FBE Insights journal Apr13

insights Melbourne business and Economics volume 13 april 2013

Lessons from the global financial crisis

By Martin Wolf Celebrating 50 years at the Melbourne Institute

By Mark Wooden Securing the future: how Australia can thrive in a volatile world

By Deborah Cobb-Clark, Hielke Buddelmeyer, Terence Cheng, Abraham Chigavazira, GaĂŠtan de Rassenfosse, Trinh Le, Felix Leung, Kris Li, Viet Hoang Nguyen, Alfons Palangkaraya, Peter Sivey, Domenico Tabasso, Russell Thomson and Roger Wilkins Sustainability reporting: past, present, and trends for the future

By Naomi Soderstrom A larger GST in a tax-mix change

By John Freebairn Reciprocity and regard

By Avner Offer Occasional Addresses Paula Dwyer

Jonathan Elliot

Insights: Melbourne Business and Economics ISSN:1834-6154 Editor: Associate-Professor Geoff Burrows Associate Editor: Ms Danielle Roller Sub-editor: Ms Rebecca Gleeson

Advisory Board: Professor Kevin Davis Professor Colin Ferguson Professor Emeritus Ian McDonald Design: Ms Sophie Campbell Illustration: Mr Marc Martin

insights vol 13 Table of contents 02 Welcome

By Geoff Burrows, Editor

05 Lessons from the global financial crisis

By Martin Wolf The big lesson of history is that crises repeat themselves, that times of euphoria are when the conditions for crises emerge and that when the crisis hits, it is too late.

31 Sustainability reporting: past, present, and trends for the future

39 A larger GST in a tax-mix change

15 Celebrating 50 years at the Melbourne Institute

By Mark Wooden A selective summary of key themes discussed at a one-day conference held at the Melbourne Institute on 6 December 2012 to celebrate the Institute’s first 50 years.

23 Securing the future: how Australia can thrive in a volatile world

By Deborah Cobb-Clark, Hielke Buddelmeyer, Terence Cheng, Abraham Chigavazira, Gaétan de Rassenfosse, Trinh Le, Felix Leung, Kris Li, Viet Hoang Nguyen, Alfons Palangkaraya, Peter Sivey, Domenico Tabasso, Russell Thomson and Roger Wilkins A selective summary of the highlights of the eighth Economic and Social Outlook Conference, ‘Securing the future: how Australia can thrive in a volatile world’.

By Naomi Soderstrom How sustainability reporting develops will have dramatic implications for the practice of accounting and auditing in the future.

By John Freebairn Large potential gains for national productivity are available from a shift in the mix of taxes from those with relatively high distortion costs to the GST with its much lower distortion costs.

45 Reciprocity and regard

By Avner Offer ‘Regard’ takes many forms and powerfully influences economic exchanges.

Occasional Addresses 51 Paula Dwyer 54 Jonathan Elliot

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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.

A feature of the Faculty calendar in the last decade has been the Corden Lecture, which honours one of the Faculty’s most influential economists, Max Corden. In the lead article, which updates his 2012 Corden Lecture, award-winning economics commentator Martin Wolf examines the lessons from the 2007 global financial crisis, particularly as they relate to ongoing problems in the eurozone.

The year 2012 saw the celebration of the Melbourne Institute’s 50th anniversary. One highlight was the publication of Ross Williams’ history of the Institute, The Policy Providers (MUP, 2012).

Another was the Institute’s 50th Anniversary Conference. Mark Wooden provides a summary of the conference proceedings, covering the Institute’s origins, the ‘big ideas’ it has generated, the importance of data collection and the new research challenges it faces.

Since their inception in April 2002, the Outlook conferences co-hosted by the Melbourne Institute and The Australian newspaper have provided a major forum for leaders from politics, academia, business, the media and the community to discuss priorities for economic and social reform in Australia. Melbourne Institute director Deborah Cobb-Clark and her colleagues provide a summary of contributions made to the November 2012 conference, in which the focus was on how Australia can thrive in a volatile world.

John Freebairn, one of the University’s most prominent public intellectuals through his policy

contributions, particularly to the debate on tax reform, argues that large potential gains for national productivity are available from a shift in the tax mix. Fittingly, at the lecture in which he presented this article, it was announced that the Department of Economics will create a ‘John Freebairn’ lecture series to honour his contributions.

In the 73rd in a series recognised as the University’s longest-running annual public lecture – the CPA Australia/University of Melbourne Annual Research Lecture – Naomi Soderstrom used her inaugural professorial lecture to examine problems in accounting for sustainability.

In his Downing Lecture, Avner Offer takes readers back to an early moral-philosophy ‘classic’ – Adam Smith’s The Theory of Moral Sentiments – to explore how the concept of ‘regard’, first articulated by Smith, powerfully influences economic exchanges.

In occasional addresses to graduands in December 2012, Paula Dwyer drew on her international experience at board level to extol the potential created for Australia by the rapidly expanding Asian economies; while more recent graduate and entrant to the workforce, Jonathan Elliot, reflected on the nature and importance of workplace culture.

In this issue, thanks must go to Marc Martin, whose striking illustrations add life to the various articles.

Geoff Burrows Editor ghb@unimelb.edu.au

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Article heading here

lessons from the global financial crisis The big lesson of history is that crises repeat themselves, that times of euphoria are when the conditions for crises emerge and that when the crisis hits, it is too late. by martin wolf

An updated version of the Corden Lecture delivered at the University of Melbourne on 17 October 2012.

The first indication that a significant financial crisis was about to hit the world came in August 2007.

At the time of delivery of the Corden lecture, in October 2012, more than five years had already passed. Yet the crisis was still alive, particularly inside the eurozone, as it is at the time of writing, in late March 2013, though the indicators of extreme stress had calmed since the summer of 2012. In the affected high-income economies, nothing like a normal cyclical recovery had occurred. The crisis undoubtedly cast a long shadow. While it is far too early to know what its full significance might be, it is already clear that it is a watershed moment in the history of the world economy. As Dorothy says in The Wizard of Oz, “Toto, I’ve a feeling we’re not in Kansas any more.”

economy. Inside this broader event, we watched an intense regional crisis inside the eurozone. The same forces that drove the eurozone crisis also drove the wider global one. But the challenge of finding a satisfactory resolution has proved even harder within this defective currency union.

What has happened?

The economic collapse in the affected economies proved both large and enduring. In the six largest advanced economies, plus the eurozone, the picture is remarkable – and disturbing. First, the recessions were the deepest since the 1930s.

Second, the recoveries have been exceptionally weak: only two economies, those of the US and Germany, were larger in the fourth quarter of 2012 than they had been in the first quarter of 2008 and even these two were only slightly bigger. The other economies were still below their starting point. Third, the economies of the eurozone, as a whole, particularly of France and the UK, stagnated from late 2010 or early 2011to the end of 2012, as fiscal austerity tightened.

Finally, Italy’s economy shrank rapidly from mid2011. By the fourth quarter of 2012, it was nearly 8 per cent smaller than it had been in the first quarter of 2008.

From the summer of 2007, we watched a global financial crisis that affected economies that, in aggregate, amount to at least half of the world

The “Great Recession”, as it has been called, triggered a no less extraordinary rescue effort. The authorities responded with de facto nationalisation

In this lecture, I address three questions raised by the crisis. The first is: what has happened?

The second is: why did this happen? The last is: what are some important lessons from what has happened? On none of these topics is the discussion comprehensive. It cannot be. But it does try to address some of the bigger issues raised by this important economic event.

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of the liabilities of the core financial system, via explicit guarantees, recapitalisation of financial institutions, traditional lender-of-last-resort operations, on an enormous scale, and direct interventions in what turned out to be a badly damaged credit system. At the same time, monetary policy was eased dramatically, with both short-term interest rates brought down to their lowest-ever sustained level and extremely rapid expansions of the balance sheets of the central banks (see Figure 1). Finally, in a number of important advanced economies, notably the UK and US, fiscal deficits reached levels – and the rise of public debt reached rates – previously only experienced during world wars. In the UK, for example, short-term interest rates became much the lowest since the Bank of England was founded, more than three centuries ago, while the increase in public debt has been surpassed only by what happened during the Napoleonic Wars and the First and Second World Wars.

gross domestic product, occurred in the UK, US and Japan (see Figure 2). In the first two, this was largely because of the devastating impact of the financial crisis on fiscal receipts and GDP, relative to prior expectations. In the case of Japan, it was rather because of the large deficits the country had been running, prior to the crisis, as well as the depth of the recession. Germany and Italy managed the rise in debt relatively well, though Italy was in a difficult position because of the already high level of its fiscal debt, prior to the crisis. France has fallen somewhere in between.

Among the six largest high-income economies, the biggest increases in public debt, relative to

Yet, despite these enormous fiscal deficits, longterm interest rates fell to extraordinarily low levels. In the US, UK and Germany, they fell to below 2 per cent. In Japan, they fell to below 1 per cent. Again, in the UK, for which data exists on yields on long-term bonds since the early eighteenth century, the rates of interest on long-term government bonds had no historical precedent. The obvious question is how huge fiscal deficits can be compatible with such extraordinarily sustained low interest rates. The

Figure 1: Central bank intervention interest rates

Figure 2: Net public debt (as a share of GDP)

7

160

140

6

120 5

100 4 80 3 60

2 40

1

0 1/01/07

20

1/01/08

1/01/09 US

1/01/10 Japan

1/01/11 UK

Source: Thomson Reuters Datastream

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Lessons from the global financial crisis

Euro

1/01/12

1/01/13

0

United Kingdom

United States

Germany 2007

2010

France

Japan

Italy

2013

Source: International Monetary Fund, World Economic Outlook Database

immediate explanation is that markets expected short-term interest rates to remain low for a long time. The underlying explanation, however, is that the economy is in a Keynesian “liquidity trap”, with chronic ex ante excess savings and short-term interest rates up against the zero bound. The best example of this condition, by far, is Japan, where short-term interest rates have been close to zero since the late 1990s and long-term interest rates are, at the time of writing, little more than 0.5 per cent, despite extraordinarily high – and rising – levels of public debt.

The global crisis had, as an important component, the crisis in the eurozone that became visible in the course of 2009. The currency union experienced a rolling wave of financial and sovereign debt crises that hit, in succession, Greece, Portugal, Ireland, Spain, Italy and Cyprus, with more, certainly, to come. The symptoms of these crises have been elevated yields on government debt and difficulties in funding banks. The two phenomena are closely related, since banks rely on governments for support, in extremis, while governments rely on banks for funding, also in extremis. The relationship is therefore rather like that of two drunks trying to hold each other up. But, as governments in vulnerable countries found it increasingly difficult to fund themselves, other than from their own banks, they could

not offer credible support for their banks. At the same time, as cross-border private finance dried up, the banks became more dependent on their hard-pressed governments for support.

Even the willingness of the European Central Bank to act as a lender-of-last-resort to troubled banks proved insufficient, in the cases of Greece, Ireland, Portugal and Cyprus, because banks in these countries started to run out of adequate supplies of acceptable collateral. Official rescue programs were launched in these cases, under the auspices of the so-called “troika” – the European Commission, the European Central Bank (ECB) and the International Monetary Fund. But, behind these, stand the creditworthy governments of the European Union, above all, Germany, which fund the €500bn European Stability Mechanism (and its predecessors, the European Financial Stability Facility and European Financial Stabilisation Mechanism), used to back such programs.

Meanwhile, the ECB, under president Mario Draghi, helped relieve the pressure by announcing its Long-Term Refinancing Operation, in aid of troubled banks, in late 2011, and its Outright Monetary Transactions, in support of the debt markets of troubled governments, in the summer of 2012. Unfortunately, while bond yields finally fell in affected countries, their economies went into very deep recessions, the results including very high unemployment, particularly in Greece Insights Melbourne Business and Economics

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and Spain, as they tried to restore lost external competitiveness, a very slow process. Not surprisingly, the political stresses on both sides of the creditor-debtor divide have proved to be extremely powerful: the former consider the latter soft-headed; and the latter consider the former hard-hearted. The atmosphere is increasingly poisonous, with dire implications for European integration in the long run.

This, then, turned out to be a huge and longrunning crisis that has, correspondingly, raised important questions about the future of the West, the stability of the market economy and the proper conduct of macroeconomic policy before and during crises. It has changed our world.

1980s and 1990s; and the emergence of huge macroeconomic imbalances in the world economy, particularly after the Asian financial crisis of 1997 and 1998, with enormous concomitant flows of excess savings from the emerging countries to a limited number of high-income countries, particularly the US. The eurozone was partly the victim of these global forces. But more important was the fact that both huge imbalances and the financial liberalisation occurred inside the eurozone, too, with the same dire results as globally.

So why did this happen? The financial crisis is the result of two economic processes: a longterm leverage cycle in high-income countries, characterised by financial sector liberalisation, which began in the 1970s and accelerated in the

Figure 3 provides an important indicator of the global savings glut: the declining real rate of interest on safe securities since the mid-1980s.

In theory, in an integrated global capital market, there should be a single real rate of interest on such securities. Fortunately, the evidence supports this hypothesis: the real interest rate on the UK’s index-linked government bonds, which have been issued since the 1980s, coincides quite closely with that on US Treasury Inflation-Protected Securities (which have been issued more recently), since the early 2000s. Using this measure, we see that

Figure 3: Yields on index-linked government bonds

Figure 4: Real house prices

Why did this happen?

6

300

5 250 4

200 3

2

150

1 100 0

50 -1

-2

86

19

88

19

90

19

92

19

94

19

96

19

98

19

00

20

UK 10-year real gilt yields

Source: Thomson Reuters Datastream

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Lessons from the global financial crisis

02

20

04

20

06

20

08

20

10

20

US 10-year TIPS yields

12

20

0

95

19

97

19

99

19

01

20

US

03

20

UK

05

20

07

20

09

20

11

20

Spain

Source: S&P/Case-Shiller National Home Price Index; UK Academetrics England & Wales Average House Price; Ministry of Housing, Government of Spain; Thomson Reuters Datastream

real interest rates fell dramatically from the time of the Asian financial crisis, from close to 4 per cent to around 2 per cent. That is what one would expect when a huge adverse shock persuaded the governments of East Asian emerging countries to prevent their countries from continuing to be net importers of foreign capital, on a large scale.

In the terminology of Hyman Minsky, the fall in real rates of interest on safe securities and subsequent upward shift in the price of longterm real assets, above all, of housing, was the “displacement event” – the event that triggered what ultimately became a huge and devastating financial bubble. Thus, the enduring decline in real interest rates triggered a rise in the price of long-lived real assets – real equity prices (which peaked in 2000) and house prices (which peaked just before the global financial crisis). Of the two, the latter was the more economically significant, since rising real house prices generated a credit boom, which, in turn, generated still higher house prices, rising construction activity and lower household savings rates (see Figure 4 for house Figure 5: US private debt (over GDP)

prices and Figures 5 and 6 for the rise and fall of leverage and borrowing in the US, by far the most important economy to be heavily affected by the financial crisis). These interconnected bubbles burst, devastatingly, in 2007 and 2008.

At the same time, as one would expect, the crisis was associated with a still bigger ex ante savings surplus: so the real interest rate on safe securities fell to zero. This is a clear indicator that the economies of the western world had fallen into a contained depression.

A crucial element in the emergence of the savings glut and consequent fall in the global real rate of interest on safe securities was the emergence of the global imbalances. Between 1996 and a decade later, these imbalances grew roughly six times, relative to global output. The big surplus regions were east Asia, particularly China, the oil exporters and Germany and Japan.

Meanwhile, the big deficit regions were the US and “peripheral Europe” – western, southern and parts of eastern Europe. The latter all fell into crisis after 2007. This was not an accident. These Figure 6: US private sector gross borrowing over GDP

350%

40%

300%

30%

250%

20%

200%

10%

150%

0%

100%

-10%

50%

-20%

0%

-30%

74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 -3 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 012 2

Households

Non-financial business

Financial sectors

Source: Federal Reserve Board, Flow of Funds Accounts of the United States; US Bureau of Economic Analysis, National Economic Accounts

2007 1

2008 1

Households

2009 1

2010 1

Non-financial business

2011 1

2012 1

Domestic financial sectors

Source: Federal Reserve Board, Flow of Funds Accounts of the United States; US Bureau of Economic Analysis, National Economic Accounts

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economies had managed to import the excess savings of the surplus regions by generating what turned out to be unsustainable credit and spending booms. These booms collapsed in the crisis, pushing much of the world economy into deep recession. The huge surplus savings of the emerging economies were, in turn, not the result of purely private decision-making. In substantial part, they reflected conscious policy, particularly the decision to intervene in currency markets, to keep currencies competitive. The result was massive accumulations of foreign currency reserves, particularly by China and other developing countries (see Figure 7). These, then, were, in important measure, official capital outflows. Inevitably, domestic monetary, fiscal and structural policies were, consciously or not, designed to reinforce such surpluses – via a combination of sterilisation of the currency intervention, financial repression and outright fiscal stringency.

The pattern inside the eurozone was not dissimilar to that in the world as a whole. Again, huge

imbalances emerged within the eurozone (see Figures 8 and 9). In the end, all of the eurozone’s capital-importing countries were hit by crises, as cross-border finance suddenly dried up, financial bubbles burst, asset prices collapsed, fiscal deficits exploded and, finally, fiscal austerity was adopted (or imposed). With both private and public sectors trying to move towards financial balance, or surplus, these countries’ external balance had to shift into surplus, as Figure 8 forecasts.

As that happened, the entire eurozone slowly shifted towards surplus, thereby imposing strong contractionary forces on the rest of the world. The conventional wisdom inside the eurozone was that fiscal irresponsibility caused the crises. This is false, except in the case of Greece and, solely because of its high legacy debt from the 1990s, Italy. The other crisis-hit economies had excellent (Ireland and Spain) or at least tolerable (Portugal) fiscal positions prior to the crisis. The explosion in public sector indebtedness was a consequence of the crisis, not a cause, in these cases – dramatically so in the cases of Ireland and Spain (see Figure 10).

Figure 7: Global foreign currency reserves ($bn)

Figure 8: Eurozone imbalances on current account (as per cent of eurozone GDP)

$12,000

3.0%

2.0%

$10,000

1.0% $8,000

0.0% $6,000 -1.0% $4,000 -2.0%

$2,000

Source: International Monetary Fund

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Lessons from the global financial crisis

China Other developing countries

Jan-11

Jun-10

Aug-11

Apr-09

Nov-09

Sep-08

Jul-07

Feb-08

Oct-05

Dec-06

May-06

jan-04

Industrial countries Other Asia

mar-05

Aug-04

Apr-02

Jun-03

Nov-02

Jul-00

Feb-01

Sep-01

Oct-98

Dec-99

May-99

Jan-97

Mar-98

$0

Aug-97

-3.0%

-4.0%

98

19

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 19 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20

Germany Vulnerable countries

Other persistent surplus Others

France Eurozone

Source: International Monetary Fund, World Economic Outlook Database

In brief, the opening of the world economy to free movement of capital, the attempt by emerging economies to protect themselves from the consequences, as they had experienced them, in the crises of the 1990s, the helter-skelter liberalisation of financial markets and the willingness of the monetary and financial authorities in important economies to ignore the growing imbalances, domestic and external, combined to produce a huge crisis. Moreover, in the case of the eurozone, these imbalances interacted with a regime that was not only rigid but was also unsupported by almost all the insurance mechanisms characteristic of a modern federation, other than a central bank. This proved to be extremely fragile.

house prices are back where they started; and substantial deleveraging has also occurred. The eurozone crisis is likely to be far longer lasting.

This is partly because the system as a whole is dysfunctional. It is also because the ECB has no will to generate rising nominal demand, unlike the Federal Reserve. It is, again, also because the adjustments in the vulnerable countries are going to be painful and, inevitably, long term. Whether, in the end, the eurozone survives in its present form is, to say the least, debatable. The economics say “no”. The politics say “yes”. It is a case of an irresistible force meeting an immoveable object.

The high-income economies have a long slog ahead of them. The US seems likely to recover first, partly because it has done more to fix its financial system, but as much because it has gone through more adjustment than European countries: real

Whatever the ultimate economic outcome, we already know the wave of crises has been immensely costly for the afflicted economies. So what lessons should we learn if we want to reduce the chances of further crises on this scale. Let us consider three questions. Can we prevent crises altogether? Can we make the financial system more robust? Can we lower the economic costs of crises?

Figure 9: Current account balances inside the eurozone (1997-2007 averages, per cent of GDP)

Figure 10: Net public debt of crisis-hit eurozone countries (as share of GDP)

What are the lessons?

8.0

200

6.0

180

4.0

160

2.0

140

0.0

120

-2.0

100

-4.0

80

-6.0

60

-8.0

40

-10.0

20

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la Ice

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to Es

Source: International Monetary Fund, World Economic Outlook Database

0

Ireland

Spain 2007

Portugal 2010

Greece

2013

Source: International Monetary Fund, World Economic Outlook Database

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Can we prevent crises?

The answer to the first question is: almost certainly not. But that does not mean we are unable to do better. The evidence from history is clear: financial crises are an inherent feature of dynamic market economies. Economists were extraordinarily foolish, if not willfully ignorant, when they imagined that achieving low and stable inflation would also stabilise the economy. We now know that the opposite is true. The “great moderation”, as the period of relative macroeconomic stability in western high-income countries that preceded the great recession came to be called, was a hubristic notion, at best, and utter folly, at worst. The truth is the opposite. Times of stable prosperity are precisely the time when people feel comfortable about taking on risk. The simplest way to take on risk is to increase leverage. This is what our bankbased financial system is designed to do. But the rise of derivatives has dramatically increased the system’s ability to embed leverage in the economy.

Inevitably, as suggested above, the rise in leverage sharply increases the vulnerability of the economy to shocks, particularly to adverse shifts in the prices of assets used as collateral in the leverage process. Thus, the scale of the crisis was, in good part, the result of mistakes in view of the risks,

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Lessons from the global financial crisis

in macroeconomic policy and in understanding of what was happening in the financial system.

These mistakes were reinforced, in the case of the eurozone, by a failure to realise that the very process which made the first decade look so good – the convergence of interest rates and the associated cross-border capital flows – was making the system more vulnerable to a sudden shift in risk appetite.

When that shift occurred, the eurozone’s capitalimporting countries experienced what was, in effect, a “sudden stop”, similar to that experienced by emerging economies in previous crises.

The big lesson of history is that crises repeat themselves, that times of euphoria are when the conditions for crises emerge and that when the crisis hits, it is too late. So policymakers must be aware of the dangers, at all times, and lean against the winds of overconfidence that bring them. Will that work? Probably not. It is too easy to think that “this time is different”.

Can we make the financial system more robust?

If we cannot prevent crises, can we make the financial system more robust? The answer: yes.

Indeed, we need to do so, though, in truth, the

sources of overconfidence are all too likely to undermine our efforts here, too. But the general ideas are clear. The financial system has to become less closely interconnected. Institutions also need to be easier to resolve, without government support. This means much more equity capital – perhaps as much as five to ten times as much as is now the norm, bringing leverage down from 30 to one to four or five to one. To the extent that capital is not raised in this way, it means ring-fencing of retail from investment banking, to make it easier to ensure continuity of service from the former and to make it more credible that governments will not rescue the latter. Finally, it means changing incentives, to ensure that employees and managers are judged over a long period of performance and share fully in losses. Paying such employees in bail-in-able debt that must be held for many years is one way to achieve this outcome.

Finally, accounting must be changed to ensure that hypothetical gains are not treated as today’s profits. One way of achieving this is through generous provisioning against potential losses.

Can we lower the economic costs of crises?

Lowering the economic costs is the easiest part, at least in theory. The key requirement is a forceful fiscal and monetary response, along with a rapid reconstruction of the financial system and accelerated recognition of the debt that has clearly become unserviceable, even at the post-crisis low level of interest rates.

This sort of aggressive policy response is at least relatively easy for countries that possess strong initial fiscal positions (which is why debt needs to be driven to very low levels in a boom) and, above all, their own central banks, particularly countries that issue reserve currencies. Such countries will be able to run the very low interest rates they will need for a very long time. But low interest rates and even quantitative easing are insufficient when short-term interest rates are at, or close to, zero. This is why fiscal expansion is also necessary.

The fiscal stimulus should, if possible, be used to generate additional high-quality assets, thereby ensuring that valuable assets match additional

liabilities. This will be relatively easy to manage during a long-lasting recession, which is what tends to follow fiscal crises, since that gives time to plan additional investment. But it will also be important to address obstacles to private investment, particularly if, as now seems to be the case in some important high-income economies, non-financial corporate sectors are running what seem to be structural financial surpluses. Also crucial will be policies that bring about shifts in the global imbalances: crisis-hit countries will need to offset private and public austerity with reduced current account deficits or even large surpluses.

The position of countries in a currency union is far more difficult. They are not fully sovereign.

They may be driven into austerity by inability to finance their debt. The central bank can help by agreeing to purchase their debt, to keep interest rates down. But the highly independent ECB will do so only on condition that countries meet the agreed goals of tough plans for fiscal stabilisation.

This would eliminate much of the potential benefits of the ECB’s commitment to keep rates down. This is made worse by the unwillingness of either the ECB or solvent governments to use their freedom of manoeuvre to generate reasonable growth in nominal incomes. Thus the vulnerable countries are forced to adopt austerity at home without any reasonable external offset. The result is sure to be long-run recessions.

Conclusion The financial crisis is a huge event, with deep roots in a malfunctioning global economy. It has created huge policy challenges and given us important lessons. A long dead friend of mine once said to me: “It is not true we don’t learn from history. We do. Then we forget.” Maybe the lessons this time will be deeply enough engraved to ensure we do learn. But I am no optimist. I expect we will soon forget, once again.

Martin Wolf, CBE, is Associate Editor and Chief Economics Commentator, Financial Times, London.

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Article heading here

celebrating 50 years at the melbourne institute by mark wooden

A selective summary of key themes discussed at a one-day conference held at the Melbourne Institute on 6 December 2012 to celebrate the Institute’s first 50 years. Papers presented at the conference will be published in full in the June 2013 edition of the Australian Economic Review.

Introduction Go to any university website, follow the appropriate links and you will invariably find a long list of research centres and institutes with impressive sounding titles. But dig a bit deeper and you will find many are little more than a nameplate on a door. Furthermore, research centres today are increasingly virtual centres, where people are connected by common interests and expertise but where the centre has no direct responsibility for the employment of those people. And of those that are ‘real’, the majority will have only been around for a relatively short period of time. The life of most research centres is an ephemeral one, often dependent on the enthusiasm of one or two key people, and often unable to survive once the original funding source dries up or if those people leave.

The Melbourne Institute of Applied Economic and Social Research is an exception. It started life some 50 years ago, and while its fortunes have waxed and waned, and it has reinvented itself a number of times, it has made an indelible imprint on policy-relevant research and decision making in Australia.

In 2012 the Institute turned 50, a customary time for all involved in its history to look back and reflect on its achievements. A history The Policy Providers, written by Ross Williams (2012), a former Dean of the (then) Faculty of Economics and Commerce, was published; staff, both past and present, and friends of the Institute were invited

to a celebratory dinner at Ormond college; and a one-day conference was held. It is the proceedings of the latter that are the subject of this article.

Inauspicious beginnings The first speaker at the conference was Ross Williams, who reflected on the environment and events that gave rise to the creation of the Institute and its challenges in those early years. He argued that the major force behind the creation of the Institute was the need for independent sources of economic advice, and that fear of such advice from the key economic policy agencies at the time was a major obstacle. Indeed, Treasury, under the leadership of Roland Wilson, actively torpedoed efforts to obtain public funds for the establishment of an institute. The newly created Reserve Bank, under the leadership of H.C. (‘Nugget’) Coombs was not so defensive and actively encouraged the setting up of an independent applied economic research group, preferably at ANU where he was Pro-Chancellor. The University of Melbourne, however, had concocted its own plan, formulated

by Ronald Henderson, a Cambridge man with interests in the study of financial markets, but with strong family ties to Melbourne. Richard (‘Dick’) Downing progressed the proposal and with Melbourne more advanced than ANU in its plans, Coombs was persuaded to back the Melbourne venture. While the Bank did not provide core funding, it would become a significant source of funds for individual research projects during the 1960s.

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Henderson was duly offered the job of heading the new Institute of Applied Economic Research, although thanks to University red tape that position was only at readership level. Nevertheless, he accepted and commenced his appointment on 15 December 1962; his promotion to professor would not come until 1966.

Key features of those early years included: – The establishment of a nationally-based advisory board (though without representation from either the Treasury or the Reserve Bank); – The establishment of the Australian Economic Review, a vehicle for publishing reviews of the state of the economy and short-term economic forecasts; – Development of expertise in both data ‘production’, including conversion of hardcopy data into machine-readable form, and data collection (as reflected in the Melbourne Poverty Study); and – The gradual extension of the Institute’s research program into what might be described as social economics, and reflected in a change in name in 1969 to the Institute of Applied Economic and Social Research.

A place for big ideas Attention during the conference naturally gravitated towards the big ideas that have emanated from the Institute. Ross Williams highlighted three major areas of research during the Institute’s first decade or so, which would prove to have an enormous impact on policy. These were: (i) research into Australia’s health insurance system by John Deeble and Dick Scotton; (ii) research into poverty and the subsequent inquiry led by Ronald Henderson that this early research called for; and (iii) research into the regulation of the finance sector led by John Rose.

The role the Institute played in the creation of Medibank (now Medicare) is almost certainly still the most significant public contribution ever made by the Melbourne Institute. This was largely the subject of John Deeble’s presentation. One of Henderson’s earliest appointments, Deeble along with Scotton proposed a system of compulsory 16

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health insurance that would become the Whitlam Government’s Medibank system, the essential features of which remain today (Williams 2012).

Deeble reflected on the critical leadership role played by Henderson, the importance of the ‘Whitlam factor’ in shaping the direction of their research, and the stark differences between the world of the 1960s and that of today. While Henderson himself had no real interest in health economics, and indeed was initially sceptical about its research potential (Williams 2012), he was soon persuaded of its importance, and according to Deeble was instrumental in facilitating the Deeble-Scotton agenda. Significantly, neither Deeble nor Scotton knew where their funding came from; this was simply something they never had to think about.

The legacy of Deeble and Scotton, however, extended beyond public policy into academic research. As Jane Hall (University of Technology Sydney) made clear, Deeble and Scotton were global leaders in the development of modern health economics. In Australia they are identified as its fathers. Nevertheless, one disappointment is that the Institute vacated this area of research once Deeble and Scotton, who were soon in great demand from the growing number of government agencies operating in the health space, left the Institute. Two decades later Peter Dawkins took up the challenge of getting the Institute back into health economics, eventually appointing Tony Scott, who arrived virtually as Dawkins left, and who has now established a small team with a growing research reputation in the areas of performance, incentives and competition in the provision of healthcare and in the study of the health workforce.

Poverty research is another area where the Institute carved out a large reputation in its early years. Andrew Whitecross from the Department of Families, Housing, Community Services and Indigenous Affairs (FaHCSIA) reflected on the importance of the Institute – and Ronald Henderson in particular – in bringing income adequacy to the attention of the Australian Government, and the enduring legacy of its research, especially in terms of measurement.

Whitecross also suggested that perhaps a more significant lesson for government concerned the value from stronger cooperation between academic researchers and the public sector. In his view, the Henderson Poverty Inquiry was one of the first real demonstrations in the social policy space of the value and power of academics and government working cooperatively. Such insights provide the rationale for many of the long-term contracts the Institute has entered into with governments and on which it depends so heavily today.

Former Director Stephen Sedgwick, for example, highlighted the partnership between FaHCSIA and the Melbourne Institute that underpins the HILDA Survey (see below), describing it as both “unusual” and a major contributing factor to the ongoing success of that study.

– The development of the Melbourne Institute Tax and Transfer Simulator (MITTS) in the 2000s and its contribution to a better understanding of labour supply responses to policy change; and – The recent contributions of the Institute to the understanding of the economics of intellectual property.

The need for data

– The development and ongoing construction of leading indicators of business activity and the monthly inflation gauge;

A theme that pervaded many of the presentations was the importance of data collection and production throughout the Institute’s history.

As already noted, following the appointment of Duncan Ironmonger in 1966 the Institute became, at least for a short while, the national leader in the development of computerised data.

Even more significant given the dearth of unit record data in Australia at the time were the primary data-collection efforts that underpinned much research activity. Included here are: (i) the Melbourne Poverty Study; (ii) the work on voluntary health insurance by Deeble and Scotton; and (iii) the beginning of the quarterly household consumer survey in 1973, which is still conducted today and is the basis for many of the products produced, and much of the research undertaken, by the applied macroeconomics group.

– The various contributions the Institute made to the unemployment debate during the 1990s;

Over the last decade, data collection has again assumed a very prominent place in the operation

Other important contributions that were recognised during the day’s proceedings include: – The work by Peter Sticker and Peter Sheehan on hidden unemployment in the late 1970s; – The development and application of computable general equilibrium models during the 1980s under the leadership of Peter Dixon;

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of the Institute. The household consumer survey (now known as the Consumer Attitudes, Sentiments and Expectations Survey), which moved to the collection of data on a monthly basis in 1986, is now the platform for not only the Survey of Consumer Sentiment (sponsored by Westpac), but also measures of consumer inflation expectations, unemployment expectations, wages growth and expectations, and household financial conditions. The Institute also currently runs a number of other major surveys including: – The Household, Income and Labour Dynamics in Australia (HILDA) Survey, Australia’s premiere household panel survey; – Journeys Home, a ‘shortitudinal’ survey of disadvantaged Centrelink customers facing housing difficulties; – The Medicine in Australia – Balancing Employment and Life (MABEL) longitudinal study of doctors; and – The Global Proxy Shareholder Confidence Index, a telephone survey of persons who own shares in companies listed on the Australian Securities Exchange.

In addition, there have been many one-off surveys of firms with a focus on innovation and aspects of firm performance.

The significance of the HILDA Survey was highlighted in numerous presentations.

Whitecross, who works for the government agency that funds and oversees the HILDA Survey, highlighted the significance of the commitment the government made and continues to make to HILDA, and the benefits that the government has been reaping. Sue Richardson from Flinders University, and an original member of the HILDA Survey External Reference Group, was assigned the task of reflecting on the contribution that it has made since its commencement in 2000.

She drew attention to its contribution to public policy and debate, and highlighted how many of the questions being addressed with the data were not even on the policy agenda at the time of its inception. Further, the easy availability of the data has been accompanied by an exponential 18

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growth in research activity, a boon to both the social science research community and policymakers alike. But the praise did not end there.

Guy Debelle, Assistant Governor of the Reserve Bank, drew attention to the value of the HILDA Survey data to the Bank’s research program, in particular its importance in understanding transmission of monetary policy. Finally, Hall pointed to the importance of HILDA Survey data in contributing to health-related research on issues such as lifestyle choices, workforce participation and mental illness.

Another important data collection exercise, acknowledged by Debelle, is the monthly inflation gauge (funded by TD Securities). Introduced in 2003, this is Australia’s first, and still its only, monthly index of consumer price changes.

New areas of research Some of the speakers focused more on the potential for further research contributions by the Institute in the future, rather than reflecting on the past. Bob Gregory from the Australian National University discussed the growth in the number of Australians dependent on welfare, and the connections (or lack of) between recent research and policy. Stephen King from Monash University talked about the emergence of twosided markets and the need for research in helping regulatory bodies understand how they work. Very differently, Andrew Leigh, MP, set out a ten-point agenda for research into education. This is an area in which the Institute has only recently invested: a dedicated economics of education program was established in 2011 with the appointment of Chris Ryan and the securing of a major research contract with the Victorian Department of Education and Early Childhood Development.

Final reflections The conference concluded with a roundtable, chaired by Judith Sloan, an Honorary Professorial Fellow of the Institute and contributing economics editor with The Australian. Current Director Deborah Cobb-Clark and recent past directors Richard Blandy, Peter Dawkins and

Stephen Sedgwick joined the forum. Each was asked to comment on the major difficulties, challenges, disappointments and achievements during their tenure, and to reflect on how they saw the Institute today.

struck a good balance between academic research and policy relevance. To quote him: “Academics are critical to public debate … but most have retreated to their ivory towers. The Melbourne Institute hasn’t done this.”

With respect to challenges, the recurring theme was the financial constraint, a concern that has shaped much of the Institute’s history (Williams 2012). Blandy, in particular, inherited an Institute in 1993 that had very few staff and a very large debt. He openly admitted that his greatest disappointment was not being able to break out of this poverty trap. However, almost as a final parting gesture (and with the considerable aid of the Chair of his Advisory Board, Peter Jonson), he was successful in getting the University to waive much of the Institute’s debt prior to his departure.

This would provide an important platform for his successor, Dawkins, who nominated identifying secure revenue streams as his biggest challenge.

As it transpired, his efforts were spectacularly successful, securing two major long-term contracts with the then Department of Family and Community Services within his first fiveyear term. As a result, for the Directors to follow the challenge was considerably easier – how to resource and retain these long-term contracts while working to diversify the funding portfolio.

One reason for such perceptions may be the efforts the Institute has made in recent times to disseminate its research to a wide array of audiences and to bring representatives from government, policy-relevant NGOs and academia together.

Perhaps the most obvious example of this has been the regular Economic and Social Outlook Conferences jointly hosted with The Australian newspaper, which have been held every 18 months or so since 2002 (see p23 for a report on the 2012 conference). Dawkins nominated establishing this forum as one of his most significant achievements.

Another common theme, and one also reiterated in Williams (2012), is the tension between the achievement of academic objectives and other broader objectives, and in particular the importance of undertaking research with direct policy relevance. Sedgwick, for example, nominated having insufficient policy impact as his biggest disappointment during his time (20072009), while Cobb-Clark described influencing policy as the main current and ongoing challenge.

This represents a turnaround from the Institute’s past, where its impact on government was often highly visible but where traditional academic output was conspicuous by its absence, and in turn potentially undermined its standing within the Faculty, University and broader academic community. Nevertheless, an observation from Debelle earlier in the day suggests the Institute has

Finally, and by way of conclusion, there was unanimous agreement around the table that the Institute has never been in a stronger position than it is today. Richard Blandy, for example, described the Melbourne Institute today as a “research powerhouse”. The consensus seems to be that the Institute has a well established reputation that continues to be supported by continuing strong links with government and other key organisations, where world-class research is underpinned by a comparative advantage in the collection and analysis of data, and where “the kind of research undertaken … ultimately benefits all Australians” (Sloan 2012).

Mark Wooden is Professorial Research Fellow and Director of the HILDA Survey in the Melbourne Institute.

References Sloan, J 2012, ‘Vital source of policy elements is thriving at 50’, The Australian, 11 December, p. 12.

Williams, R 2012, The Policy Providers: A History of the Melbourne Institute of Applied Economic and Social Research, 1962-2012, Melbourne University Press, Melbourne.

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Article heading here

securing the future: how australia can thrive in a volatile world by deborah cobb-clark, hielke buddelmeyer, terence cheng, abraham chigavazira, gaétan de rassenfosse, trinh le, felix leung, kris li, viet hoang nguyen, alfons palangkaraya, peter sivey, domenico tabasso, russell thomson and roger wilkins

A selective summary of the highlights of the eighth Economic and Social Outlook Conference, ‘Securing the future: how Australia can thrive in a volatile world’, which was hosted by the Melbourne Institute and The Australian on 1–2 November 2012 at the University of Melbourne. Many of the presentations and recordings of each speech can be found on the Melbourne Institute website at http://melbourneinstitute.com/miaesr/events/conferences/ Outlook_2012/conference_outlook_2012_program.html.

Background In 2002 the Melbourne Institute of Applied Economic and Social Research and The Australian jointly hosted the first Economic and Social Outlook Conference. The goal was to bring together leading policy-makers, politicians, academics, community service organisations and business leaders to discuss the priorities for economic and social reform in Australia. This first conference was held against a backdrop of strong economic growth and declining unemployment.

One decade on, the global economic environment is shaped by political and economic uncertainty in Europe and a slow-to-recover US economy.

Australia continues to avoid the worst of the GFC, thanks in large part to an unprecedented resources boom and extremely favourable terms of trade. At the same time, it seems clear that the days of large budget surpluses have ended.

It is now crucial to prioritise economic reforms – to support productivity improvements while constraining the government’s options for dealing with any future fallout from uncertain, volatile global financial markets. In light of these policy

challenges, participants at the eighth Outlook Conference concentrated on identifying strategies for Australia to not only cope with, but thrive in, a volatile world.

The conference was opened by the University of Melbourne Vice-Chancellor Professor Glyn Davis.

In his response, Paul Kelly, Editor-at-Large for The Australian, noted that the timing of the conference was fortuitous given the recent release of the white paper Australia in the Asian Century and the midyear budget review. These documents provided the foundation for the conference discussion given the uncertain, unpredictable and weaker global economic environment.

Two speeds, two worlds: the domestic and global economic challenges for Australia Speakers set the scene by providing an overview of the Australian situation in the global context.

Ian Harper noted that growth rates in Australia are higher than those in other OECD countries in the eurozone and the US, but significantly lower than those in developing countries such as Insights Melbourne Business and Economics

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China. This is the result of the averaging effect of the two-speed economy, where 20 per cent of the working population belong to the booming resources sector while the rest are in sectors with much lower growth rates.

Deborah Cobb-Clark said that the social groups most vulnerable to a slowdown in the economy will be young and low-skilled individuals, as well as low-income households that are increasingly struggling to pay for housing.

According to Gary Banks, reforms aimed at maintaining growth in Australia after the mining boom need to be targeted at multi-factor productivity. The priority areas include removal of trade barriers and reducing assistance to failing industries.

International financial developments: implications for the Australian economy There was a lively discussion about the likely impact of recent developments in international financial markets. Fariborz Moshirian said that the challenge for our generation is to create a system that can facilitate a global response to economic crises. In relation to the European debt crisis, the challenge for Europe’s national leaders is to act not just in the interests of their country, but also in the interests of European citizens as a whole. The short-term risks for Australia include a spike in oil prices and deepening European debt.

Adam Boyton emphasised that three factors are likely to affect the Australian economy: people are still deleveraging; we face a weak global growth environment; and low interest rates in the EU and the US – relative to Australia – further strengthen the Australian dollar. Moreover, China’s GDP growth has disappointed analysts. A decline in the terms of trade could be dealt with in two ways: either the economy adjusts or interest rates adjust. The Reserve Bank of Australia has space to move on interest rates, but not as much as was the case in 2008.

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Securing the future: how Australia can thrive in a volatile world

Alberto Calderon illustrated the current issues in the mining industry by highlighting the remarkable story of iron ore – for which exports grew from about $5 billion in the 1990s to about $60 billion today as a result of urbanisation in China. Eventually, Chinese demand will be met and prices will fall. In the long term, much of the steel that China consumed would come from recycling scrap as is currently the case in the US and Europe. Subsequently, demand will shift towards resources like oil, gas and potash, which middle-income countries require.

The importance of public debate Former Treasury Secretary Ted Evans emphasised the importance of informed public debate. As an institution, the Productivity Commission is crucial for underpinning public debate, while the media also plays an important role. Establishing informed public debate over the long term will be important given that the EU needs a decade or two to resolve its issues. As to the wisdom of the government making several expensive long-term commitments without sorting out the accompanying funding arrangements, all funding decisions should be made in the context of the budget. A very significant long-term reform would be to strengthen the interaction of the tax and social security systems. We need to broaden the tax base which invariably means we need to discuss the GST.

Asia The session on Asia focused on the white paper Australia in the Asian Century. Paul Kelly opened by raising three crucial issues: what are the fundamental changes in the region? How should Australia respond? And how to address the central conundrum, namely the tension between the ambitious benchmark in the white paper and the policy framework? He disputes whether the benchmarks can be remotely achieved in the current framework.

David Gruen provided an insider’s view of the white paper by summarising its coverage of the region’s

rapid increases in income and wealth, urbanisation and the importance of the middle class. He discussed the projected slowdown in the near term, particularly in China, due to its need to rebalance from growth driven by investment and external demand to growth driven by domestic consumption. If Australia wants to make the most of the Asian century, scientific engagement and education in general are among the ways to achieve it.

Michael Wesley had a more negative attitude to the white paper, arguing that it is not really about Asia at all; it is about Australia and completely ignores the strategic framework within which the rapid economic transformation in Asia occurs.

To Wesley, the white paper is nothing but a oneway bet which is far too optimistic, focusing only on the upsides of Asia’s economic re-emergence.

Australia must also consider the downsides.

Ross Garnaut shared a similar view, emphasising that the white paper lacked any substantive discussion about the strategic context, and raised political risks from its naïve assessment of the strategic complexity. Its ambitious targets would be hard for Australia to meet without making short-term sacrifices. To benefit from the Asian century, we would have to have a ‘soft’ landing from our resources boom and find more sustainable ways to ensure our economic growth. The white paper did not provide an adequate assessment of the risks to growth in the region, including the impact of climate change and the possibility of military-activity irruptions, as well as policy paralysis resulting from the political tensions in considering policies to ensure sustainability. It was important to realise that there is more to Asia than China and India.

Health James Angus opened the session by setting the broad discussion agenda: will health reform work?

Given the major changes to hospital funding and performance management, how would these reforms affect service delivery and costs? And is there more that needs to be done?

Stephen Leeder highlighted the current challenges facing the Australian healthcare system, including

long waiting lists for elective care, excessive workloads and industrial relations problems.

Rising expectations, exponential growth in health technology, and the focus on cost and efficiency amidst the maintenance of humane concerns are putting additional pressures on healthcare in Australia.

Anthony Scott presented evidence on the extent to which financial incentives can change – and have changed – the behaviour of healthcare providers.

The discussion was framed in the context of Activity Based Funding (ABF) that is to be implemented in many health jurisdictions, with the overarching question of whether ABF will improve efficiency. Related questions include what would be the efficient price, whether budgets are binding, how system managers are to be rewarded and, in turn, how they can persuade clinicians to respond. It was important to carefully design ABF and evaluate its impact.

Tony Sherbon introduced the role and objectives of the Independent Hospital Pricing Authority (IHPA), which oversees the implementation of ABF in Australia. The presentation covered the products developed by IHPA, how these products are to be used, and the timeframe for implementing ABF.

School education This session focused on school education reform, particularly funding reform. Lisa Paul quoted the Minister for School Education, Peter Garrett MP, in describing a virtuous circle in which investment in education compounds to boost productivity over time. The government has adopted the Gonski review’s core recommendation that every child’s education should be supported with a benchmark amount of funding.

Richard Bolt observed that there is an ambiguous relationship between strong schooling results and funding levels in a mature education system like Australia’s. While funding matters, past a certain point how the money is spent is no less important than how much is spent. From the Insights Melbourne Business and Economics

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schools’ perspective, raising the quality of school leadership, increasing school autonomy, improving school governance, and linking teachers’ pay with performance, together with rigorous performance management, are some of the measures that could empower and incentivise schools to drive improvement.

From the students’ perspective, Chris Ryan particularly emphasised the need to improve achievement for vulnerable youths who have much poorer labour market outcomes in early adulthood relative to their more advantaged peers.

Federal financial relations There was a lively discussion of the strategies for dealing with the reform impasse generated by the fiscal relations between different levels of government. Nigel Ray painted a positive picture, arguing that budget balances were significantly less volatile for the states than the Commonwealth, largely because of the vertical fiscal imbalance. This improves the capacity for federal government fiscal policy to play a macroeconomic stabilisation role.

However, demands for government expenditure were increasing and difficult fiscal choices lay ahead at both the state and federal government levels, although this was largely a matter for the political process.

Miranda Stewart argued that the ability of the Commonwealth Government to drive reforms to improve the efficiency of the tax system was hampered by the considerable taxation and expenditure powers vested in the states by the constitution and the constitutional constraints placed on Commonwealth spending powers.

However, these obstacles were surmountable, through a reinvigoration of ‘Section 96 grants’, which allow the Commonwealth Government to place conditions on grants made to the states, and through further development of institutions that facilitate Commonwealth-state cooperation.

Finally, John Freebairn argued that a raft of tax reforms provided the ‘lowest hanging fruit around’ for boosting economic wellbeing in Australia, identifying the removal or reform of land, payroll, 24

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motor vehicle, insurance and property transfer taxes. The biggest challenges to reform were uncertainty about the effects of reforms on the net revenues of governments, misplaced concerns about equity effects, and the fact that, while most reforms required state governments to act, most of the gains would accrue to the Commonwealth via increased income tax revenue.

The dinner address The Deputy Prime Minister and Treasurer, Wayne Swan MP, began by outlining several key points from Australia in the Asian Century. In particular, he emphasised that (i) lifting productivity growth at home will be vital for Australian prosperity in this century, irrespective of how economic conditions in Asia evolve, (ii) education is fundamental to achieving these gains, (iii) the responsibility for grasping future opportunities rests with all sectors of the economy, and (iv) good fiscal policy forms the foundation for the government’s future actions.

At the same time the risks of political inaction in the US and Europe had resulted in a deep sense of uncertainty in international markets. The government has consistently improved the longterm position of the Australian budget by making significant and often unpopular structural savings.

Swan concluded by stating that all governments have difficult choices to make and that he was proud of the choices that have been made to put Australia on a path to a more equal society.

Making cities productive The panel discussion was opened by George Megalogenis, who noted that Australia is one of most urbanised countries in the world. Thus Australian cities are the centre for economic activity and social engagement. He asked: how can we make them better serve the nation? How can government and the private sector share the infrastructure load to make the housing stock more responsive to our needs?

Greg Hunt MP argued that Australian cities are not broken, but they are damaged and social cohesion has broken down in some communities.

We need integrated planning commissions for

our capital cities as well as accountability in implementing the plans from those commissions.

Henry Ergas responded to several myths that stand in the way of the efficient use of urban resources, stating that there is nothing inherently bad about ‘sprawl’ (i.e. extensive land settlement) and that forced densification wastes capital and increases local congestion. Moreover, while there is often a case for subsidising public transport, there is no a priori reason to believe that, at current costs, shifting traffic from roads to public transport would increase efficiency. Clearer policy objectives, better governance and decentralisation were required.

Finally, Jane-Frances Kelly discussed the results of a recent Grattan Institute report which asked Melbourne residents about their preferences regarding housing arrangements. The responses differ according to the zone of the city in which

the respondents live. Comparing preferences to the existing housing stock indicated that there are shortages of semi-detached dwellings and apartments in buildings with more than four storeys in many parts of the city.

Demographic dilemma The Australian population is not only ageing, but also shifting in its composition. Graeme Hugo argued that we are at an important stage in that process. The big story in life expectancy is not so much overall life expectancy, but the increased life expectancy conditional on reaching 50 years of age which jumped dramatically after 1970. Because fewer people are dying at younger ages, Australians over the age of 65 have worse health outcomes, including disabilities, than in earlier periods.

Judith Sloan highlighted two important trends in the labour-force participation of women. First, Insights Melbourne Business and Economics

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women over the age of 55 have had a remarkable increase in labour force participation rates.

Second, the classic M-shape participation curve – with the dip in participation coinciding with child-rearing – is morphing towards the inverted U-shape which is common in other countries such as the UK, Sweden and the US. The latest census data reveal that, for the first time, a majority of partnered women returned to work prior to their child reaching one year of age. The flip side of women’s increased labour force participation is the big growth in the number of women on the Disability Support Pension.

Malcolm Turnbull MP argued that we are facing an environment of increasing uncertainty. Evidence for this in the area of population can be found in the various issues of the Treasury’s Intergenerational Reports in which population predictions are highly variable. One of the most challenging predictions around population change is the net migration rate, which depends on the economy.

Restoring the balance Finance Minister, Senator Penny Wong, Nick Greiner and John Daley engaged in a lively debate about strategies for moving the government from borrower to saver status. Increases in savings rates have reduced GST revenues and narrowed the tax base. Senator Wong noted that since the GFC, government receipts have been written down by around $160 billion, demonstrating the impact that global volatility can have on our fiscal position.

Population growth rates have also been reduced from abnormally high post-war levels, leading to a subsequent decline in the working-age population.

Restoring the budget needs to be based on growthoriented policies that actively prepare for the coming of the Asian century, through educational reforms and other initiatives to secure access to high-technology jobs in the future.

John Daley argued that, of the government actions that will really change economic growth, some will require tough decisions. Other options that are high-impact and easier to implement include increasing old-age workforce participation and 26

Securing the future: how Australia can thrive in a volatile world

changing the tax mix. Finally, there exists a lack of clarity with regard to overlaps in federal and state functions classified as ‘shared responsibilities’.

Reforms to governance and financial arrangements need to occur before the wider issue of budget priorities can be discussed effectively.

Trade and industry policy There was general agreement regarding the benefit to Australia of continuing trade liberalisation.

Trade Minister, Craig Emerson MP, provided an update on current trade talks. Acknowledging that the Doha round of WTO negotiations have stalled, new pathways to trade liberalisation were being pursued by the Australian Government. These include focusing WTO talks to achieve agreement on trade facilitation aspects and a recent agreement by the Asia Pacific Economic Cooperation to cut tariffs on 54 environmental goods.

Tony Shepherd emphasised the need for Australia to remain open to foreign capital, highlighting the historically important role of foreign capital in underpinning Australia’s prosperity. ‘Hysteria’ regarding the recent growth in investment from China, which contributes only a small fraction of Australia’s total foreign capital, was unwarranted.

While the Foreign Investment Review Board’s National Interest Test is sound in principle, it might need some tweaking if Australia is to avoid the perception of discrimination.

Finally, Patricia Scott charted the history of Australia’s trade liberalisation since the 1960s and its important role in underpinning productivity growth. Given that average-level trade protection is now very low, the challenge is to identify costly off-budget barriers to trade, such as those embodied in procurement and regulatory measures, and also to reduce support to the few specific areas, like the film industry, which are still receiving sizeable assistance.

While the unilateral reduction of remaining barriers to trade is overwhelmingly in Australia’s national interest, bilateral agreements have provided limited identifiable benefits.

The Coalition’s deregulation reform

Future fiscal shock

Opposition Leader Tony Abbott MP began his address by outlining the key attributes needed by a federal government seeking to ensure prosperity and security. It was important to take a long-term view with a productivity focus and a genuine commitment to fiscal sustainability, which he believes are severely lacking in the current government. There were adverse productivity effects of excessive and inefficient regulations, and the regulatory burden was a pressing and growing problem in Australia. He announced the release of the Coalition’s Deregulation Reform Discussion Paper, outlining a number of proposed measures aimed at reducing the regulatory burden:

With the US, the eurozone and the governments of many developed economies facing great fiscal challenges, Andrew Robb MP, Innes Willox and Chris Richardson engaged in a lively discussion of the future fiscal challenge facing Australian policy-makers. There was concern that revenue growth is likely to slow in the coming years due to a combination of three factors:

– Two days in every sitting of Parliament would be set aside to repeal redundant regulations;

– Falling commodity prices as a result of weak global demand and increases in supply mean less tax revenue from the mining industry.

– A dedicated unit, charged with reducing regulatory burden, would be created within each department and agency; – Each department and agency would be required to quantify the cost to business and individuals of complying with their regulations; – The Office of Best Practice Regulation would be relocated from the Department of Finance and Deregulation to the Department of Prime Minister and Cabinet to enable a whole-ofgovernment view of regulations to be adopted; – A Productivity Priorities Working Group would be established to develop implementation plans for policies to improve productivity; and – A Prime Minister’s Business Advisory Council would meet three times per year.

Other initiatives a coalition government would introduce – aimed at increasing productivity and economic growth – included major new road infrastructure projects, a ‘root and branch’ review of competition laws, an earnings-related paid parental leave scheme, further welfare reforms, restoration of the Australian Building and Construction Commission, and the removal of elements of the Fair Work Act.

– Eroding GST revenues due to the swing from consumption to investment spending in recent years; – Tax revenue from capital gains is shrinking due to weak share and housing markets in the aftermath of the GFC; and

In short, given current tax arrangements, the same-size economy is generating less revenue.

Accordingly, Australian policy-makers need to identify the sources of future revenue growth and savings from the current public spending. This is very important if the funding of long-term spending commitments, such as the National Disability Insurance Scheme and the Gonski school reforms, is not to raise national debt. Australia has always been and will always be a small open economy vulnerable to global shocks, and while the national debt level is still relatively low compared with other developed countries, a prudent fiscal policy is crucial to securing our future.

Homelessness Mary Wooldridge MLA, Minister for Mental Health, Women’s Affairs and Community Services in the Victorian Government, discussed the dysfunction of the existing system of service delivery for homeless people in Victoria. Homelessness does not occur in isolation, and is more a result rather than a cause of disadvantage. Connected services are required that address the multiple problems faced by the homeless, such as poor general and mental health, lack of education, lack of employment, and Insights Melbourne Business and Economics

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lack of social support. Unfortunately, the current system is fragmented and program- rather than client-focused. The minister noted that, following the release of the Case for Change report in 2011, the Victorian Government was implementing a new system of delivery of human services, called ‘Services Connect’.

Rosanna Scutella gave an overview of an important new longitudinal study – ‘Journeys Home’ – of those who are homeless or at high risk of homelessness, which is being managed by the Melbourne Institute on behalf of the Department of Families, Housing, Community Services and Indigenous Affairs. The study was initiated in response to The National Homelessness Research Agenda white paper, which identified a need for longitudinal data to better understand the causes and consequences of homelessness.

Finally, Tony Nicholson argued that homelessness more often than not results from policy failures in other areas than housing, such as education, employment and health policies. There should be an increased policy focus on the education and 28

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employment of disadvantaged young people as the most important means of reducing homelessness.

A large increase in the provision of social housing was essential, and such housing should be located proximate to services and jobs, and not on the periphery of major cities.

Productivity and innovation Speakers discussed the decline in productivity growth that has been occurring in Australia for about a decade, and offered possible remedies with different time horizons. John Edwards noted that the single most important factor that has been driving down productivity growth is the investment boom. The newly created assets have not yet yielded returns but will do so in the near future.

The Hon John Brumby focused on five areas with a key role to play in enhancing productivity, namely: independent institutions such as the Productivity Commission; infrastructure investment in our congested cities; health expenditure in the workplace, with a particular focus on diabetes; education; and technological innovation.

Finally, Beth Webster took a longer-term perspective and observed that the innovation process is becoming more global and more fragmented at the same time. Policies should aim at tapping into foreign expertise and fostering an exchange of ideas within the community.

Wrap up Judith Sloan began the final session of the conference by reflecting on the title of the conference, given that Australia had been ‘lucky’ to escape the GFC relatively unscathed, and the focus was now on securing future prosperity. Paul Fletcher MP suggested Australia had recently lost its ‘reform mojo’ gained in the 1980-2000 period of market reforms which led to productivity improvements. Australia was acting in an increasingly competitive global landscape and was now competing with Asian countries on, for example, corporate tax rates.

Andrew Leigh MP discussed the two policy priorities that keep him awake at night: school performance and entrepreneurship. Recent declines in Australian students’ PISA scores were worrying, and the government needed to prioritise teacher quality as a lever for improving student outcomes. On entrepreneurship, patent data indicated a relatively poor performance

by Australian innovators. Strengthening links between academia and business was an important strategy in improving innovation performance. In the current political climate, Leigh lamented the lack of bipartisanship on key policy issues; while Paul Fletcher called for political leaders to ‘make the case for change’ for unpopular productivityenhancing reforms.

The authors are all members of the Melbourne Institute.

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Article heading here

sustainability reporting: past, present, and trends for the future How sustainability reporting develops will have dramatic implications for the practice of accounting and auditing in the future. by naomi soderstrom

A condensed version of the 73rd CPA Australia/University of Melbourne Annual Research Lecture presented on 15 October 2012. A video version of the lecture can be viewed at: http://go.unimelb.edu.au/7w3

Corporations are facing increasing pressures to be accountable and transparent, and to disclose a wide variety of information about activities, including their sustainability. Sustainability is an emotionally-charged topic and its meaning may differ between individuals and corporations.

For the purposes of this presentation, I define sustainability reporting as the communications which corporations make concerning their corporate social-responsibility (CSR) activities, including social and environmental impacts in addition to financial performance.

The International Integrated Reporting Council (IIRC) has proposed a revolutionary change in the way that corporations report activities to stakeholders, essentially by replacing current financial statements with integrated reports that contain financial information, operational data and sustainability information.

In a philosophical shift in thinking about corporate accountability, integrated reporting not only changes the form of reporting, but also its purpose.

The underlying agenda is to make corporations more sustainable. Sustainability proponents argue that, in addition to providing information to a broad range of stakeholders, integrated reporting will change the way that corporations operate, helping them to make more sustainable

decisions (IIRC 2011). This is very different from the traditional role of financial reporting, centred on providing financial information to external investors.

How sustainability reporting develops has profound implications for accounting and auditing practise in the future. Even if we do not fully move to integrated reporting, increasing sustainability disclosures pose challenges to the accounting profession in terms of measurement and assurance.

The ideas behind sustainability reporting also challenge us to think about the role of accounting in business and society. In this talk, I will trace the history of sustainability reporting and make some comments about issues associated with the development of integrated reporting.

Origins of sustainability reporting The development of sustainability reporting over the last century has reflected prevailing social and political climates. The nature of sustainability combined with measurement difficulties has meant that information has traditionally been provided in either narrative form or via nonfinancial metrics. Much of corporate non-financial reporting originated as part of annual financial statements and focused on human resources and employee relations. For example, Hogner Insights Melbourne Business and Economics

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(1982) found that the US Steel Corporation’s early financial statements included topics such as worker housing, community development, worker safety and mortgage assistance for employees.

Politics and events such as environmental disasters impact the ebb and flow of concern and, hence, reporting. Arguably, US society in the 1960s and into the 1970s was concerned about social issues – women’s rights, racial equality and world peace – which became a focus of corporate reporting.

Employee-relations and human-resource reporting evolved into social reporting. The physical environment only assumed importance later through some well-publicised environmental catastrophes and ensuing regulations. Most social reporting was disclosed in company financial statements rather than in separate reports. Mid1970s surveys by Ernst & Ernst (precursor to Ernst & Young) of social reporting found that only 1 per cent of Fortune 500 companies provided separate social responsibility booklets along with annual reports (Buhr 2007).

More conservative politics and poorer economies are usually linked to reduced interest in social and environmental issues (Buhr 2007). In the UK, Margaret Thatcher’s premiership during 1979-90 included a significant period of economic hardship.

In the US, the Ronald Reagan presidency during 1980-89 was also a time of severe recession. In both countries, deregulation and economics were emphasised over other issues. Correspondingly, social reporting waned during the 1980s.

There were some exceptions to this decline.

Companies such as The Body Shop (personal care products), Patagonia (outdoor clothing) and Ben and Jerry’s (ice cream), run by enlightened entrepreneurs who based their business models on social and environmental concerns, not only pushed social agendas, but also provided information on social matters. These corporations have continued to provide social reports in various forms.

Environmental catastrophes From the late 1960s, environmental catastrophes brought environmental issues to the forefront.

On 23 June 1969, Cleveland’s oil-contaminated 32

Sustainability reporting: past, present, and trends for the future

Cuyahoga River caught fire for the third time with flames climbing as high as five stories. The fire was attributed to wastes dumped into the river by waterfront industries. The story was picked up by the national media. Singer Randy Newman’s song, ‘Burn On, Big River’, brought further attention to the disaster. The upshot was the US Clean Air Act in 1970 and Clean Water Act in 1972. These laws have since been further strengthened and have imposed significant costs on US corporations, holding them increasingly accountable for their environmental impacts.

In December 1984 the massive chemical leak and subsequent contamination in Bhopal, India, are believed to have caused 20,000 deaths and left almost 600,000 people with permanent physical damage (Ramesh 2009). Subsequently, chemical corporations pooled together to develop ‘Responsible Care’ programs in an attempt to avert government regulation. Responsible Care was launched in 1985 by the Canadian Chemical Producers’ Association (CCPA). The CCPA hoped that voluntary action would forestall restrictive government regulations. Leaders of Canadian chemical corporations were concerned about the proliferation of regulations in the US and renewed pressure in Canada for tightened regulatory controls (Moffet, Bregha and Middelkoop 2004). There are now over 50 national chemical manufacturing associations participating in Responsible Care.

The Bhopal incident is generally credited with providing the catalyst for passage of the US Emergency Planning and Community Right-To-Know Act in 1986, which required corporations to report releases of more than 320 toxic substances.

The resulting Toxics Release Inventory (TRI) was made available to the public on the US EPA website. Note that these releases were legal – they simply had to be reported. The first report indicated that about one billion kilos of toxic substances had been released. The unexpected size of the inventory had a significant effect on public perceptions of the hazardous chemicals problem, causing corporations to try to reduce their releases.

According to TRI reports, during 1988-92 toxic

releases to air, water and land were reduced by 35 per cent.1 Later EPA reports document a continued decrease in toxic releases (US EPA 2006), most likely due to the reporting requirement, since other programs implemented at the same time have been argued to be ineffective (Reitze 2001).

Similar laws have been passed internationally, based upon the underlying concept that what gets measured gets managed. Australia has mandated reporting of certain emissions since 1998.

TRI reporting disclosures were required by law.

Environmental disasters also drove an increase in voluntary disclosures in annual reports. Patten (1992) notes a significant increase in environmental disclosures by oil and gas corporations after the 1989 Exxon Valdez spill.

So, over time environmental issues have became more of a concern to society, and corporations have became more heavily regulated and pressured to provide information about how their activities affect the environment. Corporations appear to have responded to the pressure. A 1999 study by KPMG found that out of the largest 250 corporations in the Global Fortune 500 (G250), 35 per cent had environmental reports (KPMG 2005). While not a majority, it is a large proportion relative to the low social reporting frequency occurring in the mid-1970s.

Outside the US, similar issues have fostered much environmental legislation affecting corporations in Europe, some of which has been aimed at improving corporate environmental management in addition to reporting. In 1991, Germany passed the Ordinance on the Avoidance of Packaging Waste under the German Waste Act, which held producers responsible for packaging waste. Denmark has required some corporations to disclose environmental consequences in annual reports since 1999. Deegan and Gordon (1996) link an increase in corporate environmental disclosures by Australian corporations to an increase in societal concerns.

While overall environmental disclosures have been increasing, it is important to note that

environmental disclosures vary from country to country. In Jorgensen and Soderstrom (2012) we found that whether a country’s legal system is based on common law or code law affects the reporting frequency of environmental disclosures.

The reporting frequency is also impacted by the general level of environmental regulation. Further, reported environmental disclosures are related to a country’s level of accounting and auditing standards. Other authors (Simnett, Vanstraelen and Chua 2009; and Van der Laan Smith, Adhikari and Tondkar 2005) also find systematic differences across countries. These studies show that difference in stakeholder power across countries is related to reporting levels. The level of disclosure varies by industry, with more environmentally-sensitive industries having higher disclosure levels (Li and McConomy 1999).

Triple bottom-line reporting In the mid-1990s, John Elkington, co-founder of the business consultancy SustainAbility, coined the concept of the ‘triple bottom line’ (Elkington 1998). The basic idea is that financial results do not provide a comprehensive summary of performance. He suggests that in addition to financial considerations, corporations should also report on social and environmental performance; arguing that, as all of these aspects of performance are essential to future market success, so they should be reported. However, while it is satisfying to envisage an income-like number for financial, environmental and social impacts, such metrics are unlikely to be feasible (Norman and MacDonald 2004). Wheeler and Elkington (2001) subsequently proposed the development of interactive sustainability reports and communications, relying more on the conceptual notion of the triple bottom line rather than a strict interpretation and a single audited report. This proposal implies a reduced role for accountants as the nature of reporting changes from ‘end of pipe’ verification and attestation to a more strategic form of assurance based upon examination of governance and risk-management systems (Wheeler and Elkington 2001).

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According to the Global Reporting Initiative (GRI 2011), sustainability reporting is: the practice of measuring, disclosing, and being accountable to internal and external stakeholders for organisational performance towards the goal of sustainable development.

‘Sustainability reporting’ is a broad term considered synonymous with others used to describe reporting on economic, environmental, and social impacts (e.g., triple bottom line, corporate responsibility reporting, etc.). A sustainability report should provide a balanced and reasonable representation of the sustainability performance of a reporting organisation – including both positive and negative contributions.

Observe that this definition subsumes all the types of reports that we have been discussing.

The 2005 KPMG survey notes that post-1999, corporate responsibility reporting shifted toward sustainability reporting rather than focusing primarily on environmental reporting. In 2002, about 70 per cent of the reports were published as Environmental Health and Safety reports; in 2005, about 70 per cent were published as Sustainability Reports. The number of corporations providing CSR information continues to increase. In 2005, 64 per cent of the G250 corporations provided CSR reports, either standalone or as part of their annual reports. KPMG’s 2008 survey shows that nearly 80 per cent of the G250 provide CSR reports (KPMG 2008).

Integrated reporting Development of a framework for integrated reporting is led by the IIRC. The IIRC (2011) describes Integrated Reporting as bringing: … together the material information about an organisation’s strategy, governance, performance and prospects in a way that reflects the commercial, social and environmental context within which it operates. It provides a clear and concise 34

Sustainability reporting: past, present, and trends for the future

representation of how an organisation demonstrates stewardship and how it creates value, now and in the future.

Sustainability reports are currently separate from financial reports. In the US, there is an even greater level of separation than in Australia. Financial statements (10-Ks) are separate from statements about governance and remuneration. An integrated report would include all this material in one report. The basic idea is that a single report can represent all aspects of sustainability, including concepts from the triple bottom line and issues such as governance.

While the exact format for an integrated report has not been finalised, 3 per cent of the G250 indicate that corporate responsibility information is fully incorporated into their annual report (KPMG 2008). Firms listed on the Johannesburg Stock Exchange in South Africa have been required to provide integrated reports, or explain why they are not doing so, for financial years starting on or after 1 March 2010.

An example of a company at the forefront of integrated reporting is Novo Nordisk, a Danish pharmaceutical company that is a world leader in diabetes care. It also manufactures haemophilia, growth hormone and hormone replacement therapies and is currently developing treatments targeting inflammation, obesity and bleeding disorders. Novo Nordisk has over 32,000 employees, working in 75 countries, and its full 2011 report is available at http://annualreport. novonordisk.com/. Features that differ from traditional annual reports include: – A summary of key figures including metrics for financial, social and environmental performance, as well as stock market dividends and share information, including comparisons of performance with prior-year and long-term targets; – In-depth discussion of performance against long-term targets, including graphical presentations of historical performance and discussion of changes to targets; – Discussion of how social and environmental

performance is integrated into management and decision-making within the company; – Separate consolidated financial, social and environmental statements (with notes describing reporting principles, policies, etc.). Many of the social and environmental performance metrics are non-financial in nature; and – Separate audit/assurance reports for financial versus social and environmental reporting.

While integrated reporting is an interesting development, I doubt that it will result in a single report that replaces current financial statements with the same level of reporting and assurance/ audit standards as for current annual reports.

There are fundamental differences between financial and sustainability reports that will be too difficult to resolve in a fashion acceptable to current users of financial statements. For example, financial accounting standards assume a given level of sophistication for statement readers, which reduces the amount of explanation

included in the statements. Financial statements are also mandatory, follow generally accepted accounting standards, and must be audited. All of these characteristics improve the interpretability and reliability of financial reports, but are not characteristics of other forms of sustainability information.2 For example, developing sustainability reporting standards to the level of financial reporting standards is extremely difficult given the nature of environmental and social performance. These aspects of performance vary significantly between industries and must largely be reported in nonfinancial forms, making it difficult to aggregate them into a single performance metric that can be easily compared across corporations. Actually, I am unconvinced that we want to have the same level of standards for social and environmental performance. Experience in the US suggests that between standard-setters, industry lobbyists and corporate lawyers, any resulting standards

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will have to be very basic and legalistic; they are unlikely to lead to the types of disclosures that many stakeholders, particularly those with sustainability agendas, would prefer, since it would be difficult for corporations to report their unique approaches to sustainability.3 Many integrated-reporting proponents would like to see cascading links from integrated reports to the underlying data. If these elements become part of annual reports and have similar audit processes to financial statements, then all of the underlying data might also become subject to audit, making a complete audit too costly for many corporations.

This may restrict companies from making links available that they might otherwise provide, once again running counter to the desires of some stakeholder groups.

Finally, the fundamental focus and purpose of a sustainability report differ from those of financial statements. Sustainability information is more forward looking, making it more difficult to audit. Moreover, corporations will likely limit their statements about strategies, risks and opportunities in order to manage potential future liabilities and protect their competitive advantages. Current forward-looking disclosures by firms already contain elaborate disclaimers about managements’ inability to accurately predict the future. Including such disclaimers in annual reports would be a huge deviation from current practice.

Conclusion I predict that a growing number of corporations will provide different aspects of sustainability information over time. This will reflect increased demands from many stakeholder groups, regulatory and market conversion of externalities into internalities (e.g. the commoditisation of carbon) and the increasing impact of climate change and social issues related to globalisation.

I doubt that the extent of transparency desired by many sustainability advocates will become a reality due to problems of liability measurement and competitiveness. If sustainability information 36

Sustainability reporting: past, present, and trends for the future

is included in financial statements, it will be in separate sections (with separate assurance, if any).

Non-financial sustainability information will become more standardised, but due to its nature, will not achieve the level of completeness that we have for financial information. Consequently, corporations will continue to provide sustainability data that is tailored to their specific circumstances.

Additional non-financial information related to sustainability will be discussed in the morequalitative portions of current financial reports, such as CEO’s and Chairman’s letter(s), Description of Business, and Management Discussion and Analysis. Unless it fits specifically into their competitive strategies, I do not see smaller companies providing comprehensive and fullyassured sustainability reports. I envision some sort of ’sustainability reporting lite’ concept for these organisations due to the cost of compliance.

The development of sustainability accounting is a challenging phenomenon. It is clear that stakeholder demands for more information have shaped the nature of corporate disclosures. It will be interesting to see how reporting develops in response to the increasing pressure on corporations from a variety of stakeholders to provide additional information on sustainability.

Naomi Soderstrom is Professor of Accounting in the Department of Accounting, University of Melbourne.

1 However, in later reports, the EPA stated that much of the reported reduction was due to changes in how chemicals were reported, changes in how releases are estimated, and decreases in production levels (Reitze, 2001).

2 These issues are explored in Potter and Soderstrom (2012).

3 Many of my arguments are also articulated in Van der Lugt (2012).

References Buhr, N 2007, in Sustainability Accounting and Accountability, Unerman, E, Bebbington, J & O’Dwyer, B (eds) pp. 57-69.

Deegan, C & Rankin, M 1997, ‘The materiality

of environmental information to users of annual reports’, Accounting, Auditing, and Accountability Journal, vol. 10, no. 4. pp. 562-583.

Elkington, J 1998 Cannibals with Forks: the Triple Bottom Line of 21st Century Business, New Society Publishers, Gabriola Island.

Global Reporting Initiative 2011, G3.1 Sustainability Reporting Guidelines https:// www.globalreporting.org/resourcelibrary/ G3.1-Sustainability-Reporting-Guidelines.pdf Hogner, R 1982, ‘Corporate social reporting: Eight decades of development at US Steel’, Research in Corporate Social Performance and Policy, vol. 4, pp. 243-50.

IIRC 2011, ‘Towards Integrated Reporting: Communicating Value in the 21st Century’.

September.

Jorgensen, B & Soderstrom, N 2012, ‘Environmental disclosure within legal and accounting contexts: An international perspective’, University of Melbourne working paper.

KPMG 2005, KPMG International Survey of Corporate Responsibility Reporting 2005, KPMG International.

KPMG 2008, KPMG International Survey of Corporate Responsibility Reporting 2008, KPMG International.

Li, Y & McConomy, B 1999, ‘An empirical examination of factors affecting the timing of environmental accounting standard adoption and the impact on corporate valuation’, Journal of Accounting Auditing and Finance, vol. 14, no. 3, pp. 279-313.

Patten, D 1992, ‘Intra-industry environmental disclosures in response to the Alaskan oil spill: A note on legitimacy theory’, Accounting, Organisations and Society, vol. 15, no. 5, pp. 471–75.

Potter, B & Soderstrom, N 2012, ‘Can integrated reports replace financial statements?’ University of Melbourne working paper.

Ramesh, R 2009, ‘Bhopal marks 25th anniversary of Union Carbide gas disaster’, The Guardian, 3 December, http://gu.com/p/2ck97/em .

Reitze, A 2001, Air Pollution Control Law: Compliance and Enforcement, Environmental Law Institute, Washington DC. Simnett, R, Vanstraelen, A & Chua, WF 2009, ‘Assurance on sustainability reports: An international comparison’, The Accounting Review, vol. 84, no. 3, pp. 937-967.

US EPA 2006, 2004 TRI Public Data Release eReport http://www.epa.gov/tri/tridata/tri04/ ereport/2004eReport.pdf Van der Laan Smith, J, Adhikari, A & Tondkar, R 2005, ‘Exploring differences in social disclosures internationally: a stakeholder perspective’, Journal of Accounting and Public Policy, vol. 24, pp. 123-151.

Van der Lugt, C 2012, ‘The steep learning curve ahead’, in Van der Lugt, C and Malan, D (eds) UNEP, Deloitte and the Centre for Corporate Governance in Africa: Capetown, pp. 129-135.

Wheeler, D & Elkington, J 2001, ‘The end of the corporate environmental report? Or the advent of cybernetic sustainability reporting and communication’, Business Strategy and the Environment, vol. 10, pp. 1-14.

Moffet, J, Bregha, F & Middelkoop, K 2004, ‘Voluntary codes: Private governance, the public interest and innovation’, Carleton University, Ottawa, pp. 177-208, http://www5.carleton.ca/ sppa/ccms/wp-content/ccms-files/ch6.pdf Norman, W & MacDonald, C 2004, ‘Getting to the bottom of “Triple Bottom Line”’, Business Ethics Quarterly, vol. 14, no. 2, pp. 243-262.

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Article heading here

a larger gst in a tax-mix change Large potential gains for national productivity are available from a shift in the mix of taxes from those with relatively high distortion costs to the GST with its much lower distortion costs. by john freebairn

A condensed version of a public lecture delivered at the University of Melbourne on 2 October 2012.

This lecture explores the arguments for increasing the revenue collected from a goods and services tax (GST) with a more comprehensive tax base and a higher tax rate to fund reductions in moredistorting state stamp duties and federal income tax. Most of the analysis focuses on reform packages which are, in aggregate, approximately revenue and distributionally neutral. Reform of the GST was excluded from the terms of reference for the Henry Review (2010) of taxation, and the two main political parties at the federal level both deny that reform is on their agendas. Despite these denials, large potential gains for national productivity are available from a shift in the mix of taxes from those with relatively high distortion costs to the GST with its much lower distortion costs (see, for example, Daley, 2012).

The current GST The GST introduced in 2000 is Australia’s broadbased consumption tax applied at a flat rate of 10 per cent. In 2009-10, GST revenue was $46.4 billion, or 13 per cent of all taxation revenue.

It has a ‘destination’ tax base which exempts exports and taxes imports. This tax base is relatively price non-responsive, or inelastic, hence the low distortion costs of the GST. The GST applies to about 60 per cent of a comprehensive consumption tax base. Exempt products include

basic food, health, education, childcare and water.

The complicated GST provisions relating to financial services mean that households are under-taxed via the non-taxation of value-added financial services, whereas businesses are overtaxed through being unable to claim GST offsets on financial services they purchase. The exemption of imports valued at less than $1000 has become highly contentious through the claims of retailers that internet purchases from overseas suppliers are undermining local industry. Table 1 shows estimated GST revenue foregone through these exemptions.

Formally, the GST is collected by the Commonwealth Government. The revenue is then redistributed to the states (and territories) as untied grants. The pattern of distribution across the states is based on principles of horizontal fiscal equalisation (HFE) as determined by the Commonwealth Grants Commission. HFE seeks to provide each state with a comparable ability to provide services to their constituents taking into consideration differences in (i) their ability to collect own-source tax revenues, and (ii) the costs of providing services.

There is a general consensus that while businesses pay the GST to the Commonwealth, they then pass on the extra costs to households in higher prices.

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That is, households pay the final or economic incidence of the GST. Given that consumption as a share of income tends to fall as incomes rise, the GST by itself has a regressive incidence. However, tax reform packages should be assessed in terms of the final incidence of the aggregate of all taxes.

tax treatment across government, non-profit and private-for-profit providers of health, education and childcare services. Exemptions in general, and grey lines between exempt and non-exempt goods and services, invite costly and societally wasteful rent-seeking lobbying.

Table 1: GST base exemptions and revenue loss ($ billion in 2010-11)

At the time of the introduction of the GST, key reasons for the exemptions of what are considered necessities of life and higher shares of expenditures for those on low incomes were the regressive effects of a GST. These concerns are real and supported by available data. However, in the context of the total tax system, exempting some ‘necessity of life’ items from the GST is a very blunt and ineffective way of meeting society’s equity goals when compared with a progressive income tax combined with a means-tested social security system. For example, while the better-off spend a smaller share of their income on food than those on lower incomes, the percentage difference is not large. Moreover, the better-off spend twice as many dollars per week on food as shown by Table 2. To maintain the current redistributive effects of the tax system in aggregate, some of the revenue windfall by removing current exemptions for food, health, water and so on will need to be recycled in a progressive fashion to households via increases in social-security rates and reductions in marginal income tax rates.

Items exempt

Revenue cost

Food

5.9

Water, sewage and drainage

0.7

Health

3.8

Education

2.6

Child care

0.6

Financial services

3.2

Imports

1.2

Total

18.3

Source: The Treasury, Tax Expenditure Statement, 2012, Commonwealth of Australia, Canberra

A broader GST tax base Both the experience of New Zealand (NZ), and the arguments articulated in the Mirrlees Review (2010, 2011) for the UK, suggest greater efficiency and simplicity with a comprehensive consumption base for the GST with removal of the current exemptions listed in Table 1. Restoring distributional equity, as represented by the status quo, requires recycling much of the extra GST revenue to governments and households, with consequent changes to federal-state financial relations.

Consider now the efficiency and simplicity arguments for a NZ-type comprehensive GST base.

Distortions to household purchase decisions across different products will be removed. There is no compelling market-failure or equity argument for a GST on necessity clothing but not food, or among utilities on electricity but not water. Complexity is involved for GST-exempt providers of health and education and the GST treatment of business services, cleaning and other GST-taxable activities they might provide. A comprehensive base provides for greater transparency and neutrality of 40

A larger GST in a tax-mix change

Table 2: Expenditure on food and health by households by income quintile

Bottom 20%

Middle 20%

Top 20%

Food and nonalcoholic beverages $/week

127

213

281

% of total outlays

19.4

17.6

14.5

Medical and health $/week

37

61

98

% of total outlays

5.7

5.0

5.1

Source: Australian Bureau of Statistics, Catalogue No 6530.0.

In the cases of health, education and childcare, governments at both federal and state levels fund a proportion, but not all, of these services for reasons of external benefits and equity. Bringing

these services into the GST net for the efficiency and simplicity reasons noted above will require a similar proportion of the extra GST revenue to be recycled to the two tiers of government.

Importantly, these subsidies will be more transparent, direct and better targeted at meeting the reasons for government intervention – namely, correction of external benefits and equity of opportunity.

A higher GST rate Another set of reform options is to raise the current GST rate of 10 per cent to, say, 12.5 or 15 per cent, either on the current GST base or on a more comprehensive base, and to use the revenue gained to replace or reduce other moredistorting taxes. Highly distorting taxes to be replaced (or reduced) include state stamp duties on insurance and property transfers, and federal income taxation. This reform idea is similar to the philosophy behind the introduction of the GST in Australia in 2000, the rate increases in NZ and

the UK in 2010, and increases in VAT rates in other countries.

Table 3 provides a list of the taxes high on the list to be replaced, or reduced, with the revenue from a higher GST. Details are given of the revenue collected in 2009-10 and of the Henry Review (2010) estimates of the marginal efficiency costs of the different taxes. An increase in the GST rate by one percentage point would generate about $4.6 billion a year on the current base, and $5.5 billion on a comprehensive base.

Taxation involves a transfer of revenue (and ultimately of labour and other resources) from the private sector to the public sector. It also alters decisions in the private sector, such as shifting from market employment, which is income taxed, to leisure and home work which are not taxed. The changed decisions involve a loss of private-sector welfare greater than the dollar-for-dollar transfer.

This loss to the private sector is referred to as the marginal efficiency cost of the tax. For example, in Insights Melbourne Business and Economics

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Table 3, the last dollar of stamp duty on insurance involves a total loss of welfare to the private sector of $1.31, with $1 being a transfer to government and 31 cents being the marginal efficiency cost.

Table 3: Revenue and efficiency costs of selected taxes

Revenue, 2009-10 Tax

($ billion)

Marginal efficiency cost (cents/$ tax revenue)

State taxes: Stamp duty on insurance Conveyance duty on property

4.6

31

12.3

74-85

Commonwealth taxes: GST Personal income Corporate income

46.6

12

124.8

24

62.2

37

Sources: Revenue from ABS, Catalogue No 5506.0; marginal efficiency cost from Henry Review, 2010, page 13.

Differences in the marginal efficiency cost of different taxes provide one measure of the efficiency benefits, or increases in national productivity, of increasing the GST rate to fund reductions of more distorting taxes. For example, using the Henry Review (2010) numbers in Table 3, another dollar of GST to replace a dollar of stamp duty on insurance involves an additional cost of 12 cents but saves a cost of 31 cents, for a net gain of 19 cents per dollar. Of course, there are legitimate arguments about the estimated magnitudes of the efficiency costs of different taxes (including my concerns with the Henry Review numbers).

However, few doubt the ranking of these costs and that a tax-mix change involving a larger GST to replace the taxes listed in Table 3 offers very large gains in national productivity.

A larger GST to replace state stamp duties State stamp duties on insurance and the conveyance of property are among the mostdistorting taxes, and their removal would bring important gains in simplicity. Stamp duties on motor vehicles also deserve removal but, as argued by the Henry Review (2010), as part of a separate 42

A larger GST in a tax-mix change

tax reform package to capture the costs of road funding, pollution and congestion. In the case of conveyance duty, a reform package would involve a broader base and a higher rate of land tax, roughly to fund the unimproved land value component, and a higher GST to fund the improvements component of property value transfers.

Stamp duties are a form of indirect tax, similar to the GST – they are an additional cost, much of which is passed on to buyers as higher prices.

But stamp duties fall on business activities with extra distortions relative to a GST with its final incidence on household consumption. Conveyance duty as a transaction tax also reduces transfers of ownership of property from less productive to more productive owners and uses. There is no market-failure reason to impose a higher indirecttax burden of stamp duty plus GST on insurance relative to the flat GST burden on most other products. These additional distortions lie behind the higher marginal efficiency cost of stamp duties relative to the GST shown in Table 3.

A larger GST to replace the stamp duties tax reform package, as a change in the composition of indirect taxation, will have a negligible effect on the aggregate cost of living. In the short run, some winners and losers seem inevitable, however these will decline over time as net gains in productivity occur.

Aggregate revenue neutrality across the different government jurisdictions could be maintained by a corresponding reduction in Commonwealth special purpose payments. The states would benefit from more stable revenues.

A larger GST to reduce income taxation A tax reform package involving a larger GST to fund reductions in income taxation would raise national productivity. At the same time, with careful design, the package can be approximately aggregate revenue neutral, revenue neutral between the Commonwealth and the states, and (roughly) distributionally neutral across broad demographic and income categories. Of course, these latter constraints could be relaxed.

The efficiency case for replacing an income tax with a broad-based consumption tax is as follows. Both taxes fall on decisions to join the workforce, invest in skills, and vary hours of work. For a given market wage, income taxation reduces disposable income, while the GST (and indirect taxes more generally, which are passed on as higher prices to households) reduce the quantity of goods and services which can be purchased from disposable income. So, labour market distortions are similar with a tax mix change involving a larger GST and a smaller income tax which is revenue and equity neutral.

By contrast, while income taxation falls on capital income as well as labour income, albeit as a hybrid mess of different tax rates (Henry Review, 2010) – and distorts both the aggregate levels of saving and investment and the composition of different saving and investment options, such as housing, business plant and equipment, and superannuation – the GST with its consumption base lowers the tax burden on saving and investment. In the context of Australia as a net capital importer and a small open economy, the price sensitivity or elasticity of the supply of capital, and especially from non-residents, is high, and much higher than for labour. As argued in the Henry Review (2010), the Mirrlees Review (2010 and 2011) and the NZ Tax Working Group (2010), given these differences in factor supply elasticities, a change in the tax mix towards a GST and away from income tax will, over time, increase capital inflow, boost capital stock (and associated better technology), and enhance labour productivity and market wages. Lower, but still positive income tax rates reduce the dispersion of effective tax rates on different saving and investment options, which in turn reduces tax distortions to the mix of the larger capital stock and increases productivity.

For households, the higher average cost of living with a larger GST would be offset by recycling the additional GST revenue as higher social security rates and lower marginal income tax rates. The income tax rate schedule would become more progressive. In the longer run, the productivity gains of a shift in the tax mix from income tax towards the GST will provide a net gain in national income. Under an aggregate revenue constraint,

while the current distribution of the aggregate tax burden can be maintained for households across broad demographic and income groups, in a particular year there will be some losers, as well as winners, within each group.

The first-round increase in GST revenue for the states – and the fall in income tax revenue (and increase in social security outlays) for the Commonwealth – changes Commonwealth-state financial relations.

The current balance could be restored with a commensurate reduction of Commonwealth special purpose payments to the states.

John Freebairn holds the Ritchie Chair in Economics at the University of Melbourne.

References Daley, J 2012, Game-Changers: Economic Reform Priorities for Australia, Grattan Institute Report 2012-5, June, Melbourne.

Henry, K, Harmer, J, Piggott, J, Ridout, H & Smith, G (Henry Review) 2010, Australia’s Future Tax System: Final Report to the Treasurer, Treasury, Canberra.

Mirrlees, J, Adams, S, Besley, T, Blundell, R, Bond, S, Chote, R, Gammie, M, Johnson, P, Myles, G & Porterba, J (eds) 2010, Dimensions of Tax Design: The Mirrlees Review, Institute of Fiscal Studies, Oxford University Press, Oxford.

Mirrlees, J, Adams, S, Besley, T, Blundell, R, Bond, S, Chote, R, Gammie, M, Johnson, P, Myles, G & Porterba, J (eds) 2011, Tax by Design: The Mirrlees Review, Institute of Fiscal Studies, Oxford University Press, Oxford.

Tax Working Group 2010, A Tax System for New Zealand’s Future, Report of the Victoria University of Wellington Tax Working Group, Wellington.

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Article heading here

reciprocity and regard ‘Regard’ takes many forms and powerfully influences economic exchanges. by avner offer

An edited version of an essay developing themes contained in the Downing Lecture given at the University of Melbourne on 6 September 2012.

‘Regard’ – the approbation of others – takes many forms: Acknowledgement, attention, acceptance, respect, reputation, status, power, intimacy, love, friendship, kinship, sociability (Offer, 1997). The idea goes back to Adam Smith’s first book, The Theory of Moral Sentiments (1759). In a memorable passage, he states that economic activity is driven ‘chiefly from this regard to the sentiments of mankind’: What is the end of avarice and ambition, of the pursuit of wealth, of power, and preheminence? … To be observed, to be attended to, to be taken notice of with sympathy, complacency, and approbation, are all the advantages which we can propose to derive from it (Smith, [1759] 1976, p. 50).

Man is driven by self-interest, he says, but also has an innate capacity for sympathy. The book opens with a heart-warming affirmation, that ‘How selfish soever man may be supposed, there are evidently some principles in his nature, which interests him in the fortune of others’ (Smith, [1759] 1976, p. 9). That is not what it seems.

Sympathy is not separate from self-interest. What really matters is not the sympathy for others, but rather the sympathy of others: ‘Nothing pleases us more than to observe in other men a fellow-feeling with all the emotions of our own breast’ (Smith, [1759] 1976, p. 13, emphasis added). This need for acknowledgement by others is an innate

motivator, comparable in intensity to selfishness.

Hence, self-interest and sympathy are one and the same. But in order to be worth having, regard has to be genuine. It can be thought of as a signal, which needs to be authenticated. For the signal to be credible, the sender must be known to be capable of disinterested, unilateral, and authentic regard. Recipients too require these capacities.

That is why The Theory of Moral Sentiments opens with such an affirmation of the capacity for sympathy: No benevolent man ever lost altogether the fruits of his benevolence. If he does not always gather them from the persons from whom he ought to have gathered them, he seldom fails to gather them, and with a tenfold increase, from other people. Kindness is the parent of kindness; and if to be beloved by our bretheren be the great object of our ambition, the surest way of obtaining it is, by our conduct to show that we really love them (Smith, [1759] 1976, p. 225).

In other words, the best way to obtain the regard of other people is to provide them with our own regard.

The ultimate benefit is self-worth. As Smith makes clear, self-worth requires the validation of others. Approbation has to be communicated. The term ‘regard’ has two meanings: the first is ‘to be noticed’; the second is ‘to be valued’. A unilateral Insights Melbourne Business and Economics

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signal of approbation can be defined as a ‘gift’. The gift can be dear or cheap, substantive or symbolic.

It is not costless. Validation of regard is achieved by evaluating the gift. A good signal is one that is difficult to make and difficult to fake. Hence, the recipient should be able to evaluate signal quality.

At the very least, ‘regard’ is a grant of attention, and attention is a scarce resource. Withholding regard signifies indifference and rejection. To convey authentic regard, a good signal requires discrimination and effort. A handwritten letter counts for more than an email, although finding the right words might achieve the same effect.

Getting it right is not easy and the use of money to communicate regard is not efficient: a credible financial signal is costly, whereas approbation can be conveyed cheaply with an appropriate signal like a title or an award.

The economy of regard Reciprocal exchange was a feature of premodern societies and generous hospitality to strangers remains the norm in many parts of the Mediterranean, Arab, Iranian and Indian worlds.

The ethnographic record indicates that exchange begins with a unilateral transfer, for which reciprocity is expected. This is discretionary and can be delayed, though often regulated by convention and custom. When exchange is completed, a new sequence can begin. Reciprocity can also be indirect, with no return from the beneficiary (who may be unknown), but a credit notched up with the community, to be reciprocated at some future time and place.

In economic models of market exchange acquaintance is immaterial. The gains from trade are all there is. Every sale is simultaneously a purchase. Any delay incurs a discount. In contrast, in the ‘economy of regard’, both price and delay are indeterminate. Over and above the gains from trade, exchange is also a good in itself which takes the form of personal interaction.

In economics, self-interest provides sufficient motivation for driving an efficient market economy.

But this assumption is inconsistent with two large facts. One is that the unbridled pursuit of self46

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interest can give rise to deadlocks like prisoners’ dilemma. The second is that such deadlocks are routinely overcome, and that cooperation and trust are achieved at every level of economic and social activity. In standard theory this happens because reputations for honesty can be achieved by repetition. But such reputations can only be credible if authentic virtue is possible, and that would violate the assumption of unbridled selfinterest. The miracle of co-operation, a central feature of the market economy, is inexplicable in terms of standard economic theory.

It is sometimes argued that selfishness persists because it has been selected in evolution for its survival value; but the reciprocal motivation of regard must also have a similar survival value.

‘Reciprocal altruism’ is widely observed in animal species. It is easy to imagine the capacity for regard as being selected in human evolution for its survival benefits. Computer tournaments suggest that positive regard confers an evolutionary advantage; that ‘nice’ is better than ‘nasty’. The social experiments in ‘ultimatum’ and ‘dictator’ games demonstrate a unilateral human propensity to give and reciprocate (Henrich, 2004; Fehr, 2005). The capacity for regard, like the capacity for language, may be innate, even if the forms it takes are specific. On this interpretation regard arises from a propensity which is satisfied by means of giving and receiving. Positive emotions (unlike negative ones) are easy to fake (Ekman, 1985). The ability to fake regard facilitates gift exchange, but it also places a premium on material authentication, i.e. on gifts.

In recent years, several economists have developed alternatives to homo economicus, which are becoming known as homo reciprocans (Kolm and Ythier, 2006; Bowles and Gintis, 2011). Regard promotes sociability, and sociability facilitates co-operation.

It breaks the deadlock of prisoners’ dilemma with a norm of first-mover co-operation. The best way to get other people’s regard is to provide them with ours. Trust resembles a gift: a unilateral transfer with the expectation, but no certainty, of reciprocity.

Regard provides an incentive for trust, and trust is efficient: it economises on the transaction costs of monitoring, compliance and enforcement.

Socially ubiquitous Regard pervades human interaction. Conversation is a gift economy, loaded with cues of acceptance or disdain. Non-verbal cues communicate intensities and qualities of regard; the smile, like many other gestures, is universally understood. Ostracism and exclusion are painful.

Reciprocity produces ‘bads’ as well as goods.

Giving incurs obligation and debt – the giver notches up an emotional and material claim on the recipient. The term ‘bond’ can signify a repeated exchange of regard. Like a financial bond, it has some features of contractual obligation. Like the human bond, it is an emotional link. A bond can also refer to a fetter, a form of oppression. The obligation to reciprocate can be a burden, which needs to be relieved by a return gift. Asking for help is psychologically difficult, and so is the obligation to reciprocate. Excessive intimacy can be stressful. A gift without reciprocity vexes both giver and receiver, as in beggary. Gift signals can be rejected or misconstrued. They can initiate spirals of insult, hate and retribution, like duels, blood feuds, crimes of passion and divorce.

Even unilateral or asymmetric transfers are not entirely disinterested. Givers hope for regard from the younger generation, or aspire to enduring reputations. Such transfers may also have insurance attributes: treating others with consideration upholds the norm of mutual support. ‘Giving by stealth’ confirms the capacity for unilateral regard which Smith identified as necessary for sympathy to be credible.

Economically ubiquitous Shopping is satisfying, but there is also an aversion to market interaction (Frey, 1986). In advanced economies, most welfare (as measured in real or imputed money) is not provided through markets. Exchanges within households are not mediated by money. Their scale can be estimated by pricing housework time at market wage rates. In such estimates, housework and childcare amount to between one-quarter to more than one-third of national product. In affluent societies, governments allocate between one-

third and one-half of national income. The nonprofit sector typically allocates more than five per cent of income, and at least a similar share of employment. In market exchanges as well, regard is often used to lubricate the wheels of commerce.

The persistence of non-market exchanges on such a scale indicates that gifting may be, if not always ‘efficient’ in the formal sense, at the very least a viable alternative to the market system. As Smith suggested, this preference for non-market exchange arises from the intrinsic benefits of social and personal interaction – from the satisfactions of regard.

Prices facilitate exchange when information is scarce and co-ordination difficult, when goods are standardised and cheap. The market works best when the efficiency of production runs ahead of the efficiency of cognition and communication. It economises on costly information (Hayek, 1945).

Conversely, reciprocal exchange is preferred when trade involves a personal interaction, and when goods or services are unique, expensive, or have many dimensions of quality. Such contexts give rise to mutual obligation. The demand for regard exceeds the capacity for voluntary provision, and the market steps in to provide the feigned pseudoregard that is a hallmark of good service in retail and commercial hospitality.

In pre-industrial societies, intensity of obligation was inversely related to kinship. Family formation was often a contract between parents. The family could provide good protection because of the low risk of default. Today, the family retains a grip over migrants who remit money home for extended periods. Worldwide, it is estimated that 60 per cent of workers, and 70 per cent of old people still rely on family support for social security. In affluent societies, families remain the wellspring of regard. They are held together by the bonds between spouses and between generations.

Modern family formation is discretionary, and conforms more closely to the voluntary model of gift exchange. In modern courtship and romantic attachment, the road to intimacy is a spiral of mutual self-disclosure, an exchange of information and gifts. It leads to erotic interaction, another potent form of bonding. The greater economic Insights Melbourne Business and Economics

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independence of women within the family has been offset by higher expectations of emotional intimacy, which are accordingly difficult to satisfy (Offer, 2006).

Shifting the gaze from women to men, history traces a withdrawal from the market and into the household. Male working hours have fallen drastically since the nineteenth century and most of this time has been transferred into the home.

Time spent in paid employment in a seventeencountry ‘world’ between the 1960s and the 1980s, for women as well as men, amounted to only 21 per cent of the total available.

Children have also moved out of the market and into the gift economy. Before affluence, children often worked, and were also counted on for support in hardship and old age. In the transition to affluence, they lost their economic value and gained a large affective value, becoming ‘economically worthless, but emotionally priceless’ (Zelizer, 1994, p. 209).

Childrearing is a large economic cost, adding up to the value of a medium-priced house, or almost half of women’s potential lifetime earnings. Parental care is an unmeasured but vital input into human capital. When marriages break down, the risk of educational, behavioural and emotional disorders rises even after controlling for socio-economic factors. In return for care and attention, children provide parents with a sense of worth and pleasure.

In North America, at least, offspring get more than they return. In the aggregate, this asymmetry may represent delayed or indirect reciprocity.

Offspring and kin reciprocate by caring for the old, the infirm and the disabled. In the UK, the imputed wage of unpaid care was about 7.5 per cent of national income in 1992, the same as the cost of the National Health Service that year.

There is an element of discretionary gift in any fixed wage when intensity and quality of effort are difficult to observe. Wages persist above market clearing levels; this is taken as evidence of ‘efficiency wages’, an implicit contract which constitutes a reciprocal gift relation between employers and workers. Those paid more respond with a greater effort, and those with reciprocal 48

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preferences feel better about themselves as well (Dohmen, 2009). Large anonymous workplaces go through periodic fads for team production and other relational incentives. Academic tenure is a gift of lifetime income, subject only to minimal contractual obligations. Recipients repay in the time and quality of their own choosing.

Academics are kept honest by the bonds of regard via the scrutiny of students, colleagues and the ‘invisible college’ of peers. Similar regard incentives are found in most professions. During the last two decades, the Open Source movement in information technology has innovated such public goods as Linux and Wikipedia, as well as many lesser products, motivated by little more than the economy of regard (Dalle, 2004).

In agriculture, farming remains an extension of the household form of production. In the most advanced countries, it continues to be dominated by family firms with a little hired help. Individual farm acreages have risen with better technology, and the number of farms and their owners has declined, but farm work is still largely a family (or very small business) affair. The face-to-face methods of household task allocation are used to incentivise production for the market.

The problem of gifting, like selling, is to ascertain the preferences of others. Some goods are useful mainly as gifts, for example greeting cards, toys, decorated wrapping paper, flowers and wedding rings. Retailing peaks at Christmas time.

Advertising attempts to apply mass production to personal persuasion. Marketers endow their goods with a ‘personality’ through branding. An ad can simulate a smile and reproduce it by the million.

An element of direct interpersonal appeal takes the form of ‘endorsements’. This simulated regard is designed to bypass the filter of reason, in order to evoke a reciprocal obligation in the customer’s mind. As information becomes cheaper, sellers personalise their appeal and collect information about individual clients in order to simulate a personal relationship.

The standard negotiating fixture in commerce is the ‘business lunch’, which uses the gift-exchange

trappings of food and hospitality to create an emotional setting for trade. The mix of regard and salesmanship is uneasy. Many employees find fulfilment in genuine exchanges of regard, using time and goods provided by their employer. But because money is involved and authenticity is suspect, it belongs to the category of pseudo-regard.

Rapport with customers is often driven by output quotas. In the web of commerce, every human bond is open to defection. Entrepreneurship depends on the ability to attract reciprocal transfers from investors, lenders, suppliers and customers. The same applies to politics and political economy.

A common identity can substitute for face-to-face relations. Communal cultures make the penalty of exclusion too costly to bear. Faith and ethnic bonds have facilitated trading among entrepreneurial communities such as the Quakers in Britain, the Parsis in India, and the overseas Chinese. The diamond trade in Israel, Antwerp and New York is dominated by Orthodox Jews, who place their trust in handshake contracts sealed by a blessing.

Chinese culture subscribes to Guanxi, a set of norms of reciprocity and gifting which promote trust among insiders and exclude others. In the People’s Republic, Guanxi was necessary to obtain goods and services. Overseas Chinese knew the cultural codes for logging into these pre-existing webs, often by going back to their village or town of origin. In the absence of secure property rights in the People’s Republic, reciprocity fulfilled a similar function of securing expectations and underpinning trade and investment.

Loyalty and reciprocity can also work for antisocial ends. Italy has its Cosa Nostra, the Chinese their Triads. A Russian Mafia, with roots in the past, re-emerged at the end of the Soviet Union.

Small groups collude more effectively than large ones. Reciprocal communities of businessmen, professionals and workers often organise for rent seeking. A strong gift economy can crowd out the market if exchange depends entirely on reciprocal inclusion. This is an argument for liberalism, for the impersonality of the market, the law, the public service and the vote. Some forms of gifting are used to subvert the ‘rules of the game’. Even

law-abiding societies, with traditions of public integrity, are not immune to ‘old boy networks’.

Illegal gift economies subvert the effectiveness of government; sometimes due to a general ethos of reciprocity, or the activities of organised crime.

But corruption can also be beneficial. Like the market economy, the planned economies in Eastern Europe also depended on networks of ‘fixers’, who acted as brokers in a gift economy (‘blat’ in Russia) mediated by their access to resources, relationships and reputations.

Gift exchange is sensitive to the cost of information and the cost of time. As market incomes rise, so does the cost of time. On the other hand, the cost of information is declining. These trends offset each other. As the cost of time increases, regardintensive exchanges like childcare become more expensive. Women sacrifice wage income in return for more time at home – except for high earners, some of whom seek their regard in the workplace.

Those with the best careers are more likely to forgo marriage and children than lower earners (Offer, 2006). For women, market work provides additional choice and a new measure of regard.

Regard is difficult to measure because the yardstick of price is explicitly rejected. When regard and goods are traded together, consumer market preferences will not measure accurately the well-being obtained. Individuals are likely to choose what they feel is best, whether traded for money or not. In public policy, however, there is an inclination to maximise only what is measurable, and also to simulate market incentives. Such policies have often failed, because (a) quantitative measures are often unable to capture quality, which is more easily monitored in face-to-face interaction with peers and clients, (b) quantitative sanctions replace approbation with fear, and informal monitoring with costly evaluation, and lead to neglect of unmeasured but vital tasks, and (c) there are unmeasured losses of regard, goodwill and trust. Regard is a good in itself, quite apart from its instrumental value, especially where personal interaction dominates exchange, as in education and medical care.

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Conclusion Adam Smith placed mutual obligation on par with self-interest. In the modern world, reciprocity and approbation continue to motivate exchange on the largest scale. The price system is not sufficient on its own. A substantial proportion of welfare and well-being is obtained in the context of personal interaction, and is affected by the payoffs of regard. The boundaries between impersonal markets and relational exchange are affected by the cost of information, and the relative price of providing goods interactively or impersonally.

Reciprocal exchange, with its personalised gift and discretionary delay, is required to authenticate regard. It motivates gains from trade in ways that are similar to the market. It persists because regard is an abiding need – perhaps ‘wired in’ – which impersonal markets are not equipped to gratify.

Avner Offer is Chichele Professor Emeritus of Economic History at All Souls College, University of Oxford.

Henrich, J P et al. (eds) 2004, Foundations of Human Sociality: Economic Experiments and Ethnographic Evidence from Fifteen Small-Scale Societies, Oxford University Press, Oxford.

Kolm, S-C and Mercier Ythier, J (eds) 2006, Handbook of the Economics of Giving, Altruism and Reciprocity, Elsevier, Amsterdam.

Offer, A 1997, ‘Between the gift and the market: the economy of regard’, Economic History Review, 50(3): 450-476.

Offer, A 2006, The Challenge of Affluence: SelfControl and Well-Being in the United States and Britain Since 1950, Oxford University Press, Oxford.

Offer, A 2012, ‘Regard’, in Handbook on the Economics of Philanthropy, Reciprocity and Social Enterprise, eds, Bruni, L and Zamgni, S, Cheltenham, Edward Elgar.

References

Smith, Adam [1759] 1976, The Theory of Moral Sentiments, Clarendon Press, Oxford.

Bowles, S and Gintis, H 2011, A Cooperative Species: Human Reciprocity and Its Evolution, Princeton University Press, Princeton.

Zelizer, VAR 1985, Pricing the Priceless Child: The Changing Social Value of Children, Basic Books, New York.

Dalle, J-M 2004, Free & Open Source Software Creation and ‘the Economy of Regard’, Scuola Superiore Sant’Anna, Pisa, Italy.

Dohmen, T et al. 2009, ‘Homo reciprocans: survey evidence on behavioural outcomes’, Economic Journal, 119(536): 592-612.

Ekman, P 1985, Telling Lies: Clues to Deceit in the Marketplace, Politics, and Marriage, Norton, New York.

Fehr, E and Fishbacher, U 2005, ‘The economics of strong reciprocity’, Moral Sentiments and Material Interests: The Foundations of Cooperation in Economic Life, MIT Press, Cambridge: 151–191.

Frey, B 1986, ‘Economists favour the price system – who else does?’ Kyklos, 39(4): 537-63.

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Hayek, F A 1945, ‘The use of knowledge in society,’ The American Economic Review, 35(4): 519-530.

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occasional addresses

asian opportunities In today’s ‘once in a century’ shift in global growth to Asia, Australian know-how has a unique role to play in the region’s future. by paula dwyer

An edited version of her Occasional Address given at the Exhibition Buildings, Melbourne, on 12 December 2012.

Thirty years ago, I sat where you are today, wearing my mortar board and academic gown, having just graduated with a BCom degree. I had brown hair in those days. I was pretty naïve about the ways of the world but I remember being excited about the months and years ahead, and about what the future held for me as I left the University to put my education to work in the world of commerce.

I want to congratulate you all for getting to this position today, sitting there in your own mortar boards and gowns. Soon, you will be clutching a scroll, which is not just witness to your hard work over the past few years but a passport to many wonderful opportunities ahead.

I would also like to acknowledge your parents and other family members and friends who are present.

Please take time to reflect on how much support they have given you – and how much pride and joy you bring to them today.

You should know what an incredible head start you have earned yourself. This year the University of Melbourne was ranked Australia’s leading university. Perhaps even more importantly, it was ranked among the top 30 universities in the world.1 And your degree comes from a faculty

with an equally high reputation which should provide you with a wealth of opportunities. I urge you to take those opportunities; be brave, grasp the chances that come your way, broaden your horizons and further your knowledge.

I know I’m not the first person to have made this observation, but I firmly believe the timing of your graduation is perfectly aligned to the unique opportunity we have to participate in the Asian Century. Today, there is a ‘once in a century’ shift in global growth to Asia; and it is increasingly obvious that Australian know-how has a unique role to play in Asia’s future.

Australia’s endowments are not just in our natural resources but also in the quality of the people our schools and universities produce – and there is no finer example than the quality of the graduates of this University.

I have participated in the Asian Century firsthand as a director of three Australian companies that have heavy involvements in Asia – the ANZ Bank, Lion (formerly Lion Nathan), and Leighton Holdings – with the region being core to their strategies. The ANZ Bank, for example, has a strategy centred on being a super-regional Insights Melbourne Business and Economics

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bank – an ambition which is well on the way to fulfilment with a footprint extending through China, Singapore, Indonesia and India.

Lion, which I guess you may have come to know much better in your undergraduate life as the brewer of Tooheys XXXX and Little Creatures beers, is co-ordinating the initiatives of its owner – the Japanese company Kirin Holdings – to help build one of the largest fast-moving consumergoods businesses in the region.

And the third company, Leighton Holdings, is involved in infrastructure projects throughout Asia, including: – Hospitals and schools in Hong Kong; – Wind farms and mines in Mongolia; – Power stations in the Philippines; – Railways in Malaysia;

Just as remarkable, though, is that Australian companies are there building and financing this development. This is why there is such an opportunity opening up for so many talented graduates of Australian universities to participate in this growth – whether you are actually based overseas, or whether you are working from here in Australia.

– Oil loading terminals in Iraq.

Some of you will have read the Australian Government’s recent white paper Australia in the Asian Century. Its main thrust is simply this: Asia is where it’s at and in Australia we have an opportunity to get on board. But in many ways you are already on board and embracing the opportunity.

Visiting Hong Kong with Leighton Holdings’ Board last month, we toured a small sample of our current projects there: a state-of-the-art waste disposal facility, the 26km express rail link to mainland China (including 7km of tunnels); and an emergency hospital that was about to open.

Several things struck me on this trip, but chief among them was the pace and scale of Asia’s economic rise. It is truly mindboggling.

You have graduated in the most multicultural of classes, with the proportion of overseas to domestic students being about 50/50. The overseas students present hail from Hong Kong, China, Malaysia and Indonesia, as well as India, Sri Lanka, Vietnam, Korea, Bangladesh and Thailand. Students from Europe, South America, the USA and Canada are also represented in your year, although in smaller numbers.

Today, emerging economies account for more than two-thirds of global growth, of which China accounts for about half. We are now approaching a tipping point in which Asia’s middle class will expand dramatically over the next decade. This is one of the most important features of the future global economic landscape.

When I went to university I had no appreciation of the power of the University of Melbourne brand and of the enduring bonds and the friendships made. Even now, when I encounter people whom I recognise from a tutorial or lecture, the shared bond is palpable.

– Tunnels and jetties in Singapore; – The new Australian Embassy in Jakarta; – Oil and gas platforms in Mumbai; and

Three years ago, 56 per cent of the world’s middle class – some one billion people – lived in Europe and North America. By 2030, the OECD expects that 66 per cent of the world’s middle class, or over 3 billion people, will live in the Asia-Pacific region.

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This was all reinforced as I took a break with the Leighton Holdings Board after going underground to see the progress of the dual-track rail tunnel. In our meeting room were photographs and plans on the wall of infrastructure projects coming online in the next decade and beyond. I couldn’t believe the foresight and extent of the integrated forward planning. The same thing struck me when visiting Indonesia and Singapore with ANZ earlier in the year. In fact, I believe this is true throughout Asia.

Asian opportunities

Now that you are commencing the next phase of your life, pause to think of the opportunities opening up for you as you leave one of the world’s best universities armed with your degree and with the common experience you have shared with young men and women from all over Asia. Do

not underestimate the bonds formed through this shared academic journey.

As you leave today I encourage you to take a final opportunity to chat with someone you haven’t met during your time here. Go on, take a risk. You never know where it may lead.

My final thought for you today is to embrace diversity. As I look around this hall I am delighted at the representation of women. I’m told it’s up to 53 per cent of the graduate year, more than double the proportion we had 30 years ago. I don’t want to bang the drum too hard but I think there is an incontrovertible logic in the argument for women’s representation in boardrooms and senior executive positions of Australian companies, and in the senior leadership of the public sector.

Of course, today there are still too few women in senior roles in Australian business, but things have changed even in the past decade. And you today are graduating as equals armed with the prestigious degree you have earned. You have worked studiously side-by-side with other young men and women.

As you go out into the world, I encourage you to remember the diverse community you are part of and the equality you have experienced during your time at university. My hope is that this balance continues throughout your professional life. It is only through marshalling all our talent that our country will reach its potential.

In closing, I encourage you to broaden your horizons and grasp the opportunities that await you. I wish you the very best of good fortune in your future endeavours.

After earlier careers in chartered accounting and investment banking, Paula Dwyer is now a professional director. She is the Chairman of Tabcorp Holdings and her board appointments include Leighton Holdings, the ANZ Bank and Lion Pty Ltd. 1 The Times Higher Education World University Rankings 2012-2013

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workplace culture Workplace culture has an enormous impact on the performance of an organisation. by jonathan elliot

An edited version of his Occasional Address given at Wilson Hall, the University of Melbourne, on 12 December 2012.

Introduction Let me start by warmly congratulating those who will be receiving honorary doctorates and degrees this evening. This ceremony is a significant milestone in your life and represents a tremendous amount of hard work, commitment and perseverance as you pursued your goals; as well as the longstanding support of your family and friends. It is a fantastic and well-deserved achievement, and everyone here is particularly proud of you. Well done.

In the short time I have this evening, I’d like to share a brief thought about working life – one that I propose is really important to the enrichment of your career and, more broadly, your life. And that thought concerns the culture of your workplace and the contribution that you can make to this culture.

I’m mindful tonight that you are all potentially at different stages in your careers. Whether you are about to enter the workplace for the first time, return to work in a new field or continue in your current workplace or role, the common theme is that you’ll be taking the knowledge and the technical skills you’ve learned at university and applying and developing these in a workplace. It’s an exciting time.

I graduated from the University of Melbourne in 2006 and started work as a commercial lawyer, actually as an articled clerk. And I remember the 54

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highs and lows of that process – of going into the workplace and doing a job. There’s a great buzz that comes from applying what you’ve learned and achieving things for the first time; and then you can feel like you’re drowning and that you don’t know anything at all. Looking back on the six years that I’ve been working, I realise that over time things do even out and that you really can do the job – sometimes even a great job.

This university prepares you thoroughly with the knowledge and technical skills that you’ll apply in your workplace, but tonight I want to look beyond these capabilities and suggest that there’s a broader contribution, hugely important, that you can make to your workplace, specifically to its culture.

Workplace culture When I finished university and started in my first job, it only took about three days to realise that a significant part of my day, my week, my life was spent in my workplace with my colleagues. I’m not saying it’s a bad thing, just that it’s the reality for most of us in our working lives.

When you work for a little while, particularly if you have worked in several different places, you quickly realise how important the environment and culture of your workplace are to your enjoyment, performance, achievement, satisfaction and life; as well as for those you work with and the

organisation you’re part of. The culture of your workplace is incredibly important.

Employers are increasingly aware of this. More and more these days you see organisations, before proclaiming their market and competitive successes, promoting the fact that they are rated the best place at which to work. Being a great place to work and having a great culture are very tightly linked to the performance of an organisation.

Culture drives performance – whether you are working for a corporate, a not-for-profit, a professional services firm or a football club. The 2012 AFL premiers, the Sydney Swans, are not regarded as having the most talented or even the most skilful list, but as having the best culture.

Everyone wants to work in a great workplace.

And what makes a workplace great is potentially a number of different attributes. I’m not going to pretend that I know all about organisational culture and what it takes to build a great workplace culture. I’m a lawyer after all – we tend to just be known for suing people! But I do submit that workplace culture has a lot, if not everything, to do with the people who collectively make up an organisation – and consequently it has a lot to do with you.

Obviously, the leaders in any organisation play important roles in setting and maintaining the workplace culture. But in the time that I’ve been working I’ve observed that every person in an organisation has the ability to make the culture of the organisation better or worse. Any one individual, from those holding the lowest positions right through to the CEO or Chairman, can have an incredible impact on the people and culture of a workplace.

So I’m saying that you can have a great impact in your workplace. I’m not talking about going in on the first day of work and trying to revolutionise the place. Rather, it’s about being self-aware and realising that your actions and conversations can make a huge difference to the culture of your workplace – and consequently the performance of your organisation.

Some examples I don’t know if any of you followed the recent US presidential contest. I was absorbed by it.

After President Obama won, there was a video on YouTube of him speaking to a group of young volunteers who worked on his successful re-election campaign. As he spoke, he started to well up with tears as he talked about their involvement, enthusiasm and commitment – and how inspirational it was to him and how it lifted him during the campaign.

This example shows that it doesn’t matter what level you are at in an organisation. Whether a starting graduate, part-time consultant or general manager, you can impact those around you.

I was further reminded of this the other day, when I was sitting in a colleague’s office. We were talking away when another colleague came in and congratulated her on the job she had done.

Her face lit up and her whole posture changed – I could visibly see the impact of the simple act of someone in the workplace making the effort to congratulate a colleague.

I think our tendency is to look at others in our workplace and think they are ‘all together’ and don’t need anything from us. But you know that when you look at yourself, you see challenges; you see things that you are trying to understand and come to terms with; and you know you are working to get somewhere. It’s no different for those you work with – from the top to the bottom of an organisation.

A simple quote about a single conversation I recently heard a quote that I want to share with you: ‘While no single conversation is guaranteed to change the trajectory of a career, a business, or a life – any single conversation can.’ I find this quote, from Susan Scott, author of the book Fierce Conversations, very powerful.

Your conversations and actions in your workplace can have an incredible impact – both positive and negative. In my own working life, I’ve seen the performance of my team lift because of the way Insights Melbourne Business and Economics

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people have contributed positively to the culture; and I’ve seen people with great knowledge and technical skills, people who have the potential to make a great contribution to the organisation, get disheartened or leave because of poor culture in their team.

What will you bring to your workplace?

So I want to encourage you as you launch into this next stage of your career – maybe to a new job, a new role or back to an existing role – to ask yourself, what can I bring, together with my knowledge and technical skills, to my workplace.

It might be your enthusiasm, your attitude, your commitment to making everyone feel part of the team, congratulating someone, encouraging someone, showing support to someone, taking the time to have a conversation, contributing an idea, sharing the load on a project, going out of your way to assist, effectively coaching and delegating work, setting up an opportunity for people to connect beyond the work they do.

I’m not just talking about being nice but also addressing issues, being open and accountable, engaging in tough conversations to resolve difficult issues, not engaging in office politics, standing up for what you believe is right, confronting poor attitudes, upholding a standard of performance, and creating impetus for change. These things can be harder to do but are so important to the place in which we work.

Encouragement to contribute In many ways, being in the workplace is just as much about the how as it is about the what. While what we do is important, how we do these things with the people we work with is right up there.

As you go into your workplace, I encourage you to be to be self-aware. Be aware that you can make an important contribution. Not just with your knowledge and skills, but what you bring to the culture of your workplace – how you can lift those around you, your team and consequently your organisation.

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By being self-aware, you will find that your working life is enriched and your career progression is ensured. After all, employers look for people who will build the culture of their workplace.

Jonathan Elliot is a Senior Associate with international law firm Herbert Smith Freehills.

Mailing Address: The Faculty of Business and Economics The University of Melbourne Victoria 3010 Australia Telephone: +61 3 8344 2166 Email: droller@unimelb.edu.au Internet: http://insights.unimelb.edu.au Published by the Faculty of Business and Economics, April 2013 Š 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.