Thursday, November 27, 2014

Does the nation have a Digital Economy Strategy?

A group of carriers, consumer and small business representatives has formed a coalition that argues that Australia must set an ambitious broadband policy for the next 15 years.

The group today launched a "2030 Communications Vision" project and plans to hold a seminar discussing broadband issues in February.

Retiring iiNet regulatory chief Steve Dalby claimed there has been "an absence of leadership on a broader, integrated view of why telecommunications is important to Australia and the Australian economy. There is no national objective or national strategy to take us forward in the digital economy."

Well - technically there is a strategy, because it was released by the Labor Government in 2011 and updated in 2013.

The status of the 24 actions listed in the update was advised in response to an Question on Notice from February Estimates. The status of the 34 projects was advised in response to an Question on Notice from May Estimates.

Before the election the Coalition released its own - somewhat limited - Digital Economy policy. Amongst a plethora of commitments the policy stated the Coalition would "update the NDES during its first term."

Presumably the construction that the NDES is to be merely further updated not replaced  means the EXISTING updated NDES is still the actual strategy.

Commentator Phil Dobbie in his weekly Crosstalk podcast made some disparaging comment about the NDES. Unfotunately I didn't write it down when I listened and I'm not going to go through it again.

What I'm waiting for is someone to subject the plan - especially as updated - to some decent scrutiny.
 And just maybe it would have helped if industry and consumers had engaged with the Strategy rather than take it as a given.

Wednesday, November 26, 2014

Competition in telecommunications ... ITU data

This week the ITU has published its latest ICT Development Index. I don't want to write about that now - except to state that like so many other similar exercises calling this an "index" is perpetrating a fraud.

The concept of an "index number" was developed to find a way to relate different prices and quantities in different time periods. The founder of econometrics Irving Fisher analysed said "For those who have made any attempt to penetrate their mysteries, index numbers seem to have
a perennial fascination." This may not be the case for my readers, but the survey article I took the quote from provides plenty of detail on how intricate is the process of developing index numbers for their use in analysing time series data.

The ITU's IDI is not such an index. It is an attempt to make comparisons across countries at one point in time. Indeed the construction of the index guarantees that the change in the index number from one time period to the next for an individual economy has no meaning. The only temporal comparison that can be made is of the rank.

This is because the final index number is composed as the weighted sum of a three sub-indices each in turn based on a number of indicators. The data for the indicators themselves are also first manipulated in a kind of standardisation process.

The report states that "The indicator weights were chosen based on the principal components analysis (PCA) results. The access and use sub-indices were given equal weight (40 per cent each). The skills sub-index was given less weight (20 per cent), since it is based on proxy indicators." Figure 2.2 provides a table of the actual weights used and it is hard to discern from this exactly what role the principal component analysis played.

Most significantly there is no objective test by which it is possible to determine if the IDI measures anything, nor if the value of the IDI has any purposeful predictive power. Indeed, like most indices of this kind (I'm thinking here of the Global Innovation Index) the composition of the index is heavily theory laden. There is nothing inherently wrong in a theory laden index if that index can then be compared to some other observable - because it then works as a test of theory. But if there is no such observable the index runs the risk of becoming part of a circular argument in support of the theory.

But I didn't come here to discuss the IDI - I need to do more maths before I reach any conclusions.

What I did come here to do was to pass comment on analysis in the report that purports to claim that competition in telecommunications markets has a statistically significant impact on reducing prices in telecommunications. I have serious concerns about the methodology employed.

(My own simple working paper on this reached a conclusion that competition is not a significant factor in price reductions).

My two concerns are to do with the model employed and the goodness of fit. Both fixed broadband and mobile market data are modelled. In both cases a simple linear model of prices is developed. This is highly unlikely to be the appropriate functional form for the relationship between prices and the relevant variables - including GNI per capita, industry concentration (HHI), urbanisation and a regulatory variable. At the very least theory would suggest that the effect of a change in concentration would be proportional to the HHI - not a linear composition.

In both cases the modelling claims that all the variables are statistically significant - though competition is identified as explaining only 5% of the variation in prices. However the R-squared for the two models are 0.408 and 0.409. The report claims that such a value of correlation means the models have "medium explanatory power" based on the range of possible values being zero to one.

This is simply rubbish. The reality is that such a low value means that more than half the variability in prices is due to factors not included in the model. One of those at least will be declining costs of technology due to local scale economies and global experience effects. The consequence of adding other variables or changing the functional form so that the explanatory power of the model increases will affect the statistical validity of all the variables.

It is, quite frankly, embarrassing to see a major international organisation publish such a poorly constructed piece of econometric modelling.

Competition in telecommunications...UK style

One of these days I will write a definitive account of how we all got so much wrong in the pursuit of better outcomes in telecommunications than were being delivered in the early 1980s. But today I just want to compare and contrast two countries, the UK and Australia.

The first thing to note is that both countries were early leaders i the move to restructure telecommunications markets - at least amongst those that had grown up under the European PTT model. Both were early (in the 70s) in spinning telecommunications out of the Post Office. Both introduced competition in the late 80s and early 90s.

The UK did one thing differently - they fully privatised BT before undertaking competition reform. But in reality it has made little difference.

The UK stayed with an industry specific regulator with both technical and competition function (Ofcom) whereas Australia dismantled AUSTEL in 1997 and gave competition and access to the ACCC.

BT sold its mobile operation to what became O2. BT also agreed to voluntary functional separation of its access network - but only in the face of a very determined Ofcom Chair Steven Carter.

But today we learn that BTs competitors are complaining through their industry body the UK Competitive Telecommunications Association (UKCTA) that BT still retains a monopoly position "some 30 years after privatisation and 10 years after the formation of Ofcom."

I'll be honest and say that from the Foreword to their report I can't understand exactly what it is that the UKCTA is arguing for. It seems to be another version of "we need you to increase competition by increasing regulation of the monopolist."  This, I might say, sounds awfully like the current refrain of Optus, Vodafone and the Competitive Carriers Coalition in Australia.

They seem to know what they don't like but I haven't ever heard anything that sounds like a convincing story of what the market structure looks like after whatever intervention they seek today. I have drafted something for publication elsewhere on the economics and if it doesn't get a run I'll share it here.

In the meantime getting a new single technology structurally separated access network for 93% of the population was a really good place to start. But no one was ever prepared to hitch their wagon to defending the one thing that could deliver.

Disclaimer: The CCC was originally formed around the meeting table in my office at AAPT. It's original mission was a response to the content sharing deal between Foxtel and Optus. At that time I questioned my colleagues at AAPT on whether as part of the deal we should demand that the Telstra HFC cable be made open access as it provided service in areas poorly served by exchange based ADSL. There was no interest because we did not have the capacity to build a billing and provisioning system to access it.

Thursday, November 6, 2014

About tax

No matter how much modern libertarians might fantasise about small government, the size is never zero and so governments need to raise tax.

In determining tax policy there are three objectives that need to be met.

The first is to raise the revenue required to deliver the services demanded (plus or minus any desired surplus or acceptable deficit).

The second is to raise the tax efficiently. This means both the technical efficiency of raising the tax with the least expense in raising taxes and the allocative efficiency of trying to minimise the effect of the tax on price signals and incentives.

The third is equity, to ensure the tax system is equitable in its treatment. Usually two principles are considered here. The first is that two individuals in the same circumstances need to be taxed equally. The second is that tax should be rendered relative to an individual's capacity to pay.

The unfolding story of the growth in tax minimisation strategies by the largest corporations in the world shows how current tax arrangements fail all these tests.

The AFR this morning pulled out Amazon as a particular case. Amazon in Australia has two direct lines of business, and then it has its third role as an importer. Amazon Web services is a cloud hosting service that counts among its clients (possibly indirectly) both the Liberal Party and the Labor Party. It is selling these services domestically and has facilities here.

The second business is the sale of e-books for Kindle. Today as a registered Kindle shopper in Australia I can only order from, not At least the pricing looks the same (one is designated in $AU the other in $US). I'm prepared to be that delivery also happens from a local server but I can't prove that.

But the transaction by me with Amazon is occurring - in fact required to occur - in an Australian domain. Yet somehow for tax purposes the transaction doesn't occur in Australia. I wonder if it occurs ANYWHERE for goods and service tax purposes or is deemed in each country involved to have occurred in another.

The short answer is "probably not." The topic globally goes under the name of "Base Erosion and Profit Shifting" or BEPS for short. The OECD BEPS project however seems to be mostly focussed so far on inter-administration identification of the transaction flows rather than discussion of how to make sure the "proper" tax is paid. Australian action seems to be similarly limited.

How does the Australian business community react to this issue. The Chief Executive of the BCA addressed the question this week. In doing so she outlined her own view of the objective of the tax system, namely:

Digital technology and increased interconnectedness in the global economy has had a profound impact on our lives and the way we do business....The Business Council has called for a global mindset from Australian businesses to capture these opportunities, specialise within supply chains and access new markets.

In an increasingly competitive business environment, taxation arrangements influence where we work and invest. International tax laws should not be an obstacle in the unstoppable evolution of the global economy. They should not be so excessive or complex such that they hinder trade, investment and innovation. 

Rather they should be modernised to ensure they remain fit for purpose in achieving their dual objectives of revenue raising, and incentivising growth and investment.

It is worth noting the extent to which the issue of BEPS is directly associated with the Digital Economy. It provides both the transactions that are problematic, but also provides the means to make other transactions become problematic.

But far more telling is the BCA's understanding of the objectives of tax design. Firstly it is NOT an objective of tax policy to "incentivise growth and investment", the objective is to limit the distortionary effects of taxation. The second is that there is no recognition of the role of equity.

The BCA then advances this flawed thinking into its own proposals. After first cautioning Australia about doing anything alone, and how everything needs to be managed within international tax arrangements, the BCA goes on to assert that Corporate Australia is over-taxed. (That this argument sounds like the defence of copyright piracy - we only steal because you charge so much - is just delicious irony).

So as far as the BCA is concerned the real issue is simple:

But in listening to the OECD on BEPS, it is important to hear the message in the context of its overall advice on tax reform and its role in economic growth. This is about getting a better tax mix between direct and indirect taxes to better encourage investment, innovation and entrepreneurialism – key drivers of growth.

Competition in global corporate tax rates has intensified. Japan and Spain recently announced corporate tax cuts to boost investment and growth. If we look back a decade, our corporate tax rate of 30 per cent was a little above the averages of the OECD and our competitors in the Asia-Pacific region – which were about 29 and 28 per cent, respectively. Since then, these averages have fallen around 5 percentage points while we have stood still.

In a nut-shell, because corporations choose where to invest (or more importantly where to pay tax) Australia needs to lower its corporate tax rate. To make up the revenue indirect taxes need to increase.

This is where the PM comes in having been duped by this argument. So he has initiated his discussion about Federation as a means to get the States to demand the rate of the GST part of fulfilling the BCA agenda.

But it is all absolute rubbish.

Firstly, by ignoring the equity argument the BCA is ignoring the fact that some of its members are paying far higher tax rates than others - depending a lot on their corporate structure. Secondly, a lot of the Digital Economy transactions are simply escaping the nett of indirect taxes - as my e-book example shows. And finally, in a result owing to Ramsey that for a mark-up on prices to have minimum economic distortion the mark-up should be in inverse proportion to the elasticity of demand.

The most important feature of the BCA's own tax paper is that Australia is a low tax economy.

We need a decent discussion on tax, but the BCA should not be at the centre of it. Personally I doubt that any of the CEOs who actually comprise the BCA would have the slightest clue about tax as a policy issue. They understand it as a private issue - if the company pays less tax I can pay a higher dividend the share price goes up and I get a bonus.

And the first thing we need to agree globally is that shifting transactions and notional company locations for the purposes of tax minimisation are economically distortionary and to be eradicated. It can be done. A challenge is that a country that sets a low tax level can have actually increased its total tax take as a consequence and will be reluctant to change. But the change can be effected by the countries at the ends of the transactions (for example, by jointly agreeing that the intermediate transactions did not exist).

Note: Interesting question what impact the lack of a GST has had on the prices of education and health services discussed yesterday. It is possible that the relative price has been able to rise because of the lack of tax...

Tuesday, November 4, 2014

The use and abuse of price signals

I was somewhat confused to read in this morning's Oz about Tony Abbott's plans for the G20.

We all know that the G20 goal is to try to come up with initiatives to increase global growth by 2%. Apparently the PM's approach to this is a bit like his approach at the World Economic Forum - to just tell everyone what we are doing domestically.

Apparently the PM told the Oz "that price signals on healthcare and market fees for universities would be part of the nation’s formal pledges at the G20 summit."

The Australian went on to note "Mr Abbott played down the chances of a major commitment on climate change and confirmed his plan to make the gender gap on workforce participation a key issue at the event."

So let's just unpack those two for a moment. The PM is apparently a fan of the use of "price signals" and "markets" when it comes to traditional Government service delivery like health and education, but his most significant election commitment - now delivered - has been the abolition of a price on carbon. 

He wants to move away from Government spending on health and education and instead make direct payments to industry to reduce carbon emissions. This is a Prime Minister who embraces the concept of "markets" only when the direct beneficiary is the corporate sector, and embraces Government action when the direct beneficiary is...the corporate sector.

The PM who wants to be known as the "infrastructure Prime Minister" asserts that "the continued move from short-term consumption spending to long-term investment spending will continue." And yet the infrastructure Minister is struggling to find anything new to announce other than projects where rail has been de-funded to fund a road (Melbourne's East West link).

He also says "Australia’s commitment at the G20 would be to promote growth through private investment rather than relying on public outlays." This marries up with e B20 message about infrastructure. It is the corporate sector's desire to have Government fund the private sector to build infrastructure which the corporate sector benefits from. 

Let's be really clear that the main beneficiaries of the PPP model are the finance sector and the construction industry. The latter is corrupt to the core and is responsible for Australia having the most expensive construction sector (just use the North West Rail as a guide).

But let's go back to two issues. The value of price signals in health and education and the economic value of increased female workforce participation.

Despite the pervasive presence of public sector delivery of health and education services, these are not actually free. There are already prices for many of the services in these sectors - and they are included in the ABS statistics on the Consumer Price Index. In fact, they are both measured with their own group index (education since 1982 and health since 1989).

That means we can inquire into how the price of these services have changed relative to other prices. The chart below is prepared by converting all the group and overall indices to a common base of 100 in September 2014. The group indices have then been divided by the overall index to effectively create a "real" index. 

This shows that the real price to Australian consumers of health and education services has been growing solidly over the last fifteen years. Somehow the PM seems to be under the impression there is no "price signal" already in this market, whereas the reality is the price signal is very clear and has been increasing. 

Anyone who seriously wants to address the question of "cost of living" pressure faced by households should study this graph. (As an aside since this is the DigEcon Gazette - I will write more separately about the decline in communication prices...but will simply note that trend line actually stretches over 40 years!)

Now let's turn to the question of workforce participation. Two things stand out. The first is that when unemployment is high, the availability of labour as an economic input isn't a constraint on growth. The second is that the PM talks as if his initiative of a paid parental leave scheme will be the first great intervention to grow participation.

The G20 wants to increase growth BECAUSE of persistent high unemployment rates, especially in the European economies (see list below taken from the 25 October 2014 Economic Data in The Economist).

Country Unemployment Rate
 Argentina 7.5%
 Australia 6.1%
 Brazil 5.0%
 Canada 6.8%
 China 4.1%
 European Union 11.5%
 France 10.5%
 Germany 6.7%
 India 8.8%
 Indonesia 5.7%
 Italy 12.3%
 Japan 3.5%
 Mexico 4.8%
 Russia 4.9%
 Saudi Arabia 5.6%
 South Africa 25.5%
 South Korea 3.2%
 Turkey 9.8%
 United Kingdom 6.0%
 United States 5.9%

Workforce participation rates between the two genders have been converging.  

Analysis of only the lines themselves might suggest the convergence is slowing - but measuring the difference (green columns measured on right hand vertical axis) shows the trend continuing.

In other words, accelerating female labour force participation is unlikely to be the most important critical issue. (I should do additional analysis by age because I suspect that part of the effect is due to older segments of the female population having a lower participation rate - paid maternity leave doesn't fix that).

So our PM is going to lecture other leaders about his inconsistent application of price signals and markets, and a post hoc justification of his expensive PPL when labour availability is not their major issue.

This is the PM trying to sell his modern day Thatcher/Reagan agenda as economic planning. 

The PM is more accurate when he simply says "“Lower taxes, less regulation and long-term fiscal discipline are at the heart of our plan." Just what the BCA asks him to say.

It would be nice if he and his Treasurer could really look at what the economy of the future looks like and what the capabilities we need are - a skilled and healthy workforce and (as I wrote on my other blog) clean energy.