The Australian Economy: A Deficit of Long-Term Thinking?

The flood levy has caused most of the usual suspects on debts and deficits to come out and spruke their position, whether it's "increasing taxes is always bad" or "deficits are not really a problem for Australia". While my sympathies definitely lie with the latter rather than the former, I can't help but feel that we should have been building a rather large fiscal surplus over the past 20 years 'without a recession'.

While going into deficit was a necessary move by the Rudd government, the real question is whether the fiscal balance should have been in better shape before the crisis, given the mining boom and the long period of growth before the global financial crisis (GFC). Given Australia's recovery from the downturn and the increase in export prices the Gillard government certainly should be aiming to get a large surplus together sooner rather than later.

Being critical of the pro-deficit position is not an argument for less infrastructure spending, but for increased tax on super profits, especially in the mining sector, but perhaps also in the banking sector. Remember that Australia's mineral resources (whether you think we should be mining them or not) are non-renewable. Once they're gone, they're gone forever. They should be seen as the property of future generations as well as the present generation of Australians. Using taxes from mining profits to build infrastructure or to fund research into renewable energy sources makes sense on an inter-generational basis and would contribute to higher standards of living across the Australian population now and into the future.

If we look at GDP growth since the early 1990s it makes it even clearer that we should have built up a big surplus over time.

There have been only three crosses into contraction since the recovery from the early 1990s recession. This is a remarkable turnaround from the situation between 1974 and 1992 when we had three recessions and 2 other downturns. Australia has had a remarkable turnaround since the early 1990s from the seemingly terminal decline of the 1970s and 1980s.

The reasonable fiscal position of the federal government in 2008-09 made a big difference for Australia's ability to ride out the GFC and more importantly not suffer the public debt problems that the Europeans and Americans are now faced with.

But let's not forget the continuing problem of private debt in Australia. As the following graphs clearly show, Australia remains vulnerable to changes in international financial supply.

After a little dip during the GFC, Australians have returned to the unprecedented debt levels of 2007-08. The question that always need to be asked is just how high can debt go? The answer will have a lot to do with external conditions. In an expanding global economy with Asian flourishing, many Australians could probably push their debt out even further. But if this occurs a day of reckoning will eventually come. A growth slowdown in Asia because of a political shock or just the effects of boom and bust may slow growth in Australia causing rising unemployment, more defaults on debts and so on.

The other issue is the graph on the right, which shows the percentage of annual income paid in interest. Now if the Reserve Bank of Australia (RBA) were to increase interest rates because of inflationary fears and you can bet they will if there is even the faintest whiff of price pressure, the pressure on household finances will increase proportionally. The pain of Queensland households has helped to reduce the pain of households in the rest of Australia.
As the following graph shows, household net worth went down considerably during the GFC, while liabilities stayed relatively flat. While dwellings wealth has recovered financial assets have quite a deal to go before they get to pre-crisis levels.

The safe path would be for governments to encourage gradual deleveraging of households (and the private economy in general). Also important is a decreased reliance on foreign funding, perhaps through an increase in the super levy to 12 per cent as mooted in the Rudd government's aborted 2010 tax plans.

If we turn to inflation we can see why the RBA believes that price pressures almost got away from them before the GFC and why it now has a bias towards tightening. As the RBA governor said recently it's been rare that the RBA believes that it tightened too soon.

The high Australian dollar has also helped things on the inflation front. The following graph shows tradable and non-tradables inflation. Tradeables are those goods and services which can be exported or imported, while non tradables are not subject to export competition).

Tradable inflation has helped to keep overall inflation much lower and a higher exchange rate helps this as it makes the costs of imports lower.

There is no doubt that the Australian economy has performed remarkably since the early 1990s. This amazing overall performance (it's important to remember that not everyone has benefited) has been accentuated by the fact that the economy came through the GFC with little long-lasting damage when compared to most of Europe and the United States.

The following graphs on commodity prices make it entirely clear just how big a boost resource exports have given the Australian economy. Base metal prices have done well, but have some way to go before they match their peak, while rural goods have surpassed their previous highs.

Australia's two biggest exports iron ore and coal have increased enormously in value since a long period of stasis before 2000. China's increased steel use has been very good for Australia, but just how long prices can stay at these levels must be exercising the minds of miners in Australia. It should also be a subject of considerable concern for government in Australia given the 'untaxed' super-profits being made by our majority foreign-owned mining sector.

Overall, however, commodity prices have matched their previous peak before the GFC and as the terms of trade shows are now approaching the post-war high associated with wool demand created by the Korean War.

The terms of trade is an index-measure ratio of the average price level of exports to the average price level of imports. It effectively reflects the capacity of a given quantity of exports to pay for a given quantity of imports, and provides an important indication of the strengths and weaknesses of the economic structure. A rising or falling terms of trade indicates the possibility of improving or declining living standards, because if what we sell earns relatively more than what we buy, we will be relatively wealthier. Because the terms of trade is a ratio, increases can be a result of export prices increasing at a greater rate than import prices, or export prices increasing while import prices are declining, or export prices declining at a slower rate than import prices. Of course, a rising terms of trade doesn’t stop us from buying more things than we sell, which we have made a habit of for much of our history! Improvements in the terms of trade are not reflected in GDP figures, but improvements do contribute significantly to increases in national disposable income.

One thing that studying history has helped reinforce in my head is that good times don't last forever and that the history of the Australian economy is a history of boom and bust as the graph of the terms of trade makes clear. From the peak of 1950 until the late 1990s the terms of trade had been on a 50 year downward trend. It would be extremely optimistic to believe that we began a 50 year upward trend 10 years ago. But maybe I'm just being too negative!

All graphs from the RBA Chart Pack

It's time for mining companies to stop bleating and start negotiating

Let's get one thing straight, mining companies making profits from assets owned by the Australian people should pay more tax. The profits made by mining companies are huge and Australia needs to redistribute this wealth across Australia so that we can develop a more diversified economy. There's no doubt at all that cutting the company tax rate by 2 per cent to 28 per cent and increasing the level of super to 12 per cent are good ideas that will be paid for by increased resource rent.

There's also no doubt that this country is a rich one primarily because we have redistributed wealth generated by our resource wealth - mostly agricultural until the 1960s - across Australian society throughout our history. Such redistribution should perhaps have been more extensive and governments could also have used it to build a more competitive, less insular, manufacturing sector. Nevertheless it is Australia’s ability to adapt – though often imperfect – over time to vulnerabilities that have allowed it to be in a position today to respond effectively to new vulnerabilities.

Up until the 1980s part of this redistribution process was done through the inefficient mechanism of tariffs. Tariffs helped to redistribute the wealth generated by Australia’s natural resource comparative advantage because the costs of tariffs and other forms of protection were borne by the resource exporters. For example, if a mining company needed to import machinery that was subject to a high tariff that aimed to protect a local producer then this was effectively a transfer of wealth from the miner to the local producers (and their workers). Farmers who bore increased costs were often compensated by elaborate forms of agricultural protectionism, such as statutory marketing arrangements that raised prices within Australia and which involved further redistribution. Tariffs were also, of course, an important source of state revenue.

Australia has abandoned tariff protectionism and embraced globalisation, but this does not mean we need to abandon redistribution. Indeed, Australia needs to spread the benefits of growth and openness as widely as possible by redistributing wealth and compensating the losers for the continual structural change necessary for adaptation to a globalising world.

While most countries have to adjust to the world ‘as it is’, the choice of adjustment strategy is not set by the forces of globalisation. Varying responses and outcomes are always possible: both the progress of globalisation and adjustments to its opportunities and constraints involve political choices shaped by citizens and the governments they elect.

I agree that the tax was sold badly and was made too complicated by the boffins at Treasury - in particular Ken Henry - who seems to suffer, like Kevin Rudd, from "I'm the smartest boy in the room syndrome". Perhaps it would have been easier just to lift resource rents or impose a federal rent. This would have the disadvantage of not being profits based, but it seems the miners don't like that when they are making large profits and believe that they will continue to do so into the future.

As usual this is all dependent on an assessment that China and India will continue to grow rapidly over the long-term (bolstering growth in the rest of Asia as well and underpinning resource prices). The short-sighted attitudes of miners will hopefully help to get rid of the very risky 40 per cent stake in any losses that the government's RSPT proposed. This was a bad idea and exposes the government to a loss of revenue when the economy slows down, further exacerbating the cyclical decline in government finances that occur during a recession or growth slowdown.

For those interested in a good article on why we need to get more from our non-renewable resources through a resource rent tax should read Sovereign risk? No, superannuation is at risk, thanks to mine bosses by Gerald Noonan

Sovereign risk? No, superannuation is at risk, thanks to mine bosses

June 28, 2010

GERARD NOONAN

There has been an uncommon flurry of interest about Australia in the global media over the past few days, courtesy of Julia Gillard's ascension to the prime ministership.

But when travelling overseas in more normal times, it is rare to read anything about the wide brown land in the press - except perhaps a tit-bit on cricket or tennis.

So imagine my surprise when, on a recent visit to Paris, I spotted a reference to Australia in the International Herald Tribune, an English-language paper owned by The New York Times.

The topic was not cricket, nor was it the miners' squabble with Labor over a resources rent tax. Instead, it was Australia's superannuation arrangements. In the article the writer had singled out two countries - the Netherlands and Australia - as shining examples of good public policy-making in a world of seriously unfunded pensions.

In Europe you can count on one hand the number of countries that can seriously claim to be able to pay for their ageing workforces in retirement. You need both hands and all toes to count the number of countries in Europe and in North America (yes, including the US) that have not got a hope in hell of properly looking after their ageing populations over the next two or three decades.

The Tribune mentioned Australia's compulsory 9 per cent of weekly wages which all employees pay into their super funds. The story noted the government had announced it was planning to lift the rate to 12 per cent (though it did not say that it would take until 2019 to get there).

Overall, the tone was complimentary. You got the impression the Tribune was a bit surprised at least someone had got it right, given all the talk of how the debt problems of the PIIGS counties (Portugal, Ireland, Italy, Greece and Spain) were potentially contagious and threatened a second bout of world economic pneumonia.

So it was something of a shock to return to Australia recently to find all anyone could talk about was executives of very rich mining companies bleating about a tax that they themselves had asked the Henry tax review to impose. The miners had argued to Henry that they preferred a profit tax to the crude royalty system that each state imposes on the amount of minerals they dig up and sell.

These minerals are, of course, part of the common wealth - that is, they belong to us all. We are happy for miners to dig the stuff up and sell it for a substantial profit. But there is a limit to how much profit any company is entitled to make out of common resources, and they should pay an appropriate amount back to the country of origin.

It was almost breathtaking to hear and read the extraordinary assertions made by some mining executives and fellow travellers in the finance industry about how a properly constituted tax would affect their investment plans. And in doing so, they had the chutzpah of raising the spectre of sovereign risk. If anyone seriously thinks a fair tax represents sovereign risk, they are kidding themselves. Try real sovereign risk: the sort of sovereign risk faced by countries that do not look to their fiscal bottom lines. The PIIGS group of countries - and add in Britain and California, both with huge debt problems - will have to endure decades of difficulties juggling their books to pay even modest pensions to their retiring citizens.

In my puzzlement, I wondered what had happened to the previously announced superannuation changes … were they still around, and what had happened to the 2 per cent corporate tax cut that the government also promised as part of its package to help ease the transition to the higher super payments?

No, all still in place. However, the ability of the government to fund the corporate tax cut - which in turn was partly aimed at easing the impact of a gradual superannuation increase over the next decade - was being jeopardised by petulant mining companies.

Now, of course, with the chief government digger, Kevin Rudd, interred in a grave as deep as the Kalgoorlie open pit, the wrangling over the details of a resource super profits tax will pass to others.

It is time for everyone to calm down. Markets hate uncertainty, and the Australian public deserves better. The miners and the government need to nut out the finer details of an appropriate tax and resolve the matter.

It would be a great pity to have to write to the editorial people at the Tribune and tell them they had it all wrong. That, at the last hurdle, the country which had put in place one of the best global examples of social policy for its ageing population had fallen foul of an extremely well-funded and self-interested campaign.

Gerard Noonan is the president of the Australian Institute of Superannuation Trustees and a former editor of The Australian Financial Review.

The Debate between Expansionists and Restrictionists

Right now there is an important debate going on in the United States and Europe between those who think the major aim of economic policy at the moment should be to do something about growing fiscal deficits and those who believe that the major aim should be to maintain economic activity.

Mohamed El-Erian argues that we need to go beyond what he calls "the false growth vs austerity debate" He argues that at this his weekend’s G20 meeting

In one corner stand the “growth now” camp, arguing that expansion is a pre-requisite to service their debt sustainably. Without it tax receipts implode, investment is turned away, and meeting future debt payments is harder. This camp abhors Europe’s shift towards austerity, questions Tuesday’s tough UK budget, and urges countries like Germany to adopt expansionary policies. Some advocate additional fiscal stimulus even for high deficit countries, like the US.

This debate he argues is "incomplete" and backward looking and countries need "to adopt both fiscal adjustment and higher medium-term growth as twin policy goals."

Squaring the circle of growth and fiscal stability needs policies that focus on long-term productivity gains and immediate help for those left behind. This means first enhancing human capital, including retraining parts of the labour force, and increasing labour mobility. Then new emphasis on infrastructure and technology investment is needed, with greater support for scientific advances that promise increased productivity. Finally all nations must begin an honest assessment of the social frictions coming in the next few years. In some countries (like the US) this means an urgent bolstering of social safety nets.

...

The world is facing deep structural challenges yet its leaders are stuck in a short-term, cyclical mindset. Until they break out of it we will see little more than fruitless discussions, national policy flip-flops, and a troubling lack of global policy harmonisation. Without action our future will be disappointing global growth and periodic sovereign debt crises. Let us hope this, if nothing else, is enough to bring the two camps together.

Paul Krugman is a major protagonist in this debate on the side of the expansionists. He is very critical of such views, implying that this is simply restrictionism.

In The Long Run, We Are Still All Dead

So, reading Mohamed El-Erian, I’m somewhat at a loss about what he’s actually saying; what, exactly, is the policy recommendation? But in any case, here’s what struck me: he writes,
The world is facing deep structural challenges yet its leaders are stuck in a short-term, cyclical mindset.

I disagree. If anything, we’re suffering from the opposite problem. Talk to German officials about high unemployment and the looming threat of deflation, and they ramble on about the demographic challenge and the cost of pensions.

I mean, why shouldn’t we be focused on the business cycle? We’ve suffered the worst cyclical downturn since the Great Depression; in terms of unemployment and output gaps, we have recovered almost none of the lost ground. Millions of willing workers are idle because of lack of demand; let them stay idle, and we can turn this into a long-term structural problem, but right now it is precisely a short-term, cyclical problem.

So saying that we need to focus on the long term, and not worry our little heads about trivial short-term issues like the highest long-term unemployment rate since the Great Depression, may sound like wisdom — but it’s actually folly.

Oh, and one more point — not about El-Erian, but about quite a few policymakers and economists: the attempt to shift the discussion away from the short run is not, as often portrayed, an act of vision of courage. On the contrary, it’s an act of cowardice, an attempt to evade responsibility for a disastrous state of affairs that we could fix, but choose not to.

Keynes had it right:

But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.

What is most interesting for me as I read these debates are the implications for Australia. And just how different the situation is in Australia. This seems to be another 'world' that they are writing about. This is increasingly being explained by the argument that the global financial crisis should be seen as the North Atlantic financial crisis. (NAFC doesn't have as sweet a ring as GFC and makes me think of a football club from Adelaide).

Australia's fiscal position is relatively sound and the nature of the political debate in Australia ensures that even the small level of public debt is seen as a 'problem' that requires immediate action. One of the reasons why the Rudd govt introduced the Super profits tax was to bolster the ability of the budget to return to surplus sooner than originally planned.

We are in a very good position right now, but as always we continue to be vulnerable. Our success (and we could do better) has been built upon long-term growth and increases in national income bolstered by the terms of trade effect (relative increases of export prices over import prices). But eventually what happens in Europe and the United States matters to Asia and to us. China has continued to expand because of a huge fiscal stimulus and in turn growth in Europe and the United States has been bolstered by budgetary stimulus, financial guarantees and bailouts, and low monetary policy.

Without govt efforts the world would now be in a deep financially-induced depression. This is what the restrictionists and ant-govt zealots need to realise. Equally, however, expansionists need to (eventually) think about the growth of govt debt. This will involve both sides of the fiscal equation - spending and taxing.

We now live in a more globalised world economy. One of the benefits of that is that increased growth and the advancement of many developing countries with China and India showing rapid rates of growth. But globalisation increases vulnerabilities to negative effects as well. The aim of the G20 should be to foster the increased economic cooperation necessary to manage an increasingly globalised world economy. But international cooperation is no easy thing! States will have to continue looking after their own interests first, but a bias towards expansion in depressed areas will be beneficial for globalisation in the long-run.

Great video on the mining tax

Just think if the opponents of changes to better societies for more people had their way, we'd still have feudalism!!

This country is a successful, rich country because we've redistributed wealth gleaned from our natural resources across Australian society, rather than let a wealthy few nationals and foreigners commandeer them like in Nigeria etc.

http://www.youtube.com/watch?v=H4PcQfz0MfU