict’ in the Labor Caucus Room to find the ‘truth’. In contrast, there was nothing confected in the Federal Coalition Party Room. The debate was vicious, personal, dogmatic and strident. It was good theatre. But that too troubled me. The debate in the Coalition Party Room was authentic and, I suspect, unique in the annals of Australian conservative politics. Indeed, I cannot recall any issue since Federation where the Conservative battle lines cut across both traditional and nontraditional alliances so deeply. Thus: – Big business supported the Emissions Trading Scheme – whereas small business loathed it; – Farmers supported the Emissions Trading Scheme – whereas the National Party opposed it; – Energy retailers supported the Emissions Trading Scheme – whereas coal fired electricity generators railed against it; and Insights Melbourne Economics and Commerce

– Liberals in the Lower House strongly supported the Emissions Trading Scheme – whereas Liberals in the Senate comprehensively rejected it. If the French are right, that ‘through conflict comes the truth’, then the Coalition parties found the truth. And the truth is that Australia – and the rest of the world – is divided on this issue, along both traditional and non-traditional lines. Thus: – There is division between developed and developing countries – as expected; – More subtly, there is division between the powerful developing countries such as China and the politically weak and low-lying developing countries such as Bangladesh and the Pacific Islands; and – There is division and acrimony between scientists. However, these divisions vary in form, substance and degree. Before the end of 2009 we will see the fruits of Copenhagen, and the same divisions that we are witnessing in Australia will also be on show in Denmark over the next few days.

Concluding remarks I would like to conclude with a prediction. I feel entitled to do so because I sat in Wilson Hall, where you are sitting now, 30 years ago this week, as a newly-minted graduate of the Faculty of Economics and Commerce. In the past 30 years, I have generally resisted the temptation to make grand sweeping predictions. But I feel the urge to make a prediction today. My prediction is that we will look back to 2009 as a ‘tipping point’. Sometimes things need to get worse before they get better. And this, I believe, will be the legacy of 2009. Firstly, the Global Financial Crisis made things worse – but the financial architecture, and our financial understanding, will be much better, now that we have exposed some poor foundations and misconceptions. Similarly, opposition to climate change action – both in Australia and at Copenhagen – is reaching a deafening crescendo, which will provide the impetus for the opposite force, namely unprecedented national and international cooperation to deal with the issue.

2009 – A tipping point

Finally, what does any of this have to do with consumers in China buying more motor vehicles than consumers in the US? It needs to be said bluntly that the world has changed. Virtually every aspect of life in Australia will be affected by decisions made in China over the next two decades. Thus: – It is because of the Global Financial Crisis that Americans are saving more and the Chinese are spending more; – Asia – notably China and India – will constitute 50 per cent of all global carbon emissions by 2030. Indeed, at the beginning of 2009, China surpassed the US as the largest emitter of greenhouse gases; and – At a geopolitical level, neither the ‘G8’ nor the more fashionable ‘G20’ matter as much as the ‘G2’ – China and the US. This is a world in flux. I know I will look back on 2009 with great fondness, and a sense of ‘history in the making’. I cannot imagine a more exciting time to go into this magnificently beautiful but unpredictable world, with a degree under my arm, than the end of 2009. So, on your way home, please remember to take the long road; the slow road; to reminisce on this amazing year – a historical tipping point in the making. And please feel free to write to me – in another 30 years time – to let me know if my predictions were correct. Chris Leptos (chris@leptos.com) holds a BCom and an MBA from the University of Melbourne, and is a member of the University’s Faculty of Business and Economics Advisory Board. He recently stepped down from the position of Managing Partner – Government Services at Ernst & Young, and joined the KPMG partnership early in 2010. Mr Leptos is also a Director of Asialink and the Asia Society, a Governor of The Smith Family, and a CFA volunteer fire-fighter. In 2000 he was awarded the Order of Australia for his work in the area of sustainability in the global resources sector. 1 Borrowed from Andries Terblanche, Partner, Financial Services, KPMG

Mailing Address: The Faculty of Business and Economics The University of Melbourne Victoria 3010 Australia Telephone: +61 3 8344 2166 Email: fbe-gsdir@unimelb.edu.au Internet: http://insights.unimelb.edu.au Published by the Faculty of Business and Economics, April 2010 ÂŠ The University of Melbourne Disclaimer Insights is published by the University of Melbourne for the Faculty of Business and Economics. 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.