#7 March 2005

Melbourne Institute News March 2005 ISSN:1442-9500 (print)

ISSN 1442-9519 (online)

Print Post Approved PP381667/01204

Issue 7

From the Director

Professor Peter Dawkins Ronald Henderson Professor and Director

Poverty in Australia: Insights from HILDA Mark Wooden and Bruce Headey share their insights from the HILDA data into the persistence of poverty in Australia Page 2

A Healthy Life Are the effects of Lifetime Health Cover making us all unhealthy? Alfons Palangkaraya and Jongsay Yong explore the various policy options.

Page 4

Effects from the 1990s Budgets How big was the effect of budget consolidation on the Australian economy in the 1990s? Lei Lei Song and John Freebairn evaluate the effects.

Page 5

Stay at Home Mums Hielke Buddelmeyer and Ha Vu utilise the HILDA survey data to discover why many mothers are unable to find adequate child care.

Page 6

I am delighted that the appointment of our new Communications and Publicity Coordinator, Laura A’Bell, makes possible the re-launch of the Melbourne Institute newsletter in its new format. We expect to produce it quarterly from now on.

Rather than attempting a comprehensive coverage of the Melbourne Institute’s activities, we will cover a limited number of topics in each issue.

As this newsletter goes to press, we are in the final stages of organising the 2005 Economic and Social Outlook Conference, jointly with The Australian. This conference is entitled Sustaining Prosperity: New Reform Opportunities for Australia.

In Reforming Australia, the book resulting from the 2003 Pursuing Opportunity and Prosperity Conference, we concluded that to sustain Australia’s economic success story of the last twenty years and also make important social progress, renewed vigour in economic and social reform was required. This would especially involve competition policy, welfare to work, education reform, and health reform. The aim was to raise workforce participation, sustain our productivity growth and increase opportunities for the disadvantaged.

What we did not know at the time was that the Howard Government would be re-elected with a majority in the Senate. This gives them a great opportunity to pursue a vigorous and coherent policy program, especially in the area of welfare to work. There are still about one in seven children in jobless households, so by reducing the number of jobless households, we can raise labour force (cont’d on page 7)

www.melbourneinstitute.com Melbourne Institute of Applied Economic and Social Research - Page 1

Poverty in Australia: Insights from HILDA As seen recently in The Australian newspaper, Professor Mark Wooden and Associate Professor Bruce Headey distinguish between short-term poverty and the more serious issue of persistent poverty.

This distinction between long-term persistent poverty and short-term transitory poverty is critical. Clearly, mediumand long-term poverty matter a great deal more than short-term poverty. Medium- and long-term poverty have serious negative effects on adults’ careers and children’s life prospects. Short-term poverty, on the other hand, can be distressing but may have no long-term consequences.

Compared with the citizens of most other countries, Australians are rich. Moreover, material living standards in this country have clearly been rising over time. Yet only 12 months ago the Senate Inquiry into poverty and financial hardship concluded that poverty in Australia is both widespread and rising. Indeed, their best estimate was that anywhere between 13 and 19 per cent of the population were living in poverty.

The only way to confidently determine the extent to which poverty is a medium- or long-term problem is by collecting data from the same people year after year. In 2001 a new survey commenced which sought to do exactly that.

Funded by the Australian Government and managed by a team based at the Melbourne Institute, the Household, Income and Labour Dynamics in Australia (or HILDA) Survey is Australia’s first survey that will follow a large representative sample of people as they age. Further, one of the key objectives of the survey is to provide detailed measures of income, financial well-being and hardship.

So how can so many people be living in poverty in a country which is, on most objective criteria, very well off ?

One answer lies in what is meant by poverty. In developed countries it is generally accepted that poverty is largely a relative concept. That is, a person or a household lives in relative poverty if they are unable to afford the goods and services needed to enjoy a normal or mainstream lifestyle in the country in which they live. Poverty will thus exist in all countries where there is a substantial gap between the richest and poorest members of the community.

A second answer lies in the reliance on income data collected at a single point in time which refer to only a one-year period. In other words, all previously published estimates of relative income poverty describe only annual, or short-term, poverty. Further, since annual poverty rates are usually quite stable, it is perhaps natural to infer that the same people tend to remain poor year after year. But is this true?

To date, data are available for three years which, while not long enough to provide measures of long-term poverty, is sufficient to provide an indication of the extent to which there is mobility in and out of poverty from one year to the next.

While there are many ways of measuring relative income poverty, most involve setting a ‘poverty line’ which is some proportion of household disposable (after-tax) income adjusted to account for differences in household needs arising from different household sizes. Here, following standard academic practice, we define a household as poor if it has a disposable income less than half the median, or typical income.

HILDA SURVEY RESEARCH CONFERENCE 2005 The second HILDA Survey research conference is to be held at the University of Melbourne on 29–30 September 2005. The aim of the survey is to provide a forum for the discussion of research based on the Household, Income and Labour Dynamics in Australia Survey. Attendance at the conference is open to all persons interested in the HILDA Survey and longitudinal survey research.

Further information about this unique national event will be distributed via the HILDA email list and on our website www.melbourneinstitute.com.

Page 2 - Melbourne Institute of Applied Economic and Social Research

Poverty in Australia: Insights from HILDA According to this measure, the HILDA Survey indicates that poverty declined from 13.6 per cent of the population in 2000–01 to 11.5 per cent in 2002–03. Interestingly, in contrast to the conclusions drawn in the Senate Inquiry report, these figures suggest a reduction in poverty in the last three years.

is higher than for the population average—13.2 per cent among children aged under 15 in 2002-03, compared with an adult rate of 11.8 per cent. The position, however, is reversed when we use longitudinal data to make three-year estimates. The three-year poverty rate for children was 3.7 per cent, which compares with 4.3 per cent for adults.

Nevertheless, it is neither the level of poverty (which obviously varies depending on how high or low the poverty line is set) nor the trend in the annual rates which we think is of large importance. Far more important is how many people remain below the poverty line in each of the three years for which data are available. Still using the 50 per cent of median income poverty threshhold, the HILDA Survey data indicate that almost one-quarter of the population — 24.3 per cent—were poor in at least one of the three years considered. But only 7.1 per cent were poor in two of the three years, and only 4.2 per cent were poor in all three years. It is this last figure which we suggest can be regarded as an initial estimate of the rate of medium-term poverty in this country. In other words, the rate of medium-term poverty is a great deal lower than the one-year poverty rate at the centre of most previous poverty discussions.

Overall, and despite the immaturity of HILDA, one message that is emerging is clear and striking—the majority of Australians, including children, who become poor do not remain poor for long. However, we do not yet know how many of those who exit poverty fall back into it within a few years.

Another significant finding concerns children. Like most other studies, the HILDA Survey data confirm the rather alarming finding that the annual poverty rate for children

Nevertheless, these results should send a strong message to policy-makers—public policy should be targeted not simply at lifting people out of poverty but at the smaller group trapped in long-term persistent poverty.

We conclude with a warning. Income measures by themselves do not adequately assess poverty, deprivation and disadvantage. It is also essential to assess and remedy those educational, health, social and employment deficits that limit opportunities in an increasingly prosperous Australia.

Professor Mark Wooden Associate Professor Bruce Headey

Poverty Rates in Australia Part A: Annual poverty rates

All persons

Children under 15 years of age

2000–01

14.2

15.3

2001–02

13.2

14.0

2002–03

12.1

13.2

Never poor

75.7

73.0

Poor in only one year

13.0

14.6

Poor in two years

7.1

8.8

Poor in all three years

4.2

3.7

Part B: Poverty persistence, 2000–01 to 2001–03

Note: The poverty line is set at 50% of the median ‘equivalised’ disposable household income.

Source: HILDA Survey, Confidentialised Data Release 3.0 (waves 1–3), January 2005.

Melbourne Institute of Applied Economic and Social Research - Page 3

A Healthy Life New research by Dr Alfons Palangkaraya and Dr Jongsay Yong shows that the effect of Lifetime Health Cover appears to have been grossly overrated in previous studies and that the 30 per cent premium rebate and tax levy has been largely overlooked.

Private health insurance (PHI) has traditionally been an important component of the Australian health system.

However, since the introduction of Medicare in 1984, the coverage of PHI has been on a steady decline until recent years.

This downward trend was reversed after the Australian Government introduced three major policy changes to the private health insurance market over a three-year period, from 1997 to 2000.

The three major private health insurance policy initiatives the government introduced were the Private Health Insurance Incentives Scheme (PHIIS), the 30 per cent premium rebate, and Lifetime Health Cover (LHC).

The government introduced PHIIS in July 1997 under which high-income earners were ‘encouraged’ to purchase PHI by the introduction of a tax levy. At the same time a means-tested partial refund on health insurance premiums was made available to low-income households.

The response to these policy changes was apathetic; the percentage of the population with PHI actually fell from 31.9 in June 1997 to 30.1 at the end of 1998.

The PHIIS was amended in 1999 with the means-tested subsidy component replaced by a 30 per cent premium rebate regardless of income and applicable to both new and existing policies. The response to the rebate, although slow, did lead to a small increase in the percentage of the population with PHI. The rebate was initially estimated to cost the government $1.09 billion, however, with substantial increases in new members after the introduction of LHC in July 2000, the cost was $1.4 billion for the first year and was in excess of $2 billion in subsequent years.

The third major policy change was introduced in July 2000 when the limited form of risk rating known as the LHC was built into PHI premiums. Prior to LHC, health insurance funds were required, under the community rating regulations, to charge a uniform premium for any

given policy regardless of health risk. LHC allows a certain degree of risk rating by allowing health insurance funds to vary premiums according to the member’s age at entry into the fund. Under LHC, anyone above 30 years of age when joining a health fund is required to pay a higher premium, calculated at two per cent per year for every year of age above 30 years at the time of entry. This policy initiative was announced in September 1999, but took effect only in July 2000 to allow for a nine-month ‘grace period’ for people with no PHI to purchase insurance and avoid paying the higher premiums.

These policy changes, taken together, have been effective in raising the coverage of PHI. The percentage of the population covered by PHI rose from 31 per cent in 1999 to a high of 45 per cent at the end of 2001.

The difficult issue identified by Palangkaraya and Yong in their evaluation was in disentangling the effects of the three policy changes, given that they were introduced in quick succession, and that LHC was introduced on top of, not in place of, the 30 per cent rebate. Isolating the effects of each of the policy initiatives was imperative, as they involved different fiscal implications for the government.

The research paper attempts to evaluate the effect of LHC using a regression discontinuity design, an approach that makes use of cross-section data that allow the effect of LHC to be isolated via local regression. The basic intuition is as follows. LHC only affects individuals in a certain age group (specifically 30 years of age or older), whereas the 30 per cent rebate applies across the board for all age groups.

Thus, if one compares across age groups that are just below and just above the cutoff age, it is possible to isolate the effect of LHC. This is because the effects of the other two policy changes, which are common to all age groups, simply fall out after taking the difference.

The results suggest that the importance of LHC appears to be grossly overrated in previous studies. Estimates indicate that LHC accounts for roughly 30 per cent to 44 per cent of the combined effects of all the policy initiatives introduced in the late 1990s. While these figures suggest that its effect is clearly significant, it is nonetheless nowhere near the effect often associated with LHC. It is also important to note that although LHC has a significant effect on health insurance choices, the effect of LHC varies considerably between income groups.

The research paper related to this article can be downloaded at www.melbourneinstitute.com.

Page 4 - Melbourne Institute of Applied Economic and Social Research

The 1990s Budget Consolidation Effect Using a macroeconometric model, Dr Lei Lei Song and Professor John Freebairn evaluate the effects of the 1990s budget deficit reduction strategy on the Australian economy.

In the early 1990s, Australia started to emphasise the role of fiscal policy on national saving in the medium to longer term. The need to improve the fiscal balance to make a contribution to raising insufficient national saving was argued forcefully in the June 1993 FitzGerald report. In its first budget in May 1996, the new Federal Government committed itself to a medium-term fiscal strategy to maintain an underlying budget balance on average over the course of the economic cycle.

In a recently published working paper, ‘How Big Was the Effect of Budget Consolidation on the Australian Economy in the 1990s?’, Dr Lei Lei Song and Professor John Freebairn try to evaluate the effects of lower longterm interest rates associated with a tightening of fiscal policy on such macroeconomic indicators as GDP and unemployment.

The paper argues that the financial markets then seemed to have been convinced that the fiscal strategy would be maintained and in turn delivered a significant fall in long-term interest rates, which has had a sizeable impact on the Australian economy in the late 1990s. The paper identifies that long-term interest rates in Australia have had a close relationship with fiscal aggregates of the general

government sector. By analysing the movements of longterm bond yields and the spread of Australian bond yields to corresponding US yields from late 1994 to late 1998, the paper concludes that the program of budget consolidation contributed to the significant fall in Australian long-term interest rates. The paper then utilises a modified version of the Treasury macroeconometric (TRYM) model to evaluate.

The simulations show that a delay in budget consolidation, and the associated effect of the long-term interest rate being assumed to be 0.5 percentage points higher than the actual values from mid-1996 to mid-1997, would have had a small and transitory adverse impact on the economy with real GDP lower and unemployment a little higher than the actual levels. The economy, however, would have returned to the baseline by mid-2000. If the budget consolidation did contribute to the permanent reduction in the longterm interest rate, the economy received a significant and sustained boost from the rally in the bond market. The boost is estimated to be three quarters of a percentage point of real GDP and a 0.3 percentage point reduction in the unemployment rate. The impact on the economy of government spending cuts is estimated to be small and transitory.

As shown in this study and others, the sharp decreases in government deficits in developed economies in the 1990s have contributed to economic growth in the 1990s and beyond. Expected future budget shortfalls associated with the ageing of their populations and the dramatic deterioration in the US fiscal outlook since 2001 are therefore likely to have adverse implications for the world and Australian economies in the medium to longer term.

MELBOURNE INSTITUTE SEMINAR SERIES 2005 The Melbourne Institute has enjoyed a successful ongoing seminar series with recent speakers including Marianne Bitler, Marcus Reitzig, Michael Lechner and Norman Gemmell.

Upcoming seminars include leading economists Tony Scott and Hilary W. Hoynes who will be presenting a range of topics.

For further information about the Melbourne Institute Seminar Series, please visit our website at www.melbourneinstitute.com.

Melbourne Institute of Applied Economic and Social Research - Page 5

Stay at Home Mums For mothers with young children, entering the labour market is strongly linked to child care usage. However, child care usage is not exclusively limited to working mothers and for most mothers there is a wide range of child care options available which may be combined to facilitate paid employment.

The Household, Income and Labour Dynamics in Australia (HILDA) Survey was analysed by Dr Hielke Buddelmeyer and Ms Ha Vu to explore current child care issues.

Juggling different forms of child care is not uncommon in Australia. In households where both parents work, about 20 per cent use two or more types of care for children in school, and a similar proportion of households use two or more types of care for children not yet in school.

For children who are in school, care involving relatives and out of hours care at the child’s school are the most common. Typically they are combined with additional care by siblings, friends and neighbours.

The most common types of care for children not yet in school are private or community long day care, family day care and care using relatives.

Child care is not only used for employment purposes.

The second wave of the HILDA Survey collected data on child care use for non-employment related reasons, i.e. child care use for any reason when the mother (or her partner) is not at work. About 40 per cent of respondents use non-employment related care for children not yet in school and about 30 per cent of respondents use non-employment related care for children who are already in school. This care typically consists of only one type of care involving siblings, relatives, or friends. It rarely leads to an out of pocket expense for the household.

Mothers still report substantial difficulties related to various aspects of child care. When broadly defining

problems related to child care into problems with affordability, accessibility, and quality, the authors found that quality and accessibility in particular are two sides of the same coin. About 46 per cent of respondents report no, or low levels of, difficulty with affordability, quality or accessibility. Yet, about 15 per cent have a problem with two out of three, with a further 15 per cent experiencing problems with all three. The two specific problems with the highest reported levels of difficulty are finding care for a sick child and the costs of child care.

To what extent the lack of child care acts as a barrier to entry, or to working more hours, is mostly indirectly observable. About 25 per cent of mothers who work part-time for child-caring reasons report that they would like to work more hours. This could be interpreted as a lack of child care preventing these mothers from increasing their work hours. On the other hand, direct evidence from jobseekers on a lack of child care being a barrier to entry is weak. For mothers looking for parttime employment, the unsuitability of hours is reported as the main obstacle. For mothers looking for full-time work the main obstacles reported are skills mismatches and age discrimination.

A third category of mothers, who may also experience a lack of child care as a barrier to entry, consists of mothers who are currently not in work, and are not actively looking for a job. When asked, 40 to 50 per cent of these mothers reported that they would like a job, assuming that suitable child care arrangements could be found.

Of the mothers who answered that they would like a job but are not actively looking for a job, more than 50 per cent responded that they preferred to look after their children with a further 10 per cent citing other child care reasons.

These numbers point to two very important policy implications. First, there is currently a mismatch between available child care options in the market and a mother’s idea of suitable child care arrangements. Second, it indicates a large quiet reserve of the workforce that is willing to enter but not yet tapped into.

Any policies that would bridge the current mismatch between available child care and child care deemed suitable by mothers can be expected to generate a large increase in the labour force participation of mothers in Australia.

Page 6 - Melbourne Institute of Applied Economic and Social Research

...From the Director (cont’d from page 1) participation and increase the life chances of our next generation of workers. The outlines of such a welfare-towork agenda are now emerging and will be debated at the forthcoming Sustaining Prosperity Conference.

The long-run importance of raising labour force participation has been reinforced by the short-run pressures in the labour market, due to labour shortages in some areas. Whilst moving people from welfare to work is unlikely to solve some of the skilled labour shortages, it could take some heat out of the labour market.

It was pleasing to read that the Governor of the Reserve Bank, in his recent statement to the House of Representatives, called on the Federal Government to have another look at the idea of tax credits as a way of increasing work incentives. There is no doubt that tax credits can have a much stronger effect on work incentives for many families with actual or potential low-wage workers, rather than increases in the minimum wage, because of the very high effective marginal tax rates that many such families face. In addition, by taking pressure off the wage system, they can also help to moderate wage costs and support labour demand. The idea of linking tax and welfare tax reform with industrial relations reform in this way was proposed by the “five economists” a few years ago, in our letter to the Prime Minister. Now is a good time to move ahead with it.

The McClure Report in 2000 argued that it is a combination of incentives, assistance and requirements that will help move people from welfare to work. It will be a skilful combination of these three that we should be looking for in the government’s welfare reform agenda.

Taking a longer term perspective, the quality of our schools will be critical to the long-term educational and labour market performance of our youngest generation.

At the Pursuing Opportunity and Prosperity Conference, Professor Brian Caldwell argued that there was a significant danger that the government school system would become “residualised”, and that school policy reform was needed to reinvigorate the government school sector, including the possibility of having private schools operating in the government sector in a freer and more innovative environment. As government school funding comes primarily through State Governments and government

support for private schools comes through Federal Government, this is a challenge for Federal and State Governments to find joint solutions to these issues.

In the area of health policy, the inevitable rise in the proportion of GDP devoted to health will raise the stakes in having an efficient as well as an equitable health system.

The case for a more coherent health system, without cost shifting between Federal and State Governments, with increased incentive to improve health outcomes for all Australians, is a challenge for both Federal and State Governments, and especially a challenge for them to find joint solutions.

Thus, while the Howard Government’s Senate majority appears to be encouraging a welfare to work agenda and may help to get it enacted, it may not be sufficient in the areas of health and education. This is because the solutions have to be found jointly by the Commonwealth and the States. This is a much bigger challenge indeed, but one that is going to be very important for the future prosperity of Australians. This too will be on the agenda for the Sustaining Prosperity onference.

A few days after the conference I will be handing over the reins of the Melbourne Institute to Professor John Freebairn, as I take up a new position as Deputy Secretary (Economic and Financial Policy) in the Victorian Department of Treasury and Finance. It has been an enormous pleasure to be the Melbourne Institute Director, an appointment in which I entered my tenth year in January. John Freebairn is taking on the position for the next two years and I wish him and the Melbourne Institute every success for the future. I would also like to take this opportunity to thank all the staff, associates and collaborators of the Melbourne Institute and our Advisory Board for the collegiality, energy and expertise that they have devoted to the Institute in the time that I have been Director. Many thanks are extended to our clients and sponsors for their continued interest.

March 2005

Melbourne Institute of Applied Economic and Social Research - Page 7

The Melbourne Institute Founded in 1962, the Melbourne Institute, a department within the Faculty of Economics and Commerce at the University of Melbourne, is at the forefront of applied economic and social research in Australia.

As well as contributing strongly to academic literature, the Melbourne Institute continues to expand and enhance its longstanding tradition of working closely with government, business and community groups.

Activities cover a range of areas including research projects and publications in the ďŹ elds of labour markets, social policy, tax and welfare, macroeconomics, industrial economics, the economics of health and the economics of education.

The Melbourne Institute operates in three research areas including Labour Economics and Social Policy; Applied Macroeconomics; and Applied Microeconomics which includes Industrial Economics, Economics of Health, and Economics of Education.

Melbourne Institute News Views expressed by the contributors to Melbourne Institute News are not necessarily endorsed or approved by the Melbourne Institute. Neither the Melbourne Institute nor the Editor of Melbourne Institute News accepts any responsibility for the content or accuracy of information contained in this publication. Editor: Laura A’Bell, tel: 8344 2154, fax: 8344 2111, email: labell@unimelb.edu.au. Sub-Editor: Nellie Lentini. Contributors: Professor Peter Dawkins, Professor Mark Wooden, Associate Professor Bruce Headey, Dr Alfons Palangkaraya, Dr Jongsay Yong, Dr Lei Lei Song, Professor John Freebairn, Dr Hielke Buddelmeyer, Ms Ha Vu.

Level 7, The Alan Gilbert Building, The University of Melbourne P: 613 8344 2100 F: 613 8344 2111 www.melbourneinstitute.com