The latest HILDA (Household Income and Labour Dynamics in Australia) dataset has revealed some disturbing trends. All Australians have seen their incomes stagnate, but each successive cohort of university graduates for which we have data have by now actually seen their wages actually decrease, relative to older cohorts. Surging house prices especially in the two major cities of Sydney and Melbourne have contributed to rates of home ownership among the youth falling from over 36% in 2002 to 25% in 2017. This is seriously dangerous, because being unable to afford a home & stagnating earnings can contribute to an attitude of hopelessness and despair which is a breeding ground for political extremism.

What on earth is going on? We require just a little demand-supply economics to discover the root of the issue.

With respect to income stagnation, it actually ought to come as no surprise that young Aussies are suffering, given the nature of the Australian economy and the policy objectives of the Turnbull administration with respect to higher education. The Aussie economy is a (relatively) small open economy in an increasingly hypercompetitive global market being disrupted by artificial intelligence, while the government has been seeking for some time to increase the proportion of the population with a university degree. The combined effect of these trends means that very few Australians can demonstrate they have a skill set for which there are no ubiquitously available substitutes, either human or technological.

Unless someone can demonstrate no state of substitutability exists between their labour and someone else’s, the decision to hire them is subject to “trade-offs” of the benefits and costs of hiring them, rather than rules or necessity. It is extremely difficult therefore to demand higher wages, for to do so means one’s labour is a relatively worse trade-off in the mind of the employer than that of the substitute. So of course we can hardly be surprised that incomes are stagnating, especially amongst recent graduates. Where once a university degree was a signal of a skill set for which substitutes were not available, it now demonstrates a skill set for which not only are many substitutes available, but increasingly cheap ones too.

The problem as regards housing affordability is actually very simple. There are too many people wanting to live in too few homes too close to city centres. This is first year economics: take your demand-supply diagram, and simply imagine that the demand curve is increasing for the product “inner-city housing in Australia” and the supply curve, which is best understood to be vertical for housing, isn’t keeping pace. But to understand why that demand curve keeps shifting outward seemingly without end we need a little psychological economics.

The decision whether or not to live in inner-city Sydney or Melbourne is not a decision subject to substitutability. By one metric, economic activity in Sydney and Melbourne put together accounts for 67% of all the activity in the Aussie economy. We need economic opportunity because it is a pre-requisite for and compliments lifestyles. Sydney and Melbourne, being global cities with substantial populations (1 in 5 Australians live in Sydney) can offer a far greater depth and variety of services for entertainment and pleasure. Thus, the decision to live in inner-city Sydney or Melbourne is an economic and psychological necessity.

The policies forwarded by the parties to address these two emerging crises of income stagnation and housing affordability reveal they either they don’t understand the root causes of the problem, or don’t want to face them. Who can blame them? To address income stagnation requires the scary realisation that the market rewards the possession of knowledge which no one else has — a university degree isn’t enough to signal this. To address housing unaffordability requires the parties to face up to the fact that not everybody in Australia can live in inner-city Sydney or Melbourne.

So what we have heard from the Labor Party is quite predictable: to address stagnating income we require more redistribution and the need to address housing unaffordability. We require supply-side measures of eliminating negative gearing (which allows one to write off capital losses on houses) and increasing the capital gains tax. The Coalition is introducing a “SuperSaver” scheme to allow people to use excess superannuation funds to put down a deposit on their homes. Both parties maintain a commitment to providing grants for first-home buyers & want to improve transport infrastructure in Sydney and Melbourne to make living in the suburbs more viable. There has also been talk of punitive tax measures against foreign investors who leave properties unoccupied.

These are what we in Australia call “Band-Aid” measures. Redistribution as a response to stagnating incomes is all well and good, but Australia has a fairly strong redistribution system in place already & it can never be so effective a solution to problems of income as improving the ability to obtain an income. The tax measures proposed by the ALP to address housing affordability do not solve the underlying problem of demand being too great, the Coalition SuperSaver scheme amounts to “pouring petrol on a fire,” as does the bipartisan first-home buyer’s grant scheme. Improving transport infrastructure might ease demand somewhat, but it merely makes it more feasible to live a little further from the city centre.

What is required if we actually wish to address the problems is far more radical. The stark truths are that the Australian economy is far too concentrated around inner-city Sydney and Melbourne and our education policy is not serving to equip graduates with unique skillsets. If any government wants to alleviate pressure in the housing market they must account for the economics which are causing so great a demand pressure in Sydney and Melbourne. They must get far more serious about investing in regional development. Being able to meet the necessity of economic opportunity and to have that complimented by services for lifestyle and pleasure in the outer regions is essential if demand for housing in inner-city Sydney and Melbourne is to be eased.

This doesn’t require the government to invest in everything from roads to cinemas — the government doesn’t know what people in the regions want, the people in the regions do. It does require the federal and state governments to drastically improve the provision of services necessary to support substantial economic activity in the outer regions (public education being an essential one) by decentralising their operations and especially their talented workforce. I would go so far as to suggest a financial incentive of an immediate 25% boost to remuneration for employees based in regional areas.

The proverbial stone which kills two birds here is moving toward a permission less innovation system. The single best thing the Australian government could do overnight to address the problem of regional development and stagnating incomes would be to pursue an idea put forward by my colleague Doctor John Humphreys to allow any organisation to opt out of all regulatory systems (the law of contract excepted), provided they make sure this information is provided to consumers. I would go further and encourage the government to grant a tax amnesty to any business with an Australian Business Number less than a decade old. Centralised organisations rarely have better knowledge than the individuals facing a problem, and so the best thing they can do to solve a problem like regional development or obtaining a higher income is to not require them to obtain permission or otherwise dissuade them from solving it.

Unless the major parties realise the nature of the problem they are facing with stagnating incomes and inability to afford houses among the youth, we are unlikely to see them proposing measures which will actually solve them. Unless they get serious about regional development, a truly liberal education policy and permissionless innovation, we can expect a corrosive sense of hopelessness and despair to continue to erode amongst the people who are our nation’s future.