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Lucky miners can dig deep, Australian Financial Review, 24 June 2008
When British Labour assumed office in 1997, one of its first acts was to impose a one-off ‘windfall profits tax'. The rationale was simple - the previous Conservative government had undervalued and under-regulated the utilities, and the owners had made far larger profits than could have been reasonably expected. In a single budget, the government raised £5.2 billion, helping to fund its welfare-to-work reforms.
Fast-forward eleven years, and Australian coal firms are experiencing undreamt-of prices for their output. Over the decade to 2007, the price of coking coal doubled. This year, the price has tripled. Which raises the natural question: should the Rudd Government take a leaf from the Blair playbook and consider a windfall profits tax on Australian mining companies?
The arguments in favour of a windfall mining tax are easily stated. From a fairness perspective, the industry's massive profits have come not through producing a better product or service, but because of an outside factor - China's stratospheric economic growth. The coal leaving the docks today is the same stuff we sold a decade ago; it just happens to be six times as valuable.
From an economic standpoint, the strongest argument for a windfall tax is that it has the potential to be non-distortionary. A one-off windfall tax levied on past profits should not change firms' behaviour, since it does not affect future costs and prices. For example, if the Australian government were to announce on 1 July 2009 that it was imposing a windfall tax on coal companies' 2008-09 profits, there is almost nothing the companies can change about their future investment decisions that will cut their 2008-09 tax bill.
Now the counter-arguments. Morally, the mining companies would no doubt argue that they already pay company taxes. Moreover, they might point out that they made their investments in good faith, and responsible governments should not change the rules in the middle of the game. These points deserve reasonable consideration. But if we regard Australia's mining companies more like lottery winners than as toiling entrepreneurs, a windfall tax looks more reasonable. Taxing luck is fairer than taxing hard work.
The miners would also be quick to contest the claim that a windfall tax can have little economic impact on their future decisions. And it is true that as soon as mining companies hear of the tax, their decisions will change. As a result, surprise windfall taxes are more economically efficient than anticipated ones. This may be one issue on which a full and robust public debate does not lead to a better outcome.
Companies are also likely to raise the spectre of repeated raids on their revenue. Having been levied once, what is to stop a windfall tax being imposed again? To counter this, the government must be clear that the present minerals price increases are a once-in-a-lifetime event, and so is the windfall tax. The less credible this claim, the more the tax will deter future investment in the sector.
With its coffers flush, does the Australian government really need more revenue? In the short-term, the answer is probably no. But history suggests that the next slump cannot be avoided, merely delayed. When the downturn hits, it would be better to have a rainy day fund than to be forced to borrow internationally or raise taxes on a sluggish economy.
No government should lightly impose windfall taxes, but in the right circumstances, they can play a valuable role. When the High Court declared certain state taxes unconstitutional in 1997, the Howard Government imposed a federal windfall tax to claim the revenue. In the United States, Barack Obama's pledge to impose a windfall tax on oil companies has met with significantly more approval from economists than John McCain's proposal for a gas tax holiday. Even the newly-elected conservative government in Italy has approved a ‘Robin Hood' tax on the nation's energy companies, and is trying to convince other European Union countries to do the same.
Few issues require such careful political management as a windfall tax. But implemented properly, it is possible to imagine that such a tax could be both economically responsible and in line with fundamental Australian values. Why not raise a little more from our lottery-winning miners today, and squirrel it away for the next recession?
Andrew Leigh is an economist in the Research School of Social Sciences at the Australian National University.
Keeping an Eye on the Ball, Australian Financial Review, 17 June 2008
Who let the economists out of the closet? As anyone who has followed economic research over recent years will have noticed, the profession has undergone a major shift in focus over recent decades. In the 1980s, most articles in the leading journals dealt with issues such as tariffs, inflation, growth and wages. Today, many economists are exploring corruption, happiness, drugs and religion. Issues that would once have been regarded as the exclusive domain of sociologists, medicos, or educationalists are now fair game for the dismal science.
Among the topics to which economists have turned their hand is the economics of sport, which has come off the bench and onto centre-field for one simple reason: researchers have shown that studying the sporting field can provide fundamental insights into human behaviour.
One sports economics classic is a paper by Pierre-Andre Chiappori, Steven Levitt and Tim Groseclose, who ask the question: are soccer players more likely to score a penalty if they aim at the left, middle, or right of the goal? Travelling at up to 200 kilometres per hour, a penalty kick reaches the line 0.2 seconds after coming off the boot. So the goalie must decide which direction to jump before the ball is kicked. Consequently, it isn’t surprising that penalty kicks score a goal 75% of the time. But for those that are kicked to the middle of the goal, this rises to 81%. So why don’t more players aim at the centre? Writing on his Freakonomics blog, Levitt points out that players face a difficult problem: “If you kick it right down the middle and you don’t score, it is damn embarrassing. … There are some things that are even more important than winning, like not looking like a fool.” Herein lies a useful lesson for managers: workers care about saving face as well as doing a good job. Seeing their players avoiding the middle too often, a clever soccer manager might offset the risk of embarrassment by secretly offering to pay players a cash bonus for every penalty kick scored down the centre.
What about that old couch potato question: does a good player make a good coach? Studying data from the US National Basketball Association, Amanda Goodall, Lawrence Kahn, and Andrew Oswald test what happens when a team hires a former star player as its coach. They find a large positive impact: if a team replaces a coach who never played NBA basketball with one who played many years of NBA All-Star basketball, it can expect to move 6 places up the ladder. One possible explanation is that a coach cannot push top players to their limit unless he has competed at their level. Or perhaps effective NBA coaching involves a considerable degree of ego-management, and only a former champion can win the players’ respect. Either way, the results have important implications for any high-performance workplace where the CEO must manage a large number of experts. From law to technology to universities, could it be that the best boss is a former all-star?
In the most controversial sports economics study of recent times, Joseph Price and Justin Wolfers test whether referees discriminate in favour of players of their own race. Using data from the NBA, where the assignment of referees is essentially random, they find strong evidence of an own-race bias. The more white referees, the fewer fouls that white players receive; the more black referees, the fewer fouls that black players receive. Since the referees tend to be whiter than the teams, this gives a slight advantage to teams with more white players. Although the study sparked outrage among the NBA, its findings accords with experimental evidence, which finds that when people are forced to make rapid decisions under pressure, subconscious racial biases come to the fore. And it suggests that when we ask individuals to make split-second decisions (police traffic stops, intense business negotiations, emergency rooms), we should expect to see discrimination rear its ugly head.
With its mix of competition and teamwork, high-stakes and high visibility, the sporting field turns out to be a valuable laboratory for testing many of the most interesting theories in economics. Optimal incentives, good management and racial discrimination are just a few of the questions upon which sports economics can shed light. As baseball great Yogi Berra said, “You can observe a lot just by watching”.
Andrew Leigh is an economist in the Research School of Social Sciences at the Australian National University.
Class in the Classroom, Australian Financial Review, 3 June 2008
It is rarely recognised, but Australia in the 1960s had two ingenious ways of keeping teacher quality high. First, rampant gender pay discrimination in the professions pushed many talented women into teaching (where gender pay gaps were generally smaller). Second, a highly regulated labour market meant that many companies rewarded their employees based on tenure, not performance - just as teaching did (and still does).
Over the past half-century, these two factors changed radically. On balance, the large-scale entry of women into business, law, and medicine has been a terrific development. But an unintended consequence is that fewer talented women now become teachers. And while the growth of performance pay has benefited many occupations, it has made the uniform salary schedules in teaching look increasingly unattractive to today’s graduates.
Although there are many talented teachers in Australia’s classrooms, there is also a growing realisation that Australia faces a crisis in teacher quality if it does not do more to attract the best into the teaching profession. But how should ‘best’ be defined?
One simple way would be to pay a higher salary to teachers who obtain a Masters degree. If undertaking a Masters degree improves classroom performance, then this would be a no-brainer. Unfortunately, at least three US studies have found that students’ test score gains are unrelated to whether or not their teacher has a Masters degree. And my own work - using data from Queensland primary school teachers - comes to the same conclusion. Bonus payments for teachers who obtain a Masters degree therefore seem a bad idea.
Another strategy - advocated in a report last week from the Business Council of Australia - is to establish a form of professional licensing for teachers. On its face, this strategy sounds uncontroversial. If doctors, lawyers and accountants have licensing systems, surely a teacher accreditation hurdle must be good? Yet what is often missed is that accreditation systems have two effects: they impose a quality bar, but because they are time-consuming, they also act as an entry barrier, deterring some talented people from entering the profession. Since these two effects go in opposite directions, it is theoretically possible for accreditation systems to raise, lower, or have no effect on quality. Indeed, studies that have looked at the impact of stricter licensing regimes for doctors and dentists find no evidence that they benefit consumers (although they do appear to raise wages).
The accreditation system proposed in the BCA report is modelled on the National Board for Professional Teaching Standards, which has accredited about 2 percent of US teachers. Yet it omits to mention that the typical NBPTS applicant devotes a whopping 357 hours to preparing an application. Given that one of the chief complaints of Australian teachers is excessive paperwork, this potential discouragement effect should not be underestimated. Consistent with this, economists Joshua Angrist and Jonathan Guryan found that US states which implemented a teacher certification system did not raise the academic standards of new teachers.
Given the drawbacks of pay-for-credentials schemes, a natural alternative is to consider pay-for-performance, in which the best teachers are identified by their principals, school inspectors, or through some objective measure such as student test score gains. Radical as this sounds to teachers’ ears, such an approach would be pretty similar to the way that salaries are determined for most workers (including state and federal bureaucrats). And while merit pay could theoretically have undesirable effects (breaking down staffroom camaraderie; encouraging teaching to the test; tempting teachers to cheat), the evidence from places as diverse as Israel, India and the US suggests that the advantages outweigh the disadvantages.
But don’t take my word for it. If we want to know the best way to identify the best teachers, let’s run a series of randomised trials: pitting the current system against various alternatives to see which one comes out on top. In the same way that we test new drugs before putting them on pharmacy shelves, we ought to be sure that strategies to attract and keep talented teachers actually work before rolling them out nationwide.
Looking back at the fall in teacher quality should give us some modesty about our ability to predict the future. In the 1960s, few would have predicted that less gender pay discrimination and more inequality would lower teacher quality. If the goal of policy is to boost teacher quality in the coming decades, let’s make sure it’s underpinned by the best evidence we can muster.
Andrew Leigh is an economist in the Research School of Social Sciences at the Australian National University.
Sorting Good Aid From Bad, Australian Financial Review, 20 May 2008
In his 2005 book The Undercover Economist, Tim Harford revealed that fair trade coffee in some London stores cost an extra 25 pence per cup, but that only about a tenth of the markup actually reached the coffee farmer. A fair trade cappuccino might have given the drinker a warm inner glow, but it didn’t do much to reduce world poverty.
Its harshest critics sometimes say the same about overseas aid. They point out that unlike the voters who judge domestic programs, the recipients of foreign aid cannot punish bad policy at the ballot box. Aid’s critics say that with a few exceptions – like disaster assistance – the world would be better off with less aid, not more.
With this year’s budget promising a major increase, Australia’s overseas aid is set to rise from 0.3% to 0.5% of national income by 2015. So the billion-dollar question is: does aid work?
At an aggregate level, it turns out to be depressingly difficult to identify an impact of foreign aid on a country’s level of development. In the 1990s, a series of studies reached ambiguous conclusions. In a famous paper in 2000, Craig Burnside and David Dollar found that that aid did raise growth – so long as the recipient country had good fiscal, monetary and trade policies. Three years later, William Easterly, Ross Levine, and David Roodman found that these results were fragile, and did not hold up when more years of data were added to the analysis. Subsequent research by Paul Collier contends that even in badly-governed Africa, poverty rates would today be much higher had the continent received no aid.
Most recently, Jeffrey Sachs has argued that much foreign aid in the post-war era was directed towards winning the Cold War rather than helping the poor. According to Sachs, we should not discriminate against countries with bad institutions; instead we should be ruthless about not giving the wrong kind of aid. Good aid, argues Sachs, can make a difference.
This research offers two challenges to Australia. If aid only works when policies and institutions are strong, should we keep giving around one-third of our aid to Papua New Guinea and the Pacific? Ethically, it would be tough to justify withholding charity from some of the world’s neediest people. And given that they are on our doorstep, it is difficult to imagine excluding ‘fragile states’ from the Australian aid program. Yet the research suggests that despite all the hard work that is being done by aid workers in these countries, there is little chance living standards will take off any time soon.
The other challenge for our aid program is to distinguish between good and bad aid. This is a particularly thorny question at a time when the program is being expanded. This year, AusAID’s budget will rise from $3.2 to $3.7 billion. The last thing we want to happen is for the agency to lower its standards in order to get more cash out the door.
Here, the brightest hope for the aid program is that AusAID is taking seriously the question of aid effectiveness. On the last parliamentary sitting day before Easter, Parliamentary Secretary Bob McMullan quietly tabled the first annual report of the Office of Development Effectiveness – an agency established to monitor the overseas aid program.
Carrying out what it called a “health check of the Australian aid program”, the report critiqued aspects of the aid program in surprisingly robust terms. Discussing technical assistance (providing advice, or sending an Australian public servant to fill a role in a developing country bureaucracy), it pointed out that we spend twice as much as other rich donors, and warned that some of our technical assistance programs may undermine the capacity of poor countries to govern themselves. Discussing evaluation, the report emphasised the importance of carrying out more impact evaluations – asking not only whether the program was properly administered, but also whether it helped improve the lives of the poor.
The frankness of AusAID’s Annual Review of Development Effectiveness stands in stark contrast to the self-congratulatory mush of most government reports. Indeed, it is impossible to imagine the health, education, or defence departments putting out such a self-critical report. This kind of hard-headed approach is particularly valuable given that overseas aid is an area where too many advocates have focused on inputs (aid as a percentage of national income) rather than outputs (poverty reduction). Alongside a multi-billion dollar increase in foreign aid must come more scrutiny of results. If we care more about making a difference than getting a warm inner glow, distinguishing good aid from bad aid is the only way to go.
Andrew Leigh is an economist in the Research School of Social Sciences at the Australian National University.
Putting a HECS on Life, Australian Financial Review, 6 May 2008
With budget season upon us, stand ready for interest group after interest group to picture the government as kind old Uncle Oz. He gives to so many, they will argue, so why not to us? Surely a few more dollars to our special cause couldn't hurt? (Cue heartrending description of flashy infrastructure project, photogenic industry, or working family.)
The problem with this notion is that most kindly uncles don't come knocking on the door on 31 October, asking for a tax bill to pay for next year's goodies. So rather than focusing on government's role in distributing largesse, some economists - chief among them Australian National University economist Bruce Chapman - have argued that we should think of government as a piggybank, helping us to manage risk and uncertainty over our lives.
Chapman's leading contribution to policy has been the Higher Education Contribution Scheme. Adopted in Australia in 1989, HECS requires students to pay back a portion of their university tuition when their earnings pass a given threshold. If earnings drop below the threshold, no repayment is required. By requiring students to contribute to the cost of their education, HECS recognises the substantial private benefit to attending university. Its ‘study now, pay later' approach helps smooth income over the lifecycle, and ensures that the poor are not prevented from enrolling.
Since 1989, HECS has been taken up by Ethiopia, New Zealand, Thailand, and the United Kingdom. Having had more influence over worldwide policy than any other Australian economist of his generation, one might have thought that Chapman would retire to the ivory towers. But instead he has set about applying the same idea - loans instead of grants - to a wide variety of policies. Here are just a few.
* HECS for Drought Relief: When heavy rains reduce profits in beachside resorts, policymakers typically do nothing. Yet when drought hurts farmers, the government is ready with a handout. Politically, it is unlikely that we could scrap drought assistance programs. But a better way to deliver it would be through income contingent loans, repayable in good times. So long as loans are targeted towards farms with viable long-term prospects, they would help reduce volatility for farmers, while requiring those who are able to repay the loans to do so.
* HECS for Sportspeople: For those lucky enough to win a place, the Australian Institute of Sport offers elite athletes one of the best training programs in the world. Partly as a result, many AIS graduates go on to perform at the elite levels of their sport. Yet AIS graduates with seven-figure earnings - among them Lleyton Hewitt, Mark Viduka and Jelena Dokic - are not required to pay back a cent of the cost of their training. If a HECS-style loans scheme was put in place for elite athletes, the size of the AIS could be significantly increased with no additional cost to the taxpayer.
* HECS for Parents: Once upon a time, assistance to families went only to the poor. Over the last decade, changes in the Baby Bonus, Family Tax Benefits and Child Care Benefits have seen family payments grow steadily more generous for the middle and top of the income distribution. Yet Australia remains one of the few developed countries that without government-funded paid maternity leave, prompting calls for another family payment to be introduced. One answer would be for government to offer paid maternity leave through an income contingent loan - thereby providing families with more money at the time of life when they need it most, without unfairly redistributing resources from poor singles to rich families.
* HECS for Fine Defaulters: When it comes to collecting fines, governments are the world's worst debt collectors. One study estimated that the Victorian government managed to collect just 44 percent of court-imposed fines. Because we are reluctant to send non-payers to jail, and because enforcement often costs more than the fine itself, the justice system is left impotent in the face of rampant non-payment. In the same way as the taxation system is used to deduct Child Support payments from the incomes of non-custodial parents, it could be used to ensure that recalcitrant criminals paid their debts.
Once you start thinking about government as piggybank, the world starts to look very different. (You may find yourself asking questions like ‘if artists want more money, why not replace grants with loans?') Fundamentally, Chapman's simple idea accords with the Australian ideal of a fair go: helping people in their time of need, but also expecting them to give a little back when times are good. For a government with more ideas than dollars, expanding income contingent loans might be just the solution.
Andrew Leigh is an economist in the Research School of Social Sciences at the Australian National University.
Some Nuggets in the Dross , Australian Financial Review, 22 April 2008
Was it the Bold and the Beautiful, or the Young and the Restless? Big Brother, or the New Inventors? By any measure, the weekend’s 2020 summit was an unusual event. Whether it was Philip Adams embracing Barry Jones, Hugh Jackman singing a duet with Ted Wilkes, or glimpses of Cate (‘I did but see her passing by’) Blanchett, there always seemed to be something to surprise. And by Sunday afternoon, even the more sceptical summiteers seemed happy to play Tenzing Norgay to Rudd’s Edmund Hillary.
From my own perspective, the greatest insights came from chatting with indigenous leader Tania Major about her experiences in improving educational outcomes for children in Cape York. The sessions themselves had policy wonks clashing with practitioners, sometimes producing light, sometimes heat. The group discussing labour market reform was, in the words of one participant, ‘simulating a failed state’'. Yet the final communiqué was surprisingly coherent, proposing a major tax review, a rethink of early childhood intervention, and a new federalism.
Some of the outcomes might have been predicted from the outset. The foreign affairs and defence stream proposed the creation of five institutes, a forum and an advisory council. The journalist-heavy governance stream proposed a reform of Freedom of Information laws. And the culture stream proposed as one of their ‘low-cost’ ideas that an additional 1% of the federal budget ($2.5 billion) be devoted to the arts.
But other ideas were not so predictable. In particular, three small ideas caught my fancy.
* The communities stream proposed rewarding young Australians for volunteering in disadvantaged neighbourhoods by providing them with a HECS discount. Such a program might be modelled on AmeriCorps, a US scheme that provides education credits and a living allowance in return for spending a year working with a community sector organisation. Each year, approximately 75,000 young Americans participate in AmeriCorps, and many continue to work with the community after their service year ends. Implemented here, a similar program might have practical benefits for underprivileged communities. But its ‘eye-opening’ benefits could be greater still – giving affluent suburban youth a chance to spend a year facing disadvantage in all its complexity.
* The health stream proposed the creation of a ‘Healthbook’ (Facebook for your health information) that would allow people to share their medical records with their doctors. Ever had to cancel a doctor’s appointment because the x-rays have not yet been mailed across? Ever moved city and had to start from scratch with a new doctor? At a relatively modest cost, Healthbook could make medical records secure and portable. Indeed, it might even allow individuals to share their genetic information with doctors, while keeping it confidential from other organisations.
* The governance stream proposed that Australia establish a public affairs TV channel – AuspanTV – to provide Australians with first-hand access to policy debates, book launches, and conferences. Modelled on C-span in the United States, which has 50 million regular or occasional viewers, Auspan would aim to connect Australia to the global community of ideas. While Canada has two public affairs channels, Australians presently have no dedicated network through which to access local and international speeches, public lectures, and in-depth interviews. Established as free-to-air digital channel, AuspanTV might be an effective means of democratising public debates over the nation’s past and future.
The comparative advantage of an event like the 2020 summit is not in addressing the nation’s most complex problems. For all the good intentions of the summiteers, the event probably did little to advance debates around climate change or defence strategy. But I was struck over the weekend by how many nuggety little ideas emerged; not just in the official documents, but in conversations between participants, bureaucrats, and politicians. Putting these into action probably won’t change the course of history – but they might yet improve the lives of thousands of Australians.
The other recurring theme that came up in my conversations with other delegates through the weekend was the frisson of happiness that many felt at being allowed ‘inside the tent’. By definition, summits, community cabinets, and other listening exercises can only invite a few at a time. But those who enjoy permanent insider status should not underestimate the role that such events play in ensuring that new voices are heard.
Andrew Leigh is an economist in the Research School of Social Sciences at the Australian National University. He was a delegate in the productivity stream of the 2020 summit.
A Good Test of Public Policy, Australian Financial Review, 8 April 2008
To get a new drug approved in most developed countries, it is necessary to show that it works in a randomised trial. Yet to get a new policy approved, politicians need no evidence of efficacy. Consequently, while we can be confident that most pharmaceuticals work as intended, it is quite possible that some of our social policies do more harm than good.
To understand why medical scientists rely so heavily on randomised trials, we need to go back to the purpose of an evaluation. In judging the effectiveness of any intervention, we want to know the counterfactual: what would have happened if we had not intervened? In the case of a new pharmaceutical, those who choose to take a drug are probably different from those who choose not to take it. Perhaps pill-poppers worry more about their health, or maybe they live closer to the doctor. If so, then those who chose not to take the drug are a bad comparison group for those who actually took the drug.
Enter the randomised trial. By assigning participants to the treatment and control group with the toss of a coin, we can be sure that the characteristics of both groups are identical at the start of the trial. So at the end of the experiment, any differences in outcomes must be due to the intervention.
What works in the laboratory can also work in many areas of policy. Here, the power of randomised trials lies in two things. From a statistical standpoint, they are regarded as the ‘gold standard’ of policy evaluation, beloved by policy wonks. And from a policymaking standpoint, randomised trials are the simplest form of evaluation, providing compelling results in a simple graph.
In the policy arena, the United States has conducted many more randomised trials than any other country. For example, one of the reasons that early childhood intervention is so high on the policy agenda is the results from the Perry Preschool program. For social researchers seeking to understand neighbourhood effects, there is no better source of evidence than the five-city Moving to Opportunity experiment. Many of the early insights about health insurance came from the RAND Health Insurance Experiment. And wage subsidy programs rapidly gained ground after the National Supported Work Demonstration was conducted.
Randomised policy trials can also show up policy failure. A randomised evaluation of the US Job Training Partnership Act found that job training for low-skilled youths did not make them more employable. Randomised evaluations of pre-licence driver education programs have found no evidence that it makes youths into safer drivers. And DARE, a school-based anti-drugs program, was revised following randomised trials showing that the program did not deliver promised results.
One excuse that Australian policymakers sometimes give for failing to conduct randomised trials is that they cannot face the ethical dilemma of denying some people a potentially beneficial new program. But here again, the policymakers can learn from medical researchers.
For the past two years, an NRMA CareFlight team, led by Alan Garner, has been running the Head Injury Retrieval Trial, which aims to answer two important questions: Are victims of serious head injuries more likely to recover if we can get a trauma physician onto the scene instead of a paramedic? And can we justify the extra expense of sending out a physician, or would the money be better spent in other parts of the health system?
To answer these questions, Garner’s team is running a randomised trial. When a Sydney 000 operator receives a report of a serious head injury, a coin is tossed. Heads, you get an ambulance and a paramedic. Tails, you get a helicopter and a trauma physician. Once five hundred head injury patients have gone through the study, the experiment will cease and the results will be analysed.
Although he has spent over a decade working on the trial, even Garner himself admits that he doesn’t know what to expect from the results. “We think this will work”, he told me a in a phone conversation last week, “but so far, we’ve only got data from cohort studies”. Indeed, he points out that “like any medical intervention, there is even a possibility that sending a doctor will make things worse. I don’t think that’s the case, but [until HIRT ends] I don’t have good evidence either way.”
For anyone who has heard policymakers confidently proclaim their favourite new idea, what is striking about Garner is his willingness to run a rigorous randomised trial, and listen to the evidence. Underlying the HIRT is a passionate desire to help head injury patients, a firm commitment to the data, and a modesty about the extent of our current knowledge. What area of Australian public policy could not benefit from a little more of this kind of thinking?
Andrew Leigh is an economist in the Research School of Social Sciences at the Australian National University.
Getting School Funding Right, Australian Financial Review, 25 March 2008
Of all the policy debates in Australia, school funding is perhaps the feistiest. If you have children at school, you’re an instant expert. If not, you can always talk about how things were when you went to school. So even the merest whiff of change is guaranteed to prompt a barrage of talkback calls and bagfuls of letters to the editor. Add a dash of religion and a pinch of class warfare, and you have all the ingredients for a first order political barney.
Yet as Julia Gillard’s recent entry into the debate illustrated, school funding is an area that desperately requires reform. Indeed, it may be that the best way of delivering on the promise of equality of opportunity is to get school financing right.
The last revolution in school funding occurred with the Howard Government’s 2001 shift to fund private schools based on parents’ socioeconomic status. Introduced by then education minister David Kemp, the so-called ‘SES formula’ aimed to ensure that schools with more students in poor neighbourhoods got more money.
Unfortunately, the 2001 reforms also included a guarantee to all private schools that if the SES funding formula made them worse off, then they would receive their year 2000 funding amount, adjusted for inflation in the education sector. Seven years later, this ‘grandfather’ clause applies to about half of Australia’s private schools; making a mockery of the notion that private school funding is needs-based.
Another odd feature of the current school funding scheme is that private schools do not adjust their fees to take account of differences in the ‘voucher amount’ that parents bring to a school. For example, high school students in the most advantaged suburbs last year brought their schools just $1333 in federal funding, while those in the most disadvantaged suburbs were worth a whopping $6807 apiece. Yet the typical high-end private school did not offer a $5000 discount to poor parents.
Rather than arguing over particular policies (which themselves often reflect the oddities of historical compromises), the best way of moving the school funding debate out of the ideological mire might be to see whether we can reach agreement over the basic principles that should guide the debate. Here are four core notions that I think all sides should be able to agree to.
First, the wellbeing of children is more important than anyone else. Teachers and school administrators matter, but the top priority of education policies is to help kids, not adults.
Second, we should not penalise parents for spending more on their children’s education. To the extent that education has ‘positive externalities’ (higher productivity, more social capital, better civic engagement), we should encourage it. There is a real difference between a policy that says ‘the richer you are, the less the government should give your child’ and one that says ‘the more you spend on your child’s education, the less the government should give you’. The former targets resources to those who need them most, while the latter operates like an education expenditure tax.
Third, schools should be judged on outputs, not just inputs. At present, the federal government allocates billions of dollars to private schools, but asks little in return. Taxpayers who fund these schools have a right to demand that they provide empirical data such as test scores, dropout rates, or parental satisfaction surveys.
Fourth, funding should be transparent. Parents should know precisely how much government funding they bring to their child’s school.
Acceptance of these four basic principles could lead to better reform of our education system.
Recognising that kids come first, we might agree that it is good for a child to move to a better school (though we might still argue about how to help those who remain).
Accepting that we should not penalise education spending might allow us to revamp the private school funding formula so that all schools are financed according to their needs. Middle-income parents who choose to send their children to high-fee schools should get more government assistance than rich parents who opt to send their children to low-fee schools.
Measuring outputs would help parents select the best school, and let voters find out which private schools are adding value, and which ones are skimming the cream.
And making funding transparent puts the bargaining power in the hands of low-income parents, who can march up to the principal and ask why they’re bringing the school nearly $7000 in federal funds, yet not getting a discount on their tuition.
Ultimately, getting private school funding right is essential if the system is to be applied to public schools, as Gillard has proposed. Tantalising as it is to envisage public schools in the poorest neighbourhoods bidding six-figure salaries to attract the best teachers, there’s a long way to go yet.
Andrew Leigh is an economist in the Research School of Social Sciences at the Australian National University.
Shedding a Healing Light, Australian Financial Review, 11 March 2008
One of the astonishing statistical regularities of human life is the bell curve. Plot the test results of a class of students, the running times of a group of adults, or the blood pressure of men and women, and you will find that they trace out a bell-shaped pattern. At the very edges of the bell are a few people who do very well or very badly. As we move towards the centre there are others who are noticeably below average or above average. And the rest are clustered in the middle. So established is this pattern that statisticians call it “the normal distribution”.
In the case of the medical profession, the same pattern holds. Whenever data on the performance of hospitals or individual doctors is plotted on a curve, large gaps separate the best and the worst. There is nothing surprising in this; most of us can probably imagine the same distribution of performance in our own occupations. Yet it does suggest that choosing the right doctor can be good for your health.
Because information can help more patients choose the best service, and spur reform among the rest, it seems natural to think that data on hospital performance should be made publicly available. (Adjusted, of course, for the fact that some hospitals deal with older and sicker patients than others.)
To her credit, federal health minister Nicola Roxon has been pushing for just this outcome, supported by consumer group Choice. But attempts for more health data to be released into the public domain have been strongly resisted by the Australian Medical Association and some state governments. Their opposition to data release has been based around two arguments - both of which will be familiar to anyone who has followed the debate over the release of schools’ test score data.
First, they argue, the performance measures are imperfect. This is undoubtedly true, but it sets the bar too high. Last week, the Australian Financial Review published its list of Australia’s best lawyers, based on peer assessment. No-one would contend that these rankings are flawless, but they nonetheless provide a useful source of information to clients seeking to choose a lawyer, and may spur those who just missed out to lift their game.
Second, those who oppose data being released claim that it will lead to underperforming hospitals being stigmatised. But so long as the data are collected so as to minimise the potential for manipulation, and provide the broadest possible set of indicators, it will help identify the strongest and weakest hospitals. Rather than allowing poor performance to continue under a veil of secrecy, we should let a little sunlight in.
In his book Better: A Surgeon’s Notes on Performance
Making hospital performance information publicly available should help all patients, but there are good reasons to think that the poor may benefit more than the rich. Under the current regime, information is restricted to doctors, nurses, and hospital administrators, who naturally share it with their friends. Publishing statistical data on hospital performance would democratise access to information - allowing everyone to see what the insiders already know.
In attempting to change the culture of information in Australian health, it is possible that those in favour of secrecy will prevail. Yet if they do, the effect may be to promote less reliable sources of information. For example, one rapidly growing website allows Australian patients to rate their doctors. But a quick browse shows it to be dominated by the ecstatic and the enraged. (Moreover, you also have to wonder about a site in which the infamous Queensland surgeon Jayant Patel is rated “average”.) The more comprehensive public data is, the less individuals will need to rely upon questionable sources of information.
Just as in the case of schools, making data on hospitals publicly available is a useful first step to spur reform. When insiders claim that the public can’t handle the truth, we should respond that taxpayers have a right to receive feedback on the services we fund. The more we can learn from the best, the better our public services can become.
Dr Andrew Leigh is an economist in the Research School of Social Sciences at the Australian National University.
Give Peaceful a Chance, Australian Financial Review, 26 February 2008
Writing the story of his childhood, Barack Obama narrates an incident in which his father was drinking in a local bar, when a white man abruptly announced that he shouldn’t have to drink “next to a nigger”. The bar fell silent, expecting a fight. Instead, Obama’s father “walked over to the man, smiled, and proceeded to lecture him about the folly of bigotry, the promise of the American dream, and the universal rights of man”. When the speech finished, the white man reached into his pocket and handed over a hundred dollars on the spot; so ashamed of himself he wanted to purchase forgiveness.
Eighteen months ago, Presidential prediction markets had Obama just a 1 in 50 shot of winning the nomination. Now, he is a 4 in 5 chance of being the Democratic nominee. Obama’s meteoric rise can be traced to two themes – hope and bipartisanship. But how has he managed to turn apparent platitudes into rallying cries? And could a little of the Obama magic rub off on Australia’s politicians?
Obama’s ability to use powerful rhetoric to inspire others has drawn comparisons with John F. Kennedy, Martin Luther King, and Abraham Lincoln. Few doubt that he is one of the best speakers of his generation. Yet the critics argue that stirring oratory matters less than solid public policy. So long as you get the ideas right, who cares whether you can make a crowd laugh and cry?
The problem with this critique is that it misses the point that successful politics is about building and maintaining coalitions. This is particularly true of the United States president, but also to a lesser extent of the Australian Prime Minister, who generally must win over a hostile Senate in order to pass legislation.
Creating broad-based coalitions is difficult if you regard your political opponents as knaves and ideologues. What is striking about Obama is that he goes out of his way to see the reasonableness in the other side’s positions. “Spend time actually talking to Americans”, he writes in his most recent book, “and you discover that most evangelicals are more tolerant than the media would have us believe, most secularists more spiritual. Most rich people want the poor to succeed, and most of the poor are both more self-critical and hold higher aspiration than the popular culture allows.”
Recognising that your political opponents are actually striving towards a better world sounds simple; but it is surprising how rarely it is done in Australia. Most federal politicians, and most federal political staffers, have no friendships with anyone from another party. This lack of social contact makes it easy for them to caricature and stereotype their opponents; and stymies the attempt to build lasting political coalitions for change.
What many political players miss is that it is possible to respect and understand your opponents’ perspectives without compromising your own beliefs. Obama has one of the most left-wing voting records in the Senate, but that hasn’t stopped him from criticising the left-wing Daily Kos blog for its ad hominem style. In Australia, one wishes that more politicians walked into Question Time aiming to ‘disagree without being disagreeable’.
While the Rudd government has quickly demonstrated its commitment to rigorous public policy, it would be good to see it governing in both poetry and prose. The bipartisan ‘war cabinet’ to address Indigenous disadvantage is a useful start, but more could be done that unites the values of both left and right. Cutting back on middle-class welfare, improving the performance of schools in disadvantaged areas, improving the incentives for low-skill workers to join the labour market, and carrying out a raft of randomised trials are all initiatives that should be able to transcend the political divide. Yet without bipartisan support, it is easy to see how vested interests will torpedo them one by one.
How positive should we be about the politics of hope and bipartisanship in Australia? To answer this question, I searched the parliamentary database for speeches by Bob Hawke, Paul Keating, John Howard and Kevin Rudd, looking to see how often each used “hope” and “bipartisan”. To account for the number of speeches they had given, I then normalised this using other common parliamentary words: “speaker” and “member”. A rough proxy, to be sure, but one that might nonetheless give insights into the rhetorical priorities of Australia’s last four Prime Ministers.
According to this simple metric, Bob Hawke is the Prime Minister who has spoken most about hope, while Kevin Rudd is the Prime Minister who has spoken most about bipartisanship (Paul Keating scores lowest on both measures). Perhaps Rudd’s speechwriting team should take a leaf from Hawke’s book. And maybe they can learn from Obama’s style, and find fresh ways to tap into the fundamental optimism of the Australian people.
Dr Andrew Leigh is an economist in the Research School of Social Sciences at the Australian National University.
Moving away from trouble, Australian Financial Review, 12 February 2008
As the machinery of government passes to Labor, a bevy of new buzzwords has hit Canberra. Less talk of free nations, markets, and efficiencies. More discussion of working families, apologies, and challenges. And among the new terms being bandied about is “social inclusion”. A new Social Inclusion Unit has been established in the Department of the Prime Minister and Cabinet, and the government is presently canvassing for a Social Inclusion Board.
If the example of British Labour’s Social Inclusion Unit is anything to go by, a core focus of the Australian social inclusion initiative will be on neighbourhood disadvantage, and on answering the question that has puzzled social scientists for decades: Would a poor family do better if they lived in a middle-class neighbourhood than if the same family lived in a low-income community?
From a theoretical standpoint, there are good reasons to think that neighbourhoods might matter. If getting a good job depends on informal ties, then it will be easier to find work if most people in your street are employed. If community norms count for a lot, then poor children who grow up in poor neighbourhoods may find it harder to break out of the poverty cycle. And because low-income communities also tend to have worse public amenities and higher crime rates, living in these places may be bad for your physical and mental health. If these theories hold, then they have major implications for housing policies; suggesting that mixed-income neighbourhood should be the name of the game.
But separating the effects of being poor from living in a poor place turns out to be a tricky research problem. To find good answers, we have to cross the Atlantic to the United States, where an ambitious five-city randomised trial has provided some of the best evidence to date on how neighbourhoods affect individuals’ life chances.
Implemented in 1994, Moving to Opportunity offered families in public housing projects in Baltimore, Boston, Chicago, Los Angeles and New York a voucher that would enable them to rent in a lower-poverty neighbourhood. Because demand outstripped the number of available vouchers, the vouchers were randomly assigned through a lottery. As with a randomised medical trial, this ensured that at the outset, those who moved to lower-poverty neighbourhoods (the treatment group) were identical in all respects to those who stayed (the control group).
In the early-2000s, economists Jeffrey Kling, Jeffrey Liebman, and Lawrence Katz followed up the experiment, to judge how a change of neighbourhood affected those in the treatment group. Contrary to some initial expectations, they found no significant impacts on adults’ employment outcomes. Movers were no more likely to have a job than stayers, nor did movers tend to earn higher wages. Summing up the evidence on earnings, the researchers concluded that “housing mobility by itself does not appear to be an effective anti-poverty strategy”.
But money isn’t all that matters. Asked why they wanted to leave the housing projects, many participants said “to get away from drugs and gangs”. Consistent with this, the follow-up study found that those who moved to a lower-poverty neighbourhood had better mental health. Indeed, the psychological benefits of moving were so large and consistent that they alone could have justified the cost of the program.
Might Moving to Opportunity have implications for Australia? According to a paper by Australian National University researchers Bob Gregory and Boyd Hunter (in my view, the best piece of unpublished economic research in Australia), the economic indicators in Australian neighbourhoods have diverged markedly since the 1970s. If you walked across Australia in the mid-1970s, you would have seen much more similarity in employment and earnings than if you trod the same path today.
This growth in neighbourhood inequality led Gregory and Hunter to warn of the growth of Australian ‘ghettos’, and to suggest that better understanding patterns of poverty should be placed high on the national agenda. One way of building on this research would be for Australia to conduct its own Moving to Opportunity experiment – offering randomly selected families in large public housing projects the chance to move to a middle-income suburb.
The best way to redress disadvantage is to put our ideas to the test. As 19th century British economist Alfred Marshall once said, we should combine “cool heads and warm hearts”. If the federal government’s social inclusion agenda prioritises evidence and results over ideology and rhetoric, it will be off to a fine start.
Dr Andrew Leigh is an economist in the Research School of Social Sciences at the Australian National University.
Shares still beat roulette, Australian Financial Review, 24 January 2008
Despite talk in recent years about Australia being better shielded from global fluctuations, it still seems that when America sneezes, Australia catches a cold. And with our stock market losing nearly an eighth of its value over the past fortnight, some investors are naturally wondering whether shares are really such a good place to keep their assets (as distinct from, say, a shoebox under the bed).
In such an environment, it’s worth recalling a few lessons that economics research has taught us about the stock market. While some have become common wisdom among investors, others are yet to percolate from the campus to the trading floor.
The first is that the long-run record of stocks is very good. While shares are typically more volatile than property and bonds, their long-run performance has been better. Particularly for investors with a reasonable time horizon, nothing beats shares. This is why investment advisers typically suggest that a person in their twenties or thirties should have more than half of their investments in shares (a rule of thumb that is sometimes difficult to follow if you want to also buy a house in a big Australian city).
The second lesson is that most traders trade too frequently for their own good. In a paper in the American Economic Review last year, Ilia Dichev (University of Michigan) showed that in most share markets around the world, the typical ‘buy and hold’ return is higher than the ‘dollar-weighted’ return. From 1973-2004, the typical stock on the Australian market earned a return of 12.3 percent per year. But the typical investment dollar earned an annual return of 11.7 percent. The problem is that investors tend to buy and sell at the wrong times – overinvesting in stocks just before they peak.
The moral here for investors is that a passive investment strategy tends to lead to better long-term returns than jumping from fad to fad. Such a strategy avoids the mistakes identified by Dichev, and minimises brokerage fees. (Incidentally, the same often holds true in at the supermarket, where switching from one checkout line to the next is rarely optimal.)
The third lesson from economics is that in an efficient market, stock prices incorporate all publicly available information about the firm. Consequently, short-run changes in stock prices cannot be predicted. As Burton Malkiel put it in his 1973 classic, A Random Walk Down Wall Street, this means that a portfolio chosen by “a blindfolded monkey throwing darts at a newspaper’s financial pages would do just as well as one carefully selected by the experts”.
A clear implication of Malkiel’s study is that investors cannot make money from obvious information. For example, the recent rise in Australia’s birth rate is likely to increase consumer demand for baby toys. But any consequent increase in profitability in toy-making companies has already been factored into their share prices.
A less obvious implication is that index funds tend to outperform managed funds. Tracking 355 US equity mutual funds over the period 1970-2001, Malkiel showed that only 22 managed to achieve a higher return for their investors than the S&P 500 index. Of the remaining 333 funds, 50 achieved about the same returns as the market as a whole, 86 underperformed the index, and 197 did not survive.
But surely the 22 high-performing funds have something to brag about? Not so fast. To test whether their success was due to luck or skill, Malkiel took the best-performing funds of the 1970s, and looked to see how they did in the 1980s. In virtually all cases, outperformance in one decade was followed by underperformance the following decade. The same was true the next decade. The top mutual funds in the 1980s tended to be low-performers in the 1990s. Rarely do active money managers make enough to justify their fat fees. Most investors would do better in an index fund.
Of course, all this ignores the fact that many day traders are in the markets not only to make a buck, but also for the excitement of buying and selling. After all, where’s the adrenalin rush from following sensible economic principles and putting your money in an index fund? While few traders consistently beat the market, most still manage to turn a profit. If it’s a choice between the share market and the casino, go for shares – and may Lady Luck smile upon you.
Dr Andrew Leigh is an economist in the Research School of Social Sciences at the Australian National University.
What turns the aid tap on, Australian Financial Review, 10 January 2008
Just over three years ago, the 2004 Boxing Day tsunami struck, wreaking havoc in Indonesia, Thailand, India and Sri Lanka. With little else to occupy the Australian media during January 2005, the tsunami received near-blanket coverage over subsequent weeks. In total, the Australian public donated nearly a third of a billion dollars to help the victims.
At the time, many commentators attributed this to the natural generosity of the Australian people. But might it also have had to do with the timing of the tsunami? Or to put the question another way: if the disaster had been on page ten rather than page one, would Australians have been as generous?
If two recent studies are to be believed, the answer is probably no. Analysing the factors that predict private donations to World Vision and public grants through AusAID’s emergency relief scheme, Simon Feeny and Matthew Clarke found that the more newspaper articles written about an overseas disaster, the more money Australians gave. A 10 percent increase in the number of articles was associated with a 10 percent increase in the amount of money given by private donors, and a 37 percent increase in the amount of money given by AusAID.
But while media coverage might be idiosyncratic, it could also tell us how ‘needy’ the victims are. So to get at the true causal impact of the media, we need some source of variation in coverage that is unrelated to the crisis itself. In their study of disaster relief provided by the United States government over the past thirty years, Thomas Eisensee and David Strömberg come up with a clever solution: they look at how domestic preoccupations affect a nation’s generosity. What happens when an overseas famine, volcano or flood occurs at the same time as an event of local interest such as the Olympics, the OJ Simpson trial, or an American school shooting?
Eisenee and Strömberg show that when the US media is preoccupied with another story, it is less likely to pay attention to the international crisis. In turn, this has a direct impact on US government donations. To have the same chance of receiving US assistance, a disaster the coincides with the Olympics needs to have three times as many casualties as a disaster occurring on a regular news day.
Coverage of international disasters also seems to skew aid in other ways. In both Australia and the United States, visually dramatic events such as volcanoes and floods receive significantly more media than famines and civil wars. According to Eisenee and Strömberg, for every person killed in a volcano disaster, 40,000 people must die in a drought to receive as much media coverage. Access matters too. For an African disaster to receive as much media coverage as an Eastern European disaster, 40 times as many people must die.
These studies have profound implications for slow-moving African crises, such as the humanitarian crisis in Darfur. With fewer images to put on the television screen and the front page, Darfur rarely rates a mention outside the foreign affairs pages of serious newspapers. As a result, Sudan’s evacuees probably receive a smaller share of international assistance than would people displaced by a volcano in South East Asia.
Sometimes the neediest causes are not the most newsworthy. Several months after the Indian Ocean tsunami, a famine in Niger killed around 360,000 people. As Feeny and Clarke point out, this was a higher death toll than in the tsunami. Yet the Niger famine received minimal media coverage, and less than one-hundredth of the aid that went to tsunami-affected countries.
No-one expects academic research like this to transform news priorities. But that should not stop policymakers and donors from taking them into account when deciding how to allocate money. As economist Robin Hanson argues, social science is increasingly uncovering instances in which individuals make systematic errors. In these cases, the right response is to work at overcoming our biases.
For the media, overcoming bias might involve finding innovative ways of bringing important stories to readers’ attention, such as Time Magazine’s recent feature on the ‘Top 10 Underreported Stories of 2007’. For individual donors, it could involve doing a bit more due diligence before choosing a charity. And for politicians, it may mean ensuring that Australia does not divert a disproportionate share of our aid budget to those who make the evening news.
Dr Andrew Leigh is an economist in the Research School of Social Sciences at the Australian National University.
Schools need a report card too, Australian Financial Review, 20 December 2007
As Prime Minister Kevin Rudd sits down with premiers and chief ministers at the Council of Australian Governments meeting in Melbourne today, one of the topics of conversation will doubtless be how to implement Labor’s “education revolution”.
Past education policy debates in Australia have often been unproductive. While the Howard Government proposed some useful reforms, they were ultimately unable to find a way to work with teacher unions, and found themselves caught up in distracting debates about Maoism. For its part, Labor’s rhetoric can give the impression that the party believes reform requires little more than opening up the funding spigot.
Breaking the ideological deadlock requires attention to the new productivity agenda in Australia: making public services work better. In the case of schools, there is strong evidence that reform is needed. Despite a significant increase in funding, literacy and numeracy scores of Australian teenagers have failed to rise over recent decades. On average, new teachers are less academically talented today than they were two decades ago.
Boosting the performance of Australian schools is far from straightforward, but one sensible reform would be to begin reporting on the performance of individual schools, so that parents can better choose between their local schools. Such a reform would bring us into line with Britain and the United States, where policymakers across the board take the view that a school’s test scores are quintessentially public information.
Now, new research has shown that better information has direct benefits for children. In a novel experiment in North Carolina, Yale University economists Justine Hastings and Jeffrey Weinstein randomly provided some parents with more information about the quality of their local schools. They found that that one in twenty parents responded to the additional information by switching their child into a better school. Notably, African-American parents were more responsive to test score information than white parents (perhaps because they had less school information to begin with).
But does school choice really benefit kids? The following year, Hastings and Weinstein followed up the children who switched schools, and compared their test scores to the non-switchers. They found that moving to a better school raised test scores substantially. In other words, the new schools didn’t just skim the cream; they added value.
In Australia, very little information about school performance is presently available. Some states only release information on the top students, while others provide data to newspapers on the condition that schools be listed alphabetically. Most public information relates to year twelve, though the Western Australian government publishes a website with primary school results shown in a graphical format. The most restrictive rules apply in New South Wales, where an infamous 1997 Daily Telegraph headline (“The class we failed”) has stymied test score reporting for over a decade.
Fortunately, there now seems to be a bipartisan federal consensus for change. Prior to the election, Labor’s then education spokesman Stephen Smith said that a Rudd Government would attempt to make available test score data at a school level for literacy and numeracy tests in grades 3, 5, 7 and 9. Over the next few months, federal Labor can expect pushback from the states and territories, and should have its answers ready.
Some critics will argue that test scores aren’t all that matter. True, there is more to education than standardised tests, but a thorough knowledge of the basics complements critical reasoning. Moreover, plenty of research shows that employers prefer to hire literate and numerate workers. In the North Carolina experiments, Hastings and Weinstein estimate that switching to a better school may end up raising students’ lifetime incomes by as much as $100,000.
Others will claim that raw test scores don’t provide useful information. The simple answer to this critique is to produce what Bill Louden of the University of Western Australia calls “smart” league tables, which are adjusted to account for socio-economic status, or which measure value-added.
Another common criticism is that parents can always visit the school to get more information. Yet for disadvantaged parents, making an appointment with the school principal can be daunting. As the North Carolina experiments suggest, making test score data readily available may well benefit the underprivileged most of all.
As a first stage in the education revolution, Kevin Rudd and Julia Gillard should bring more sunlight into the schooling system, making public all test score data for all schools in Australia. School league tables are no magic bullet, but you can’t have a revolution without information.
Dr Andrew Leigh is an economist in the Research School of Social Sciences at the Australian National University.