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18 June 2008

Supply - not Demand 2

To continue the discussion of "Supply - not Demand" (see original post here)...

The New Norm

As economic expansion becomes its own problem and the difficulties facing an economy with almost full employment become the new norm... more and more issues arise that ask the question:

"how do we increase supply, and not demand"

I was listening to Radio National this morning (details and podcast here). Professor Deborah Brennan was talking about the Rudd Government's new Child Care policies and the ways in which increasing the Child Care benefits will simply increase demand and not help the supply problem.

I agree with her - and I am sad to think that the Rudd Government has come up with policies as cynical and pointless as the "first home-owners grant".

It makes people feel better. It makes them feel as if the government is doing something... but in the end it simply increases demand, drives up prices, creates more "burn" in the tax benefit system and does nothing to actually make anyone's life easier.

Housing and R&D

It did set me to thinking, however, about how one might manage to improve the supply situation without increasing demand.

The answer, in a way, is simpler for houses. We have a whole industry based around the supply of houses - the construction industry, housing developers... there are people to whom we can give direct tax credits, simply for doing their job, in order to increase the supply of houses being built in the economy (more about this idea).

There is no equivalent for Child Care. There is no Child Care Centre construction industry.

But the concept of tax incentives based on particular activity within an industry is not a new one. Think of the generous tax incentives for R&D that have been implemented in some countries.

Yes, admittedly, there is always the problem of "what is R&D"... but that is for the tax department to work out. You know when you're doing it... and if you've got any queries, don't depend on the tax rebate until the department has made a ruling... it's simple really, and it's been done before, many times.

Finding the Answer

What we need is a 150% (or at least something 100%+) tax rebate on all the costs involved in the first year's set-up and running of a "new" child-care centre.

Yes, the tax department will need to define "new". Yes, it will need to clarify what can be included in the list of expenses. But the basic list is easy to come up with - the details can, as always, be worked out in the fullness of time.

The list includes, but is not limited to, the costs of:
  • building new premises intended for the purpose of housing a new Child Care centre, which is then used to house said Child Care centre for at least 12 months. (If premises has other purposes, as well, then a pro-rata calculation can be made)
  • Renting premises intended for the purpose of housing a new Child Care centre, which is then used to house said Child Care centre for at least 12 months.
  • All wages for staff involved in supporting and running a new child-care centre.
  • All office expenses, new materials etc. involved in supporting and running a new child-care centre.

Facing the Problems

There is then the problem of Child Care centres not being viable after the initial 12 month period. But the problem is a small one.

The point is, there is a lot of unmet demand out there. There are more children than places. If that isn't the case, we don't have a problem. Once a Child Care centre is up and running - it is unlikely to be torn down and replaced with something else, unless someone has made a very stupid business calculation and is now running a Centre where the prospect is truly unsustainable.

If this is the case, then the problem is with the business case, not the incentive scheme - and the Centre deserves to shut down, as per the laws of Supply and Demand that we are trying to utilise.


Would it be expensive?


Would it cost more than the current rebate extensions?
Possibly, depending on tax rebate levels

Would it help supply without increasing demand?

Can we afford it?

Would it help "working families" more than the current rebate, in the long run?
Most certianly, YES!

Let's stop just making people feel better, and help the whole economy.

The Reasons

Access to Child Care is an equality issue.

Increasing access helps new parents back into the workforce. It increases levels of participation. It helps single parents. It increases overall output and productivity.

It simply IS a good idea.

This isn't some "anti-market" strategy. It's a market shaping strategy... and a good one... one that works. Only the absolute free-market purists could argue against it... and, well, really... arguing against a purist of any persuasion is a bit pointless.

Questions, comments, further ideas and foreseen problems welcome. Let's work out the details and get this implemented.

11 June 2008

Supply - not Demand

Australia's housing afford-ability

OK. So what's obvious is that the current housing afford-ability problem, in Australia, is a basic Supply/Demand problem.

What's also obvious is that any attempts that try to fix the problem by giving people money only supports the demand side of that equation and completely fails to deal with the problem from a supply side - which, in effect, only makes the problem worse.

So giving people a "first home owners grant" only raises the cost of housing, on average, by the amount of the grant - it might make it slightly cheaper for first home owners and slightly more expensive for anyone not buying a first home. But on average, the market simply corrects. There's still a lack of supply, and raising demand simply raises the equilibrium point.

And in the face of the, more recent, rental squeeze in Australia's urban centres, giving people rent assistance only pushes the price of rental properties up even further - for exactly the same reason.

What we need is more houses. More houses means greater supply - greater supply means cheaper sales and rent. Simple, isn't it? Obvious!...

What is not so obvious, however, is how the current tax incentives for investors effects the afford-ability problem.

The current housing tax regime, in Australia, was originally designed to help afford-ability by encouraging people to invest in housing, therefore encouraging investment in building houses, therefore raising supply, therefore reducing prices and rent...

There are a number of "but"s here:
  1. Much of the tax relief goes to people investing in pre-owned houses - making the expenditure inefficient. Why are we helping people invest in and make money out of 100 year old houses... we need new houses, not more investors in old ones.
  2. The tax incentives only work as planned when the market is going up.
    1. They encourage extra investment when investment is a good idea anyway, by increasing profits... but they are of little help when the market is going down. At end of the day, if the capital value of houses is going backward, it doesn't matter how much money you refund on the costs of running the house, it's still a bad investment, and needs to be sold.
    2. By encouraging over investment on the way up, they encourage a greater boom and bust throughout the housing price cycle.
So, if cash payouts don't do any good and tax incentives for investors cause extreme markets... what's the answer?

Well, actually, it's really not that complicated.

If you wanted to reduce the cost of cars, you wouldn't start by making investing in cars cheaper, you'd start by making the manufacturing of cars cheaper.

In the same way, in order to make houses cheaper... forget the tax incentives for investors... give tax benefits to builders.
  • Reduce company tax for companies that make building materials - bricks, building timber etc. Tax return incentives for investment in certain areas of business have precedent and are not that new.
  • Give tax reductions to companies that build houses - developers etc.
  • Create subsidies for companies that sell housing products to individual builders and contractors
  • Give tax credits or bonuses (think "the baby bonus") to individuals who build their own houses.
It's a simple equation:
  1. make building a new house cheaper
  2. increases the number of competitors and competition in the market
  3. makes the final sale price of each house lower
  4. drives down prices for currently standing houses (people who can pay less for new houses won't pay as much for similar non-new houses)
Where does the money come from to pay for all these tax incentives?

In past versions of this plan, I outlined ideas like reducing the current 100% tax benefit for investors by 5% a year, and putting the money saved towards tax benefits for builders... but, quite frankly, with the kind of surpluses we've been seeing in the budget recently, we can simply afford these tax breaks... we don't need to "find" the money. We've got it already.

By keeping the current tax incentives for investors, the combined effect will continue to have downward pressure on rents by encouraging investment... however, over time, the idea of reducing tax benefits for investors could/should be looked at in order to encourage people to buy their (now cheaper) houses, and discourage the low owner-occupier / high-investor model we're currently locked in.

On top of that, by my readings, it's not a particularly inflationary tax-cut. It's upshot is to reduce the cost of building new houses, which immediately takes the pressure off wages by reducing mortgage stress and rental stress.

There don't seem a lot of down-sides to the plan in general - the details, of course, will need to be fought over.

10 June 2008

The Wealth Spread Index - The Fairness Bourse

A friend of mine and I went out for drinks recently. While we were speaking about politics, economics and how to solve the future... he gave me a great idea for a use for something I've been messing around with.

The History

Wealth Distribution - how we compare

Some short time ago I was doing some research on wealth distribution. I wanted to come up with a way of comparing countries directly.

Recently, I heard a talk from Paul Krugman, a Professor of Economics from Princeton University. In fact, I've written on that talk before.

What had stuck in my head from Krugman's talk was the issue of "wealth spread" and "fairness" within an economy - we should have a way of comparing different economies directly.

More specifically - while I "know" from common understanding that the US economy has become much less evenly spread over the last couple of decades, and many of the Scandinavian countries have maintained their even equality of wealth - I wanted to be able to calculate the situation more accurately; to clearly measure and compare the different economies; possibly work out where Australia is on that scale, right now.

I looked around and couldn't find any consensus on the issue - no standard way of measuring what I wanted to measure.

After some hunting around and a little experimenting I came up with with a basic model/system of my own.

Now at that point I had no idea what to do with it. It was interesting to me and I liked to see the results - but I couldn't see what the practical upshot of it could ever be to anyone.

And this is where my drinks with Simon come into it. He gave me the idea of what to do with it while we were talking that night.

Why do we so easily measure a country's health and value by:
  • GDP Growth
  • Interest Rates
  • Inflation
  • Unemployment Rates
  • Stock market values
Why can't we talk about "Spread of Wealth", "Long term vs Short Term Unemployment", "Ease of Basic Living"... the simple reason, I would hypothesise, is because GDP, Interest Rates, Inflation and Unemployment all have single numbers attached to them - and the Stock market has the "bourse" value (e.g. ASX200, FTSE, Nasdaq etc.)

All the other issues (Spread of Wealth etc.) have no single number that can be associated with them - and therefore can't be summarised as easily.

One example in support of this theory is the topic of "housing afford-ability". Until recently, in Australia, the issue had never been discussed widely. In order to have the conversation about it - in order to make it news worthy - we needed a specific housing afford-ability index, so that we could compare States with each other, record whether it's gone up or down and by how much... and generally discuss the issues using simple concepts. That's what we did. We made a "housing afford-ability index".

And so... the idea that came out of my discussion with Simon is this:

If we want to have a discussion about "fairness" and the "spread of wealth" in our economy, then we need a fairness bourse... a wealth spread index; a single number that can be compared between economies and over time within an economy.

So - let's make one.

The overview

The original ideas

Using data easily available, I wanted to find a value that would vary within a known range (say 0 to 100) and that would represent the level of inequality within an economy.

So allowing for the idea that the "worst" possible economy is one in which the bottom 60% of the population own nothing at all and the "best" economy is one in which everyone owns a completely equal share of the wealth - it was fairly simple to come up with a reasonably basic way of scoring economies within the given range.

With a tip of the hat to Ghandi's/Churchill's/Truman's quote (see many confused references to this quote across the internet - Florida Today, Ask MetaFilter, Memorable Quotations, Askville to list a few):

"A nation's greatness is measured by how it treats its weakest members"

the formula I used gives more weight to the fairness imparted on the bottom feeders than the big end of town. So while an economy could improve its rating by decreasing the amount of wealth that is "soaked up" by the richest people, it will improve its index value far more quickly by improving the lot of its worst off inhabitants.

Here are the initial results:

All of the initial results were between the values 57.5 (Turkey) and 77 (Slovakia) (represented by the red bars).

These values can, alternatively, be viewed by stretching them out between 0 and 100 so that the lowest scoring economy always receives a score of 0 and the highest 100 (represented by the blue bars).

Some notable scores amongst the list are:
  • America - 23.08
    • 2nd worst score
  • New Zealand - 38.46
    • I was surprised by how low NZ scored
  • United Kingdom - 38.46
  • Australia - 53.85
  • France - 64.10
  • Sweden - 87.18
  • Japan & The Czech Republic - 94.44
    • 2nd highest score
On a comparative basis - I think this system of scoring shows some merit and represents a step forward in finding a single value to represent the spread of wealth within an economy.

However both systems show some limitations.

The first version, with values between 57.5 and 77, show little absolute variance and gives the mistaken impression that there isn't much difference between these economies in the terms being measured.

The second version with values between 0 and 100, tries to deal with that limitation, but suffers from, or emphasises, a few more:
  • it stretches out values at the bottom of the range and compresses values at the top
  • it could make countries in the lower values appear as if they were improving or slipping faster than they are
  • it could mask improvements/drops in countries with higher values by making the changes seem smaller than they are
  • one country slipping at the bottom or the top could make the others appear as if they were improving when they weren't
  • one country improving at the bottom or the top could make all the others appear as if they were slipping when they weren't

The final solution

It soon became clear why these systems each had these particular problems.

They treated "100" as an attainable goal, as if the "perfectly fair" society was something reachable.

In order to make the scale work like a normal bourse, the "perfect" solution needed to remain something unattainable. Something that everyone aims for, but no one can ever reach - stretching into infinity.

Taking this into account allowed me to calculate these values:

The final results varied from 5.0 up to 22.23 and will increase in rate of growth (approaching infinity) as the economies being measured approach "perfect".

Some notable scores amongst the list are:
  • America - 6.2
    • again, 2nd worst score
  • New Zealand - 8.26
    • again, surprised
  • United Kingdom - 8.26
  • Australia - 8.9
  • France - 11.5
  • Sweden - 17.4
  • Japan & The Czech Republic - 22.23
    • Now the highest score

The Details

All calculations were based on details of the relevant economies from this UNICEF web site:

The calculations are based on 2 main values:
  1. Low = the % of the nations wealth held by the bottom 40% of the population
  2. High = the % of the nations wealth held by the top 20% of the population
The accuracy of the figures, and how up-to-date they are are somewhat irrelevant at this point. The point was, and is, to come up with a reliable, convenient and illuminating way of measuring an economies fairness.

The values actually used were as follows:

Czech Republic2536
Korea, Republic of2238
New Zealand1844
United Kingdom1844
United States of America1646

The Final Results

The fairness values calculated, in order form "worst" to "best", were as follows:

United States of America6.2
New Zealand8.26086956521739
United Kingdom8.26086956521739
Korea, Republic of15.1666666666667
Czech Republic22.2258064516129

The Final Calculation

The calculation used was as follows:

((100 - High) + Low^2)/((High - 20) + (40 - Low))

The Reasoning

The reasoning is as follows:
  • The value of "High" varies between 20 -> 100
  • The value of "Low" varies between 0 -> 40
  • In the "perfect" situation - High = 20, Low = 40
    • (High - 20) + (40 - Low) = 0
  • In the "worst" situation - High = 100, Low = 0
    • (High - 20) + (40 - Low) = 120
  • The inverse of (High - 20) + (40 - Low)
    • maximum (infinity) in the "perfect" situation
    • minimum (1/120) in the "worst" situation
  • To further increase the exponential effect of both "High" and "Low" (but particularly of "Low") multiply the above calculation by ((100 - High) + Low^2)

And you are left with final calculation:

((100 - High) + Low^2)/((High - 20) + (40 - Low))

The Conclusion

After some experimentation and testing with varying values around the current "correct" values, I am convinced that this is a valuable way of calculating the over-all fairness of an economy.

I would be very interested to hear any feedback, comments or findings related to the calculation - how its adoption could be encouraged, and what might improve its usefulness.