Tuesday, January 29, 2008

Tuesday Column: It's the Treasury, but not as we know it.

This Rudd fellow is becoming harder to put in a box. On one hand he is an economic conservative. He has locked himself into days of talks with the head of the Treasury and the head of the Reserve Bank and he is keen to follow their advice. When the spending cuts that he has promised are delivered in May they are likely to be big.

On the other hand he is dead serious about ending homelessness. As he put it on Sunday: “I’m not interested in being the Prime Minister of Australia for the sake of being here. Frankly, I’m just not. I want to be here in order to make a difference and this is one area where we as a nation can make a difference, if we get it right.”

Kevin Rudd seems at home with the ‘hard heads’ in the Treasury and also the ‘soft hearts’ who want to fix Australia’s social problems.

It’d be tempting to say that sooner or later he’ll have to choose between the two.

But it would be wrong...

The Department of the Treasury, once correctly thought of as being principally concerned with saving money and advancing GDP, has changed almost beyond recognition.

Remarkably - and quietly - it’s done it during the life of the Coalition government.

Its mission statement does not, as you might imagine, require it upfront to increase the nation’s GDP. Nor does it require it to save the government money.

It’s new statement, adopted a few years back, instead simply requires it “to improve the wellbeing of the Australian people”.

Which would be fairly meaningless if it stopped there. But it’s has gone much further. After years of tossing around ideas and paying particular attention to those of the Indian-born Nobel prize winning economist Amartya Sen the Treasury has published a five-point definition of wellbeing that reads most unlike anything ever to have come out of a Treasury in the past.

The first point that it uses to define wellbeing doesn’t even mention GDP, or even anything material.

It is this: “The opportunity and freedom that allows individuals to lead lives of real value to them”.

It’s as if the 900-odd Treasury officers in the iconic building across the road from the National Library have downed their calculators and donned caftans.

“Freedom” once wouldn’t have had any obvious spot on the Treasury’s agenda, let alone the pole position. But it is absolutely importaqnt to Sen. He believes that freedom is the real measure of the quality of a life, rather than wealth.

Within weeks of his appointment as Treasury Secretary in 2001 Ken Henry was lecturing business economists about Sen’s insights. In 2004 he published a closely-worded guide to the Treasury’s five-point definition that quoted Sen arguing that freedom was important in its own right, beyond its impact on happiness.

The popular press and bookstores are just catching on to happiness. They are talking as if it’s the next big thing in economics. Dr Henry, the Treasury and Sen are looking beyond way it.

(Anyone who has seen the first Matrix movie knows that there are more important things than happiness. The humans in the movie are vegetating in a pleasure-inducing stew. They are happy, but they are not free.)

The Treasury and Sen insist that freedom has to be real and practical rather than merely notional. In our context that means that indigenous Australians have to be actually able to find jobs rather than theoretically free to do so, something that Dr Henry has mentioned repeatedly in recent speeches.

The second of the five points that The Treasury uses to define wellbeing is apparently more conventional.

It is “the level of consumption possibilities available to the community over time”. In other words, people’s ability to get hold of the goods and services that they want and need.

That sounds a bit like GDP. But the Treasury says it should be interpreted “in its broadest conceptual sense”. Things not measured in GDP are important too. Products such as breast-milk, services such as those provided by volunteers, as well as the environment and our ability to enjoy it.

As the Treasury puts it: “The needs and wants to be satisfied range from meeting basic material necessities such as food and shelter, through to non-material desires for emotional satisfaction or political participation.”

And it’s not enough that those things be available to the people who are here now. They have to also be available to future generations. The Treasury has produced two Intergenerational Reports. It has taken a leading role in the development of our emissions trading system. Its former Deputy Secretary now runs the new Department of Climate Change.

The third point on the Treasury’s list relates to distribution. Long gone are the days when it only concerned itself with increasing the size of Australia’s economic cake rather than how it was divided up.

How the cake is divided matters not only because it should, but also because it matters to human beings. That’s one of the most important findings from the relatively new field of behavioural economics. Experiment after experiment has found that an extra dollar is valued more by a poor person than by a rich person and that most of us care more about what we earn relative to other people than we do about the absolute amount we are paid.

The Treasury quotes both findings with approval.

It’s foUrth point relates to the level of risk in our lives. We shouldn’t have to bear more risk than we want to. Any government program that makes us more vulnerable to, say, the gyrations of the share market or the consequences of a firestorm is in part a program that has made us worse off.

Point five relates to complexity, “the number of considerations, and the interconnections between those considerations” in our daily lives.

Changes that make us financially better off but make our lives more complex do not necessarily improve our lives.

The Treasury’s five-point definition is doubtless incomplete. It makes the point that the disciplines of “sociology, politics, theology and philosophy” have much to tell us about of wellbeing as well.

But it’s a darn sight more complete a definition than anything that’s gone before.

It empowers the department to fight homelessness just as much as it empowers it to fight inflation.

Rudd has a soul mate in the Treasury.

Perhaps without realizing it it’s been preparing for him for quite some time.


In assessing public policy issues, we apply a broad wellbeing framework comprising five elements:

> the opportunity and freedom that allows individuals to lead lives of real value to them;

> the level of consumption possibilities available to the community over time. This includes both market and non-market goods and services, such as voluntary and community work, the quality of the physical environment, health and leisure;

> the distribution of these consumption possibilities, including among different groups within society, across geographical regions and across generations;

> the overall level and allocation of risk borne by individuals and, in aggregate, by the community; and

> the level of complexity confronting Australians in making decisions about their lives.


Ken Henry Secretary to the Treasury

I will conclude with some remarks about the role of economists.

Official and private sector forecasters on the one hand, and economic journalists on the other, interact to powerfully influence not just the day’s ‘news’, but more fundamentally the entire public perception of what economics is about.

Virtually no reporting of an ABS release of data on anything economic would be printed, or broadcast on radio or television, without its including a few quotes from an economist. For this reason, even if the reporter manages to avoid introducing his or her own opinion into the story (a feat that most would appear to find altogether too challenging) all ‘news’ stories become, through the extensive use of verbatim quotes, little more than comment pieces of economists.

It is often remarked that the Australian media is at the most sensationalist end of the international spectrum. In this, it appears to have found a willing accomplice in the economics profession. No doubt, sensationalism sells; if it didn’t, we would have much less of it. But I would ask you to ponder how much good it is doing to the reputation of the economics profession.

On that broader topic, of the reputation of economists, I cannot let this opportunity pass without saying something about economic rationalism.

A thesis is emerging [4] that the reason economists are so out of touch with their detractors is that economists are interested only in the maximisation of material wealth, having no interest in the non-material consequences of economic activity. Thus, for example, the thesis maintains that economists believe that market liberalising policies will improve an economy’s capacity to deliver greater material wealth, but are not in the slightest concerned that those same policies impact adversely on job security. Moreover, so the argument goes, economists have no interest, or expertise, in distributional or environmental issues.

An implication of this thesis is that the detractors of economists are motivated by a better balanced consideration of all of the various factors that contribute to, or subtract from, human happiness.

Those of you who have undertaken some formal study of economics at tertiary level will know that this thesis betrays an ignorance of economics. But it may, nevertheless, reflect a keen observation of economists.

Jacob Viner is reputed to have said that ‘economics is what economists do’[5]. Irrespective of whether you agree with that statement, I would ask you to accept that economics is not what most people think economists do. This proposes a challenge for economists around the world, but perhaps especially in Australia, given the intensity of the largely misguided (and most assuredly misinformed) criticism of ‘economic rationalism’[6] in this country.

In the interests of a more honest debate, I will make just a few points today.

First, the motivational force behind the tradition of liberal economics transcends materialism. John Hicks put it in the following terms: ‘The liberal, or non-interference, principles of the classical (Smithian or Ricardian) economists were not, in the first place, economic principles; they were an application to economics of principles that were thought to apply to a much wider field. The contention that economic freedom made for economic efficiency was no more than a secondary support.’ [7]

Hicks noted that there was, however, a risk that economists had lost sight of the primary support for liberal markets: ‘What I do question is whether we are justified in forgetting, as completely as most of us have done, the other side of the argument.’[8] In Amartya Sen’s words: ‘The role of the market mechanism is another subject that calls for some reclaiming of old heritage.’[9]

Adam Smith’s Wealth of Nations can be seen as an attempt to lay the foundations for the argument that liberal markets act to enhance material wealth, the secondary leg of support. The heroic utilitarian tradition and the more recent neoclassical economics have built on this foundation.[10] The widespread application of neoclassical principles by contemporary economists may go some way to explaining why there is an equally widespread view today that economists are interested only in the material. Indeed, it is easy to understand why an astute observer of the public behaviour of economists could very probably be entirely ignorant of the primary support for liberal economics.

Yet not all economists have lost sight of the ‘old heritage’. David Henderson, for example, writes that ‘a liberal is...one who emphasises the value of individual freedom, and who therefore judges measures and policies, economic as well as political, primarily with reference to their effects on freedom. Economic liberalism favours policies that promote and enlarge economic freedom, both for their own sake and because they make for greater prosperity’.[11]

I suspect that, if put to the test, all liberal market economists would share this view. The fact that they spend so much of their time arguing the material (GDP) benefits of liberal markets does not mean that their support for market liberalising policies betrays a concern for the material to the exclusion of the substantive. Indeed, most liberal market economists would have little difficulty agreeing with Sen’s emphasis on the substantive freedoms of political and civil liberty, social inclusion, literacy and economic security, as ‘constituent components’ of development. Moreover, they would likely agree that the regulation of markets to prevent two people’s engaging voluntarily in commercial exchange is as indefensible in principle as legislating to prevent those same two people’s sharing a conversation, a public bar, a classroom, a house or a family.

My second point today is that even the most liberal of economists recognises that markets may fail. And many economists working in the public sector, in particular, are involved in finding solutions to such things, including in environmental economics, health economics and (perhaps more controversially) education and innovation policy.

Third, the detractors of economists make no less of an appeal to the material consequences of their policy prescriptions. Their complaint is not that economists are preoccupied with materialism, but rather that liberal markets do not contribute to advances in human income and wealth. They disagree fundamentally with Sen’s statement of the secondary leg of support for liberal markets, ‘that markets typically work to expand income and wealth and economic opportunities’.[12] They disagree also with Ross Gittins’ description of economists as ‘experts on how communities can make themselves richer, have higher incomes so they can afford to consume more goods and services each year’. [13] Instead, our detractors believe that nationalistic, paternalistic and protectionist policies offer better prospects of increases in material standards of living.[14]

Fourth, there is absolutely no respectable evidence that market liberalising policies reduce economic security, not even job security. Certainly, liberalising reforms may produce transitional adjustment costs, including temporary insecurity for those adversely affected by the reform; and indeed, in the absence of compensation, some may well be adversely affected permanently. But there is simply no compelling evidence that liberal policy regimes are associated with less economic security for societies in general. Indeed, on any reasonable interpretation of the concept of economic security, the converse is the case. Just what would our detractors say of the economic security of a peasant farmer in sub-Saharan Africa denied an income by the anti-liberal, regulated, protectionist agricultural trading regimes of much of the developed world? Don’t blame liberal market economists for this particular tragedy. And don’t blame them either for the fact that the annual value of agricultural subsidies paid by taxpayers in the developed world to their farmers is five times what those same taxpayers are prepared to distribute in aid to the developing world.

Fifth, as in many other areas of social science, the economic debate is prone to its being hijacked by people with opaque agenda. There is no better illustration of this than the work of the United Nations Development Program (UNDP) on globalisation and poverty. On this topic, I urge you to read the article in the most recent (centenary) edition of the Treasury Economic Roundup,[15] and the paper by Ian Castles on the UN Human Development Report 1999 cited in the bibliography to that article. Treasury is in the midst of a substantial program of work on globalisation and poverty issues, including in the fora of the recently established G20, of which Australia is an active member.

And finally, don’t assume that because the last two decades of the last century were characterised, generally, by market liberalising reforms there is something inexorable about the direction of economic policy change. Liberal market economics is under attack, and not just in the streets. The critics must be answered. And in that task, all of you have an important role to play. Can I ask you to heed the urging of one of my predecessors, John Stone, and ‘point out trenchantly that the charlatans (we could hardly call them emperors) have no clothes’[16]?


4 - See, for example, Ross Gittins, "When the pursuit of happiness is a bit rich", Sydney Morning Herald, May 16, 2001, p.12

5 - Lawrence A Boland, The Foundations of Economic Method, London, George Allen and Unwin, 1982.

6 - Without wanting to buy into the debate on what defines ‘economic rationalism’, I would be comfortable with this term’s being used, for present purposes, interchangeably with the more conventional ‘liberal market economics’.

7 - J.R. Hicks, Wealth and Welfare, Oxford, Basil Blackwell, 1981, p.138; cited in Amartya Sen, Development as Freedom, Oxford, Oxford University Press, 1999, p.28.

8 - ibid.

9 - He goes on to say that: ‘a denial of opportunities of transaction, through arbitrary controls, can be a source of unfreedom in itself. People are then prevented from doing what can be taken to be ¾ in the absence of compelling reasons to the contrary; something that is within their right to do. This point does not depend on the efficiency of the market mechanism or on any extensive analysis of the consequences of having or not having a market system; it turns simply on the importance of freedom of exchange and transaction without let or hindrance. This argument for the market has to be distinguished from a second argument, which is very popular right now: that markets typically work to expand income and wealth and economic opportunities that people have. Arbitrary restrictions of the market mechanism can lead to a reduction of freedoms because of the consequential effects of the absence of markets. Deprivations can result when people are denied the economic opportunities and favourable consequences that markets offer and support.’ Sen, op. cit. pp. 26-27.

10 - This tradition scales lofty heights in establishing the so-called ‘first fundamental theorem of welfare economics’, according to which, in the absence of externalities and other instances of market failure, a competitive general equilibrium is Pareto efficient, in the sense that nobody can be made better off (materially, of course) without at least one other person being made worse off.

11 - David Henderson, ‘Anti-liberalism 2000’, Wincott Lecture, London, 12 October 2000, available from the Institute of Economic Affairs website: http://www.iea.org.uk/.

12 - Sen, op. cit. p. 26.

13 - Gittins, op. cit.

14 - The ‘mainstream’ criticisms of liberal economics are addressed comprehensively by David Henderson in his recent Wincott Lecture (Henderson, op. cit.)

15 - Treasury, ‘Global poverty and inequality in the 20th century: turning the corner?’, Economic Roundup, Centenary Edition, 2001; available on the Treasury website at: http://www.treasury.gov.au.

16 - John Stone, Australian Financial Review, 16 May 2001.