Friday, December 15, 2006

Saturday Forum:The impressive Warwick McKibbin

Time is important to Warwick McKibbin. Arguably Australia’s busiest, quite possibly Australia’s most brilliant, technical economist he measures it in slivers. It is also at the core of his world-renowned economic model.

When I tried to find just half an hour to see him at his office in the ANU I was told he busy at meetings of the Switkowski inquiry into nuclear energy, then he was off to Sydney for a day-long meeting of the Reserve Bank Board (the one that pushed up interest rates) then off to speak at the Lowy Institute to speak about climate change.

At other times he is briefing John Howard’s Cabinet (twice a year as a member of the Prime Minister’s Science Engineering and Innovation council - “I keep throwing my pet topics on the table and the Cabinet engages”) or in Washington where he is also a Senior Fellow at the Brookings Institution, or at home in Deakin where he runs a business selling software for his computer model of the economy to international clients including central banks, funds managers and global corporations...

He has sold more than 150,000 copies of his software worldwide. His clients like it because it is better at predicting how an economy will react to shocks than its more expensive competitors. It takes into account the value of time. McKibbin likes to joke that he is only small businessman on the Reserve Bank Board.

When I do meet him in his office at the ANU’s Coombs Building there is no time to waste. We sit down at a side table and he explains with passion how almost everyone on both sides of the climate change debate is wrong.

It takes me back to when we first met, in Tokyo when I was working as the ABC’s correspondent. Warwick McKibbin phoned, said he was visiting and suggested that we have a bite to eat. Back then experts were either supporters or opponents of the Kyoto Protocol. I don’t remember the detail what he said over soba noodles but I do remember the way in which he said it.

It was obvious that both sides were wrong. Globally agreed targets to cut carbon emissions would never work, and nor should they. Why adopt a target when no-one knew what it was necessary to achieve? What you needed was a mechanism that would set up a framework for action and get people on board. He had come with a framework that would work and in time people would see that his was the right one.

I asked him where I could find out more. He spelled out his web address:

Warwick McKibbin is used to being right when almost everyone else around him is wrong.

At the age of 17 he joined the Reserve Bank in Sydney as an office assistant.

“My job was emptying the punch card machines. It was great because if you dropped them and had static electricity and a synthetic carpet it took about a day to pick them up.
It was really funny,” he remembers. “I did that during the day and I went to university at night.”

After six months the Reserve Bank decided that he might make a good computer programmer and enrolled him in a training course in the Bank.

Later it awarded him a scholarship to study economics fulltime, in Australia and at Harvard where he obtained his PhD.

He returned to the bank in 1987 because he had made a commitment but had “not a very pleasant time”. At that time when everyone in authority in Australia from the Treasurer Paul Keating down believed that the way to fight Australia’s growing current account deficit was to push up interest rates. Warwick McKibbin insisted that they were wrong.

“I even published a paper saying so and I was told if I published it I would probably never get promoted. So I published it any way.” He left after three years.

McKibbin’s view is now universally accepted as correct.

When the Berlin Wall fell in the late 1980’s it was generally believed it would turn Germany into an economic powerhouse. McKibbin’s model said it would instead be the start of Germany’s decline. So far he has been right. During the Asian economic crisis of the late 1990’s it was widely feared that Australia would fall into recession. McKibbin said the crisis would on balance be good for Australia. He was right again.

But what about the US-Australia Free Trade Agreement I ask him: “You put your name to modeling commissioned by the Department of Foreign Affairs and Trade that said it would be an economic bonanza for Australia. Three years on we are hardly selling any more to the US than we used to.”

He replies: “Actually our argument wasn’t that the trade flows would change very much, but that capital flows would change. There would be a lot more US investment in Australia than before.”

I think of this week’s $11.1 billion takeover bid for Qantas, the multi-billion dollar equity fund deals involving Channel Seven and Nine.

“Well not in that form, but that’s exactly what we were talking about. We didn’t think it would be equity capital but in fact we predicted that there would be quite a big change in the country risk premium because people in the US would be more confident in Australia,” he says, adding in a moment of rare modesty: “I am a bit reluctant, but I think that’s right, I can claim that one I suppose.”

McKibbin says he was selected personally by the Prime Minister to serve on the Switkowski Review into Nuclear Energy. “He wanted serious people on this review and I am probably the only person in Australia who has done serious work on this.”

The review was widely expected to find that there was an economic case for uranium enrichment, for the storage of foreign nuclear waste in Australia and for a domestic nuclear power industry without the need for a carbon tax. It found none of those things.

McKibbin says he is pretty sure that John Howard was surprised: “…but then I usually don’t toe any line, I just speak what I believe.”

He believes that it is the Switkowski inquiry that has led to the current remarkable inquiry into carbon emissions trading, an idea the Prime Minister once said he never would countenance.

McKibbin asked not be a member of the Prime Minister’s emissions trading task force. He wants to present his ideas to it. They are ideas that should strike a chord with the Prime Minister.

McKibbin says the Kyoto Protocol cannot and will not work. For one thing it requires international governments to trust each other to do the right thing. And even if they did the flows of capital across borders as emission permits were traded would massively distort exchange rates.

And there’s something else. Treaties lock governments into targets that they lack the political ability to meet. “In a democracy, a policy doesn’t become credible simply by being written into law. Every subsequent government will have the ability to repeal the law or to relax enforcement until it is irrelevant. Why would an energy company want to make a long-term investment knowing that? It’d easier to lobby to neuter the law.”

McKibbin says what is needed is a scheme that will create a constituency with a strong financial interest in keeping the climate change policy on track: “Bluntly, you’ve got to create a powerful lobby group that will vigorously resist backsliding.”

Here’s how it work for Australia. Carbon emissions would be illegal without a permit. But the government would issue lots of them, enough to cover somewhat less than Australia is emitting now. The permits would allow the emission of one tonne of carbon each year for the next 100 years. (“About the lifespan of a Canberra lease,” he says).

The government would hand them out for free. But – it would hand out only half of them to carbon emitters. The rest it would give as a gift to each Australian household – probably two permits per household, worth about $1000 each. Polluters will need them and they will try to buy them from households.

“But $1,000 doesn’t sound like much money”, I suggest. What sort of incentive is that going to give households?

“If you hold on to it, it would be like being given Microsoft shares. Eventually as the price of carbon emissions climbs those permits would be worth an enormous amount of money,” McKibbin says.

Households will find it worthwhile to lease their permits out to business rater than sell them. Each year the government will set a new price of carbon (“in the same way as the Reserve Bank sets interest rates”) and if that price is higher the value of the permits will increase. A constituency will be created that wants the government to increase the price of carbon every year.

If the government ever tried to walk away form the scheme or water down its enforcement, it would have a mutiny on its hands. Householders, businesses and superannuation funds would be ropeable at the prospect of seeing the value of their investments plunge to zero.

No-one could ever corner the market in permits because the government would always supply on demand a permit for one year’s worth of emissions at the price it had set. Businesses would always be able to pollute if they really wanted to, at a price that ordinary citizens would be pushing to have increased.

Because the government could vary the “spot price” for each year’s emissions of carbon as it wished, it wouldn’t be locked into anything. If the evidence about climate change became more compelling, it could push up the price. If it became less so it could push the price down.

When other countries saw that the system worked they might adopt it too. But they wouldn’t have to. And Australia’s participation in the scheme wouldn’t depend on other countries.

The McKibbin scheme is carbon trading without a carbon target and without Kyoto, the sort of thing likely to appeal to Australia’s Prime Minister. As might the notion of a nation of carbon-permit capitalists. John Howard has talked often of his pride in helping create the world’s biggest share-owning democracy. McKibbin’s idea might help him go further.

But what if Australia isn’t ready for it? McKibbin says he is used to that. He will be proved right in time. But quite possibly not in this country. He says the US is interested in his scheme. He resigned from his position at the ANU this week but is still in discussions with them about his future. “I am not sure how it will turn out. After February, I might become the Reserve Bank's first unemployed Board member, which would be funny.'”

But he thinks things will turn out alright. It's another Warwick McKibbin forecast that might be proved right.