Tuesday, 23 June 2009

Voodoo economics

Consultants are often willing to write reports to support floundering arguments. The forest industry's commissioning a report comparing the assistance it receives with other industries is a case in point.

At first I thought it (see Brucey hits back for forestry) was written as a spoof.

Or maybe similar to the recent Sunday Tasmanian Op Ed piece that was riddled with errors from the very first paragraph, designed as an educational exercise, encouraging students to spot the incorrect facts, identify the non sequiturs and the sophist techniques with a view to honing their skills.

Consider the following. “The rationale for paying subsidies to move ferry passengers across Bass Strait is the contributions the ferries make to tourism particularly along Tasmania’s north west coast” (p8).

Then on p 52, “(t)ourism activity in Tasmania is subsidised by both the Australian and Tasmanian Governments. The (allocations to the) Passenger Freight Equalisation Scheme (are on the basis) that the transport sea route should be treated in the same way as the other major truck routes in mainland Australia”.


The last bit suggests a persuasive reason for ignoring the Passenger Freight Equalisation Scheme as a tourism subsidy.

But p 52 continues, “(t)he Tasmanian Government also funds the TT Line operation and in 2006 committed $115 million over three years to secure the Bass Strait ferry system’s future…….the average payment per year is $38 million. This sum is included (as a subsidy) for tourism.”

So even though it is acknowledged that Bass Strait should be treated in the same way as the other major truck routes in mainland Australia, the passenger subsidy and the funds to TT Line are both included as subsidies to the tourism industry.

Bass Strait subsidies of $72 million took the total tourism subsidies to $92 million, more than 3 times greater than that provided to forestry (p 52).

These forestry subsidies had however been neatly pruned.

In the matter of infrastructure assistance on p 12 it was stated that “forestry roads bestow benefits for both public and private industry users and the separation of these benefits is a complex task given that roads and bridges serve multiple uses”.

But don’t the ferries bestow multiple benefits?

Let’s not worry about inconsistencies while we backtrack a little.

What is usually included as industry assistance?

The starting point for almost all analyses of industry assistance is the Productivity Commission. (PC)

Overview of the Productivity Commission

Government assistance to industry is provided by tariffs, budgetary outlays, taxation concessions, regulatory restrictions and other measures.

The Productivity Commission Act 1998 defines government assistance to industry as “any act that, directly or indirectly, assists a person to carry on a business or activity, or confers a pecuniary benefit on, or results in a pecuniary benefit to, a person in respect of carrying on a business or activity”.

Assistance thus takes many forms. It extends beyond direct government subsidies to particular firms or industries, and includes tariffs, quotas, regulatory restrictions on imported goods and services and tax concessions. Assistance can also arise from the provision of services below cost by government agencies and from government procurement policies.

Each year the PC publishes a Trade and Assistance Review, the latest for 2007/08 issued 27th May 2009. The review gives detailed estimates of Government assistance to industry, mainly tariff assistance, and Federal budgetary measures including outlays and tax concessions.

Mining and primary production industries receive little tariff assistance on outputs, and tariffs are not levied on services. On the other hand, because of their cost-raising effects on inputs, tariffs impose penalties on all industries.

Outside the manufacturing sector, the forestry and logging industries are estimated to receive net-positive tariff assistance in 2007-08. Some imported products attract tariffs (for example softwood conifers). All other primary, mining and service industries incur a net penalty from the level and structure of tariffs in Australia.

The estimates do not aim to capture all Australian Government support for industry; nor, do they include State government assistance other than some rural support programs

Also excluded are key government measures affecting forestry relate to resource management issues, such as the pricing of forest products, and certain tax provisions relating to investments in plantation forestry by managed investment schemes.

The Graeme Wells approach

Graeme in estimating subsidies to the forestry industry has essentially used the PC approach.

There is very little tariff assistance to the forestry industry, a small amount to softwoods as mentioned above.

To the items of assistance detailed in PC’s Trade and Assistance Review, Graeme has added estimates in the missing areas, viz, additional State Government support, subsidised wood prices from FT and tax subsidies via MISs.

The approach is a conservative orthodox assessment of the level of assistance to the forestry industry.

The aim of an economic assessment like this is to enable a judgement to be made as to whether the money could be better spent elsewhere.

The Bruce Felmingham approach

It must be said at the outset that Bruce’s aim is not to offer a different view of the quantum of assistance to the forestry industry per se, but rather to compare assistance to the forestry industry with 4 other industries, notably tourism and mining.

Rather than start with the PC baseline levels, Bruce starts with a much narrower definition of industry assistance by excluding amounts usually otherwise included.

On p12 “(t)ax concessions or other forms of favourable tax treatment are not included because they are not necessarily paid to the industry directly or indirectly. In some cases (they) are not designed to facilitate the operations of an industry…… it is quite appropriate to disregard (MISs) as a subsidy paid to industry when they benefit investors only.”

The supporting arguments as to why it is appropriate to disregard MIS assistance are very skimpy.

The whole MIS system prospered because it provided a structure for investors to fund an investment in trees which in turn were fully controlled by a MIS company, who were rewarded by receiving prepaid fees, thus relieving them of the need to offer their own security to borrow.

It provided extra cash flow to MIS companies. They outsourced their working capital requirements and obtained access to a resource they controlled.

It was an unbelievable bonanza.

If an MIS investor who has borrowed say $100,000 to lease land from a forestry company and establish a plantation, is not part of the forestry industry, then to what industry does he/she belong?

If MIS investors are not part of the forestry industry there is no need to consider MIS tax concession as assistance to the forestry industry. That is Bruce’s argument.

Is not the fact that in 2007, 50% of Gunns’ profits were attributable to MIS activities of some relevance?

Not the % of turnover, remember Bruce, but the contribution to the bottom line.

One positive aspect is that if Bruce is correct with his implied contention that the MIS subsidies assist investors and not the forestry industry, the forestry industry will remain unscathed from the current fall out in the MIS industry.

Then why all the panic amongst MIS companies?

As mentioned above, forestry infrastructure spending is also excluded as an assistance measure, as these assets have multiple uses and it’s too difficult to separate the different uses.

Meanwhile the tourism industry was lumbered with the full costs of maintaining links across Bass Strait.

Then import tariffs were ignored (on p 13) as few benefits of tariff protection are felt in Tasmania.

Maybe, but what about the costs of tariff protection?

The PC in their latest Trade and Assistance Review found that accommodation, cafes and restaurants (which include tourism) suffered the second highest impost caused by tariffs on their inputs, a total of $393 million Australia wide in 2007/08.

In any comparison of assistance surely this impost needs to be deducted from other assistance to give a net figure for assistance to the industry.

When comparing industries especially extractive industries like mining and forestry with a service industry like tourism, is it not necessary to make adjustment for imputed or unpaid royalty amounts to arrive at comparable value added amounts? And for these imputed or unpaid amounts to be included as industry subsidies?

Bruce acknowledges the relevance of such subsidies but then deftly sidesteps the problem because of the lack of data.

This is the point where credulity becomes a little too stretched. FT commissioned a study by Bruce to compare assistance across industries then refused to part with relevant data because it was commercial in confidence.

Bruce nevertheless proceeds. He simply ignores the subsidies resulting from the concessional wood supply price because his client is unwilling or unable to supply details.

Doesn’t even attempt an estimate.

Is this an economic study or a PR exercise?

Once the quantum of assistance is determined for each industry, an attempt is made to compare 5 industries, on the basis of average assistance received over the study period relative to the value added by each industry.

The measures are then converted to indices for ease of explanation, a Subsidy Intensity Index (SII) and its inverse, a Bang for Bucks Index (BB).

Dr Wadsley pointed out (Comment #18) ”the various measures of value added are not the same.……This mish-mash is inexcusable given that Dr Felmingham built the Tasmanian Input/Output model (TIRO) which is designed, in part, to resolve just such issues.”

If it is true that the author is responsible for TIRO, shouldn’t he perhaps have alerted his readers to the possibility that Input-Output relationships change over time and the concept of an average is bordering on the meaningless, especially if no explanations are given.

Squirrell (comment #12) was spot on with his observation that a measure of average generates a rather useless figure. It’s what happens at the margin that is useful to policy makers.

What is meant by this is that an average is simply that. It doesn’t indicate if the trend is up or down. It doesn’t mean that merely because the average indicates that $1 in subsidy produced $56 in value added, then another $1 will lead to an increase in value added of $56.

Bruce acknowledges this but says (on p 54) the indices provide some clear guidance for policy making pertaining to industry support.

It may be clear to the writer but not to the reader.

In the words of Ms Hanson, “Please explain”?

The Felmingham Report has been described as groundbreaking by those who commissioned the Report. Either they’ve been conned or they’re merely putting on cheery faces, happy to participate in the PR exercise.

If it were groundbreaking Bruce would be queuing to present the findings at a conference of his peers.

Little chance of that happening.

There is nothing particularly groundbreaking about the study. It is not too dissimilar to all the partial multipliers that economists calculate and politicians and spin merchants use indiscriminately.

For example, Paul Lennon’s claim the mill will mean an extra $870 each year for every Tasmanian household. Or Bryan Green’s claim that plantation forestry generates 2.5 jobs per 1000 hectares. Or that the Hawk’s deal produces $15 million in economic benefits, $3.4 million of media exposure and $1.12 million of media value.

All too often there is a complete lack of understanding of all these measures. Cash flow is confused with profits, value added is confused with cash flow, average measures are passed off as marginal measures, turnover is confused with economic value, turnover %’s are used as proxy profitability %’s, the list is endless.

Politicians and others use these measures, sometimes in a deliberately misleading manner, sometimes in ignorance.

Paul Krugman alerted us to Voodoo Economics.

We need to remain vigilant.

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