Australia's economy has become increasingly dominated by powerful firms that are extracting "economic rents" from the system, economist Ross Garnaut is warning.
Their market dominance has contributed to declining real incomes for workers, has made our cost-of-living crisis worse, and is undermining productivity growth, he says.
The professor emeritus in economics at the University of Melbourne says Australia needs a new policy framework to manage the reality of industries with too much power.
He says it will require looking afresh at our economic institutions to see how they can work together to combat the growing problem.
It will also mean the Reserve Bank will have to acknowledge the truth about the nature of much of the profit-taking in this country, he says.
"There have been big changes over the 21st century that greatly affect Australia's capacity to deliver rising standards of living to most people in a growing population," Professor Garnaut said.
"It is a striking fact that the profit share of income is decisively higher than ever, and the wages share lower. To understand these developments, we must look afresh at the role of rent."
He has also warned that, given the dominance of a handful of firms in key industries, the standard approach to monetary policy in response to inflation — to lift interest rates — was leading to perverse outcomes for households.
He singled out two areas of the economy where that was particularly bad: rents for houses, and energy supply.
The economic public interest in a world of oligopoly
Professor Garnaut delivered his warning about Australia's economy this week in the 2023 Bannerman Competition Lecture in Sydney on Wednesday evening.
The title of his speech was The economic public interest in a world of oligopoly.
Professor Garnaut told his audience there had been fundamental changes in the structure of Australia's economy in the past 20 years and some of our traditional tools of economic management and analysis were no longer fit for purpose.
He said policymakers needed to realise how much the world had changed so they could develop new policies to deal with an increasingly unequal market economy.
"My special focus this evening is on policy related to management of economic rent," he said, in the transcript of his speech seen by the ABC.
"There have been big changes over the 21st century that greatly affect Australia's capacity to deliver rising standards of living to most people in a growing population.
"Most importantly, there has been a large increase in the rent component of total income. This has diminished growth in productivity and output, while reducing the share of income accruing to the general run of citizens."
Professor Garnaut said "economic rent" referred to income that was greater than necessary to attract the economically optimal amount of investment into an activity.
Monopoly rent persisted when there was little or no competition in the supply of a good or service, and it could have a deleterious impact on political systems over time, he said.
"Economic rent arises whenever high profits in an economic activity fail to induce expansion of supply to reduce prices and profits to normal or competitive levels," he said.
"Different sources of rent can interact with and reinforce each other. Rents from any source can be invested in influence over public policy and its implementation to maintain and extend oligopolistic positions," he said.
He said in Australia, a high and increasing proportion of income had been emanating from rent‐heavy sectors, especially mining, but also urban real estate, information technology, financial services, media and large‐scale retailing.
"Profits of mining, with economic rent contributing a considerable proportion, were larger than the whole of the rest of the economy in the final quarter of last year, the latest data available," he said.
He said it was time for these developments to "enter the mainstream" of our discussion of Australia's economy and economic policy.
He said the growing problem of economic rent was a global phenomenon, and countries such as the US and UK had been dealing with it for longer than Australia, but it was now undermining our traditional methods of measuring how income is generated and distributed through the economy, and it was undermining our ability to understand the world around us.
"Robert Solow, a long-time professor of economics at the Massachusetts Institute of Technology, received a Nobel Memorial Prize for work in the 1960s," Professor Garnaut said.
"This research developed what is now the standard way of measuring the contributions respectively of capital and labour to economic value.
"In a letter to my long-time friend and colleague Professor Max Corden on 17 September 2017, Solow said that he was rethinking his contribution:
"We conventionally allocate all of the value added to either compensation of labour or return to capital (debt and equity). That would be fine if there were perfect competition. In reality, there is a third component, monopoly rent … it gets allocated to labour and capital in unknown proportions. What one would like is a three-way breakdown in market return to labour, market return to capital, and rent."
The increasing role of economic rent
Professor Garnaut said Australia's economic officials — including those at the Reserve Bank — had to acknowledge how much the world had changed.
He said returns to low-risk capital in competitive markets were close to zero in real terms currently, and yet returns to business investment were higher than they had ever been in the developed world "and most impressively of all in Australia".
"Attempts have been made to rationalise the facts," he said.
"The Business Council of Australia and the governor of the Reserve Bank have said that mining profits (including petroleum extraction) are more than half the total and if you exclude them there has been no increase in the profit share.
"The council and bank are speaking power to truth," he said.
"Take mining out of the [equation] and the profits share is still historically high. This is at a time when the cost of capital in competitive markets is close to zero, and when low productivity growth demonstrates that high profits are not flowing exceptionally from innovation and entrepreneurship.
"The increased profit share reflects the increased role of economic rent in the Australian economy."
Professor Garnaut said the recent RBA review was an example of how policymakers were not dealing properly with the reality of the structural changes in the economy.
He said the RBA review was built on the premise that Australia's economy had performed reasonably well over the past three decades.
He said on average, over those three decades, it had performed reasonably well.
"But that average hides close to the lowest growth in productivity and output per person and real per capita household income amongst developed countries over the past decade, by averaging it with the developed world’s top performance in the 1990s," he said.
He said if you looked at Australia's terms of trade (our high export prices relative to import prices), a high terms of trade had historically been associated with pressures for higher real wages.
But Australia's terms of trade over the past year have been higher than ever before, and yet real wages have fallen more through last financial year and this financial year than in any other two-year period in our history.
"To understand these developments, we must look afresh at the role of rent," he said.
"After we have come to understand the changes in the structure of the economy that have produced these outcomes, restoration of economic dynamism and growth in ordinary Australians' standards of living is going to require policy coordination across parts of the economy that we have been managing separately," he said.
How lifting interest rates feeds higher inflation
Professor Garnaut said a genuine response to large structural changes in the economy required many institutions in different areas of policy to work together, with coordination across them.
He said policymakers must also allow themselves to use a variety of instruments to solve economic problems.
"As John Maynard Keynes once said, we need an orchestra with a range of instruments and a good conductor," he said.
He said as the market dominance of certain businesses and industries had grown, our over-reliance on monetary policy to manage inflation — and the economic cycle — had been having perverse outcomes for Australian households.
He singled out two parts of the economy in which economic rents were important, and in which standard approaches to monetary policy were driving prices higher: rents for houses, and energy supply.
"For housing and electricity prices and their large contributions to [inflation] and community concern, raising interest rates does more to raise than to lower prices," he said.
"Housing costs are currently a source of much community stress.
"The Bureau of Statistics data say that rents have been increasing at high rates and contributing substantially to consumer price inflation (CPI).
"Rents are increasing because record-high immigration rates are lifting demand, and investment in new residences is low.
"Higher rents feed into a higher CPI, which is interpreted by the RBA as a signal to raise interest rates again. Higher interest rates reduce investment in housing and after a time raise rents, and so strengthen the single-instrument case for even higher interest rates."
He wondered how, if our economic framework was designed differently, policymakers would try to reduce upward pressure on housing rent.
They would not think about raising interest rates, he said.
How to fix the rental crisis and bring power bills down
Professor Garnaut said policymakers would ease immigration until demand for rented housing was more closely aligned with supply, and they would look at easing restrictions on the supply of land on which residences could be built.
He said they would also consider if far more public investment in housing was warranted, and they would look at taxation arrangements that were encouraging owners of housing assets to keep some properties off the market, among many other things.
"And if [they] thought that higher interest rates were necessary for their effects in the rest of the economy, [they] would think about macro-prudential measures that reduce their impact on housing investment," he said.
He then turned to the energy sector.
He said higher oil, gas and electricity prices had been the largest contributors to higher inflation in Australia over the last 12 months, with electricity prices up over 15 per cent and gas over 26 per cent.
He wondered how, if our economic framework was designed differently, policymakers would go about reducing upward pressure on domestic energy prices.
He said they would not think about raising interest rates in the first instance.
"[They] would be aware that for many household users of power, the charges for using poles and wires represent about half the power bill," he said.
"Prices are regulated by arrangements that guarantee specified rates of return on past investment.
"The rates of return rise with higher interest rates, so higher interest rates feed directly into higher power prices.
"[And] to the extent that higher interest rates reduce demand for power — and the RBA sees rising interest rates reducing inflation because they reduce demand — the reduced use of poles and wires requires a compensating increase in prices to compensate for lower volumes of sales."
He said in such a situation, future policymakers would look at the regulatory arrangements that set prices for the distribution and transmission of power to make sure they served the public interest.
And when it came to the other half of the cost of electricity to users, which comes from the supply of wholesale electricity and profit margins for retailers, there were other things that could be done, he said.
"The increase in wholesale power costs has been driven overwhelmingly by increased prices for coal and gas," he said.
"Higher interest rates reduce domestic coal and gas prices a bit … but this effect is small compared with reductions that could come from driving a wedge between domestic and international prices.
"Placing caps on coal and gas prices as agreed by the national cabinet is one way of doing that. Alternatively, state governments onshore, or the Commonwealth offshore, could increase royalties, or the Commonwealth could increase profits-based taxation to support compensatory payments to some or all users of power.
"On retail margins, there are a few dominant retailers in each state electricity market, and much scope for oligopolistic pricing. So [policymakers] would be doing what [they] could to reduce, or at least avoid, increases in market concentration, and to make sure that retail margins were not markedly above those that could be justified in a competitive market," he said.
Overall, Professor Garnaut said to adapt to the structural changes that had occurred in Australia's economy in the 21st century, good policy would bring in a range of instruments, with renewed competition policy playing an important role in a new economic framework.
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