Institutional Cryptoeconomics: A New Model for a New Century

With Sinclair Davidson and Jason Potts

While cryptoeconomics is already a vibrant research field, the study of the blockchain must not be left solely to computer scientists and game theorists.

The rollout of blockchain technology raises complex questions in economics, public policy, law, sociology and political economy. What we call “institutional cryptoeconomics” starts from a simple premise – the blockchain is not just a new general purpose technology, it is a new institutional technology.

This may sound like a pedantic distinction, but the difference between these two conceptions is profound. General purpose technologies allow us to do what we already do better, faster and cheaper. Economists understand general purpose technologies (like steam power or the semi-conductor) as great engines of economic growth.

There is no doubt that the blockchain is a general purpose technology, but it is much more.

Rather, the blockchain is a new mechanism to coordinate economic activity and to facilitate cooperation between individuals. It opens up new opportunities for exchange, for collaboration and for building communities that were previously closed off due to high information costs and transactions costs.

As a new institutional technology, we expect that blockchains will disrupt and transform both economic activity and social organization. Institutional cryptoeconomics is a new analytic framework to study that evolutionary process.

In the very first instance, we believe that the transaction costs approach of Oliver Williamson – who won the Nobel in economics in 2009 – is the ideal theoretical framework to understand the blockchain. Williamson was primarily interested in understanding the ‘make’ or ‘buy’ decisions that firms have to resolve.

Is it better the buy inputs on the open market or produce them in-house?

That choice defined the limits of the firm, which in turn determined the incentive structures that decision makers faced.

A key determinant of the limits of the firm is “opportunism” or “self-interest seeking with guile” as Williamson described human behavior.

The combination of opportunism and asset specificity (which refers to how easily an investment can be resold or repurposed for another use) meant that complex economic behavior had to take place in large corporations. This in turn implied the need for substantial financial capital investment.

Thus, we saw the dominance of shareholder capitalism in the 19th and 20th centuries.

The blockchain breaks this relationship between size, opportunism and asset specificity.

By substantially eliminating opportunism (that is, being a ‘trustless’ technology), the blockchain allows specific assets to be deployed in small businesses supported not by large amounts of financial capital but by large amounts of human capital. It allows market incentives to deeper penetrate into firm structures resolving problems of team production.

For many industries, the blockchain will radically redefine the boundaries of the firm, allowing individuals to trade their talents and skills in an environment devoid of big business.

The eclipse of the large public firm has been predicted before, of course, but this time we believe those predictions will eventuate for many, if not most, industries.

The decline of shareholder capitalism will have ricochet effects across the economy and society itself. It will put new pressures on employment, inequality, political power and the regulatory state. And it opens up vast new opportunities. The Williamson framework can also help us understand how the blockchain changes – and enhances – the provision of insurance, the provision of public goods, and the provision and protection of identity.

It is often said that we are at the start of a “blockchain revolution.” Institutional cryptoeconomics offers an exciting way to understand what features of the ancien régime we’re about to lose, and what might take its place.

Government must leave encryption alone, or it will endanger blockchain

With Sinclair Davidson and Jason Potts

If we could give Malcolm Turnbull one piece of economic advice right now – one piece of advice about how to protect the economy against a challenging and uncertain future – it would be this: don’t mess with encryption.

Earlier this month the government announced that it was going to “impose an obligation” on device manufacturers and service providers to provide law enforcement authorities access to encrypted information on the presentation of a warrant.

At the moment it’s unclear what exactly this means. Attorney-General George Brandis and Malcolm Turnbull have repeatedly denied they want a legislated “backdoor” into encrypted devices, but the loose way they’ve used that language suggests some sort of backdoor requirement is still a real possibility.

Hopefully we’ll discover more when the legislation is introduced in the August sitting weeks. Turnbull did say at the press conference “I’m not suggesting this is not without some difficulty”. The government may not have made any final decisions yet.

But before any legislation is introduced, the government needs to understand what the stakes are in as they strive against encryption.

Anything the government does to undermine the reliability of encryption could have deleterious consequences for what we believe will be the engine of economic growth in decades to come: the blockchain protocol.

The blockchain is the distributed and decentralised ledger that powers the Bitcoin cryptocurrency. Blockchain constitutes a suite of five technologies: cryptography, a database that can be added to but not altered, peer-to-peer networking, an application of game theory, and an algorithm for ensuring a consensus about what information is held on the ledger.

Taken separately, these are long established technologies and techniques – even mundane ones. But taken together, they constitute an entirely new tool for creating political, economic, and social relationships.

The possibilities far exceed digital currencies. Already banks and other financial institutions are trying to integrate blockchains into their business structures: blockchains drastically reduce the costs of tracking, recording, and verifying transactions. Almost any business or government organisation that is done with a database now can be done more efficiently, more reliably, and cheaper with a blockchain – property registers, intellectual property, security and logistics, healthcare records, you name it.

But these much publicised blockchain applications are just a small taste of the technology’s possibility. “Smart” self-executing contracts and massively distributed organisational structures enabled by the blockchain will allow the creation of new forms of business structures and new ways to work together in every sector and every industry.

In fact, we think that the blockchain is so significant that it should be treated as its own category of human organisation. There are firms, there are markets, there are governments, and now there are blockchains.

But the blockchain revolution is not inevitable.

If there is one key technology in the blockchain, it is cryptography. There are lots of Silicon Valley entrepreneurs playing around with lots of different adaptations of the blockchain protocol, but this one is a constant: the blockchain’s nested levels of encryption are built to ensure that once something is placed on the blockchain it is permanent, immutable, and only accessible to those who own it.

Blockchains only work because their users have absolute confidence that the system is secure.

Any legal restrictions, constraints or hurdles placed on encryption will be a barrier to the introduction of this remarkable new economic technology. In fact, any suggestion of future regulatory challenges to encryption will pull the handbrake on blockchain in Australia. In the wake of the banking, mining and carbon taxes, Australia already has a serious regime uncertainty problem.

Melbourne in particular is starting to see the growth of a small but prospective financial technology industry of which blockchain is a central part. The Australian Financial Review reported earlier this week about the opening of a new fintech hub Stone & Chalk in the establishment heart of Collins St. What’s happening in Melbourne is exactly the sort of innovation-led economic growth that the Coalition government was talking about in the 2016 election.

But the government won’t be able to cash in on those innovation dividends if they threaten encryption: the simple and essential technology at the heart of the blockchain.

Malcolm Turnbull’s Super Ministry

The new Home Affairs Ministry will be an administrative behemoth. It is unlikely that it will bring any great national security dividends. It is very likely that it will have undesirable consequences for Australia’s immigration program.

The Home Affairs Ministry takes the federal police, ASIO, the Australian Transaction Reports and Analysis Centre, and the Australian Criminal Intelligence Commission away from the Attorney-General. It takes the Office of Transport Security away from the Infrastructure Minister. It gives them all to the Immigration Minister Peter Dutton, who already has his own quasi-security agency, the Australian Border Force.

The politics here are obvious. Dutton is a senior conservative in a government that conspicuously lacks senior conservatives. But as a policy matter, there’s little public evidence to suggest that we our federal agencies are struggling to coordinate on security matters – although the 2014 Sydney siege did reveal weaknesses in federal-state security coordination, which the government has rightly moved to repair.

Where agencies sit on the ministerial map can have significant policy consequences. The creation of the Home Affairs Ministry locks in this government’s recasting of immigration as an economic opportunity to immigration as a security threat – a threat to national security, biosecurity, even economic security. Malcolm Turnbull has begun to use Julia Gillard’s old formulation: “Australian jobs are for Australians”.

Immigration and security are only a good fit if you squint very hard. For the most part Dutton’s day job has been the mundane work of supervising and approving or denying marginal visa applicants. The immigration minister is vested more discretionary powers than anyone else in the cabinet. Now that his focus is on security – taking constant briefings from ASIO and the AFP about domestic threats – security is how Australia’s immigration program will now be framed.

Medicare details available on dark web is just tip of data breach iceberg

Modern governments use a lot of data. A lot. Our social services are organised by massive databases. Health, welfare, education and the pension all require reams of information about identity, social needs, eligibility, and entitlement.

A major investigation is underway into how patients’ Medicare details are being sold on the dark web by cyber criminals.

Our infrastructure is managed by massive databases holding information about traffic flows, public transport usage, communications networks, and population flows.

Our security is maintained by complex information systems managing defence assets, intelligence data, and capabilities and deployment information.

We should be thinking about these enormous data holdings when we read the news that thieves have been selling Medicare numbers linked to identities on the “dark web” – a mostly untraceable anonymous corner of the internet.

That last detail is what has made this such a scandal for the government, as Human Services Minister Alan Tudge and the Australian Federal Police have scrambled to identity the systems’ weaknesses.

But the fact that the Medicare numbers are being sold is the only thing that makes this an unusual data security breach. Australian government databases are constantly being accessed by people who are not authorised to do so.

Here’s just a taste. Last year the Queensland Crime and Corruption Commission revealed it had laid 81 criminal charges and 11 disciplinary recommendations in the space of 12 months for unauthorised access to confidential information by police. One of those was a police officer who had been trawling through crime databases looking for information about people he had met on a dating service. He was convicted of 50 charges of unauthorised access.

A Queensland police officer was disciplined in May this year for using the police database to share the address of a woman with her husband who was subject to a restraining order.

The Victorian government’s police database was wrongly accessed 214 times between 2008 and 2013, by “hundreds” of officers.

Earlier this year 12 staff were fired from the Australian Taxation Office for accessing tax data on celebrities and people they knew.

We could go on. These of course are the instances we know about because they have been detected and reported on. There are undoubtedly others.

Governments manage a lot of data because we ask them to do it a lot, and to do what they do well.

They run thousands of complex systems. Many of these systems have been jerry-rigged and adapted from earlier systems, a series of politicised, over-budget and under-delivering IT projects stacked on top of each other over decades.

But these repeated episodes of unauthorised access show that these complex systems are in dire need of reform.

It is clear that the “permission” structures on these government databases are deeply broken.

In the debate over mandatory data retention one of the big questions was whether law enforcement and regulatory agencies should have to obtain a warrant before accessing stored data. In the end the government decided no warrant was necessary – because warrants could only slow down investigations.

This is exactly the sort of loose permission structure that leads to abuse. Just two weeks after data retention officially came into effect this April, the Australian Federal Police admitted one of its members had illegally accessed the metadata of a journalist.

This breach was entirely predictable. Data retention opponents repeatedly predicted it.

Last week’s Medicare breach has been made possible because thousands and thousands of people – bureaucrats, health professionals, and so on – can access the Medicare database. Most police officers, bureaucrats, and health professionals are trustworthy. But it only takes a few bad actors to wreck a system built on trust.

Rather than leaving data access up to the discretion of thousands of people, we need stricter codified rules on data access. Government databases need to be restructured to prevent, not simply penalise, government employees from going on fishing expeditions through our data.

The point isn’t to provide a legal or technological fix to the problem of unauthorised access. Rather, we should completely reimagine who owns the information that the government keeps on all of us. We ought to own and control our information, not the state.

New cryptographic technologies increasingly being applied to blockchain and cryptocurrency applications allow for even greater personal control over information. If applied, they would only allow government agents to know exactly what they need to know.

And it would move us from a system of surveillance and big data, to one of personal disclosure and privacy.

In the past, economic reform was targeted at big sectors like banking, telecommunications, and trade.

As Australian governments evolve inevitably into complex information brokers, the next wave of reform will have to focus on data management.

State Government bank levy makes South Australia riskiest place for investment in Australia

Imagine being an international investor looking at Treasurer Tom Koutsantonis’s Budget. You wouldn’t be interested in his infrastructure spend and “future jobs fund”.

You’d immediately hone in on the fact that the South Australian government has doubled down on the Federal Coalition’s bank levy by introducing its own state bank levy.

And you’d immediately understand that this makes SA the riskiest state to invest in, in a country that is looking like an increasingly risky place to invest.

South Australia has the highest unemployment rate in the nation. It needs firms to put their money into the state and create productive private sector jobs. No government spending can substitute for an attractive economic investment climate.

In this, the state’s bank levy is almost comically bad. The federal bank levy is arbitrary, punitive and unjustifiable. Treasurer Scott Morrison groped around for a rationale for taxing the big banks, finally landing on: people “don’t like you”.

Koutsantonis’s tax is even more arbitrary and its rationale even more slight. In his Budget speech, he said that the “banking sector is very profitable” and that given, in his view, the GST should be applied to financial services, SA should expropriate some of the big banks’ money.

But this is nothing more than a rhetorical shell game. The SA bank levy looks nothing like the GST, developed and refined over nearly two decades to be as efficient as possible. The GST is a consumption tax specifically designed to be paid by consumers.

Koutsantonis says he will ban the banks from passing his tax onto consumers. (This is astonishing by itself – the SA government is going to start regulating banks? We ended state-based financial services regulation 20 years ago.)

Finally, the GST was specifically devised in order to get rid of state-based taxes on financial products. These taxes – the bank account debits (BAD) tax and financial institutions duty (FID) – were uniformly agreed to be inefficient, to disproportionately harm the poor, and to harm Australia’s international competitiveness.

Getting rid of the FID and BAD tax was a key part of the GST deal. Is SA going back on that deal? Is it dipping out of the GST compact? How do Koutsantonis and Premier Jay Weatherill think the other states and Commonwealth, should respond?

With the imminent closure of Holden, SA needs to be looking to grow its economy and attract investors. But if there’s one thing investors hate, it is policy uncertainty.

Policy uncertainty is exactly what Koutsantonis has delivered.

The end of liberalism?

Nothing in the language of the 2017 Commonwealth budget was exceptional by Australian standards. Treasurer Scott Morrison stood in parliament and announced what he described as a ‘fair and responsible path back to a balanced budget’, followed by an optimistic account of global macroeconomic conditions, a happy assurance that surpluses would be achieved in years to come, a brief panegyric of the virtues of small business, followed by a list of infrastructure projects to be built near marginal electorates.

Nonetheless, the 2017 budget is likely to be seen as one of the most significant in Australian history. In a very real way, the budget bills that Morrison announced can be said to cap not the era of economic reform (Australian governments have long given up serious market driven reform and privatisation), but an era where at least one side of politics was offering any ideological or intellectual support for free market policies.

There have been disappointing budgets before, of course, and disappointing budgets from Liberal governments. But there are two features of the 2017 budget that make it significantly different from the disappointments that have gone before: the bank tax and the increase in the Medicare levy to fund the National Disability Insurance Scheme. The first is a punitive, distortionary, arbitrary, and incoherent fiscal attack on an unpopular but absolutely vital economic sector. The second is a broad based tax increase to finance a new social service that seems more like Whitlam-era public policy.

The bank tax is most striking because it is almost entirely disconnected from any explicit policy rationale. The complete argument for the bank tax Morrison presented on budget night was this: it ‘represents an additional and fair contribution from our major banks, is similar to measures imposed in other advanced countries, and will even up the playing field for smaller banks.’ In other words, it is ‘fair’, other countries have done it, and it will cut the big banks down to size.

Since budget night advocates of the tax have been trying to retrofit justifications to the proposal: arguing that it is a payment for deposit insurance or the government’s implicit too-big-to-fail protection. But the new bank tax does not even pretend to be pegged to the value of any implicit government guarantee. The government just wants money, and banks are where money is.

Of course, governments have always looked to the banks for money. Arbitrary, punitive taxation is hardly unprecedented. But we are not living in just any historical moment, in any country. Australia is one of the richest, freest and most open countries in the world, the beneficiary of three decades of economic reform — reform that sought to reduce the number of arbitrary, punitive and counterproductive taxes and regulations on the industries central to our wealth.

The budget in the sweep of Australian history

The era of economic reform is typically said to have begun in 1983 and ended in 1993 or 2000. It kicked off with Paul Keating’s floating of the dollar, from which so many other reforms had to flow. It ended either with the Fightback! election loss, or the introduction of the GST by the Howard government.

But of course no policy reform movement comes from nothing and disappears immediately without leaving a shadow. Political interest in market reform survived the reforms themselves. The Abbott government’s 2014 Commission of Audit remains an impressively radical and ambitious document.

Likewise, the ideas of market reform significantly predate the Hawke government. The floating of the dollar and the subsequent liberalisation of banking would not have been possible had the Fraser government not commissioned the Campbell inquiry into the Australian financial system in 1978, and directed it to develop recommendations consistent with ‘the Government’s free enterprise objectives’. And those objectives did not come from nowhere. Malcolm Fraser himself might have been a reluctant free marketeer but the Fraser government was starting to feel the ideological heat from the Dries within its ranks. The sense of a sharp division between the reform period and the 2017 budget is in part because Morrison and Malcolm Turnbull have chosen totarget, of all sectors, banks — the high ground of market reform for half a century.

Yet by the time of the Campbell committee, economic liberalisation had been a pitched battle in Australian politics for more than a decade. The truly pivotal ideological moment was the appointment of Alf Rattigan as chair of the Tariff Board in 1963. Rattigan, who had been assumed at that time to be a quiet, unassuming and pragmatic bureaucrat, waged a long running war against Australia’s high tariff regime from his Tariff Board post. Working with sympathetic and economic literate journalists like Maxwell Newton, Max Walsh, Alan Wood, P. P. McGuiness, Tony Thomas and Ken Davidson, as well as parliamentarians like the legendary maverick Bert Kelly, Rattigan made tariffs and trade a central political issue, redefining the terms of Australian policy debate, and, over time, creating the divide between those who wanted to reduce the government’s reach over the economy and those who wanted to maintain the status quo.

It is often forgotten how this division shaped the bitterly personal contests between John McEwen, John Gorton and William McMahon. This convoluted battle was focused as much on Australia’s tariff regime as anything else. In the 1966 election, a group of woolgrowers and graziers created the free trade lobby, the Basic Industries Group. Although it wished not to harm the Coalition and campaigned only in a few safe seats, it nearly tore the Coalition apart, creating a divide between Liberal free traders like McMahon and the protectionist McEwen. Maxwell Newton, who had been editor of The Australian Financial Review and founding editor of The Australian, used the small trade newsletters he ran in the late 1960s to conduct what the journalist Alan Reid described as a ‘free wheeling political vendetta’ against McEwen on the issue of the tariff.

The tariff contest burbled away in the background of the Liberal Party and the conservative movement more generally during the Whitlam years. Milton Friedman came to Australia in 1975, and Friedrich Hayek visited the year after that. By the time the Society of Modest Members — the group of current and former state and federal MPs dedicated to market reform — had its first meeting in 1981, the free market insurgency had been long established. The ideas on which the Modest Members pinned their hopes had been the source of bitter division in the Coalition for a decade and a half.

The origin of the victory of market economics over technocratic social democracy dates further than even the most senior of our press gallery journalists. Yet with Morrison’s budget, that victory seems to have expired.

Is market liberalism exhausted?

Market liberalism has gone through cycles of decline and resurgence before. Historical perspective helps because it is easy in the current political environment to personalise what is happening: to blame Tony Abbott or Malcolm Turnbull, or any other constellation of political leadership. It is certainly the case that Australia has been poorly served for the last decade. But the leadership comes from the political class itself; they provide the pool from which the leader is chosen and they have the votes. Every prime minister, even the most disappointing, had, at one stage, the endorsement of majority in their party room.

The Liberal Party has been severed from its base — the core voters which support it, raise money for it, man booths for it, and generally give it social force — and has not been rewarded with national popularity.

The Liberal government has tried to echo the Labor Party on notions of ‘fairness’, but why would you buy Liberal fairness when you can buy Labor’s real thing? If trying to reduce inequality by taxing the rich is desirable, why vote Coalition? If the banks need to be punished, why not support the parties that really believe it?

Opponents of reform to section 18C of the Racial Discrimination Act have repeatedly argued that the fight for freedom of speech is a ‘distraction’, and that the Coalition government should be allowed to concentrate on economic reform. But now it seems that the government has given up on both free speech and lower taxes — civil liberties and market economics go hand in hand, and the government seems uninterested in both.

The decline of the Liberal Party, and to a lesser extent the Liberal-National Coalition, into a shadow of its opponents is a sign of exhaustion in the centre-right political class. It also reflects a failure to revitalise free market ideas — and liberalism more generally — decades after the age of Margaret Thatcher and Ronald Reagan.

The window for ‘reasonable’ policy ideas in Australia is remarkably narrow and parochial. No government wants to be caught stepping even slightly outside the thin band of mainstream policy ideas. Canadian income tax rates are indexed to inflation, eliminating the problem of inflation-induced bracket creep. Yet it would be seen as radical and unrealistic in Australia to propose anything of the sort, even though tax rate indexation has successfully worked overseas and was trialled in Australia under the Fraser government.

The unwillingness to puncture some of these sureties, to develop, legitimate and push through policy in the face of opposition, and to seriously challenge the status quo has left Australia’s policy regime stagnant and fragile. Market liberalism arose in just this sort of historical moment, when the Keynesian policies of the mid-century exhausted themselves, unable to provide answers to the economic decline throughout the developed world. Is market liberalism now exhausted too? Certainly parties that profess market liberalism seem to be tired of pursuing free market policies.

The Coalition’s push to the left on economics has been paralleled in other developed countries. Theresa May’s 2017 manifesto declared that conservativism ‘is not and never has been the philosophy described by caricaturists’:

We do not believe in untrammelled free markets. We reject the cult of selfish individualism. We abhor social division, injustice, unfairness and inequality. We see rigid dogma and ideology not just as needless but dangerous.

But far from rejecting the caricature, this seems to reinforce it. Who, after all, believes in ‘untrammelled free markets’? Even the most vigorous anarcho-capitalist believes that markets are ‘trammelled’ by the constraints of norms, values and human-made institutions. If there is a cult of selfish individualism, does it have any members? May claims to be distancing the Conservatives from some sort of spartan Thatcherism but the frivolous nature of this attempt only underpins the impression that ‘May-ism’ is just unmoored from any philosophical foundation.

Against this, the appeal of a Jeremy Corbyn — whose public persona is inseparable from his deeply held political views — is obvious.

Market liberalism looks slightly better across the Atlantic but even in the United States it is in a bad way. The Trump administration’s red tape reduction program, ambitious tax reform, and budget proposals look exciting — if they can be accomplished. Withdrawing from the Paris Agreement is deeply symbolic, but needs to be married with specific policies that roll back the renewable energy labyrinth put in place by the Obama administration.

Otherwise, Donald Trump’s explicitly anti-trade position undercuts one of the founding principles of market liberalism.

Seen in this context, the exhaustion of liberalism in Australia is hardly surprising — it’s exhausted everywhere.

Rebuilding liberalism

Yet we should not look to high politics for a guide to the vibrancy and potential of a set of ideas as rich as the philosophy of liberty. In 1929 a group of Australian economists wrote that in Australia:

practically all shades of thought are committed to some form of Government activity in the economic sphere, whether it be wage regulation or assistance to immigration, criticism of the policy of laissez faire is unnecessary.

The Institute of Public Affairs was founded fourteen years later, and half a century later the idea that we needed to introduce competition and markets into our stagnant economy was a bipartisan view. Long before this year’s budget it has been obvious that our politicians had declared free market ideas as empty platitudes; a period of time in the wilderness will allow for the intellectual rebuilding of centre-right politics.

In fact, the times suit the ideas of free markets and individual liberty more than our political parties realise or acknowledge. The IPA has spelt out at length the tax and red tape challenges holding back the Australian economy — nothing the Labor Party or the newly centrist Coalition are currently proposing have a hope of tackling those two fundamental economic problems.

If the retreat of market liberalism globally has the effect it had in earlier times — greater macroeconomic instability and uncertainty — Australia will need a resilient and adaptable economy to suit.

Other trends demand a revitalised liberalism: the spread of automation from the industrial sector to the high-end service sector, the increasing demand for personal control over healthcare, the move of global economic power from the West to Asia.

Malcolm Turnbull failed to turn his 2016 innovation agenda into anything more than slogans, but like it or not, this is where the big changes are going to come. Doubling down on the twentieth century welfare and planning economic model is not going to help the losers from those changes, nor will it ensure the benefits are distributed widely.

The task now is an intellectual one — to build a new liberalism, a neo-neoliberalism, out of the failures of centre-right politics.

GST change is a plain and simple tariff, Scott Morrison

With Sinclair Davidson

The Turnbull government’s proposal to eliminate the $1000 threshold before the GST is levied on imported goods is not a tax integrity measure. It is a tariff, and one that will have serious repercussions that the government does not seem to have considered seriously.

The end of the low-value threshold was first flagged by the government in December 2014. It formed part of last year’s budget. Now there is actual separate legislation before parliament, and a Senate committee inquiry that will give its verdict on the legislation the same day Scott Morrison releases his 2017 budget.

By July, if everything goes to the government’s plan, the commonwealth will be receiving a stream of GST revenue from every global internet retailer that supplies Australian customers with a total of more than $75,000 worth of goods.

That’s the plan, anyway. This proposal is no more convincing now than it was two years ago when it was first announced.

In 2011 the Productivity Commission concluded that inspecting low-value imports at the border to assess their GST liability would cost more money than it would raise. So rather than getting Customs to collect the GST, the government wants to convince foreign online retailers to do it for them.

Let’s imagine this ploy works. Some of the consequences are easily predictable. First, many Australians will substitute away from well-known online sellers — such as eBay and Amazon — that have built excellent reputations for facilitating and protecting trade, to those less well-known sellers that are likely not to charge the GST.

Doing so will expose more Australians to online fraud and lead to them purchasing less reliable products from unreliable suppliers that may not meet our high quality and safety standards. It also will expose more Australians to the more unsavoury sellers on the internet, possibly leading to an increase in unlawful imports into the country.

At the very least, a 10 per cent increase in the cost of digital goods will make intellectual property ­piracy just that little bit more ­attractive. This is a real cost of the policy that must be fully accounted for.

Second, the way the government proposes to implement this measure constitutes an exercise in extraterritorial power. The commonwealth Treasury does not have jurisdiction over eBay (headquartered in San Jose, California) or Amazon (headquartered in Seattle). Attempting to rope them into our tax system will place the Australian government in conflict with our major trading partners. At the very least this should generate trade disputes at the World Trade Organisation.

Doubly so if our trading partners read the Treasurer’s second reading speech introducing the legislation, which makes it clear that this is a protectionist measure to benefit the Australian small businesses that have been “unfairly disadvantaged” by the fact they pay taxes that firms in other countries do not.

This is the nub of the issue. Transactions that occur in foreign countries should not be liable to the Australian GST.

The GST is usually described as being a “consumption tax” but in fact, for practical reasons, it is a tax on sales.

When Australian consumers purchase goods online from, say, a company based in Britain, the sale does not occur in Australia — it occurs in Britain.

The money is exchanged in Britain, the order is produced in Britain, the sale is processed in the Britain and the dispatch order is made from Britain.

The fact the goods are subsequently imported into Australia does not mean those goods should be liable to an Australian sales tax. A tax levied on imports is a tariff. This legislation is an embarrassing reversal of Australia’s longstanding free trade agenda.

Morrison pointed out in his second reading speech that his legislation is a “significant world first”. That is not something of which he should be proud.

In the realm of tax administration, at least, Australia is showing itself to be a bad international player.

Rather than introducing a new tariff to protect Australian business from international competi­tion, the government should focus its efforts on those features of the Australian business environment that impose such high prices on local consumers.

Working to lower company tax, high wage structures and reducing red tape would benefit Australians far more than protectionist measures for their small-business constituency.

Diverted Profits Tax Will Go Nowhere

With Sinclair Davidson

The Turnbull government’s diverted profit tax has passed the Parliament. Introduced in response to the moral panic that, somewhere, somehow multinational corporations don’t pay a fair share of taxation, this new tax is at odds with the government’s professed belief in lowering the corporate tax burdens, is at odds with our international competitors, and (as we learnt just this month), is even at odds with the Australian Taxation Office’s tax enforcement priorities.

The 40 per cent tax on diverted profits is expected to raise $100 million. That implies that the federal government estimates a mere $250 million of diverted profits. To put that figure into perspective, the federal government recently announced a tightening of the rules on the grandparent child care benefit. That policy change would result in welfare savings of $250 million.

Grandparents allegedly rorting the welfare system are a much bigger budget problem than multinational corporations allegedly rorting the tax system.

Indeed, Tax Commissioner Chris Jordan gave the game away on March 16 when he told a Tax Institute conference that the gap between what large corporates and multinationals pay and what they should pay in tax was “relatively modest” and that “the biggest gap we’ve got in the system is us” – that is, individual taxpayers.

After five years of hyperventilating about corporate tax avoidance, this is a striking confession. The previous treasurer Joe Hockey made much of the fact that the ATO had identified 30 multinational corporations likely to offend and had embedded agents in those firms and would carefully investigating their practices.

True, Scott Morrison did say that this diverted profits tax is a tax integrity measure. Ensuring the integrity of the tax base is a legitimate policy goal. But a diverted profits tax is a counterproductive and illiberal way to go about it.

It allows the ATO to impose upfront liability and collect tax on allegedly diverted profits. It reverses the onus of proof and removes the right to silence – thus multinational corporations the right to natural justice under the Australian legal system. That is not a reasonable integrity measure but rather a punitive regime that targets foreign investors and successful Australian companies.

This is a policy that substantially increases the powers of the ATO without any governance measures to ensure that abuses do not occur. No doubt these powers will be exercised by the ATO to collect revenue beyond the amount intended by Parliament. That is simply the nature of regulatory bureaucracies and it will be small comfort for those multinationals who successfully challenge the ATO that their money is eventually returned to them.

Even more fundamentally, the diverted profits tax doesn’t sit well with current policy settings, nor with economic reality. There is currently a lot of effort and anti-business rhetoric to collect $100 million. Is it a coincidence that business investment is low? Or is that government is passing tax laws that violate societal norms of fairness and are creating an uncertain and arbitrary tax environment?

Business doesn’t know what tax rate they will face in Australia in years to come. It could be 30 per cent. It could go down to 25 per cent over 10 years if the Turnbull government’s corporate tax cut goes through. Or it could be as high as 40 per cent if some Canberra bureaucrat, empowered by the diverted profits tax, gets a bee in their bonnet about multinational structures they do not understand.

There’s been a lot of talk about policy uncertainty in the Australian energy market. With a lot less fanfare the corporate tax confusion is doing the same to the entire corporate sector. This is not how to ensure jobs and growth

In the meantime, Australia is facing an international environment where the British Prime Minister is openly discussing turning the UKinto a tax haven, and the Trump administration wants to reduce America’s corporate tax rate to between 15 and 20 per cent. The Turnbull government has chosen the wrong time to put multinational engagement with Australia at risk.

Is reform hopeless in an era of disillusion?

Around 23 per cent of Australians gave their primary vote to minor parties and independents at the July federal election. This is the highest number since the formation of the Liberal Party and the three party system at the end of the Second World War.

When political historians look back on our era it is unlikely they will focus on the machinations that have seen prime ministers spilled and governments rolled. Rather, they are likely to see the most important trends of our time and the growing popular disillusion with the major parties — indeed, the growing disillusion with the entire political class. It’s no surprise that in the privacy of the ballot box, more and more Australians are voting for none-of-the-above.

This trend is not unique to Australia. In the United States, the support for Donald Trump in the Republican Party and Bernie Sanders in the Democrats shows that even party loyalists are tired of what the mainstream is offering up. In the United Kingdom, Jeremy Corbyn’s ascent to the Labour leadership and Brexit — the successful referendum to withdraw from the European Union — was driven by a similar anger.

This is the politics of our time. It’s not about individual politicians — it’s no more about the individual characters, even policy positions of Nick Xenophon or Pauline Hanson or Derryn Hinch, no more than it is about Donald Trump as an individual or Bernie Sanders or Jeremy Corbyn. It’s about what has driven so many voters in the richest, most stable liberal democracies that human history has ever known to reject the political mainstream.

A matter of trust

A democratic political system is based on trust. Each party trusts that the other will accept the result of an election that does not go in their favour. This is a trust we take for granted in a country like Australia but a very real challenge for weak democracies in the third world.

But there are other layers of trust. We the voters trust that having elected a party it will govern in a way that resembles that which it promised before the election. In a representative democracy no government is obliged to fulfil its campaign promises — it does so by convention and fear that it will be punished by voters for failing to do so.

That promises are often broken is one of the long-standing norms of democratic politics. One 2009 survey of studies into election promises found that political parties in Europe and the United States kept an average of 67 per cent of their promises when in government. This number is if anything remarkably high. But in the Australian context what has mattered in recent years is not the number of promises broken or fulfilled, but how those achievements or failures have reflected in the perception of the government that promised them.

Take Julia Gillard’s infamous election-eve statement that there would be ’no carbon tax under a government I lead’. This was followed in government by a fixed price emissions trading scheme that all commentators on the left and right admitted was functionally equivalent of a carbon tax. Were many voters duped into voting Labor because of the specifics of a fixed price emissions scheme, and subsequently angry that they had voted under false pretences?

This seems unlikely. But it spoke to a betrayal of the values which the Labor party had presented in 2010. Before the election, Gillard had punted the divisive issue of an emissions trading scheme to the ‘citizen’s assembly’ — 150 ordinary Australians who would listen to experts on climate change and what to do about it, and provide recommendations to the government. Labor’s deal with the Greens to push through a carbon tax immediately not only reversed the go-slow approach but it gave the impression of a vastly different Labor government to that which had been cultivated during the campaign.

Broken promises only hurt when they speak to a party’s overall identity. Likewise, Tony Abbott’s decision not to pursue his promised repeal of section 18C of the Racial Discrimination Act has been a running sore on the Coalition’s time in power because it presented, for the government’s supporters, a rejection of the ambitions of a centre-right philosophical resurgence.

Section 18C is not the be all or end all of liberal policy, or even of the threats to freedom of speech in Australia. But its promise sent a powerful signal that the tide could be turned towards liberty, and that a mainstream party was able and willing to make that change. When Abbott abandoned the promise, he undermined the vision of liberal-conservative government he had cultivated in opposition. The Coalition surrendered the very ‘Freedom Wars’ it had declared.

It must have been somewhat to their horror that Malcolm Turnbull and Scott Morrison spent the first half of their eight-week election campaign talking about their changes to superannuation. Superannuation stung them for the same reasons that the carbon tax stung Julia Gillard and 18C stung Tony Abbott. Repeatedly throughout the Coalition’s term in government it rejected the possibility of increasing taxes on super. Tony Abbott had ruled out no changes to superannuation in the 2013 term ‘or the next’. Scott Morrison was publicly opposed to changes as recently as November 2015.

The Coalition was gearing up for an argument that pitted the high taxing Labor party against the low taxing, small government Liberal-Nationals. Their error was in part strategic — to announce an extremely complicated policy that harms self-funded retirees, many of whom would be expected to be Liberal voters was always going to be fraught — but it was a serious policy mistake as well. It was a breach of faith that recalled the deficit levy in 2014, demonstrating that the Coalition was happy to whack its own supporters for expediency.

Trust, indeed, is fundamental to the superannuation system itself. Superannuation has long been presented as a secure foundation for savings. But now the Coalition has established that the Commonwealth sees it as a money pot which can be dipped into for fiscal or political expediency. Having changed the rules this time, savers will rightly believe the rules can be changed again. This is the sort of policy manoeuvre that erodes faith in the public policy system as a whole.

In his 2016 book The Trust Deficit, Sam Crosby, executive director of the Labor leaning think tank the McKell Institute, points out that voters who do not trust that governments will act in their interests will vote for non-incumbent and third party candidates. Trust — as nebulous as it is — is the bedrock of political power in a democracy. And the major parties have been systematically eroding it, by governing contrary to what people thought they were voting for.

Kevin Rudd promised fiscal conservatism, and gave us the record stimulus spending. Julia Gillard promised a sober approach to climate change policy and gave us the carbon tax. Tony Abbott promised a slower, more adult government than Labor and could not live up to that. Malcolm Turnbull promised us a new disciplined approach to economic management, and gave us six months of policy confusion, a tax increase, and an eight-week election. The minor party vote is a reflection on the failures of the major parties.

The consequences

Australia’s fiscal and economic problems demands serious reform. In 2016-17, the Australian government will spend, as a percentage of GDP, as much as it did when Kevin Rudd was stimulating the economy. In other words, the Commonwealth is at a permanent emergency level of spending.

Furthermore, our policy settings seem deliberately geared against the needed economic growth that might bring the budget back to surplus. For instance, Institute of Public Affairs calculations have found that red tape — that is, unnecessary and counterproductive regulation — costs the Australian economy $176 billion a year. There are nearly 500 separate government bodies at the Commonwealth level involved in the imposition, administration and design of red tape.

Australia has fewer taxpayers supporting more people who are dependent on the state. As the Weekend Australian pointed out in May 2016, if you add the 4.48 million people who are wholly dependent on federal government pensions, allowances and parenting payments to the 1.89 million people who are public sector employees, that means 44 per cent of Australians draw their livelihood from the non-productive sector.

This is not sustainable — certainly if we are to maintain the high living standards we expect.

Whether they like it or not, the Turnbull government is going to have to reckon with these deep structural problems in the Australian economy. Yet the eroded trust between population and politician is going to make it extremely hard to do so. That lack of trust affects the possibility of reform in two ways. First, it is not clear that the minor party and independents that have been thrown up by the anti-major vote are capable of reckoning with this problem.

Neither Pauline Hanson nor Nick Xenophon — to take the two most prominent winners from 2016 — have an appreciation of the need for drastic economic reform. If the Coalition acquiesced to some of their policy positions — such as subsidies for private firms and protectionism — our economy would be in a substantially worse shape than it is now.

Second, and more fundamentally, reformers need the trust of the voting population in order to push major reforms through. Complex reform needs explanation, and if the public believes that explanation is not done in good faith they will reject it. No matter how certain they are of their course, few governments can swim against the tide of public opinion indefinitely.

This looks like a pessimistic story but it is not. One of the arguments that came out of the Gillard years was that the era of reform was over. Paul Kelly, most influentially, argued that the political system had evolved a few key features that made reform if not impossible, then improbable. In his argument, the faster pace of political life (encapsulated by the unending panel shows of 24-hour news networks and the anarchic, unpredictable world of social media) along with the power of sectional interests (here he is thinking of the mining industry’s campaign against Labor’s mining tax) are structural barriers to reform.

There is no question that the pace of political life has changed. It’s unclear how this selects against reform — more venues for political commentary does not imply the population is more interested in politics than they were in the past. Kelly’s concern with ‘sectional’ interests is also misplaced. We are in an era where old power blocs are breaking down, rather than consolidating their power — at no time in history have the old industrial empires (media, unions, corporations) been under as much pressure and contestation as today.

In fact, Kelly’s argument would be more convincing if he had traced the opposite argument: getting through political reform is no longer a matter of a few handshakes between unions and corporate leaders. The trust deficit is in part a reaction to that cosy, conspiratorial style of politics.

Seen through this light, there’s a clearly undemocratic thread running through complaints that minor parties make reform impossible. The criticism that non-major parties are ‘populist’ is a bizarre complaint in a democracy where voting is supposed to aggregate the popular preferences of the masses.

The nostalgia for political moves like the Hawke government’s Accord is a nostalgia for government by handshake rather than popular consent. Political strategists advise governments to shirk reform because it is unpopular. It is true that John Howard took a GST to an election, explained the need for reform clearly and comprehensively, and nearly lost. But he pushed the policy through parliament after that election, and the GST is widely seen as the cap on the reform era.

By contrast, Malcolm Turnbull took very little to the 2016 election — failing to explain either his superannuation tax increase or his corporate tax reduction — and nearly lost.

Howard left 1998 empowered, despite the election being a close run thing. Turnbull looks wounded from his 2016 near loss. Reform is hard to argue for. But if we are to tackle the substantial economic problems facing the Australian economy, the focus will have to be establishing a trust between the political class and the population they purport to represent.

Populism is not a dirty word

The political news right now is Malcolm Turnbull’s tenuous hold on government.

But tight elections aren’t unusual. The real significance of the 2016 election is how it reveals the growing dissatisfaction with the political class and mainstream parties.

This is a thread that links the support for Nick Xenophon and Pauline Hanson in Australia with the support for Donald Trump and Bernie Sanders in the United States and for Jeremy Corbyn and Brexit in the United Kingdom.

It’s easy to dismiss these movements as “populist”. That word has already been spat out hundreds of times on panel shows and through the quality media since last weekend’s election results began to come in.

But “populist” is a strange insult in a democracy. Democracy is a system by which we come to agree as a group about how we live together. It has lots of flaws. The idea that the conclusions it comes to are too popular – too widely accepted – surely aren’t one of them.

To call a politician or political movement populist is a dodge. A comforting, revealing dodge. An admission that the speaker sees the consent of the governed as a frustrating hurdle, rather than the reason parliament exists in the first place.

But even more than that, it’s deeply condescending. Yes, they’re less polished. They’re less refined. But those apparently dangerous and unacceptable populists deploy much the same arguments and same rhetoric as the major parties.

Consider their approach to foreign investment. Nick Xenophon and Pauline Hanson both want to “take back the farm” and make it harder for foreigners to buy Australian assets. This could have catastrophic economic consequences. Australia needs international capital.

But then again the major parties have been telling us that foreign investment is risky, even dangerous, for years.

The Coalition government has been running a crackdown on foreign investment in housing. It prevented the sale of the cattle station Kidman & Co to a Chinese company. It blocked the American firm Archer Daniels Midland from buying GrainCorp. Kevin Rudd made foreign investment scepticism a key plank of Labor’s 2013 election bid.

So if it is agreed by all parties that foreign investment is a bit of a problem, why would anyone vote for a major party whose concern for this issue seems only skin deep? Why not support a minor party that takes the concerns more seriously? The majors make the argument, and the minor parties increasingly grab the votes.

Likewise free trade. The Coalition government signed some important free trade agreements that are important for the future of the Australian economy. The Labor Party professes support for trade as well.

But too often those free trade agreements are presented by the political class as extracting concessions from foreign countries for Australian exporters, rather than allowing us to import goods cheaper and thereby raise our living standards.

The Labor Party used the Trans-Pacific Partnership for a scare campaign about Chinese workers being brought into the country. When Qantas moved its operations into Asia a few years back, the Transport Workers Union screamed that the company was being “Asianised”. Who does that sound like?

The Nick Xenophon Team wants the next government to directly support struggling companies – particularly the Arrium steelworks in Whyalla. On the one hand this flies in the face of every basic principle of sound economics, representing a transfer of wealth from taxpayers to public companies. On the other hand the major parties do that sort of stuff all the time. The Napthine government handed money to SPC Ardmona after the Abbott government refused. The only jobs plan either major party has for South Australia is to pay South Australians to build submarines.

In other words, no major political party has been making the argument for free trade, foreign investment and market competition. Yet now they blame the voters for being anti-market.

Major party strategists will tell you quietly that they have no choice but to take “populist” positions. Only the impotent are pure and all that. If the voters want protectionism the parties need to deliver it.

But this belief confuses policy means with policy ends. Do voters want higher tariff schedules, or do they want jobs and a sense of economic security? Do voters want lower immigration quotas or employment opportunities for their children?

The Australian public cannot be expected to know every detail of every policy, or the voluminous literature on trade and migration. They have families and businesses to worry about. But the protectionist and interventionist economic policies attracting people to the minor parties won’t protect jobs. They will hurt jobs by slowing the economy.

Basic economics can be counter-intuitive. It needs to be argued for. No major party is making that argument. They’re fudging and hedging, trying to be all things to all people, never committing, constantly doing one thing and saying another. No wonder people are voting for something else.