Email sent 6/10/10
Red Book's hard reading
for Labor, The Australian,
suggested that the 2010 federal election would have been more meaningful if
information contained in the Treasury's 2010 Red Book briefing to the incoming
government about Australia's outlook had been available beforehand.
Undoubtedly this is so.
The Red Book seems to reflect a more realistic
view of Australia's financial and economic challenges than was previously
available. But it also arguably advocates policies that are part of
Australia's problem. An outline of your article about the Red Book is
presented below, together with speculations about the substantive issues. In
brief these suggest that:
- the primarily financial criteria that
Treasury rely on in suggesting policy are limited and inadequate;
- Treasury is unduly pessimistic in
suggesting there is no alternative to simply reacting to
market forces and accepting the uncomfortable structural changes that
these force. Similarly;
- the concentration of population
growth in major existing cities might be efficiently reduced by
innovative methods to create market-driven population 'magnets' in some
- infrastructure problems would
be worsened by the Red Book's reform suggestions. Rather institutional
obstacles need attention (eg federal fiscal imbalances and inappropriate
- tax reform proposals need to
be based on also seriously considering the tax revenues available to state /
local governments, and the differences between economic systems in Western and
East Asian societies;
- putting a price on 'carbon'
will not reduce investor uncertainty in affected functions as much as reducing
scientific uncertainty would.
Moreover the absence of reliable information as
the basis for political debate is not Treasury's fault.
is a symptom of
Australia's Reliance on Luck (eg natural resource wealth, and on copying
policy ideas from UK / US / OECD / etc), which has traditionally made civil
institutions (eg associations, institutes, universities) believe that it was
not necessary for them to provide up-to-date and practical ideas about public
policy issues to opinion leaders. Moreover that deficiency is only one of the
weakness that are now taking Australia's system of government to the point of
Australia's Governance Crisis and the Need for Nation Building)
Red Book's hard reading
Treasury's post-election Red Book reveals
federal government's tough choices. It reveals 'econocrats' frustration with
bipartisan retreat from economic reform. Whereas in 2007 the incoming
government could 'buy' difficult reforms because of its budget surplus, such
reforms must now be revenue neutral, and this is harder. The mining boom,
population growth and climate change all have structural adjustment costs
that will hit consumers. However soaring export prices and low unemployment
have made reform hard. Issues raised during the election (eg population
growth, infrastructure; congestion; cost of living; regional / sectoral
disparities; pace of change) are manifestations of structural adjustment.
Though adjustments come with costs, markets must be allowed to operate so
that true costs flow through (with appropriate social safety nets).
Government needs to build consensus on each policy, to get agreement.
Economy: If hard budget choices are not made, interest
rates will rise. Economy is strong - because of China-fuelled mining boom,
and will soon be at capacity. Skill shortages will fuel inflationary
pressures. Tighter fiscal policy will be needed to reduce the need for
interest rate rises. Budget also needs to be tightened because mining boom
made economy more vulnerable to another financial crisis (eg due to
double-dip US recession, European sovereign-debt fears, or China relapse).
These put very high mineral prices at risk. Low public debt and strong
banking system leave Australia well placed to cope with any future financial
crisis, but the confidence of international financial markets is also
important (eg by maintaining policy credibility). The banking system remains
a risk because it relies heavily on offshore borrowing - and heavily
indebted households as well as high housing prices further increase
vulnerability to economic shocks. Reducing this risk requires further
efforts to improve the structural position of budget - probably going
further than ALP's existing 2% real growth cap. Population:
Labor and Coalition are wrong to pretend population growth can be cut much.
Immigration will reduce the budget costs from aging and baby boomers.
Projected growth to 36m included allowance for reducing immigration from
300,000 to 180,0000. 2/3 of additional people are likely to settle in
cities, because of superior opportunities and services. Regional settlement
policies would be expensive and inefficient. Infrastructure:
Bigger cites need better housing and transport, and more
competition and user-pays for essential infrastructure. The NBN is risky.
Population growth has exceeded strategic capabilities of state and local
government. They can't develop 'shovel ready' projects, and refuse to make
appropriate use of price signals so as to encourage private investment. This
has led to serious infrastructure bottlenecks. Heavy trucks should pay for
road damage. Congestion charging should be applied in cities. Urban water
reforms should be more ambitious - including structural separation of
government water monopolies and allowing private competitors to access
water, sewage and stormwater systems. The NBN proposal turns Telstra into a
retail Telco, but has significant risks. Tax: Tax reform
is vital, requiring losers or large budget costs. Henry review called for
shift from taxes on business investment and domestic savings to broad-based
taxes on less mobile land, resources and consumption. Inefficient state
taxes (stamp duties, payroll tax and land tax) should abolished or reformed.
Climate Change: Cutting carbon emissions requires pricing
carbon. Direct action will cost more. Concerns about ETS's effect on
electricity prices are valid, but the cost of unmitigated climate change
will be severe, and delaying action would be costly and disruptive (eg by
making power generation investment uncertain). Direct action measures (eg
carbon sequestration) have problems. A need is also seen to: streamline
COAG; make vocational education and training more responsive to industry;
increase health co-payments; review self-managed super funds; and look
beyond bi-lateral free trade deals. If this information had been available
before election, the election process would have been better informed.
/ Financial Criteria: An Insufficient Basis for Policy
The proposals in
Treasury's Red Book are based on economic considerations which treat financial
criteria (eg a balanced budget, enterprise profitability, economic value
added, etc) as the primary criteria for policy.
such criteria are valuable, they are also limited - and those limitations need
to be considered (see
The Advantages and Limitations of Financial
In brief the
latter argues that
economics is built on the useful role that finance / money plays as: (a) a
means of exchange and a store of value; and (b) in motivating, coordinating
and directing economic activities;
- money also
has more fundamental advantages that economics does not conventionally
recognise, ie in helping to create a simplified economic environment in which
rationality (the preferred means for problem solving in Western societies) can
be effective. This is important because the failure of rationality in dealing
with complex problems is recognised in many disciplines;
- there are
limits to financial / conventional economic criteria in guiding decisions by
individuals, enterprises and public policy analysts. For example: (a)
non-economic criteria may also need to be taken into account; (b) some
financial techniques can create obstacles to rational decision making; (c)
government functions can't be satisfactorily coordinated in terms of financial
criteria, and past attempts to improve efficiency by using such methods have
been counter-productive; (d) information (which can potentially change the
functions that economics analyses) may be a more effective tool for economic
management than fiscal or monetary policy; and (e) developing tax policies (eg
for the mining industry) on the basis of financial criteria that make sense in
a Western economic context can be hazardous in an East Asian economic
of financial criteria as a basis for public policy have significant
implications for many of the suggestions Treasury advanced in the 2010 Red
Australia's Strategic Position
Despite strong growth prospects associated with
a mining boom (which imply that overheating and regional imbalances will be
Australia's major economic problem), Australia now faces risks because of
its dependence on that boom and on foreign capital inflows - both of which
could be disrupted because of unresolved stresses in international financial
The Red Book's views about Australia's current
challenges appear excellent from a financial viewpoint. There is (for
example) now official recognition of: (a) the need for difficult action to
deal with a structural deficit; (b) the risks of further global financial
and economic instability; and (c) the need to consider Australia's credit
rating, given heavy reliance on international investors and potential risks
such as banks' exposure to property markets [Qualification].
the Red Book seems much weaker in relation to current 'real economy'
challenges (eg in relation to the mining boom, adverse impacts on other
sectors and on some regions, potential skill shortages, population growth,
assumes that nothing can be done except react to market forces and tolerate
the adjustment stresses they generate. However this is overly simplistic.
For example a systematic process of 'nation building' could include the
empowerment of business / community leaders to take effective initiatives to
accelerate market-focused change in economic systems as a whole.
attention has been drawn to the ability that East Asian economies have
exhibited to change the nature of the market signals that they respond to
(eg consider sources referenced in
Correcting a Few Misconceptions).
The latter argues that: (a) economic 'miracles' in East Asia have been based
on the assumption that economic outcomes are not determined by any
inevitable economic logic; and (b)
used are based on traditions that are alien to Australia's heritage and have
serious limitations. However, over two decades ago methods were trialled in
Queensland that could probably have achieved similar outcomes (in terms of
accelerating change in the real economy in advantageous directions) while
being compatible with Australia's institutions and while avoiding the
limitations faced in East Asia.
current economic risks are serious because efforts to diversify its
traditionally commodity-dependent economy since the 1980s have been
unsuccessful and the economy remains relatively under-developed. The official
approach to economic reform has been unbalanced. Emphasis has been placed on
promoting competition, but this was not balanced by efforts to reduce systemic
obstacles to competing successfully in high productivity activities (see
Lifting Productivity: Considering the Bigger Picture). The latter includes
suggestions about how the productivity and competitiveness of the real economy
might be enhanced. Methods suggested might (for example) be used to: (a)
diversify the economy and reduce dependence on mining exports and the
difficulties facing other industries and some regional economies; (b) create
institutions for workforce training that are responsive to industry needs; and
(c) identify options for, and stimulate commercial initiative to provide,
high-speed broadband access across Australia.
There is little
doubt that the Red Book is correct in suggesting that Australia's population
will probably grow to the levels that Treasury has previously suggested.
Overcoming Infrastructure Inadequacies
The Red Book is
correct in identifying Australia's infrastructure deficiencies, but inadequate
in suggesting how that problem could best be overcome (eg see
Constraints on Australia's Economy, 2005).
while infrastructure certainly exceeds the capacity of states and local
authorities, this deficiency is arguably due to:
distortion of their operations by the perceived need for federal government
involvement that results from the extreme fiscal imbalances that have come to
characterise Australia's federal system (see
Federal State Fiscal Imbalances).
Centralisation of planning and control makes no more sense for infrastructure
(which often involves the capital component of various state and local
government functions) than it does for other economic activities (see
The Secret of Failure: Claim Wisdom Without
Practical Realism); and
- the erosion
of public officials' knowledge and skill base through 'reforms' aimed at
increasing political responsiveness and increasing efficiency through the use
of 'business-like' methods in undertaking governments' non-business-like
Decay of Australian Public Administration, 2002).
assumption that even more competition, price signals and private investment
would be effective in future in coordinating functions that suffer real market
failures is likely to be counter-productive (see again
Infrastructure Constraints on Australia's Economy, 2005).
As the latter
implies the (artificial) obstacles that have been created to the development
of infrastructure might be be overcome by a serious approach to 'nation
building' (see also A
Nation Building Agenda).
Tax reform is
very complex. However the reform agenda canvassed by the Henry review (which
the Red Book has re-emphasised) is not a sufficient basis for this because:
provision of public goods and services is unlikely to be achieved without
attention to the fiscal imbalances that cripple Australia's federal system
Vertical fiscal imbalance).
There is much more to be gained by enabling state and local governments to
operate effectively, than by centralised efforts to optimize resource
- changes in
the sources of tax revenues available to states seem necessary to motivate
them to take development of productive modern regional economies more
Economic development incentives);
- changes to
taxes on mineral resources may put revenue from this source at risk, if
account is not taken of difference between East Asia and Western systems of
political economy (see
RSPT Won't Hurt Miners: But Pity Help Naive
The suggestion in
the Red Book that putting a price on 'carbon' would increase investor
certainty seems most unlikely to be correct, as real certainty can't be
achieved until serious efforts are made to reduce the scientific uncertainty
about the link between greenhouse gas emissions and climate change (see
Carbon Certainty is a Long Way Off).