The cost of poor government policy

A research note from Macquarie has laid bare the extraordinary schisms in the consumer price index.

Market & government administered inflation gt

The economic system, what most people call capitalism, has had a rough trot in the publicity stakes for about a decade now. Anaemic wage growth and perceptions of soaring inequality have eroded confidence in government and business.

Between 2017 and 2018 trust in institutions fell in Australia, according to the latest international Edelman survey. We were almost classified in the “extreme trust loss category” in fact, ranked 7th out of 28 countries based on the change in trust over the two years.

The political farce playing out in Canberra this week is in part another symptom of that discontent. It is that rapid loss of popularity by new leaders that prompts politicians to rearrange the deck chairs in the hope of hanging on to power. To the extent increases in costs of living are the cause, governments aren’t doing much to get themselves out of this predicament.

Trying to shore up her embattled government on Tuesday, Foreign Minister Julie Bishop told the ABC’s 7.30 Report that “people want] to hear about how they’re going to get a job, how they’re going to keep a job, housing affordability, downward pressure on costs”. That may well be so, but the government hasn’t done much to lower costs.

On the surface the rate of inflation appears low. The Reserve Bank has struggled to coax it back to the midpoint of its 2 to 3 per cent medium-term target despite repeated forecasts to the contrary.

But a research note by Macquarie’s Justin Fabo laid bare the extraordinary schisms in the consumer price index.

As the accompanying chart shows, the prices of goods and services provided or heavily regulated by the government — think health, education, childcare, beer and cigarettes — have galloped ahead of those provided by private enterprise.

Since 2008 the prices of these goods and services have collectively risen more than 71 per cent. Meanwhile, the inflation rate for market-determined goods and services has been about 0.5 per cent a year — far below the average rate of wage growth. Suddenly, we have “strong real wage growth” if we strip out the government stuff. Alas people can’t: they tend to be the essentials.

To the extent poor policies are contributing to this rapid growth in prices, sluggish real wage growth is our own fault, not the fault of “capitalism”.

And it’s certainly not “free trade”. In fact it’s the tradeable goods, typically manufactured overseas, that have been keeping price inflation low. A trade war would be disastrous, putting pressure on the source of goods and services that’s done most to ease cost of living pressures.

The price of tradeable goods (which make up about 35 per cent of the CPI) are overall only 2 per cent higher than they were in 2011.

Even the fall in the Australian dollar hasn’t changed that. Fabo points out the “pass through” from movements in the currency to retail prices has become more muted than it used to be. There are no definitive explanations.

For all the criticism of the big supermarket chains, the price of groceries has been falling. The index of food and non-alcoholic beverages has barely risen since 2009. Market-determined goods and services overall, although making up 73 per cent of the consumer price index, have contributed less than a quarter of the headline inflation rate in the past few years. Electricity, childcare, medical and hospital services, school fees and property charges have been the main culprits, rising on average more than 5 per cent a year in recent years.

Nothing has done as much as tobacco though, to prop up the CPI. Continual increases in excise, which appear to be having less and less impact on the smoking rate, have ensured double-digit price rises annually since 2013. Cigarettes, consumed overwhelmingly by those on lower incomes, were up 17 per cent last year.

Childcare is the poster child of bad policy, where subsidies to parents have been gobbled up by providers at the same time as a heap of regulations has throttled businesses’ capacity to respond to demand. Its costs have risen 6.3 per cent a year on average since 2013.

It’s hard to know what happened in 2008 that sent public sector prices hurtling off in a different, higher direction. Sure, government services are often labour intensive, but wages, even those in the public sector, have been below 3 per cent a year. And governments always have the ability to buy no-labour inputs cheaply, given their buying power.

It must be poor regulation, primarily a refusal to take on the health and education unions that refuse to countenance changes, that would see prices fall.

Electricity prices were expected to fall as a result of the National Energy Guarantee, which is no longer happening.

“Most government-administered items have experienced weaker inflation in recent years relative to the post-2000 average,” Fabo says. Perhaps it’s some consolation that it’s not quite as bad as it was. Although with such meagre nominal wage gains, most people wouldn’t care for the curiosity.