Australia has the 'Dutch Disease'

The Australian economy is sick. Mining exports and the relative strength of the domestic economy have kept the Australian dollar elevated in recent years and stifled manufacturing and other industries that are susceptible to foreign exchange rate movements. In economics this is known as the Dutch Disease.

During the mining investment phase (feasibility and construction of mines), people tend to ignore any of the adverse impacts because of the immediate benefits and spill over benefits being generated. However,  when the mining investment phase ends there is a risk that the dollar will remain high and continue to put downward pressure on other industries. This is what is currently happening within Australia.

The adverse symptoms of this economic ailment include: an unemployment rate that is hovering around 6%, low business confidence, the lowest wage growth on record, low economic growth and a dismal federal budget. The symptoms are treatable and the disease is curable, however the RBA and incumbent government have misread these symptoms and are prescribing the wrong economic medication.

To date, the medication has included low interest rates coated with some liberal/neo classical economic ideology, which has basically involved the twiddling of thumbs while markets work things out, while 'scape goating' the welfare system.

Let us take a look at why the medication ins wrong and what is needed, starting with the RBA.

Typically, central banks lower interest rates with the intention of stimulating aggregate demand.  The RBA has argued, aggregate demand can be increased by stimulating growth in the housing market, which will create jobs for a large proportion of the population as well as increasing the wealth of home owners, which will have flow on effects within the wider economy.

On face value the logic is there, a strong housing sector is integral in pulling countries out of stagnant growth.  In fact a healthy housing market is usually a leading indicator to suggest the wider market is recovering. But unfortunately it is not as easy a+b =c.  Furthermore, focusing on just housing can be dangerous, one only needs to look at Ireland pre GFC then post GFC.

I agree lower rates will create big employment opportunities initially. Approximately 60% of businesses within Australia are small and a large proportion of that 60% would be tradies. However building houses is honestly one of the most unproductive activities for a work force. We have been building houses nearly the same way for over a century and for whatever reason we have refused to adopt, at a large scale, more efficient and affordable approaches such as tilt up construction.

It seems that as a society we have a vested interest in housing because it employs so many people, as a result more efficient and affordable construction approaches have not been adopted because it would minimise jobs. Furthermore we miss out on wider efficienies and growth which could have been achieved if the labor was being directed to more productive industries.

A recent report from the OECD highlighted that while Australia has one of the highest minimum wages out of the developed countries, productivity is relatively low. It seems ludicrous that our Reserve Bank would provide forward guidance that promotes exclusive investment in such an unproductive industry.

The other issue is that this strategy will only increase the wealth for a small number of Australians that can afford to buy a house. First home buyers have essentially been locked out of the market because house prices to incomes are still relatively high. On the other hand the share of investors within the house market has continued to grow. The result is a disproportionately high amount of the wealth being shifted to investors.

So what needs to happen? First the RBA needs to realise that rate cuts will not act as they intended. Instead, they need to take the focus off the housing market and stimulate other parts of the economy. This can be achieved through my easy 2 step herbal cure.

Step 1. Put reforms in place that create a competitive and robust finance markets for startups, R&D and new innovation. Currently these industries are locked out because the big 4 banks are only interested in one thing - increasing their residential mortgage portfolio. This will improve labor productivity and create a more diversified robust economy.
Step 2. Adopt macro prudential policies like in NZ. This means lowering rates and increasing loan to value ratios in the housing market. This will assist wider parts of the economy through cheaper debt and also assist by putting downward pressure on the dollar. In contrast it slows growth within 'arguably' overheating housing markets (Melbourne and Sydney). This will eventually improve the probability of first home buyers owning a home.

The other change that needs to occur is the way the incumbent federal government approaches the challenge of turning around a soft economy. Recently, this government has blamed the poor state of the budget on the ballooning welfare system. However the reality is we spend very little on welfare. Economist Matt Cowgill recently wrote an interesting article in the The Guardian, regarding welfare, he stated:

We spend less on welfare (by which I mean cash payments to households) than just about any other advanced economy. Last year we spent 8.6% of our gross domestic product on welfare. That’s less than Canada (9.1%), less than the US (9.7%), New Zealand (9.8%), the UK (12.2%), and every other member of the EU. Even in 2005, well before the financial crisis sent unemployment soaring in most OECD countries, our welfare spending was below all of these countries, including the infamously frugal US…

Our problem, to the extent we have one, is that our governments don’t collect enough tax. We’re one of the very lowest taxing advanced economies in the world, with revenues about $30 billion a year lower than they were when John Howard left office…

Adding to Matt's comments, the same OECD report as mentioned before, highlighted that the direct taxation revenue from income, profits and wages is higher than the OECD average. Hence, the prescribed medicine from a fiscal viewpoint needs to be lower company taxes and income taxes, which is the best way of reducing the barriers to investment and hiring. Meanwhile expanding GST will increase the taxation base.

It is recognised the total cost of pensions will increase as life expectancy gets higher. As already suggested by the government a debate needs to take place about increasing the retirement age which has not grown in line with life expectancy.

So thats my diagnosis share and like for a lolly pop.

Holy Shit! Austerity Sucks

I have been saying austerity does more harm than good for a long time. 

How can you expect long term growth if you destroy the economy in the short term. Well well, it seems as if the empirical evidence, which has supported the pro austerity arguments is severely flawed. 

Check it out:

http://nymag.com/daily/intelligencer/2013/04/grad-student-who-shook-global-austerity-movement.html

Socialism operating in the capitalist world

It has been along time between posts - I know. But it is a little hard to be creative or discuss something unique when on a daily basis we are bombarded with articles about economic and business topics that get rehashed and reconstituted with a slightly different spin. Albeit, it is not always bad to be exposed to this replicated material because out of sheer boredom it forces us to explore different topics and makes us consider what are the big issues. 

So during the summer break I stopped reading publications like Macro Business and The Economist and set about reading a book called Capitalism Socialism and Democracy written by the late great Joseph Schumpeter. It is a behemoth piece of literature that covers all aspects of social and economic theory and is one of the most famous texts ever published on social and economic theory, specifically socialism. 

The task of reading and digesting the content of this books is nothing short of an economic marathon. The foot notes alone require a cup of coffee and 30 minutes of your time. The overall schema is as complex as a spiders web where every proposition discussed is as integral to the structure as the former and latter propositions; so no speed reading. And at the pillar of this text is the prediction that the capitalist world has an inherent propensity to become socialist in some way or form. 

Although he did not put a time frame on socialism, there is no denying that capitalism has been extremely resilient to date. This is partly because it is the best vehicle we have for increasing the welfare of the greatest number of people. Although the gap between the top 1% and the middle class within developed countries has grown, the gap between developing nations and developed nations is shrinking.

In addition, I also think think capitalism is partly resilient because it subsumes many socialist components. Heaps of Schumpeter's predictions that were made over half a century ago have occurred.  However rather then transitioning to full blown socialism, developed nations in my opinion have moved more and more closer to a socialist system operating within the strata of a capitalist system. Something that he had identified as a possibility.

Whether or not socialism will ever be reached is not something that I really want to discuss because I am pretty sure we will all be dead if that ever does occur. Rather I want to show how the self destructing components of capitalism that Schumpeter identified have mutated into either new capitalist systems or quasi capitalist/socialist systems, which have effectively allowed capitalism to thrive.

1. The first point that really made me stop and think went something like this. As the cost of production decreases by virtue of more efficient production methods and better technology goods become cheaper. Hence a growing number of people have the ability to consume these goods because they are offered at a lower price. If this tendency continues to take place we would end up at a point in time where every one can achieve a fairly equal quality of life and there would be no incentive for individuals to get promotions, invest or simply make more money because they can satisfy all their needs and wants at their current level of income. This tendency would destroy one of the main cogs of capitalism - the drive to create wealth.

I read this and went shit there are a lot of bogans within Australia with brand new HSV Holdens watching Biggest Loser on there LCD TVs, which are nested in the back of their driver seats. Schumpeter assumed since they have the same goods as others making much more money than them the incentive to work would decline. 

But what Schumpeter failed to see was how capitalism would adapt to this. Most developed economies are service based economies, meaning large proportions of GDP are produced via services. Within these economies there still remains an incentive to increase income and wealth so that more services or better quality services can be consumed.  I can’t imagine the owner of that HSV listening to a musical or eating at a fancy restaurant.

In addition, premium branded and priced products will always carry a greater level of relative satisfaction and status. An extreme example is taking place within China where there is a stigma developing around counterfeit products. I read about a case where friends were actually out-casted from groups because they had bought counterfeit products.

Finally new products and patents will always be created. In the infant stages these products will always be more expensive until the technology becomes wide spread. The product and utility attached to the product will only be accessible to a certain proportion of consumers that can afford it, for example Dyson Fans with no blades.

2. The second salient point he made was that the ownership of shares and other financial instruments will eventually become meaningless. That is to say investors are only interested in the expected return of an investment and offsetting the return of other investments within their portfolio, in contrast to actively optimising the entity they are invested in. Consequently investors do not monitor the use of their invested capital which can lead to capital being misallocated.

On a grand scale this could lead to the unravelling of the capitalist system yet it would seem that when ownership becomes irrelevant and due diligence is not conducted asset bubbles occur, which are followed in extreme cases by a recession.  I present to you Exhibit A The US recession; where people around the world effectively lent money to home buyers within America, yet due to the complexity of the arrangement they had no idea what buyers they lent to or what homes provided the collateral. Ownership and investment can not become much more meaningless and inefficient then this, but capitalism still thrives. 

Why you ask? High volumes of public spending provide a quasi socialist fix to this issue at all points of the business cycle (before and after recessions). While admittedly public spending is typically viewed as a macro economic tool rather then a socialist tool.  Under the strictly capitalist viewpoint public spending should be minimal. But this is not the case. What we observe is that public spending has been steadily increasing relative to GDP in many developed nations around the world. Within the USA the ratio is in the order of 40% and in many Nordic countries it sits above this figure.

This high volume of public spending ensures capital is invested in new technologies that have not been developed within the private market due to inefficiencies.  To date it has brought you such things as the internet, wifi, space travel and Google maps, which have inadvertently facilitated inventions and business growth within the private sector.

3. Off the back of this point it becomes apparent that there is a past and observable tendency of rising public spending within developed nations.  It is therefore a possibility public spending may eventually comprise 100% of GDP and developed nations would become socialist.  Schumpeter implicitly argued this and at this point he suggested it would become impossible to resist a transfer to a socialist system. However, recent history would show us that countries with too high public debt and public spending will be faced with a recession rather then a socialist transition i.e. Greece, Spain Ireland and Portugal.

The point that I am trying to make is that while public spending especially the level that we see around the world now can be viewed as a quasi socialist tool, which promotes investment in infrastructure and inventions that have not been provisioned within the private sector, there is a limit to the amount of public spending and debt which can be sustainably provisioned. Economists such as Paul Krugman put that limit somewhere between the US public spending/debt ratio and the Nordic public spending debt ratio.

Perennial Gale

Schumpeter’s forecasting abilities were uncannily accurate. Yet while many of the situations that he extrapolated from past observable tendencies have come to fruition within the modern capitalist world – the world remains capitalist. And although he put no deadline on when the world would be come socialist there is no denying capitalism has been resilient to date. Based on these resiliencies it does not look like changing any time soon.

In addition, since his passing the world has experienced China’s rise which could be described as an economy with a socialist structure and capitalist mechanics. What ever way you view the world it would appear that the modern system requires components of capitalism and socialism to thrive.

Joseph Schumpeter once described economic mutation as the process that “revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one”….yet it would seem the process of mutation looks vastly different if the old system is not destroyed.

CEOs and Superstars

As part of an article about about bankers this morning The Buttonwood Columnist from The Economist purported that;

"The laws of supply and demand do not apply. When food producers compete to supply a supermarket, the retailer has the luxury of selecting the lowest bidder. But when it comes to investment banking, wages are very high even though the number of applicants is vastly greater than the number of posts. If the same was true of, say, hospital cleaning, wages would be slashed"

While it is easy to argue that the demand and supply pricing mechanism doesn't apply to bankers it doesn't mean that it is the correct argument. Rather then throwing these economic models out the window I am more inclined to explain this phenomena with them.

The CEO market is akin to a superstar market where there is a myriad of potential actors that will attempt to make the big screen, but only a select few will make it. What drives these actors to make the top is the massive payoff. In the banking world potential CEOs will work extremely long hours and put them selves through higher education to achieve CEO equivalent wages. Similarly, only a few will make it to these positions, hence the wage must compensate the potential candidates for the risk of not achieving the top job.

On the demand side an investment in a super star needs to generate blockbuster sales for it to be a viable business decision.  Just as Brad Pitt's talents aligned with, lets say, Inglorious Bastards, a CEO's skill set must align with the objectives of a specific bank for it to be a viable decision. The end result is an extremely exclusive labour market characterised by high demand, low supply and high wages that compensate both the CEO and yield a positive investment for the bank.

However, just like a movie a bank can either flop or be a success depending on what CEO is chosen. But, who is going to take the risk of not employing the best CEO or face loosing them to another bank because they were not offered enough.

What about Estonia?

Since my last entry which looked at Greece's debt woes and the problems with severe austerity there has been a lot of talk about Balkan nations, in particular Estonia, that has achieved robust growth after austerity. Yes Estonia has performed better relative to the rest of Europe, but not due to the hard, fast austerity measures that their incumbent government is 'talking up'. Krugman and commentators from The Economist have been quick to point this out for a number of reasons. 

Firstly, the marginal cost of labor and per capita wealth within Estonia is much lower then other European nations, this has allowed them to produce competitively priced exports and subsequently sustain growth during the unfolding euro crisis. Countries like Greece do not have this luxury because they are 'stuck' with; high wages and a fixed currency, meaning they cannot be competitive, and cannot not export themselves out of the recession, or at least with out external fiscal assistance.

Secondly, as illustrated below Estonia had a much lower volume of public spending.

(Krugman, 2012)

The corollary being that relative to many of Germany's neighbours that required a large quantum of debt to sustain public spending, Estonia required much less and in-fact carried a current account surplus. Hence, the level of austerity required within Estonia did not need to be as severe and the subsequent adverse impacts were less. 

. 

However, something that the prominent commentators have failed to consider was why there was considerably less public spending within Estonia. Well I put this down to two first reasons. The former being that Estonia needed to sustain healthy balance sheets to meet the criteria that ultimately would allow them to adopt the Euro currency. This meant being fiscally conservative and keeping sovereign debt levels low. In regards to the latter, the cost of debt was too high to seriously consider any public investment. Many of the countries that binged on credit and public investment did this because the investment decision was sound due to the extremely low cost and high availability of credit.

In summary, the reason for strong growth in Estonia is not due to hard fast austerity or their post recession brinksmanship. Estonia has had to work hard to get their economy in shape pre rescission.  Their incentive - EMU membership and adoption of the EU. The structural changes they made before the recession, which encompassed; low public spending and debt, plus the benefit of having a cheap labor market has allowed Estonia to weather the storm. 

My Big Fat Greek Bailout

The sovereign debt crisis in Greece continues to play out in an ongoing pernicious cycle of immediate positive sentiment (after a European Central Bank announcement) followed by an equally or greater, and supposedly unforeseen, catastrophe. This unfolding disaster has rained havoc on global and domestic markets and will continue to do so unless a sustainable solution is agreed upon.

Despite this, no one within my circle of friends really gives a shit. I mean they have read about it, and maybe even know more than the average person, but it's not really conversation worthy. To be fair, the issue is massive and complex, so let’s dumb down the history and complexity of this issue just a touch. In doing so lets go behind the scenes of My Big Fat Greek Bailout - the most expensive production to come out of the European Debt Crisis, staring the Credit Fiend. So who is this Credit Fiend? 

Greece, and lets not forget many other peripheral German countries, are analogous to our movie star that has been using several unrestricted credit cards attained on the back of his membership within the actors guild (European Monetary Union: EMU). The card has an extremely cheap rate of credit and the actor buys plenty of useless shit and occasionally an ‘investment’ like a Hummer, because with really cheap credit you can carry groceries in whatever the hell you want. This Credit Fiend only works a few days a week, but when he is at work he can usually be found out the back kicking boxes and smoking cigarettes. On his day off, our movie star can be found mooching; pulling back a bong while simultaneously swallowing a Xanax. 

But the utopia soon falls apart when the bank (bond holders) realise they have issued too many of these credit cards (bonds) because arrear incidences increase. As there is a greater risk of default than was initially forecasted banks increase interest rates. The cost of servicing the debt becomes progressively more expensive until the Credit Fiend can no longer afford the repayments. As a solution the movie star applies for another credit card with a higher interest rate to pay for the outstanding debt repayments, but the result is a pernicious cycle that causes the quantum of debt to become too high – the risk of default becomes extremely likely.

The bank falters under the sheer quantum of the movie star's bad debt. To ensure the viability of the insolvent bank the central bank (European Central Bank) does two things. Firstly, it gives direct credit to the fiend, which allows him to cover credit card interest repayments in the short term. Secondly, it extends a line of credit to the bank. With the additional debt the bank issues more credit cards to the Credit Fiend, subject to him agreeing to repay the debt by working harder and cutting costs (austerity). Although it sounds counterintuitive to increase the number of credit cards, it is intended to reduce the cost of debt and put the Fiend on a sustainable re-payment trajectory: this is known as restructuring.

However this is not the case as the bank (bond holders) fears the Credit Fiend will not be able to service the debt, especially since it is anticipated that their gross income will fall because their wage is fixed and uncompetitive, akin to the Greek adoption of the Euro currency. Furthermore, they have undergone a significant reduction in spending on not only unnecessary items but necessities. This would be hard for anyone, but even more difficult for an individual that is used to such a high level of luxury.

As a result the bank increases interest rates as compensation for the inherent risk, also known as a risk premium – the Credit Fiend comes close to defaulting again. The bank finally resorts to cutting 50% of the debt owed, but it seems to late. A point is reached where the Fiend threatens to reneg on the caveats attached to the current credit card repayments and future credit card issues. And this is the ominous position that Greece finds itself in today.

Within this analogy there are two key discourses that need to be given a high degree of consideration; pre-crisis conditions that propagated debt levels and post-crisis measures. In regards to the former, there were no restriction surrounding the level of debt or number of bonds issued to Greece, and in all honesty it is hard to retrospectively critique rating agencies such as Moodys, which measure the level of risk and subsequent cost of debt for countries. This is because on paper important Greek macro-metrics were comparable with the all mighty Germany, but look at it now - it’s fucked. 21.7% unemployment with only resource driven inflation!

Unemployment                                                       Inflation

                                                             2007            2012                         2007         2012

Germany                      9.0               6.8                            1.9            2.1

Greece                         8.4              21.7                           2.6            1.9

(Sourced from the economist 2012)

But if these agencies dug a little deeper they would have found a whole tapestry of structural issues. Just like the bong smoking, pill popping, shit kicking credit fiend: Greece's economy is corrupt and inefficient. And as complicated as it is for economists to look past numbers, structural inefficiencies need to be given a greater degree of consideration in the future because they inevitably impact on a countries ability to repay debt. One of the biggest overlooked areas was the tax system. In some ways, the system was as informal as putting cash in a brown paper bag and giving it to some random dude who was the ‘tax man’.

The free flow of sovereign debt to Greece also outlines some of the issues inherent within the EMU system. The EMU basically controls the monetary policy of members because they have all adopted the Euro and subsequently surrendered their constituent monetary power. As a result they can not manipulate the relative exchange rate. This is now a major issue because Greece cannot devalue and make their goods and services more competitive relative to other countries.

But the odd thing is although the EMU supposedly controls monetary policy they do not control member debt markets or bonds - odd because bonds are a major part of monetary policy as the supply and demand for them influences interest rates and the relative exchange rate of a currency. Hence, why would they not issue one single Euro bond that could be more tightly regulated? Analogously, why was the movie star issued a platinum MasterCard rather than a monitored company card.

In regards to the latter discourse, the timing and severity of the austerity was too soon and too much.  The ECB and other governments around the world need to stop interpreting World Bank and IMF recommendations about the benefits of debt reduction as gospel and be more pragmatic about the situation. An insolvent country like an insolvent individual can not pay back debt if they are stifled by restrictions in the short term – they will be dead from starvation before they pay back the debt. 

In saying this governments and central banks do not want to prescribe too much debt and it needs to be prescribed in the correct manner - there is a fine line. Unlike other nations, the ECB typically prefers to indirectly influence debt markets by extending cheap credit to banks at around 1%, which then purchase sovereign debt, similar to the bank extending more credit cards to the credit fiend within the analogy. The issue with this strategy is that it crowds out lending to other areas, data from the ECB shows lending to businesses and homeowners stagnating or receding, hence stifling recovery efforts.


I am not suggesting the ECB drops everything and adopts a direct method such as: Quantitative Easing as seen in the US or UK where bad debt is bought directly from insolvent zombie banks with toxic assets(assets with no value), as this has its issues as well. But what ever approach is adopted needs to be backed 100% by the ECB with unlimited debt support.


Furthermore, the ECB needs to play a bigger role in encouraging growth, as it is in their interest because more growth means more interest repayments and less chance of default. From a macro viewpoint this is known as Keynesian Policy: policy that increases aggregate demand through public spending. However, the situation in Greece is complex, firstly because it has no money; secondly it is part of a larger organisation, the European Monetary Union (EMU), which refuses to handout more money. I believe Germany, the powerhouse of the EMU, should be playing a bigger role in stimulating the Greek economy through Keynesian measures rather than solely synthetically adjusting debt yields, which has done nothing to fix the problem as of yet. On balance, if it is to follow a debt restructuring strategy it needs to instill confidence within the debt markets by giving its full unlimited support to Greece.

Coming back to the analogy, it is inventible that the insolvent credit card holder, which has not been supported and who is presumably starving and tired from sleeping upright in his Hummer, will eventually switch to anarchic survival; put simply, don’t-give-a-shit mode. In Greece this has already involved erratic and costly behavior such as rioting, mass withdrawal of deposits and now the possible adoption of an extreme political leader such as Alexis Tsipras, leader of the radical left Syriza party, that want to repudiate Greece’s rescue deal with its European and IMF creditors. The scary thing about this negative public sentiment is that it may fuel the sequel, My Big Fat Greek Break Up.

The costs of a break up are high for both sides. In Greece’s case a break up would result in something similar to the Argentinean crisis and that is probably best case scenario. According to Japanese financial company Nomura, an exit would lead to a 60% devaluation of the new drachma. For Germany and the EMU, the loss is in bad debt, the credit already invested into Greece and the likely negative sentiment that would contaminate other peripheral bond markets. The best outcome would be a re-evaluation of Greek austerity, with achievable goals over a longer time horizon and unlimited sovereign debt support coupled with Keynesian assistance from Germany.

But like this analysis, even the most intelligent high calibre figures within these countries can be simple, even just plain dumb. Logic and pragmatism is one road, while IMF/World Bank austerity dogma is the other. A lack of the former has led to My Big Fat Greek Bailout; let’s hope neither a lack of the former or extreme adoption of the latter lead to the sequel.

    

Plain-Packaging For Cigarettes - A Few Cigarettes Short Of A Pack

On April 17, four tobacco consortiums initiated legal action against the Australian Federal Government over Labor’s world first laws requiring all cigarettes to be sold in plain generic packages. The hearing took place at the High Court of Australia over three days and has been closely watched by other countries and tobacco firms who are concerned the Australian plain packaging legislation may set a global precedent.

The latest anti-tobacco legislation represents the final blow to an already heavily regulated Australian industry which, in the past few years, has experienced tax hikes, the compulsory provisioning of graphic health warnings on tobacco products and restrictions preventing retailers from displaying cigarette products. Not to mention the restrictions that have been placed on smoking within many public areas around Australia.

However, the issue in this case is that the High Court will give limited consideration to the effectiveness of the laws in reducing the incidence of smoking uptake and cessation, rather its ruling will be based on whether the destruction of the tobacco consortium's goodwill is constitutional. This is a little disturbing because this legislation has been passed and is currently being challenged without due consideration of the consequences.

So in the absence of due consideration lets blow the dust of our economic text books and prosecute the consequences of this legislation? Economic theory assumes that consumers know what is best for them. This concept is known as 'consumer sovereignty'. According to this economic framework, if smokers freely and willingly consume tobacco with full information about the health consequences and addictive potential, and if they also bear all the costs and benefits of their choices, then the market could be described as operating efficiently and there would be little grounds for the government to intervene.

Economists and most people within the wider community agree that this is not the case due to three market failures: information failure about the health risks of smoking; failures resulting from the addictiveness of smoking; and the external costs of smoking or externalities i.e. passive smoking and health costs.

Without going into the detail, previous laws have been effective in addressing these market failures. And like the preceding laws, generic packaging is aimed at reducing external costs by reducing the utility (level of satisfaction) and subsequent demand of the product and increasing the awareness of adverse health effects while reducing misleading perceptions around branding, e.g. the misconception that Marlboro gold is less harmful than higher strength cigarettes.

Despite the good intentions of the legislation it has been implemented when the impacts of generic plain packaging on tobacco cessation and uptake are not fully understood, meaning the legislation may not be effective in achieving it's intended economic objectives. The most recent literature review produced by the Cancer Council of Australia brings together 24 studies over two decades. Yet, the studies are mostly from different countries and are experimental in nature, hence the impact has only been tested on samples at a specific point in time.

Virtually all the findings of the studies converge on the following conclusions.

“Plain and generic packaging of tobacco products (all other things being equal), through its impact on image formation and retention, recall and recognition, knowledge, and consumer attitudes and perceived utilities, would likely depress the incidence of smoking uptake by non-smoking teens, and increase the incidence of smoking cessation by teen and adult smokers”.

But as mentioned above, the caveat attached to the results is that, “this impact would vary across the population. The extent of change in incidence is impossible to assess except through field experiments conducted over time”.

It seems ludicrous that no one considered that the population and tobacco market within Australia is considerably different to samples from international studies during the development and provisioning of this legislation. Politicians and the public have been hoodwinked by the Cancer Council, which has effectively created an argument around equivocal evidence with limited relevance in an Australian context.

Firstly, the experiments do not consider the ‘no display policy’ within Australian retail outlets that supply tobacco. When a smoker purchases a product from a store they are unable to see their preferred brand or label. Hence, a generic pack may not cause a further reduction in utility for current smokers because they cannot actually see the packaging at the time of the purchase. Subsequently, it would be expected that there would be no further impact on the incidence of smoking cessation within current smokers.

Secondly, while the removal of brands may reduce the utility attached to specific brands for new smokers, it will not reduce the utility of smoking. To get this concept across picture the scene from Pulp Fiction where Vincent and Jules are arguing about the meaning and pleasure of a foot massage –  "touchin' his wife's feet, and stickin' your tongue in her Holiest of Holies, ain't the same fuckin' ballpark, it ain't the same league, it ain't even the same fuckin' sport". Likewise, a cigarette achieves a certain state of mind and happiness which is not comparable to the utility achieved by any other alternative good or service. A person can not, and will not, substitute to three cans of coke, Mc'donalds burgers, or whatever because it 'aint the same fuckin' ballpark'.

However, the most significant aspect that has been overlooked within the research is the battle which would take place between incumbent tobacco consortiums and oligopolist supermarkets – Coles and Woolworths. In supermarkets and subsidiary petrol stations, the sales contribution of tobacco is equal to approximately 7 and 30 precent respectively. According to Richard Dennis of the Australian Institute, an independent think tank, this in conjunction with the generic packaging was the incentive needed for Coles and Woolworths to vertically integrate within the tobacco industry and increase profits. But first Coles and Woolworths would need to ensure generic labelling laws were passed.

So it would come as no surprise that in August 2010 Coles and Woolworths both withdrew funding from the tobacco industry’s war chest which was creating awareness about the ineffectiveness of plain packaging via commercials in what can only be viewed as a direct attack on tobacco consortiums.

Around this time, Coles began importing home-brand-style packs of 25 cigarettes at around $11, almost $4 a pack less than Australian-made Winfield and other leading brands.

The strategies implemented by the supermarkets so far are exactly reminiscent of a typical new firm entering an oligopoly. It is hard to see how government and the Cancer Council over looked it. But, they blatantly did, in fact they did not even consider it. Anita Dessaix from the Cancer Council of NSW was shocked when she heard the news that Coles was selling their own line of cigarettes, "this is sneaky and disappointing," she said.

So in lieu of the Cancer Council anticipating anything, what should we expect in terms of firm behaviour if the High Court rules in favour of the legislation? In a typical market, tobacco consortiums could use their goodwill to compete with Coles and Woolworths and possibly force them out of the market. But in a generic labelled marketing environment, it is likely only existing smokers would stick with brand labels. The opportunity for Coles and Woolworths lies in producing cheap cigarettes for new smokers that have not been exposed to tobacco brands and smokers that have a price elastic demand function, that is customers struggling to buy cigarettes after the tax increase.

This strategy will be complimented with a strategy that aims at promoting their own products, which is akin to a pharmacist offering generic labels. And by the looks of things, this has already been implemented. A Coles employee, who preferred to remain anonymous said "when customers came in and complained that their usual cigarettes are too expensive we suggest they try one of the new ones, like Tradition".

The rational strategy for tobacco consortiums would be only to slightly discount well known brands because these will still produce revenue within the medium term on the back of current smokers. It is also likely that they will reduce the price of other cigarettes to compete with Coles, and Woolworths if it enters the market. Some of you may be asking, wouldn’t the rational strategy of the tobacco consortiums be an all out price war? But a price war would be dubious because the government would just increase taxes to negate the adverse increase in quantity demanded. Secondly, it is likely big brands will still maintain customers into the medium term based on the ‘no display’ rationale discussed previously.

In a nutshell, Australia will act as a petri-dish for the rest of the world on the back of equivocal evidence. Effectively there is likely to be a negligible impact in the incidence of cessation and an unknown impact on the incidence of smoking uptake, especially because particular brands will be heavily subsidised by the supermarkets. Meanwhile, the law will propagate the supermarket oligopoly, which we are already concerned about within Australia. Not to mention the economic risk surrounding the provisioning of a Band-Aid policy such as a price ceiling, which would have a number of adverse impacts.

The irony of all this is that generic packs have been provisioned to rectify imperfect information, yet this law has been developed and provisioned on the back of a body of research, which is a few cigarettes short of a pack.