Quality modelling more important now than ever

Given the outcome of the recent election, it is apparent more than ever that economic policy at the Federal level will be now open to more scrutiny, debate and negotiation given the rise of minor parties and independent candidates in both houses of the 45th parliament.

Rather than lamenting this situation, the question for policy makers is how to effect positive changes in such an environment. This is particularly critical for Australia going forward given our need to undertake serious productivity enhancing economic reform and budget repair.

A glance at some of the key economic and fiscal indicators demonstrates that Australia is barely treading water and perhaps losing ground to our major trading partners. For instance, Australia's Real Net National Disposable Income per capita has gone backwards since the end of the mining boom. This indicator takes into account the effects of the volatile terms of trade and is a more accurate measure than GDP per capita of how people are doing (and feeling).

A key measure of our fiscal solvency is the Commonwealth Government's net debt as a proportion of GDP. Our net debt rises if we record deficits because we need to borrow to cover the shortfall of revenue relative to spending, and falls if we record surpluses since we are then able to pay down debt. The worrying aspect about the chart below is the trajectory of net debt if we don't change course. Without serious budget repair, our net debt is on a trajectory to rise to 40% of GDP by mid- next decade. This is not a forecast, rather a simple extrapolation of our recent net debt trajectory.

Indeed, all three major credit ratings agencies have recently said that Australia's AAA credit rating is at risk if a sensible fiscal strategy cannot be agreed to by the 45th Parliament.

One thing that can prevent economic and budget reform paralysis in the 45th Parliament is an evidence-based public policy debate.

Australia has a long history of using applied economic modelling to inform our public policy debate, assisting policy makers identify and understand key trade-offs in relation to proposed reforms, assess various policy options and articulating the mechanisms driving the benefits of better policy choices.

As the former Chairman of the Productivity Commission Gary Banks said in 2009 barely a year before the previous hung Parliament, "It is as important that we have a rigorous, evidence-based approach to public policy in Australia today as at any time in our history". The challenges Banks' outlined in his 2009 essay are significantly more pressing today. The mining boom is over. And we have a serious structural problem with the Federal Budget.

Unfortunately, a high-level observation of some of the economic modelling that appeared in the context of the 2016 Federal Election would cast serious doubt on the ability of quantitative analysis to positively influence policy debate. Indeed, recent calls for a modelling 'Code of Conduct' is symptomatic of the perceived decline in the quality of economic modelling.

We do not believe a regulatory approach such as a 'Code of Conduct' is warranted, given the contestability of economic modelling. Whether the analysis is commissioned by private sector providers or undertaken by government themselves, all economic modelling is subject to scrutiny and will be assessed on its relative merits. Quite simply, good analysis will be more effective than bad and those spruiking bad analysis will be less effective in policy debates.

That said, transparency is the key to quality economic modelling. And transparency also protects the Australian taxpayer, especially in relation to debates around whether or not to go ahead with large multi-billion dollar infrastructure projects. In that context, three basic key questions are important to answer modelling any proposed policy change.

The first question is 'what was done?' A key criticism of economic modelling usually starts from 'garbage in garbage out'. In many cases, it is difficult to establish the exact basis of the analysis (what went in), the justification of the modelling framework used as well as the key assumptions underpinning the model being used (which determines what came out).

The second question is 'who benefits (and loses)?' There is growing scepticism of economic modelling that is simply based on the production of a single large number, usually an increase in gross domestic product, as the basis of a positive policy change. There is growing interest in modelling that assessed the impacts of policy changes at the regional level as well as considering the equitable distribution of proposed policy changes.

The third question is 'why is there a benefit?' The strength of economic modelling is that the process of quantification is based on a logical flow of causes and effects. The explanation of the mechanisms by which benefits of proposed policy changes are transferred are, in many cases, just as valuable as the numbers assigned to these benefits. When those explanations are not apparent we are simply left with a set of numbers that we are expected to believe because 'the model said'. Especially in contested debates, with many viewpoints, an understanding of the distribution of costs and benefits will be as important as the overall 'net benefit'.

With the make-up of Australia's 45th Parliament now determined, the challenge for policy makers is to harness the diversity of views, experiences and backgrounds of our elected decision makers. Quality economic modelling can play a critical role in policy development bringing discipline, rigour and structure to the economic debate. Arguably, this is more important now than ever.

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