Bitcoin investors should be taxed like any other investor

By Chris Berg, Sinclair Davidson and Jason Potts

Despite its name, cryptocurrency isn’t just money. It could also be debt or equity and so it should be regulated and taxed in the same way as other finance.

The tokens investors get when they buy a cryptocurrency, like Bitcoin, can be used to buy into blockchain startups (businesses that use the same online ledger as cryptocurrencies). When blockchain startups issue shares in their businesses using cryptocurrency, it’s called an initial coin offering. For investors, this is like any other equity investment.

Cryptocurrency can also be used to finance specific assets, like debt. So what we have is a single financial instrument that has the advantages of both debt and equity.

So startups issuing their own tokens for investment purposes should have to comply with the same rules and regulations that startups issuing more traditional instruments must comply with. Cryptocurrency investors should be taxed on the same basis as traditional investors.

Why cryptocurrency is a mix of money, debt and equity

Money is very often defined by its functions: a medium of exchange, a unit of account (used to represent the real value or cost of any economic item), and a store of value (that can be saved, retrieved and exchanged at a later time). The early consensus about Bitcoin among economists is that it’s not money.

At best cryptocurrencies are a medium of exchange. But many economists doubted that Bitcoin, given its volatility, could ever serve as a unit of account, let alone as a store of value.

So if cryptocurrency isn’t money, is has to be something else. It could be an asset of some sort.

Usually if investors acquire or sell an asset, it would be liable to tax, such as the GST. This means people using Bitcoin would be taxed twice when using it.

It would be taxed when the person buys the Bitcoin and taxed again when they used it to buy something. Luckily the federal government realised this was a bad idea and moved to repeal the double taxation of Bitcoin.

Clearly the federal government’s view is that cryptocurrency is not legal tender – so don’t try pay your income tax in Bitcoin anytime soon. And there are important differences between money, specifically legal tender, and cryptocurrency.

Cryptocurrencies tend to strictly rules bound. How they’re created, when they can be earned, how they’re distributed and how many there ever can be, is all determined by rules. In fact, users like strict rules.

By contrast government controlled money is not rules bound. Government employs substantial discretion in exercising control over money. So while the US dollar has the words “In God we trust” printed on it, this system actually requires substantial trust in government.

This trust has been repaid by a substantial reduction of value over the past century. It seems that government-backed money may also be a poor unit of account and store of value.

Debt and equity are financial instruments used to raise money to finance economic activity. It is something of a puzzle to financial economists why firms use debt in some instances to raise finance while using equity in other situations.

An important 1988 paper by the 2009 economics Laureate Oliver Williamson provides a possible answer to that question. Williamson argues that debt, being a strict rules bound financial instrument, is best used to finance general assets, while equity is best used for so-called specific assets. Specific assets are those assets that cannot be cheaply or easily redeployed from their current use to alternate uses without a substantial loss of value.

As it turns out Williamson had speculated about the existence of such an instrument (that he labelled “dequity”) and then rejected that instrument as being unworkable. The reason dequity was unworkable was due to opportunism – investors simply could not trust dequity issuers.

The ledger that cryptocurrencies use – the blockchain – is a actually “trustless” technology because it’s decentralised. It allow users to see each other’s ledgers and transactions, negating the need for a trusted third party to manage risk. Instead it relies on cryptographic verification.

With the absence of the ability for investors to game the system, cryptocurrencies are the dequity Williamson first imagined and it could become an efficient financing mechanism.

How dequity should be regulated

The idea of regulating or taxing cryptocurrency finance may not be to the liking of many crypto-enthusiasts who are likely to argue that traditional rules and regulations are very onerous. They are correct, of course. Yet the solution to over-regulation is not a carve-out for special interests but rather regulatory reform that reduces the burden for all business.

The good news for crypto-enthusiasts is that some governments appear willing to engage in genuine regulatory reform and tax competition to attract investment in this space. For example, the Singaporean government is relaxing existing regulation to accommodate cryptocurrency. Its proposed framework would require applicable companies to obtain a license from the Monetary Authority of Singapore, and divides payment activities into several categories.

But regulators should really regulate cryptocurrencies in much the same way as they do existing financial instruments. It shouldn’t be given special treatment.

Despite all the complexity of cryptocurrency it really is simple: it’s a financial instrument that combines all the advantages of money with debt and equity. It’s none of those well known concepts in isolation, but a viable and workable hybrid of all three.

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.

The Economics of ZPG

With Jason Potts

In the dystopian 2013 film Elysium, written and directed by Neill Blomkamp, the earth is badly overpopulated. The society that results is deeply unequal. The haves flee to a luxurious space station orbiting the earth. The have-nots remain on an increasingly polluted and decaying planet, subject to the robotic oppression of the haves in space above them.

The dangers of runaway population growth, and the dangerous society that such growth would create, have been an enduring Hollywood obsession for half a century. Elysium nostalgically recalls a spate of films in the 1970s that predicted overpopulation—and increasingly totalitarian measures of controlling population—from the famous, Soylent Green and Logan’s Run, to the forgettable, ZPG and The Last Child.

Yet in the early twenty-first century it is increasingly clear that if humanity faces a population crisis, it is a crisis not of overpopulation, but underpopulation. Neill Blomkamp derived a sort of crude Marxist vision of capitalism from the overpopulation crisis, depicting workers toiling under oppression to feed the demands of the comfortable and distant rich.

While the economic analysis shown in Hollywood films might be questionable, the idea that dramatic changes in population will have significant economic consequences is not. Today, fertility rates are below replacement level in developed countries like Australia. They are heading in the same direction in the developing world. Nearly fifty years after the American biologist Paul Ehrlich published his book The Population Bomb, sparking off the modern overpopulation panic, it seems more urgent to consider the costs of population stagnation than population explosion.

A society’s demography is shaped by three factors: fertility, ageing and migration. Australian fertility rates were as high as 3.5 in 1961, giving us the baby boom generation. But they sharply declined from those heights, so that by 1980, the fertility rate was 1.9. It has remained there ever since, and the Commonwealth Treasury assumes the fertility rate will remain at 1.9 for some time to come. But this is below replacement rate: that is, the couples of Australia are not reproducing enough to replace themselves.

The second factor is ageing. The Commonwealth government’s Intergenerational Report suggests that life expectancy at birth will increase from its 2015 state of 91.5 years for men and 93.6 years for women, to 95.1 and 96.6 years respectively by 2055. When Joe Hockey said that it was possible that a child born today might live to 150 it was widely seen as a political gaffe but, with the rapid changes in molecular biology, living to 150 is not at all absurd. The sequencing of the human genome, completed in 2003, has been described as the biological equivalent of the development of the table of elements in the nineteenth century, a breakthrough which led to a revolution in chemistry. Placing genetics at the centre of medical practice is almost certain to dramatically change our expectations about longevity and health. Whether Hockey is right or not, the consequence of these trends skews the age distribution so that the Australian population is older.
The countervailing demographic pressure against increased longevity and fertility decline is migration. Simply put, what we no longer produce ourselves we can import. However, our migration intake selects against the highest-fertility population. Policy favours skilled migrants over unskilled migrants, and highly educated migrants over migrants with less education. These are the same populations that are going to be both older and less fertile. The obvious exception to that approach is our refugee intake, but refugee numbers are a tiny subset of the immigration total. Migration expands the population, because while Australia’s fertility is under the replacement rate, the global fertility rate is 2.4. Global fertility was around 5 in 1960. But where Australian fertility has plateaued, global fertility is still on its trajectory of long-term decline. And migrant populations quickly adopt the fertility rates of their new homes.

However, while the mathematics of population decline are fairly straightforward, history shows that untangling the economic consequences of population stagnation or decline is not. Between 1347 and 1351 the Black Death killed between a quarter and a half of Europe’s population, even more in some major centres. Three quarters of the population in Florence may have died in 1348. The plague sparked a century-long population decline across the continent. Where England had a population of 2.8 million people in the 1370s, it had only around 2.3 million in the 1520s.

The plague and the subsequent demographic decline cut short a relative economic boom in the high Middle Ages, which had seen the buds of capitalist exchange, expanding markets, technological development and population expansion. The first economic consequence of the Black Death that historians have long pointed to was its role in rewriting the structure of the labour market. The sudden scarcity of labour pushed the price of wages up dramatically, to the extent that the English parliament attempted to place a maximum ceiling on wages.

This smaller number of workers changed the economic and political leverage of the survivors. Contemporary elites complained about the newly demanding workers, who would refuse to work—or would work poorly—if they were not rewarded the market wage. “So the world goes from bad to worse,” wrote John Gower, a poet and friend of Geoffrey Chaucer, “when they who guard the sheep or the herdsmen in their places, demand to be rewarded more for their labour than the master-bailiff used to be.” Labour scarcity broke the traditional peasant–lord relationship, as workers went on the road looking for the best wages and short-term contracts. “Servants are now masters and masters are servants,” complained Gower. Economic power tends to become political power. A sense of the political consequences of this population shift is offered by the Peasants’ Revolt in 1381, when rural workers reacted to the introduction of a series of poll taxes by forming an army and ransacking government buildings in London. This was a proletarian parallel to the rebellion of the elites that had given England Magna Carta a century and a half earlier, but one which ended unhappily for the rebels.

The long-term consequences of the Black Death were more subtle. Demographic change allowed for rapid institutional innovation as the bonds that maintained the old order were weakened. It has been too common for popular historians to strip the medieval world of agency of its own and imply that only an outside shock—in the form of the bacillus Yersinia pestis—could alter fixed political and economic dynamics. The humans of the medieval world adapted to their new demographic environment in complex ways. The fact that the plague was less severe in some parts of Europe has allowed economic historians to show that even where the population continued to rise, as it did in Holland, wage rates increased in this period. The supply-and-demand relationship between population decline and labour costs does not necessarily mean that in all regions affected by the plague wages increased at a higher rate than in those which avoided the plague. And while Holland fared well in the long run from its relative avoidance of the Black Death, other places which also avoided the plague—such as Prague or Bohemia—did not experience the same sort of economic prosperity as the Low Countries.

This non-linear relationship between demographic change and economic change is not surprising. How societies responded to the consequences of the Black Death depended on their institutional environment: the legal and regulatory framework, the capacity of classes enfranchised and disenfranchised by change to prevent or exploit those changes through the political system, the capital structure of the economy, resource endowments, the depth of market exchange for goods and labour and so on. The Black Death wrought institutional changes that gave us the modern world—institutional changes that were unpredictable to those who lived through the crisis and which historians are still trying to trace. Higher wages moved economic activity towards capital-intensive agriculture and proto-industrialisation, sparking changes in urbanisation and the organisation of guilds and communities. Rather than the short-term effects on the supply and demand for labour, it will be in institutions that we see the long-run significance of modern population change.

This captures one of the essential errors in much of the popular debate about the consequences of population change. A strictly mathematical approach to population analysis—fertility plus migration equals population—transposed onto the current political order does not capture the institutional evolution that would result from the trends. In the January 1977 edition of Quadrant, the Liberal gadfly W.C. Wentworth derived the consequences of population change from such an accounting of fertility rates, concluding, “There may be serious doubts as to how many can really live well on the limited surface of the globe.” Decades on, in the wake of the digital and agricultural revolution, it is clear that such negativity was unjustified.

The direct economic consequences of a declining population could be a slow increase in the price of labour, as occurred suddenly in the years after the Black Death. As the scarcity will be concentrated in the younger population, these price increases will be particularly for work which has traditionally been performed by the young, including service jobs and unskilled manual labour. Technology allows for some substitution, and higher labour costs encourage development in further innovation. Existing tendencies towards automation of labour—encouraged by the demands of consumption and the prohibitive strictures of industrial relations laws—will be accelerated. Every Australian suburb now has a vision of the future in the McDonald’s automated ordering system, and it is easy to imagine further automation of service industries that were once believed to be immune.

More diffuse economic consequences of population stagnation will be delivered through the political system. All else being equal, an older population means that the interests of older citizens will be better reflected in public policy. We are already seeing some of the direct political economy consequences of an ageing population. Much current public policy tends to favour older rather than younger people. One of the most harmful is the restrictions on land use that benefit established home-owners over possible new entrants to the housing market. Both controls on urban development and limits on land release raise the price of housing by creating artificial scarcity. This works out very well for home-owners but terribly for those who want to enter the housing market for the first time. These sorts of policy-induced housing shortages ultimately divert capital away from more productive investments—Australians end up using more of their wealth for what could otherwise be much cheaper—with long-term consequences for living standards.

Other political economy consequences could be less harmful—even beneficial. High rates of population growth distort the political system towards the interest of its younger members. For instance, while the overwhelming benefit of education accrues to the person who is being educated, governments have long paid the bulk of education expenses out of taxpayer funds. This over-subsidisation of education may be reduced as the population skews older. Wasteful or unnecessary family payments are less likely to be tolerated by an older population that does not feel it receives direct benefits from these funds. On the flip side, that older population will be much more protective of generous pension schemes and health subsidies. A rebalancing between older and younger generations is likely to lead to more social spending rather than less. Pensions are a far larger drain on the Commonwealth budget than family payments, and the cause of market-oriented reform in healthcare provision is much less advanced than in education. While the shape of social spending will change, population stagnation is more likely to increase that spending rather than decrease it.

We have already hinted at some of the causes for optimism. One approach might be to use policy to reverse negative trends. In the overpopulation dystopias of the 1970s, Big Brother governments took it upon themselves to limit breeding or eliminate the elderly. Governments have long been aware of the declining fertility rate and, particularly under the Howard government, sought to align policy incentives to encourage people to have more children through baby bonuses and tax benefits. However, the downsides of using the political and legal system to influence the demographic profile of the population are substantial. Obviously those dystopias imposed huge costs of the rights of the citizenry, and the one-child policy in China has had enormous human costs. The modest family payments designed to boost fertility in Australia are subject to the same inefficiencies, churn, opportunities for rent-seeking and politically motivated subsidisation as any other part of the welfare system.

We see more reasons for optimism in the development of healthcare technologies that might both lower the cost of providing healthcare services to an ageing population, and also allow an ageing population to work more productively. The net effect is that an ageing population becomes less of an economic burden on the rest of society, requiring fewer resource transfers.

There are multiple sources of such technologies. At the biomedical level, enormous improvements in new biotechnologies such as personalised genomics may significantly improve the effectiveness of targeted medicines. The breakthrough gene-editing technology CRISPR may dramatically reduce the incidence of chronic genetic diseases and improve our ability to repair diseases of senescence. Very large falls in the cost of wearable personal monitoring technology and the internet-of-things may greatly improve access to healthcare and increase the incidence of low-cost early interventions. Personal robotics may facilitate greater ability for the ageing to continue to live independently, both as providing services that range from robot vacuum cleaners and quadcopter drones for delivery, which already affordably exist, to robotic assistants (imagine the Artificial Intelligence platform Siri on Apple’s iPhone coupled with industrial robots), to driverless cars (which already exist), to personal exoskeletons, which are in use in the US military. This list can go on and on, and while there are certainly high development costs, the economics of mass adoption and market competition will drive these costs down.

Such benefits do not depend on a special class of technologies for the ageing and elderly, but are adaptations of general-purpose technologies (for instance gene-editing techniques, big-data, industrial robotics, and so forth) that are subsequently applied to particular and growing market segments. We can rely on the market mechanism and profit-seeking entrepreneurs to figure out how to adapt new general-purpose technologies to create value by improving the lives of an ageing population. Many such benefits can be expected to maintain health, well-being and independent functionality to enable continuing participation in society and contribution to the economy.

Of course, a longer working life is not just a joy for the federal Treasurer; it is also a very good thing for each individual person because it means a higher level of income and freedom, which in turn means greater independence and ability to consume. Working longer is a good thing not because work is a good thing—although there are surely benefits from increased social and community engagement that come from gainful employment. Working longer is good because more production means more consumption. These higher levels of income and consumption may be spent on travel and experiences, higher quality of living, on family, or on greater levels of healthcare or even enhancement.

These causes for optimism are dependent on current trends in innovation holding true. It is equally obvious to observe that an ageing society will experience second-order effects that can reasonably be expected to dampen the rate of innovation and technological change. These are effects that go directly to the underlying incentives to develop the new general-purpose technologies mentioned above, rather than the specific adaptations of these innovations to the needs of the elderly.

The first is that an ageing population has a different overall risk-reward profile than a younger population, particularly among males. The young of all species (and not just humans) have a higher risk-taking propensity because they are engaged in mate competition. We’re wired this way. This increased risk-taking propensity can be destructive when it is channelled into fighting, raiding and warfare. But a great benefit of a free-market society, as economists from Adam Smith to Joseph Schumpeter to Deirdre McCloskey have pointed out, is that there are substantial pay-offs to society when this competitive instinct is harnessed towards entrepreneurial action to create and develop new ideas—whether great artworks, new technologies or new products.

Entrepreneurship and innovation are risky. But when they succeed they furnish substantial benefits for many, and possibly a great many. The US economist William Nordhaus estimated that entrepreneurs only capture (as Schumpeterian profits) about 2 per cent of the social value of their innovations. That means that 98 per cent spills over to society as consumer surplus. But other economists such as Edmond Phelps have pointed out that the net private return to innovation is actually pretty close to zero. This should not be surprising. Most entrepreneurial endeavours to develop new technologies, companies and innovations fail. The few that succeed in effect balance the many that fail, such that there is a Pareto distribution of returns. But because most of the value of an innovation spills over as consumer surplus, the social returns to innovation are everywhere substantially higher than the private returns. (Another way of saying this is that innovation has public good qualities, or can be subject to market failure.) One of the great benefits a society with a young population experiences is its high natural propensity toward risk-taking entrepreneurship, and the associated social benefits that brings. Equivalently, one of the great although often hidden costs of an ageing population is the loss of entrepreneurial dynamism. Along with this comes an increased tendency to seek political solutions rather than market solutions to social problems, which further drives an economy towards rent-seeking.

A second and related point that further constrains innovation in an ageing society is that the basic economics of investment returns to innovation are different. Specifically, in respect of the costs of adopting new technologies the discount rate for a younger population is lower than an ageing population. This is for the simple demographic expedient that an older population has less time to amortise the costs of developing and adopting a new technology and also less time to receive and accumulate the benefits. In short, because the costs to innovation are upfront while the benefits accrue through time, innovation is simply more expensive when you have less expected life in front of you. Now the elderly might actually care not just about themselves, but also about the future welfare of their children and grandchildren and so on, creating what economists call an infinite overlapping generation model. But without such an assumption, or some attempt to engineer it through the tax system, an ageing population will rationally invest less in innovation.

A third observation follows from these two and connects the types of economic institutions that a democratic society will choose when the population is relatively younger and growing or older and stable or shrinking. One of us has written recently about why the mass leisure society that John Maynard Keynes famously envisaged in his 1930 essay “Economic Possibilities for Our Grandchildren” has never come to pass, by emphasising that the sorts of economic institutions of a wealthy prosperous society are those that encourage entrepreneurship and innovation and not just consumption. But this same argument also runs the other way. As we have noted above, the sorts of economic institutions that a zero population growth society chooses are likely to be geared towards political redistribution of economic resources. These institutions require higher taxes, which penalise entrepreneurial action and therefore blunt the rewards to innovation.

An ageing society tending towards zero population growth also risks tending towards zero economic growth because of the harmful consequences on the supply of entrepreneurship and innovation, because of its effect on risk preferences and on investment, and also on the way such a demographic transition will likely distort economic institutions away from a liberal market ideal. In the long run, it is hard to say whether these headwinds on general-purpose entrepreneurship, innovation and new technology are likely to dominate the more optimistic tailwind scenarios on the specific application to the problems and opportunities of an ageing population.

An obvious class of solution is to recognise that an ageing zero-growth population will create increased pressure on political solutions to economic problems, and therefore to seek to constitutionally head that off by constraining and limiting the powers of politicians to offer political solutions. Privatising more of the healthcare system would be a start. Our institutions need to be capable of adapting to the consequences of ageing and population stagnation—consequences which are now unpredictable. Allowing for greater market control of social services will provide such adaptability. The fragility of medieval society to the Black Death and its demographic aftermath was not only technological and medical: medieval markets were shallow, meaning that resources could only slowly reallocate to new uses, if at all.

Another class of solution follows from the diagnosis of the intergenerational nature of the innovation problem. Innovation requires both an entrepreneurial risk appetite and liquid resources. A young population has much of the former, and an older population has more of the latter. If pension funds were able to function more effectively as venture capital funds, that would be a step in the right direction. For instance, financial regulations designed to protect investors by constraining pension fund investments to say ASX30 listed companies stand in the way of such reform.

But the most important factor is the importance of maintaining an open economy with free and easy movement of people, resources, capital and ideas. If risk preference and investment in creating new ideas and innovations will decline in a zero population growth economy, then it becomes critical to be able to import new ideas from elsewhere. This will also be true of gaining access not just to technologies but also to services offered in other countries. Perhaps certain types of regenerative therapies or surgeries will be developed in Singapore or the Philippines. It may not matter much if they are not invented, produced or delivered in Australia, provided Australians have access to them, through having produced things of value that we can exchange for them. This is where the importance of continued participation in the labour force matters.

A zero population growth economy will impose substantial challenges on Australia in the future. It is not the ecological utopia that some imagine, but nor is it likely to be a Marxist dystopia. It will make us all poorer. And it will do so in significant part because of its effect on entrepreneurship and innovation. But these consequences can be mitigated by sensible and far-sighted commitment not to allow the harms to happen. Maintaining an open economy, constraining government growth with commitment to free-market institutions, will go a long way towards allowing us to live well as population growth slows.